Many people have heard about ‘private equity’ or ‘private markets’ in the news, or from movies made in the 1980s, but do not know much more about it than the name and a vague sense it is only for the wealthy. It is an investment class shrouded in secrecy. It is as if many in the industry have taken the word ‘private’ too seriously.
Yet, if private equity were a sector on its own in Australia, its income would exceed the insurance or the coal mining sector. In fact, the number of people it would employ would be more than the banking or automotive industries (Preqin, 2021). In the last decade, the amount of assets under management in private equity in Australia has almost doubled, from just over $20bn to just under $40bn (Preqin, 2021).
This is an asset class that is too important to have Australians excluded from the conversation. If you’ve always wanted to know more about private markets, read our first instalment in our PE101 series below. Here we explore the universe of private markets and what different types of strategies there are out there.
Finance is full of jargon and those in private markets can be some of the worst offenders for creating new fancy sounding terms. We’re here to help demystify the industry so you can better understand the pros and cons of private market investment opportunities.
Let’s start with ‘private markets’ and ‘private equity’. What is the difference?
Private Market assets are assets that are not traded publicly on a stock exchange, such as the Australian Securities Exchange (also known as the ASX).
The world of Private Markets is typically opaque, but it occasionally breaks cover to make headlines such as “Blackstone to rebuild Crown as takeover ends Packer’s reign”, or “How Bain Capital played Hard ball to secure Virgin”.
Such headlines give the impression that Private Markets may only operate with household company names that are in stressed situations (what more do you need for a headline?), but this does not do justice to the breadth of assets and strategies available within Private Markets.
Broadly speaking, there are three sub-classes of Private Markets: Private Equity; Private Real Assets; and Private Debt.
In this instalment we shed light on the key types of assets and strategies within the Private Equity and Private Real Assets sub-classes.
In general, private equity firms will raise money from large institutions and the ultra-wealthy for their funds. After they pool enough money, the private equity firm will start to buy and sell companies. Typically, these companies are private companies (meaning they are not listed on a stock exchange), but they may also be public companies that they then remove from the exchange (think, AGL, Crown Casino or AMP, as recent examples). These private equity firms are typically looking for business not wholly dependent on the operation of a physical asset (think Bing Lee, Sanitarium, and at the other end of the spectrum, the local cafe) and may be underperforming.
Typically, the fund will not last forever. The purpose is to buy businesses, improve their revenue and profitability, with a view to selling them again. Each fund is typically liquidated, selling all its business, within a certain timeframe (usually no more than 10 years).
While private equity is about taking ownership stakes, depending on the strategy, the amount taken can vary.
Private Equity can be broken down into a number of strategies that focus on the different life stages of a company, namely:
This strategy is focused on investing in companies that are not yet generating revenues. Investing at this stage in the life of a company is considered the riskiest of all the Private Equity strategies, as it is largely investing in the potential of an idea that is yet to be proven. To mitigate this risk, the equity invested in such companies are typically a minority stake.
Managers that execute this type of strategy look for companies that are more established than those targeted by venture capitalists. Such companies typically have a consistent but small revenue stream and need additional funds to grow and diversify it. Like the Venture Capital stage, the level of equity that is sought in companies in the Growth Capital stage is still a minority stake.
Companies targeted for investment are established and mature and will generally have significant revenue streams. Their growth trajectory is more muted than a company needing Growth Capital. A Private Equity manager working on “buyouts” may have identified some operational improvements/efficiencies that may be implemented to unlock higher profit margins for the target company, thereby increasing the value of their investment. The equity invested in such companies are typically a majority stake.
Mature companies may find themselves in a position of distress due to regulatory changes, new competition, technological advances or unsuccessful expansion into new markets. Such companies can become the target of a manager that believes it can “turnaround” the distressed company and stabilise its operations and profitability.
The level of risk/returns within the different Private Equity strategies can vary markedly and can indeed overlap across the groups listed above. As such, it is important to understand the strategy that a Private Equity manager is implementing and the associated risks when considering whether a particular strategy is appropriate for investment.
Private Real Assets are physical assets whose operations are typically necessary to facilitate the smooth functioning of society. Such assets include investments like real estate (think office buildings, shopping centres, apartments, warehouses etc.) and infrastructure (think toll-roads, airports, ports etc.).
Within the sub-class of Private Real Assets there are three key types of strategies:
These strategies invest in real estate or infrastructure assets that have highly visible and stable revenue streams. In the real estate context, the asset could be a building located in a capital city with long term leases and little to no vacancy. While a core infrastructure asset could be a toll-road with clearly defined long term contracted revenue with in-built inflation indexation. The returns of a typical core strategy will have a relatively larger focus on income returns rather than capital gains. As such, core assets typically have a risk/return profile more akin to the traditional fixed income asset class.
Value-add strategies are riskier than core strategies. These strategies will have exposure to assets that can in someway be improved or re-positioned to improve revenue, or there is a greater level of variability in the revenue, or have revenue contracts with non-government counterparties. For example, in terms of real estate, a value-add strategy may involve purchasing a building with a significant level of vacancies; reducing the level of vacancies; and then on-selling the building for a capital gain once the new leases have been locked in. A value-add infrastructure asset could be say a data centre that is contracted to a private company that is not as creditworthy as a government. The return from a value-add strategy will have a larger capital gains component relative to a core strategy.
This is typically the riskiest of strategies within Private Real Assets. Opportunistic strategies typically involve more ground up development and less certain ongoing revenue streams. For example, it could involve the construction of a building or a solar farm on vacant land. Compared to the core and value-add strategies, opportunistic strategies typically target greater total investment returns, which are mostly comprised of capital gains rather than income.
The chart below illustrates where each of these strategies are placed within the risk/return spectrum of Private Real Assets.
It is no secret that institutions and the ultra-wealthy have for years been turning to the world’s leading fund managers, and the various strategies they curate, to help the investor seek to strengthen and diversify their investment portfolio.
These investors have been using select exposure to leading private equity funds to inject diversification, potential outperformance and, perhaps the most sought-after goal, uncorrelated returns into their investment portfolio (uncorrelated to listed equities).
While not many of the world’s largest fund managers are household names, collectively they manage trillions of dollars of assets. These are managers like The Blackstone Group, KKR & Co, Brookfield, CVC Capital Partners, PGIM, Apollo Global, among others.
These firms bring scale, expertise, resources, and long track records to the task of building funds, made up typically of opportunities from hard to source private market opportunities, to drive risk-adjusted outperformance to their institutional clients.
Up until now, private equity has largely been the domain of institutions that have the capacity to meet the investment minimums of private equity managers (typically in excess of US$10 million).
However, just as history has shown us, markets are often disrupted in the interest of their investors. Reach Alternative Investments has managed to get access to some of the world’s most exclusive fund managers and the institutional-grade private equity funds they run. We are now offering qualified sophisticated investors access to those institutional-quality private equity funds with minimums as low as AU$75,000.
This smaller minimum means that certain individual investors can now not only include private equity as an allocation within their broader investment portfolio but also potentially improve the diversification within their private equity exposure by investing across a number of private equity managers or strategies.
In addition, through our Education Hub we seek to help all Australians learn more about private markets and how to invest responsibly.
Reach Alternative Investments' vision is to democratise the world’s leading private capital funds, allowing Australian investors the same level of access and support that an institution receives. We want you, with the help of your financial adviser where needed, to be able to access and build your own investment portfolio that suits your needs and stage of life.
For more information about our available private equity funds, please visit our private equity funds page.
1.Source: Fowler, E 24 June 2022, ‘Blackstone to rebuild Crown as takeover ends Packer’s reign’, The Australian Financial Review, accessed 11 July 2022, https://www.afr.com/companies/games-and-wagering/blackstone-8-9b-takeover-of-crown-ends-packer-s-reign-on-asx-20220623-p5aw7v
2.Macdonald, A and Thompson, S 23 December 2020, ‘How Bain Capital played Hrd ball to secure Virgin’, The Australian Financial Review, accessed 11 July 2022, https://www.afr.com/companies/financial-services/how-bain-capital-played-hrd-ball-to-secure-virgin-20201212-p56mxy
