PE success all about fund selection: Rest

Australia's private equity market solidified its position as the fastest-growing sector to boost private capital markets in 2022, following a raising of about $9 billion. When hunting returns off the back of its success, Rest head of private equity Marina Pasika says it all lies in meticulous fund selection.

Speaking at a joint webinar hosted by Preqin and the Australian Investment Council, Pasika said private equity performance has been highly cyclical over time, both for buyouts and for venture capital.

She said it's this kind of cyclicality that can sometimes lead to investors attempting to time the market.

"There's been a fair bit of research done on this over the years with various simulations run on different market timing approaches to private markets," she said.

Sponsored by Macquarie Fixed income ETFs: The opportunity is now

"I think it's important to remember that investors can only time their commitments to funds, they can't time when commitments are called or when investments are exited."

On the co-investment side there's a slightly higher degree of control, Pasika explained.

"But typically, deployment is highly deal flow and manager dependent," she flagged.

So, with that in mind, research on the topic tends to show that there are only relatively small performance benefits available from timing strategies.

"Even if the hypothetical investor had a crystal ball and was able to get the timing right, funds selection, I believe, has a much larger impact on portfolio performance than vintage year timing in private equity," Pasika said.

She said a top quartile manager or fund in a worst-performing vintage would typically outperform a medium manager in a strong vintage.

"We actually see this across sectors also," she said.

"Investors are always asking, 'what are the hot sectors to invest in, it was tech and then it was healthcare, what is it now?'"

But when reviewing sectors, interesting a top quartile manager in an unfavoured sector will outperform a medium manager in a hot sector, she said.

"Given the huge variation in performance that we see in private equity managers within the same vintage and strategy compared to other asset classes, we continue to look for the right managers and really focus on fund selection rather than trying to time the market," she said.

Preqin head of APAC valuations research insights Angela Lai explained by 2027 the firm believes private capital assets under management (AUM) will reach $18 trillion from its current $9 trillion.

"... with private equity and venture capital just continuing as the main drivers of this growth," she said.

However, Lai said there is an expectation that fundraising will slow down.

"We could first see a little bit more participation from the private wealth segment of investors to slightly offset the limitations of institutional investors," she explained.

"We also expect that as exits slow down, fund holding periods and asset holding periods will be extended... providing some support for this AUM growth."

Commenting on exits and divestments in initial public offering (IPO) markets, Pasika said the outlook will depend on which part of the universe investors play in.

"I think definitely at the larger end, exits feel difficult at the moment. The IPO market is a lot harder to access than what it was in the golden years for private equity," she said.

Strategic exits certainly become problematic for larger companies due to a smaller pool of potential buyers, but this isn't the case at the smaller end.

"At the smaller end of the market, we continue to see managers that can exit fairly successfully to the huge overhang of capital that we see amongst the larger private equity firms," she explained.

Exploring the private equity versus private debt debate, Pasika said it's important to remember the two aren't entirely comparable.

"You're not necessarily looking at the same company and asking if you should invest in debt or equity, there are fundamentally different approaches," she said.

When looking at private equity, investors are typically seeking alpha, she added.

"You're looking to select the very best opportunities that are out there and not necessarily looking to diversify a loss, not to the extent that it starts to eat into your alpha," Pasika said.

On the other hand, investors deploying capital into private debt will see the upside capped.

"It's a much more diversified play, where typically there is a benefit to having a broader exposure which is still carefully selected," she said.

"I think it's important to remember them as not being entirely comparable."