Accessing Private Equity in a diversified portfolio strategy

Our next speaker is Lou Durbin, Lead Portfolio Manager at Oracle Investment Management.

His presentation topic is assessing private equity in a diversified portfolio strategy.

Oracle Investment Management specializes in the active management of equity, property, and fixed income portfolios that can be tailored to individual circumstances.

They follow an active high-conviction investing philosophy combined with a bottom-up growth investment process.

Luke oversees the investment team and works alongside each portfolio manager.

He takes a long-term view and puts a particular emphasis on valuation but also believes that the best way to outperform is to find great companies.

longer term than the market and anticipate earnings remaining stronger that is currently being forecasted by consensus.

Welcome to the presentation, Luke.

Thanks very much, Angelina.

As Angelina said, my topic today is accessing private equity in a diversified portfolio.

Now, given that introduction that Angelina has just given,

That may seem like a bit of a funny topic for someone that's focused on primarily on public equities.

So there's a good reason for that, which I'll get to throughout the portfolio.

But for right now, I'll just dive in.

So for those that aren't completely aware, I'll just give you a quick overview of what is private equity.

So in its purest form,

private equity run funds that own private businesses, not publicly traded businesses.

So the average investor is probably most familiar with companies traded on stock exchange like the ASX, whereas a private equity fund focuses on the private end of the spectrum.

And so there's a few different types of private equity.

And I'll mainly be talking to the first one and the third one, buyout and secondaries,

To give a quick overview, the buyout firm is one that investors may be the most familiar with or may have come across most regularly.

They're the ones that come through ASX announcements that say, we'd like to buy this company at a certain price and take it private.

They'll then manage it as part of their portfolio and then in a few years, likely to sell it onto someone else or relist or something.

Direct investments is

when a private equity fund will take a minority stake in private companies, secondaries, that you can think of that sort of like a fund of funds where a fund will invest alongside or in within other funds.

And then you've got venture capital, which is the very early stage companies.

And I won't really be speaking to that today.

So

Traditionally, the characteristics of a private equity fund, you can see there on the screen, so they're closed-ended and they generally have a limited life, so maybe around a decade, plus or minus a little bit.

But once that capital is in the fund, you don't actually have access to it.

So I've got there zero liquidity, so you put your money in, you can't access it.

Either distributions start coming through or capital is returned at the end of the fund's life.

The other characteristic is there are minimum investment sizes and these can usually run up into the multi-millions, like 5-10 millions that are not irregular at all.

So that's a bit of an overview.

So given all of those restrictions, why should the average Australian investor consider private equity?

And I will get to that, but I've come up with six reasons why it should be considered as part of a diversified portfolio.

And I've got a slide for each of these, which I'll run through now.

So the first one is, for all of those reasons I've just discussed, it is a very underrepresented asset class for the average investor.

And you can see on this slide here, going back to 2000, the size of private market,

including private equity, but also others, was not much and it's grown over the last couple of decades to be a lot.

The next point is that it really improves diversification for a portfolio.

Yes, it does move in the same direction as stocks, but the quantum that it moves is a lot less and so

When you're looking at stocks and bonds, maybe in a traditional 60-40 balanced portfolio, in the last few years, as we've seen higher inflation, the correlations of those have actually moved closer to one.

And so adding a different asset class, as in private equity, can add to the diversification of this portfolio.

And it has been proven over time that private equity does tend to outperform in those times of turmoil or in recessionary times.

Speaking of which, the performance of private equity has actually been a lot stronger than public markets over almost any period you like.

On this left hand chart, we've got over

between three and 25 years, the performance of the global private equity index versus the Miski world, which you can probably just use as a proxy for what public market returns have been.

And over any of those periods, private equity is actually outperformed.

So it really is an asset class that you want to be having exposure to if you can.

The other thing is that the private market is so much bigger than the public market.

And the public markets are actually shrinking.

This left-hand chart is just the US market, but I think it's representative worldwide as well.

That number over the last couple of decades has shrunk by 38.5%.

And then that right-hand chart is just a breakdown of revenue between private and public revenue.

And it's a no contest.

There's so much more revenue being generated in the private markets.

And another point is that companies are staying private for longer.

And when they do come to list, they're much bigger.

So a lot of the gains or the growth is being enjoyed in the private market.

And so if you're only fishing in the public market, you're missing out on a lot of those potential investing gains.

So I will just quickly

address in private equity.

And it's one that I've been guilty of holding myself, but it's the one that where private equity performance is a lot better because valuations are theoretical.

In public markets, performance is determined by transactions.

So whatever the last traded price is, that's where performance is marked.

You don't have that in private markets.

And so

performances determined by valuations done by third parties.

Yes, these are theoretical, but what we tend to see is that once private equity exits their holdings, they're typically still exited at a premium to their valuation.

So if this were true, it would really be only temporary and it would have to catch up over time as things correct, but it's really not what is seen

in reality.

So there are a couple of downsides and risks to investing in private equity.

A couple we've already talked about.

Access is difficult for all those reasons that I mentioned at the top.

I'll skip to the other one that I've mentioned.

Liquidity is difficult.

The other one is expensive.

The typical fee is 2% management and a 20% outperformance fee.

That's average.

Sometimes

a little bit lower, a little bit higher, but two and 20 in the parlance of the industry, that's quite normal.

And it's probably at least double what an average public equities fund manager is charging.

But if you can get that performance, you're probably very happy to pay that.

So all that to say, and this is the big but, private equity is becoming a lot more accessible

And this is through open-ended Evergreen funds, which have been increasing in number in the last few years.

And so all of those restrictions that I mentioned at the top, they sort of have an answer to that.

So they're open-ended.

So you can invest today in an existing fund and there's no end date to that fund, which is similar to most other funds that you'll come across.

The minimum investments are much lower, and this can be around 50 to 100,000.

It obviously varies, but the quantum is a lot different.

The capital is typically fully employed for the life of your investment.

When you compare that to the closed-ended funds that I talked about earlier, that tends to take a few years to become fully deployed.

And you do get some liquidity.

It's not the same as an ETF or a public stock or even a managed fund, but it is monthly or quarterly, which is better than in a decade.

Access is often possible via a platform, which is the same way that many funds are accessed.

So that's through a hub 24 or a net wealth or a BT panorama, someone like that.

And so all of these things make it much easier to include a private equity fund in a diversified portfolio.

Now this might be one you do yourself or it might be through an advisor, but either way, it's a lot more accessible to the average investor.

So who might this be good for and where might it fit in?

It's probably not designed to replace your portfolio for all it's good and it's bad.

Portfolio typically should be diversified by sector and asset class and according to risk tolerance and private equity, it's probably considered, it is considered an alternative asset, which is classed as being higher risk.

And so it's probably more appropriate for those that do have that higher risk tolerance investing for growth, probably a longer time period investing horizon as well.

So Oracle, we're setting up

some multi-manager portfolios that will have exposure to private equity.

And based on what I've just said there, it'll have a small allocation in the balanced risk profile, a little bit more in the growth portfolio, and then a little bit more again for the high growth investors.

So that's where I might leave it.

Thank you very much for your time.

Thank you, Luke.

Do you have time for two questions?

Yeah, sure.

The first one being, do you think private equity is higher risk and better left to those with money to lose?

Yeah, so I touched about this a little bit.

I think probably not necessarily.

It is classed as higher risk.

But I think in any sort of investing, you really should only be investing capital that you don't need to live on.

um, day to day.

So I don't want to say money that you're happy to lose because that's probably, you shouldn't be investing in, um, in that case, but, um, history has shown that it is a class that outperforms not every period, but, uh, pretty close to it.

And then at the end of the day, it's still, it's a, it's a fund that's made up of, uh, businesses in the same way that a public equity fund is.

So, um,

I think what is perceived as investment risk is really just liquidity risk.

That's one of the main things that would stop someone from investing in a private equity fund.

And I think this new sort of a class of private equity fund that we're seeing a lot more of helps to solve that.

Luke, you probably touched on this again in your presentation, but what expertise does Oracle have in private equity when all your products are equities and fixed interest?

Yeah, that's a question we're probably going to get a lot.

And the honest answer is we don't really have expertise in private equity.

Like we don't run a private equity fund and we're probably not likely to.

Our expertise lies in

investment manager, picking stocks, building portfolios of stocks and understanding that investment process.

Where we can apply that is selecting investment managers.

Now we can apply that to investment managers, building public equity funds.

We can also apply that to those building private equity funds.

So our team or my team

that are like building these sorts of portfolios.

We're not advisors whose expertise is dealing with clients and who are maybe picking funds on the side.

This sort of is our core competency in being able to select good managers based on our understanding of investment markets.

So I think that's really how we can differentiate there.

OK, thank you, Luke, for your presentation and the Q&A.

I look forward to seeing you next time.

Take care.

Thanks very much, Angelina.