Questionable practices in the Australian private credit sector are an issue for retail investors, not instos, UniSuper CIO says.
Institutional investors should be able to avoid private credit vehicles that might deploy questionable practices as identified in an independent report commissioned by ASIC and published at the end of September.
ASIC warned of related-party transactions, opaque fee structures or unjustified upfront charges.
I think ASIC is pointing out the right issues. There are issues around disclosure, issues around conflicts, issues around liquidity, et cetera. But I'm equally convinced that this is a retail issue, not an institutional [one]
John Pearce, Chief Investment Officer of UniSuper, said the corporate regulator was right to highlight these practices, but didn’t think any institutional investors would fall foul of these practices.
“I think ASIC is pointing out the right issues. There are issues around disclosure, issues around conflicts, issues around liquidity, et cetera. But I’m equally convinced that this is a retail issue, not an institutional [one],” Pearce says in an interview with [i3] Insights.
“Any insto worth its salt should know this. These are due diligence 101 issues. So any instos that get caught because of a lack of liquidity have themselves to blame.”
Pearce Sees No Contagion Risk
UniSuper has been building up its exposure to private credit in the United States in recent months, but Pearce says it is still a small percentage of the overall portfolio. When looking at the MySuper option, for example, the exposure is materially less than 5 per cent, he says. The fund’s Australian Income Option can hold more private credit, up to 20 per cent.
Asked if he is concerned any of the bad practices found by ASIC could affect the entire industry and, for example, bring down underwriting standards, Pearce pointed out the issues are contained to a relatively small amount of assets.
“Is there contagion risk? Not really. If you look at the $200 billion, then it is a big number in terms of private credit. But if you look at the proportion of that, where there actually are issues around transparency, conflicts, et cetera, it would be a subset of that $200 billion. And then when we look at that in the context of total Australian credit, it is still pretty small,” he says.
UniSuper Ups Private Equity Exposure
Private equity funds, especially the $6 trillion global buyout industry, have struggled in recent years, as higher interest rates have made financing more expensive, while dealmaking has slowed down.
This has given rise to so-called continuation funds, which allow private equity funds to hold on to investee companies by rolling them over into new funds and hopefully generating the returns they are seeking.
Yet, UniSuper is currently in the process of increasing its exposure to private equity and is about to fund a new manager, although Pearce says it is still too early to announce which one. Asked whether he is concerned about the current state of the private equity industry, he says he has been quite selective in the type of manager the fund plans to employ.
“The partner that we’re using has a different structure to your normal fund where you’re pretty much writing a blank cheque and pay outrageous fee structures. We’ve negotiated something that’s totally aligned, where it’s a genuine partnership,” he says.
“I always come back to the idea of: ‘What if you can't exit? What if you're left holding this [private equity] asset? Is it something that we'd be comfortable holding for a lot longer than seven years or 10 years?’ They are the sort of assets that we're looking at
“When you look at your typical private equity investment, they’ll talk about IRRs (internal rate of return) of let’s say 20 per cent and they’ll have some very optimistic assumption about exit multiples.
“I always come back to the idea of: ‘What if you can’t exit? What if you’re left holding this asset? Is it something that we’d be comfortable holding for a lot longer than seven years or 10 years?’ They are the sort of assets that we’re looking at.”
UniSuper doesn’t have many venture capital investments and Pearce doesn’t expect to increase them anytime soon either.
“We’ve got a small exposure to venture capital through our investment in Uniseed, but it’s small and we don’t really have any plans to see that become a material part of our portfolio anytime soon.”
Uniseed funds the commercialisation of cutting-edge research coming out of Australian universities, including biotech and quantum technology start-ups. In May, UniSuper announced it would increase its allocation to Uniseed from an initial $75 million to $100 million.
YFYS Makes Quantitative Strategies More Attractive
Earlier this year, UniSuper seeded a quantitative, long/short fund that invests in ASX 300 companies. The strategy is managed by First Sentiers boutique fund manager RQI Investors and is led by Joanna Nash, Head of Portfolio Management, and David Walsh, Head of Investments at RQI. It received $500 million from UniSuper.
Although UniSuper is known for its active, quality-style approach, Pearce says it is neither the first long/short fund nor the first quantitative fund it has invested in. But he does expect to increase the fund’s holdings to quantitative strategies, partly in response to the Your Future, Your Super performance test.
“I’d have to say [the test] has been an influence, but we still see ourselves as an active house,” he says.
“We’re looking at more quant-driven strategies. [But] rather than going totally passive, what we’re looking for quant to do is more of an enhanced passive [approach].”
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[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.