The Rising Tide of Private Capital in Australia

By the end of this calendar year, it is now expected that the Australian Stock Exchange (ASX) will shrink by A$43bn, or by about 2 per cent.[1] The last time this occurred was in 2005 and would mark the end of a prolonged stretch of expansion by the Australian share market.

A number of factors are driving this, including several major takeovers in the natural resources and energy sectors (including Newcrest, Origin Energy and OZ Minerals), a higher level of share buybacks and a severe lack of IPOs (the ASX has only seen one float worth more than A$100m since the start of 2022).

For some across the market, it is the complete drop off in IPOs that is the key trend. While some of this is cyclical given the current macroeconomic environment, it also reflects a structural shift towards more and more Australian companies being kept out of, or taken from, public hands.

Whereas a company used to go public because it needed liquidity and capital, the increasing abundance of private capital today means you can now readily access both and conveniently avoid the continuous scrutiny and regulatory burdens a public listing demands.

Of particular interest, private capital in Australia is maturing and generating strong assets under management (AUM) growth given high levels of capital raised.  Industry AUM for closed-end Australia-focused funds achieved a record A$118bn as of September 2022, growing 21% in the nine months from December 2021 and continuing a trend of high double-digit year-on-year growth since 2016 (see Figure 1). Real estate is the largest asset class, with A$44.4bn in AUM, closely followed by private equity (A$41.7bn) and venture capital (A$17.9bn).[2]

Figure 1: Australia-Focused Private Capital Assets Under Management [3]

Notably, dry powder grew by 30% to A$37bn in the same period, backed by record private equity and venture capital fundraising, even as institutional investors around the world grew cautious on the back of rising interest rates, recession fears and geopolitical tensions.  In 2022, 13 Australian private equity funds (excluding venture capital) raised A$9.0bn, more than double that of A$4.3bn in 2021, while 17 VC funds raised A$2.7bn, almost doubling the record of A$1.4bn in 2020.  In comparison, the total raised by Asia-focused private equity and venture capital funds fell by nearly 60% year-on-year.[4]

So, where is this money coming from and what makes Australia an attractive investment market?

Australia’s A$3.4tn superannuation (or pension) sector is playing a significant role as an investor into private capital.  As the Australian population continues to age and grow, superannuation funds are becoming significantly larger, driven by a superannuation guarantee scheme that requires 10% of every Australian employee’s salary be contributed to a superannuation fund.  At the same time, superannuation funds are committing more to alternative assets in search of diversification and higher returns.

Preqin data shows that Australia-focused private capital funds with vintages between 2012 and 2020 delivered a median net IRR of 14.9%, comparable with Europe’s 15.2%, but lower than Asia (16.4%) and North America (17.7%) (see Figure 2).  Private capital’s positive returns contrast with the recent trend of negative returns for Australian equities (shares) and fixed income (bonds), building a stronger case for private capital allocation in an investor’s portfolio.[5]

Figure 2: Private Capital: Risk / Return By Primary Geographic Focus (Vintages 2012-2020) [6,3] 

For example, our largest superannuation fund, AustralianSuper, has A$271bn in total AUM and plans to double its investment in private equity from A$13bn to A$26bn by 2024, with its target allocation increasing from 5% to 7%.

While superannuation funds comprised a 42% majority of all active Australian private capital investors in 2018, their proportion has fallen to 28% of all investors in 2022.  This is because of mergers between superannuation funds, as well as higher participation among other investor types, including family offices, wealth managers and corporate investors.[4] 

Meanwhile, Australian private capital funds have continued to attract higher levels of foreign investment. According to David Lang, KKR’s Co-Head of Australia and New Zealand:

“[Australia] has built a dynamic economy with many outstanding businesses continually reshaping their industries, particularly in healthcare, education, financial services and tourism. Australia offers investors an impressive combination of an established and transparent rule of law, a well-educated and diverse population, robust infrastructure planning and an important–and-necessary open stance towards global commerce. These come together to provide a highly attractive investment environment.” [2]

Two decades ago, foreign investors accounted for just 18% of investors in Australian-based private funds. This has steadily risen to nearly half of investors (45%) in the past five years (see Figure 3). [4]

Figure 3:  Active Investors in Australia-based Funds (By Location and Vintage Year) [3]

North American investors remain the largest contingent of foreign investors in Australia, accounting for almost half (46%) of fund commitments with foreign funding over the past five years (see Figure 4).  Many of these investors, particularly pension funds, have been significant long-term investors into the region. [2]

Private equity is the most attractive asset class to foreign investors, making up over half (55%) of known commitments to Australian private capital funds in the past five years (see Figure 4).

Figure 4:  Mix of Foreign Funding in Australia-Focused Funds (By Region and Asset Class), 2017-2022 [3]

So, what does this all mean as we look forward in the current environment?

In early August, the Reserve Bank of Australia announced that it now expects a soft landing for the Australian economy.  After sinking to a downwardly revised pace of 0.9 per cent at the end of 2023, economic growth across Australia is expected to rebound steadily to 2.3 per cent by the end of 2025. [7] 

In addition, the recent August reporting season – most listed Australian companies have a 30 June financial year-end – has demonstrated that domestic facing companies are doing better than expected, delivering strong results and raising expectations that most of the economy could sidestep emerging troubles in China.

With business conditions stabilising, inflation easing and interest rates at or near their peak, pressure to deploy significant dry powder is also, anecdotally, increasing across the market.

Against this backdrop, we are expecting a significant increase in activity across Australia’s private capital market as we move towards calendar year 2024.

Footnotes

1 Sourced from MST Marquee Research (July 2023).

2 Sourced from Australian Private Capital Market Overview: Preqin and Australian Investment Council Yearbook 2022.

3 Sourced from Preqin Pro Research (March 2023).

4 Sourced from Australian Private Capital Market Overview: Preqin and Australian Investment Council Yearbook 2023.

5 Sourced from http://www2.asx.com.au/blog/investor-update/2022/outlook-for-2023

6 Note the size of each circle represents the capitalisation of private capital funds used in the analysis. These funds are invested by Australian and / or global institutional investors.

7 Sourced from Reserve Bank of Australia Quarterly Statement on Monetary Policy (August 2023).