Kieran Canavan (Centric/Findex Group) and Adam Myers (Pengana Capital) discuss their approaches to providing investors with solutions to access opportunities in private market equities.
Compared to public markets, there are approximately 25x more private equity and venture capital companies, providing investors with a much larger universe of opportunities to explore. However, globally, the actual size of private markets is much smaller — with assets under management (AUM) of about US$11 trillion compared to US$87 trillion in the public market space, according to HarbourVest.
“In reality, the actual size of the private equity market is close to 12 per cent of the listed public market,” says Jason Petras — Director, Investments at Resonant Asset Management. He adds that in 2024, the amount of ‘dry powder’ (uninvested capital that private equity companies have ready to invest) was approximately US$2.51 trillion, which Jason says has been growing in line with the sector. He believes this is a healthy sign for the sector overall.
It’s a view shared by Kieran Canavan — Chief Investment Officer of Centric and Findex Group — who defines private equity as ownership of non-public companies that have an active plan to create value and to exit at some stage.
“When considering private equity there are two key things we look for: capital growth, which is long-term performance that can be compounded over long investment horizons; and access to secular growth — multi-year, above GDP expansion, which is driven by long-lasting forces, such as technology and demographics, but not driven by multiple business cycles,” says Kieran.
By Jayson Forrest
Adam Myers
Pengana Capital
Jason Petras
Resonant Asset Management.
Kieran Canavan
Centric Findex Group
Speaking at an IMAP webinar on the topic of ‘Private market equity opportunities’, as part of an IMAP Specialist Webinar Series on ‘Growth outside of Australia’, Kieran acknowledges that over the past several years, private equity hasn’t generally delivered the types of outcomes expected for a variety of reasons. These include the COVID pandemic and the rise in interest rates.
Against this backdrop, a key learning for Kieran when allocating to private equity is not to ignore the macro-environment. He says investors need to be able to tactically risk manage their portfolio against macro events, like interest rates and global pandemics, citing the many funds that were affected by write-downs in 2022.
“This means you still need to be able to move tactically at a strategic asset allocation (SAA) level. In addition, highly capable managers and investment structures are required by investors, in order to access both early and late-stage private equity,” Kieran says.
When considering private equity there are two key things we look for: capital growth, which is long-term performance that can be compounded over long investment horizons; and access to secular growth — multi-year, above GDP expansion, which is driven by long-lasting forces, such as technology and demographics, but not driven by multiple business cycles
The private equity ecosystem
It’s important to note that when considering the private equity ecosystem, investors need to understand the role of the General Partner (GP) and the Limited Partner (LP). In a private equity fund, the GP is the fund manager, responsible for making investment decisions and managing the fund’s operations, while LPs are the investors who provide most of the capital but have limited liability and no management control. The GP has unlimited liability and receives compensation through management and performance fees, whereas the LPs’ financial exposure is limited to their investment.
When looking at private equity funds, Centric typically classifies them as alternatives — longer term (10 year +) investments that often experience a J-curve. Centric uses a variety of ways to access private equity, including via evergreen private equity funds (an open-ended, perpetual-capital fund with no fixed end date, allowing for continuous fundraising and capital recycling, unlike traditional closed-end funds with a set lifespan), secondaries (the buying and selling of existing LPs’ commitments to private equity funds during the fund’s lifetime, rather than direct investment into a new fund), and follow-ons (additional investments made in a company after the initial acquisition by the private equity firm).
However, it’s the following two structures, which Centric prefers for accessing the private equity market. These are:
- Crossover funds — an investment fund that holds both public and private equity investments. These funds bridge the gap between venture capital/private equity and public markets, investing in late-stage private companies that are nearing an IPO or have recently gone public.
- Co-invest funds — allows LPs to make direct, minority investments into a specific operating company alongside a private equity firm (GP), rather than investing through the main fund. These co-investments provide LPs with greater transparency, more control over their portfolios, and the ability to diversify their investments into specific deals, while also giving the GP access to more capital for a transaction.
“We really like the crossover-type strategy,” says Kieran. “That’s because it allows us to access late-stage private equity, as well as providing access to public markets. There is more liquidity in these types of structures, and if the manager does it well, they will only go into privates if they can get a better return than on the publics.”
Kieran adds that while Centric likes crossover funds, it has only found a handful of these funds to be “really good”. However, he says these funds are out there and available for investors.
Private equity has historically outperformed over the longer term, which we believe will continue. However, to have a better chance of capturing favourable long-term risk-adjusted returns, we do recommend a diversified portfolio
Private equity at the right price
When investing in private equity, price is also an important consideration for Centric. As Kieran says: “Every one loves private equity, but they hate the price.”
A key piece of work Centric has undertaken over the past several years has been to work out how it can pay the same price as institutional investors (such as sovereign wealth funds and larger pension plans, like CalPERS) for private equity, which is not at parity with other investors.
“Typically, large investors (like CalPERS) place money with GPs, where the GP is on a ‘2 and 20’ fee structure (a common fee structure used by private equity firms, where the GPs charge an annual 2 per cent management fee on AUM and a 20 per cent performance fee on profits, often above a certain benchmark or a minimum acceptable rate of return. This fee structure aims to align the GP’s incentives with the LPs, by ensuring they earn more by generating higher returns).
“Often, the GP will provide a co-invest deal at one-to-one (where the private equity firm and the co-investing LP are making an equal or proportionate investment in the target company), which means you can build-up a portfolio that looks predominantly the same as what you’ve got in the fund,” says Kieran.
“Centric uses this structure and we really like it. To run that type of structure on just a co-invest portfolio, you can run the fee structure at about ‘1 and 10’, and that includes running an Australian feeder fund (an investment vehicle that channels capital from Australian investors into a separate offshore ‘master’ private equity fund, to provide broader access to private equity strategies) into that, which helps reduce the price you’re paying.”
In addition, Kieran adds that if investors run co-invest portfolios, not only do they get diversification from the individual investments they have, but they will also have diversification across the GPs.
For example, they can benefit from vintage diversification (an investor strategy of allocating capital across funds that began investing in different years [vintage years] to reduce risk and smooth out returns by avoiding concentration in any single economic cycle) and reduce or remove the J-curve from the portfolio.
We really like the crossover-type strategy. That’s because it allows us to access late-stage private equity, as well as providing access to public markets. There is more liquidity in these types of structures, and if the manager does it well, they will only go into privates if they can get a better return than on the publics
The Pengana Private Equity Trust
Adam Myers — Executive Director of Pengana Capital — agrees the last couple of years have been tough for private equity. He says the industry had to adjust with interest rate increases and the compression of valuations, which have taken time to work through the system. In addition, the market also had to deal with negative sentiment, with investors concerned about failed deals that occurred during the COVID period when interest rates were low, valuations high, and the system was awash with cash.
However, Adam says the private equity sector is now seeing a definite improvement, with dealer activity and distributions (which are often seen as gauges of industry health) both trending higher. He adds that distributions across the industry are now running ahead of contributions for the first time since 2021. This means on a net basis, the private equity sector is returning capital.
Launched in 2019, the Pengana Private Equity Trust (PE1) is the manager’s solution for investors wanting to access opportunities in private markets. PE1 is an Australian-listed investment trust that offers retail investors access to a diversified portfolio of global private equity and private credit investments. Managed by GCM Grosvenor, PE1 allows investors to gain exposure to unlisted companies with the flexibility to buy and sell units on the ASX, which provides liquidity that is otherwise unavailable in direct private equity investments.
PE1 seeks to generate attractive returns and capital growth through a selective and diversified approach to private market investments, over an investment horizon of at least 10 years. PE1 also targets a 4 per cent annual distribution yield.
“Pengana created PE1 because we wanted to give investors an opportunity to access an asset class that has historically been extremely difficult for retail investors to access, all contained within a single vehicle,” says Adam.
According to Adam, the private equity sweet spot for Pengana remains the mid-market, which is much less reliant on IPO conditions. Pengana also refrains from taking “massive” individual bets on any stock with PE1.
“Private equity has historically outperformed over the longer term, which we believe will continue. However, to have a better chance of capturing favourable long-term risk-adjusted returns, we do recommend a diversified portfolio,” says Adam.
There are niches that perform well, and they can be included in a portfolio. However, what advisers should aim for is diversification in their portfolio. This will enable them to capture enhanced risk-adjusted returns that specific sectors offer (on average). Conversely, if you are too concentrated, while you might outperform over the short-term, you also expose yourself to significantly more risk
Declining persistence
While past performance is never indicative of future performance, Adam admits that when considering a manager, regardless of what the asset class is, Pengana still analyses past performance. However, he acknowledges that past performance should always be taken with “a pinch of salt”, because there isn’t any real advantage looking at the track record of a previous strategy that operated under different market conditions.
He adds that while returns in private equity used to be persistent, Adam acknowledges that this persistence has declined to the point that consistency of returns are now relatively random. So, if past performance doesn’t help investors to identify future outperformance, what then should they be looking for?
“It’s a good question,” says Adam. “This is where it’s really useful to align yourself with a skilled allocator that is able to see the breadth of what is being offered, and can undertake due diligence and rank managers on a range of forward-looking factors. These include the capability of the investment team, investment strategy, and the current market and regulatory environment.”
For investors approaching the drawdown phase, Kieran believes a sensible allocation into private equity depends on how the portfolio is constructed. He says Centric aims to run portfolios like CalPERS, with the same price structure and access to the same investments.
“In terms of liquidity, CalPERS runs at about 5 per cent per quarter. So, for someone in drawdown phase, that’s quite appropriate, depending on the other assets they hold. You really need to look at the other assets,” says Kieran. “We want a multiple on invested capital (MOIC) of about 3-3.5x. If you get that right, you’d expect at least (a return of) 10-15 per cent in a balanced portfolio.”
According to Kieran, Centric runs bespoke portfolios for very large family offices, which sit at around 40 per cent alternatives (including infrastructure, opportunistic investments, and private equity), as these clients are able to handle the illiquidity. However, for Centric’s retail clients, the allocation to alternatives is around 15-20 per cent.
Adam agrees the liquidity needs are much different for retail investors compared to ultra high-net-wealth investors. He believes the industry is still very focused on a model portfolio approach, where advisers seek to maximise returns for a level of risk. However, Adam acknowledges while that’s great for the accumulation phase, as investors move towards decumulation, their objectives start to change. This means shifting to focus on ensuring that liabilities are met, so retirees have enough money to live on.
“How does this relate to private equity,” asks Adam. “Private equity is self-liquidating. The private equity managers sell down assets in the portfolio at the optimal time on an asset-by-asset basis. This is great for retirees because it leads to better returns and it also contributes to lower volatility and lower correlations in portfolios.”
Adam attributes the reason for this lower volatility and lower correlations in portfolios to the ability of private equity managers to use committed capital to buy when everyone else is selling, and sell when everyone else is buying.
Key questions to consider
Whilst there are genuine advantages investing in private equities, like the benefits of diversification and the illiquidity premium, private equity also comes with its risks. It can be difficult to access, and a complex asset class for advisers and clients to navigate.
Kieran agrees that private equity is a complex asset class, which works incredibly well in portfolio construction. However, for advisers considering allocating into the private equity space, he offers the following advice:
1. You need to get the cost right and understand what it is you’re paying for.
2. Look closely at the liquidity structures, because there is always a cost for liquidity.
3. Use reputable managers.
4. Don’t be dissuaded from investing in private equity because you’ve been told it’s too complicated. Take the time to properly understand private equity.
To this list, Adam warns advisers to be aware of unintended risks. He explains: “Private equity has outperformed reasonably consistently, however, it doesn’t always outperform over the short-term. We’ve seen this recently, with listed equities running hot and private equity less so.”
He believes this shouldn’t be an issue, because no investor should have “all their eggs in one basket”. So, while listed equities are performing well, it’s not a disaster for private assets to be lagging behind.
This leads to Adam’s final advice — diversification. He warns against trying to pick ‘winners’, because there is always the chance of getting stock picks wrong. He adds advisers should avoid being exposed to a single vintage (the year in which a fund began making investments or the date in which capital was deployed to a particular company or project), a single region, or a single strategy.
“There are niches that perform well, and they can be included in a portfolio. However, what advisers should aim for is diversification in their portfolio. This will enable them to capture enhanced risk-adjusted returns that specific sectors offer (on average). Conversely, if you are too concentrated, while you might outperform over the short-term, you also expose yourself to significantly more risk.”
Secular themes driving long-term growth
Looking forward over the next 10 years, Rakesh believes the secular themes that will drive long-term returns revolve around population trends and improving governance structures in emerging markets.
“Twenty-five years ago, there were no industry leaders in emerging markets, but today, we have leaders in technology, automotive, and many other industries. From a secular standpoint, this is why the valuation of assets in emerging markets should continue to rise over time,” he says. “The opportunity within emerging markets is the ability to find those areas where growth has not already been priced in.”
As an example, he cites India, where the fundamentals are solid: it has a large and growing middle class; it is a democracy governed by the rule of law; and it has improving governance and economic structures. However, looking at the valuations in the Indian market, a great deal of optimising has already been priced in. “So, while all the structural elements could be right, you still might not make money in that market.”
However, Rakesh believes that although the fundamental trends are structurally good for emerging markets, it’s still going to be a stock picker’s or research-driven investor market for the foreseeable future.
And what about global SMID caps?
As bottom-up investors, Bell Asset Management seeks a diversified spread across various sectors, to ensure it benefits from the tailwinds coming from the likes of healthcare, software, automation, and AI.
“For us, it’s about identifying quality companies that can continue to compound their earnings growth over time, irrespective of what the external environment is doing. Over the past 12-18 months, quality in developed markets has actually had a really tough time. So, there are many amazing quality companies currently on sale. If you can buy these quality companies and they can compound their earnings over the next 10 years, investors can make some very strong returns,” says Joel.
“There are some excellent quality companies that have great long-term tailwinds, which are on sale right now. Buying these quality companies is where we’re going to make money over the next 5-10 years.”
About
Kieran Canavan is Chief Investment Officer of Centric and Findex Group; and
Adam Myers is Executive Director of Pengana Capital.
They spoke on the topic of ‘Private market equity opportunities’ at an IMAP Specialist Webinar Series on ‘Growth outside of Australia’.
The session was moderated by Jason Petras — Director, Investments at Resonant Asset Management.