Alternative Assets - Healthy Performance
Now a well-developed and sophisticated industry, Erika van der Merwe* believes that private equity provides rewarding returns for a range of investors and benefits for the broader economy.
The SA private-equity industry has demonstrated impressive growth. Funds under management have increased from R39bn at end-2003 to R171bn at end-2014. The typical third-party investors in private equity include pension funds, endowments, development-finance institutions, sovereign-wealth funds, life offices, fund of funds and high net-worth individuals. These investors see private equity as a vital element in their investment mix, enabling them to diversify an institutional portfolio while delivering superior returns.
There is growing and significant interest from the public sector in this long-term alternative asset class. For instance, the Government Employees Pension Fund has become a major investor.
In SA, government private equity investment assets have grown from a fledgling R5bn to R66bn during the eleven years to 2014. The most recent level of private-equity activity by government-owned entities represents 39% of total SA private-equity assets under management. Government is now matching allocations from the private independents.
One of the most prominent regulatory changes in recent years is the amended Regulation 28 of the Pension Funds Act. It allows SA pension funds to invest up to 10% of contributions in private equity, an increase from 2,5% prior to 2012. This change aligns SA with practice in many developed markets where institutional investors are experienced allocators to private equity. In time, local pension funds will begin to shift their investment focus accordingly.
The range of private-equity funds on offer to institutional investors should satisfy the requirements of a broad range of investment mandates. There are fund managers with a generalist focus who invest across the industry spectrum. And there are fund managers with specialist focus who variously concentrate, for instance, on infrastructure assets, impact investing, smaller enterprises or specific geographies.
Private equity contrasts with traditional listed equity investing. It requires a unique investment philosophy and tolerance. Investors in private equity are committed for the long term, generally a 10-year period. After the fundraising is complete, the private-equity fund managers typically have five years in which to deploy the funds through the purchase of businesses for the private equity portfolio. The serious work continues as private-equity fund managers devote time and resources to hands-on management of these underlying portfolio companies. The objective is to create more vibrant, sustainable and profitable businesses from which capital returns can be generated.
Returns from SA private equity reflect consistent success. The most recent RisCura-SAVCA Private Equity Quarterly Performance Survey – which covers activity up to the first quarter of 2015 – shows that over a 10-year period the annualised internal rate of return for SA private equity was 20,5% in comparison to the return from the JSE All-Share Index of 18,1%. While private equity undoubtedly is a profitable asset class for investors, its influence goes beyond the return metrics. Private equity is a force for good. It has a far-reaching impact on broad variables such as economic growth and employment. It fosters sustainable growth and efficiencies in the underlying portfolio companies.
Also, the SAVCA-DBSA Economic Impact Study 2014 – which surveyed private equity portfolio companies – shows that the industry drives good corporate governance. It further supports the capital expenditure and expansion plans of portfolio companies, facilitates innovation, drives black economic empowerment and leads to increased employment during the private-equity partnership.
Now an established and dynamic industry in SA, it has plenty of scope for growth. Foreign institutional investors are increasingly looking to SA private equity to boost their investment returns. More than this, we’re seeing an expansion in geographic investment mandates to include direct investment into the rest of Africa as well as a trend of encouraging portfolio companies to develop their operations into the continent.
* Van der Merwe is chief executive of the Southern Africa Venture Capital & Private Equity Association (SAVCA), the industry body representing approx R170bn in assets under management.