*This story is written in partnership with MLC Asset Management
In a trend expected to become increasingly mainstream, market analysts have noticed a much larger pool of money being funnelled into private equity in an effort to achieve better market diversification.
The shift toward private equity is playing a crucial role in the nation’s economic recovery as businesses get a shot in the arm to expand and grow though a range of state and federal government grants, while generating material gains for investors in return.
Investing in private equity provides a pathway to growth not available in public markets, enabling investors to leverage the detailed analysis that private equity funds conduct ahead of a deal, head of research at SQM Research, Rob da Silva explains.
Investors also appreciate that private equity can withstand market volatility during a downdraft such as the pandemic.
“Investors are realising that private equity has the potential to balance out market volatility due to the way these products are structured and valued over time. This sector tends not to be as volatile as what you’d see in public markets, which helps smooth out the returns,” da Silva says. “Also, private equity covers a huge part of the economic activity, giving investors the opportunity to tap into pockets of growth that you just don’t necessarily get direct exposure to in public markets.”
With listed share market investments dominating many investors’ portfolios, private equity can help diversify their Australian and international shares investments and enhance risk-adjusted returns.
In times of economic uncertainty, private equity can help small businesses to become attractive acquisition targets for strategic acquirers or public market investors.
Private equity investors can also help businesses by providing industry expertise when navigating unchartered territory, such as the pandemic.
The deep dive
MLC Asset Management has one of the most established global private equity programs in Australia, with 10 experienced investment professionals based across New York and Sydney.
With $6 billion AUM in private equity alone, MLC Asset Management has deployed capital into the private equity sector each year since 1997, resulting in long-established and difficult to replicate relationships with some of the most successful private equity firms in the world, some of which are otherwise closed to new investors.
Private equity is nimble and adds value by providing founders with additional senior management capacity, expertise and capital to scale their businesses sustainably, MLC’s Private Equity portfolio manager Rachael Lockyer says.
Publicly listed companies do sometimes struggle with balancing the need to meet short term profit objectives with investing for growth or taking on higher risk growth opportunities which may not be initially profitable, and can drag down earnings. On the other hand, privately held companies enable founders and private equity firms to work together to grow the business over three to five years and make changes without the scrutiny of quarterly earnings updates and disclosing sensitive information to the market, she says.
Investing in intel
Private equity firms work closely with the businesses they invest in, supporting them to identify growth opportunities and providing know-how on operational best practices, such as sales and marketing, new product development, supply chain optimisation and expansion into overseas markets.
Analysis by Bain Capital highlights the extreme lengths that sector specialists take to make it their business to gather intelligence on a target sector. The institutional knowledge these firms have built provides differentiated insights that either win auctions or provide access to deals and drive value creation, its Global Private Equity Report 2020 reveals.
This deep dive provides private equity managers with a vast bank of knowledge built up on these businesses, giving investors confidence that they’ll be able to execute on the value creation plan that they intend to achieve over the life of the investment.
“Private equity funds have full information on the businesses they are buying, often spending millions of dollars on financial, legal and commercial due diligence before deciding to proceed,” Lockyer says. Private equity managers typically spend about one per cent of the value of the deal on due diligence and other deal related costs. On a typical $300 million deal, that’s $3 million worth of insights.
Some of the most interesting opportunities in the market right now are medium-sized, high growth companies, Lockyer continues.
“The ownership of privately held SMEs is concentrated in the hands of a generation approaching retirement, with more than 60 per cent of Australian SME owners expecting to exit their businesses within the next decade due to retirement. Of those owners, more than 60 per cent don’t have succession plans, which is consistent with global trends,” she says.
“These types of companies, when publicly listed, are often poorly researched due to their size and not well understood by the market, making it difficult for investors to build an informed investment decision.
“By contrast, private equity funds perform rigorous and detailed due diligence on investment opportunities, drawing on in-house expertise and typically engaging high quality advisers and consultants to implement value creation initiatives,” Lockyer says.
It’s a strategy yielding strong results and delivering consistent and attractive returns for investors for over a decade, Lockyer adds.
“We’ve established very solid relationships with private equity managers, and because of that, we receive preferential access to co-investment deal flow, which has contributed to our strong performance.
“MLC’s private equity team utilises a rigorous, tested and replicable selection process to ensure only the best deals are accepted. We’re presented with a large number of opportunities globally, and can afford to be selective.”
Runs on the board
MLC’s first co-investment fund has exited nine of its 14 investments. To the end of September 2021, it has delivered an IRR net of all fees of 22.5 per cent since inception (above a target of 15 per cent), and has achieved a multiple on invested capital of 3.0X to the same date, ranking top quartile for its vintage by Cambridge Associates.
Within this fund, MLC co-invested with technology specialist private equity fund Potentia Capital, into payroll management firm Ascender, which delivered MLC 2.4X return on money and 24 per cent IRR across a hold period of four years, with an exit in May 2021.
During the period of investment, Ascender undertook a corporate restructure, shifted toward cloud-first platforms, and went from being Australia-centric to having a presence in 31 markets, Lockyer explains.
“MLC partnered with Potentia due to their expertise and track record in technology investments, with the leading partners having previously transformed accounting software business MYOB from a small business to a leading multinational software provider,” she says.
Like all investments, the key is patience. Holding steady during periods of market instability will yield better long-term results, but too often, investors bail at the first sign of trouble, da Silva says.
“The worst possible time to get out is when everybody is panicking. You’ve already taken the majority of the hit by then, and usually the better strategy is to hang on and wait for recovery. History shows that recovery always follows a fall,” da Silva says.