Private equity is set to benefit from the Future Fund’s most comprehensive investment review since its beginning. We speak with Alicia Gregory about the fund’s private equity approach
Last year, the Future Fund conducted “the most comprehensive review of our investment strategy since the Future Fund was established”.
The reason being that the world is not what it used to be.
Deglobalisation, climate change, the rise of populism, quantitative easing and technological disruption have all contributed to an environment where returns are likely to be lower and much more volatile than they have been in the past.
“Significant changes are underway in the world, catalysed or accelerated by COVID-19. We believe that the investment thinking that has delivered strong returns over recent decades needs to be revisited,” the fund stated in a position paper published in September.
As a result of this, the Future Fund has decided to increase its risk tolerance and appetite for illiquidity in order to achieve a decent rate of return in line with its mandate.
“We believe that modestly increasing our structural risk profile will enable us to better target our desired returns while continuing to appropriately moderate risk,” the paper states.
“We see scope to increase our tolerance for illiquidity to access value-add from less liquid and skill-based investments. In this environment, skill-based returns are even more attractive and worth the higher fees required to access them.”
One asset class that ticks all the boxes under this new direction is private equity, and in a portfolio update from 30 September, the fund shows it has already increased the allocation to private equity from 14.4 per cent in September 2020 to 17.3 per cent this year.
When looking at private equity, people always talk about a return of four to five [per cent] over equities and actually people's expectation of earning that four to five over equities hasn't changed. But if the base rate is much lower, then four to five over equities is much more valuable
“When looking at private equity, people always talk about a return of four to five [per cent] over equities and actually people’s expectation of earning that four to five over equities hasn’t changed. But if the base rate is much lower, then four to five over equities is much more valuable [than in the past],” Alicia Gregory, Head of Private Equity at the Future Fund, says in an interview with [i3] Insights.
Gregory arrived at the Future Fund almost three years ago and has been building a team that now includes eight private equity specialists.
“Part of the attraction in joining was a phenomenal opportunity to come in and really get to build a team from scratch and I think we now really have a significant direct investment experience across the whole team,” she says.
“We will continue to build our resources, but it is going to be in a very prudent manner in the next few years. I want to bed down what I’ve been doing for the last couple of years and make sure that is well integrated before we do too much of anything else.”
Although Gregory has deep experience in private equity, including more than 17 years with MLC, it took her a little while to wrap her head around the total portfolio approach (TPA) of the Future Fund.
“When I spoke to people globally, the total portfolio approach and the way we do this whole-of-fund piece is rare, not only in Australia, but it is really rare globally too,” she says.
One of the key differences between the Future Fund’s TPA and a more common multi-asset fund approach is that the Future Fund has no strategic asset allocation (SAA). Every asset class head has to convince the rest of the investment team that the opportunities they see are worth pursuing.
“You’re coming to the Future Fund and the way that things get done is just really different, and that is around this element that there is no strategic asset allocation,” Gregory says.
“Most investors will have a bucket of money, based on the strategic asset allocation, that they’ve got to deploy. Instead, we just look for the best investment opportunities in our universe because we don’t have a bucket to start with. You’ve got to convince your peers to spend the money in this total portfolio approach.”
Private for Longer
Historically, private equity investors have been able to generate higher returns than public market investors because often they invest in young companies that still have most of their growth ahead of them. It is also a research-intensive asset class, which makes it harder for new investors to compete with the incumbents.
But these benefits are somewhat offset by the complexity and illiquidity that come with the territory. Yet in recent years, the relevance of private equity as an asset class has increased as many companies today choose to stay private for longer than in the past.
“Companies are choosing to stay private for a lot longer and so a lot of the growth is taking place outside of listed markets,” Gregory says.
She points to online retailer Amazon as an example of the changes that have taken place.
“Amazon was founded in ‘94 and it IPO’d three years later in ‘97, and so most of the value creation in Amazon has happened in the public market since May ‘97. If you had invested a thousand dollars in Amazon in May ‘97, then I think today it is worth something like $1.5 million. So that is a huge value creation in the public market,” she says.
If I go back 15 years ago, when I was talking to what was then my board, private markets were probably a nice-to-have in your portfolio, if you could handle the complexity and if you had some room for illiquidity. But now all that value creation that went on in the likes of Amazon is happening in the private market and so I would say private equity is no longer a nice-to-have
“Now, if I fast forward to the last five to seven years, with that trend of companies choosing to stay private for longer, I think the average age before a company IPOs is almost 10 years.”
This means private equity has become a key avenue for participating in economic growth, making it an important source for future returns in a world where returns are hard to come by.
“If I go back 15 years ago, when I was talking to what was then my board, private markets were probably a nice-to-have in your portfolio, if you could handle the complexity and if you had some room for illiquidity,” Gregory says.
“But now all that value creation that went on in the likes of Amazon is happening in the private market and so I would say private equity is no longer a nice-to-have.”
Technology and Disruption
Technology and disruption have been identified as key themes in the recent investment review and it is an area private equity is quite comfortable investing in.
The bent towards technology has also meant the asset class has been less affected by the global coronavirus pandemic than listed markets and the infrastructure sector have, both of which saw big drawdowns in travel and leisure-related sectors.
“We’ve been fortunate in that we’ve had these tilts to venture and growth in our private equity portfolio, which is more in technology than in travel. But even so, technologies that play to the consumer, to the travel sector have been hit very hard and we got a little bit of that,” Gregory says.
There were some unexpected winners and losers from the pandemic, many of which were related to the prolonged lockdowns, she says.
We've been fortunate in that we've had these tilts to venture and growth in our private equity portfolio, which is more in technology than in travel. But even so, technologies that play to the consumer, to the travel sector have been hit very hard and we got a little bit of that
“When we look at the data, for example, kids are not needing school shoes and sport shoes because nobody’s going to school, so demand for these items has fallen. And similarly for suit-making; the high-end suit makers in particular have been doing it really tough,” she says.
“But then we have watched this trend of activewear and it has gone through the roof because everyone’s wearing activewear all day.”
The Future Fund also experienced disruption in its own operations, as videoconferencing replaced face-to-face meetings. But it also came with some unexpected benefits, she says.
“A really big one for us is annual meetings with managers. We only ever have done them in person, but they have all gone online in the last couple of years,” she says.
“The good thing though is that my entire team could attend an annual meeting now because you just dial right in. That has been really helpful for our more junior people and helped them grow, because if that had been a meeting in New York, then I wasn’t going to put six people on a plane to go and see them.”
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.