Already a key element of the investment strategy of many sophisticated international investors, such as pension funds, endowment funds, institutions, family offices and wealthy individuals; private equity (PE) continues to gain momentum on the local front – particularly among institutional investors seeking superior returns, a high degree of diversification, and lower portfolio volatility.
To date, South African institutional investors have focused on local private equity investment that has delivered impact benefits as well as consistent investment returns. However, whilst local PE returns continue to outperform the benchmark JSE index, the opportunity for risk-adjusted returns available through local PE remains somewhat subdued in comparison to what is attainable through the more established international market.
This is according to Craig Beney, co-CEO of Helical Capital Partners – a South African-based private markets firm – who highlights the variance between the reported 10-year returns across local PE (11.6%* (in ZAR)) to the international benchmark PE index (12.3%** (in USD)).
“This is largely because PE portfolio companies are restricted by not only the GDP growth of the countries in which they operate but also by the nature and make-up of that GDP. In addition, the performance of the local currency must be taken into account when measuring returns in US Dollar terms, or conversely the currency benefit of investing in a developed market.
“South Africa’s disappointing economic growth, and lack of additional organic growth opportunities, in recent years therefore means that local companies will generally experience lower growth trajectories and, potentially, greater volatility of sustainable earnings than international peers,” explains Beney.
Carlos Ferreira, co-CEO of Helical Capital Partners, adds that investors must also take heed of the fact that South African GDP only contributes 0.5% of global GDP. “In terms of asset allocation, this fractional current contribution to global GDP begs the question: would local institutional investors want more than 30% international exposure to markets that are responsible for producing 99.5% of global GDP, if they were not restricted by regulation?
“This, coupled with the reality that South Africa’s GDP continues to grow at a slower pace than our international peers, is a strong indicator that local investors should seek exposure to international PE markets, in addition to their local PE investments, as part of their international investment allocation.” Ferreira adds, referring to the MPC’s recent downward revision of the country’s GDP growth forecast for 2019, from 1.3% in March to a mere 1%.
Lastly, Beney notes that while only a handful of South African managers are on their third generation of PE funds, the average in international market is sixth or seventh generation with the quantum of international PE fund managers available exponential when compared to their South African counterparts.
“Overseas markets also have a more developed secondary market, where Limited Partners (LPs) in PE funds can sell their interest in a fund to so-called secondary buyers. Further evidence that international PE is extremely well established is that US funds raised US$453 billion in 2018, as compared to South Africa raising R7.5 billion in the same period,” he explains.
While the asset class has become increasingly accessible over time to individual investors via local JSE listings, Ferreira notes that international PE is still restricted to larger institutional-type investors. “That being said, the opportunity to gain exposure to an integrated portfolio of primary, secondary and direct private equity investments should not be overlooked by sophisticated local investors,” he concludes.