The Australian market is being seen as a relative bright spot for capital raising amid an otherwise tough environment
Across the globe, private capital fundraising is getting tougher. For some time now, institutional investors have been rotating into private capital at the expense of traditional assets. While many portfolios still have significant headroom for further allocations, some investors are now approaching, or exceeding, their long-term strategic asset allocation targets.
The market environment has not helped either. The sell-off in public markets this year has left allocators feeling more risk-adverse on the margin while their private capital allocations have increased as a percentage of their portfolios by default. As a result, we expect investors to slow their pace of commitments to private capital funds – especially for higher risk private equity and venture capital strategies. We forecast global private capital fundraising to grow at a comparatively modest 3.6% CAGR to $1.6tn until 2027, compared with 11.7% CAGR from 2015 to 2021. Across the APAC region the slowdown in expected growth is even starker, with a 1.7% CAGR expected until 2027 compared with 7.2% from 2015 to 2021. This comes at a time when the number of funds in the market looking to raise capital continues to climb to new highs.
This is an evolution in the industry that GPs have been responding to in a number of ways. On the research insights team at Preqin, they've had several discussions with North America- and Europe-based asset managers that are looking further afield to raise capital. Australia has always been perceived as a tough market to do that, but one that is gaining new attention by fundraisers – especially considering the recent regulatory changes in recent years for superannuation schemes.
The market has long been seen as a tough nut to crack. A strong home market preference and the dominant role that investment consultants play in the market have often been cited as reasons that make fundraising conditions a challenge. Furthermore, Australian assets have performed well over the past couple of decades, and this has limited the need for domestic allocators to look further afield. Although the Australian private capital market remains comparatively small, with $68bn (AUD 90bn) in AUM as of June 2021, it has provided investors with attractive risk-adjusted returns. The median net IRR of private capital funds with a focus on Australia returned 17.8% for vintages between 2012 and 2019, with a standard deviation of returns of 25.6%. On a risk-adjusted basis, this compares favorably with North America, Europe, and Asia.
Despite this, the trend has been starting to change and allocations have been shifting offshore. This is not necessarily due to a shift in investment preferences, but more out of necessity. Superannuation schemes have been managing an ever-growing pool of assets, which have arguably begun to exceed the capacity of the domestic investment market to absorb it.
To illustrate, Australian equities currently have a remaining free float-adjusted market capitalization of $1.3tn, which compares with the $1.86tn (AUD 2.48tn) that Australian super schemes have invested in domestic equity according to APRA. Considering the presence of other long-term domestic investors in the asset class, such as family offices and insurance companies, it is easy to see why continuing to deploy fresh inflows into domestic markets would push valuations higher and create relatively unfavorable liquidity conditions. Instead, much of that marginal capital has begun to flow offshore – primarily into more liquid international public equities. The allocation that Super funds have to international public market equity increased from 18.6% in December 2013 to 28.8% in December 2021 as a result, according to APRA.
However, we view this as the first stage of investment into international markets. As investment teams have become more familiar with new markets, the sophistication of investment allocations has increased. As a result, investment teams have felt more confident about, and capable of, allocating to private equity and private capital funds.
Superannuation investment teams are continuing to build their capability and becoming more confident in investing in private capital deals directly and via co-investments. This is adding to the challenges for traditional fund managers who are raising capital for traditional fund vehicles. In addition, they are also facing fierce fee negotiations on the back of the Your-Future-Your-Super initiative. Nevertheless, we expect Australia to be seen as an attractive market for established private capital managers to raise capital over the medium to long term.
This article first appeared in FS Super: The Journal of Superannuation Management on 27 October 2022.