Q2 2022 - (released August 2022)
SA's quarterly Private Equity & Venture Capital magazine
Show me the money
by Steven Nathan
Investment companies seldom hide good news from their clients, intermediaries and the public. In fact, the opposite is true, as they typically relish the opportunity to promote a top performing fund with glossy media spreads and billboards, often while ignoring other funds that perform poorly.
Private Equity (PE) markets itself as a higher return, lower correlated asset class, thus is “ideally” suited to improve investors’ risk-adjusted returns. If this is true, the South African PE industry should manage far more assets than its current R200bn. If this is not true, then maybe the PE industry needs to reconsider its value proposition and business model as a value-adding capital allocator.
Investment performance for over 1,600 unit trusts is publicly available. This performance is standardised and discloses all investment fees. We can also track down funds that closed due to poor performance. Every unit trust is required to disclose a monthly minimum disclosure document showing fund and benchmark returns, fees and large investment holdings. This transparency does not guarantee that investors will make the right decisions, but it does help them make more informed decisions about what they are investing in and what they pay.
Unlike unit trusts, PE funds have no obligation to publicly disclose their performance and fees. A few years ago, I was able to find some PE Fact Sheets online, but they have since disappeared. My assumption is that investment performance has been poor and these funds prefer not to make this information publicly available.
A review of SAVCA’s (Southern African Venture Capital and Private Equity Association) 40-page 2021 PE Industry Insights Survey includes detailed industry analysis, but fails to provide any data on the two things that matter to investors: investment performance and fees. Is this a deliberate choice to overload the public with data while hiding critical information, or merely an oversight? Can it be that the PE industry is hiding its superior track record in fear of embarrassing fund managers operating in a less lucrative part of the investment industry?
In the US, there is concern around the integrity of investment performance from PE Funds. One concern is that funds assume that realised cashflows are reinvested at the same rate of return, which materially overstates returns. A Harvard Study (entitled “The Truth About Private Equity Performance”) of 1,184 PE funds over a 20-year period showed the top 25% “delivering” an average net-of-fees IRR of 35.3%, but this falls to 18.6% when measuring the actual IRR.
The Harvard study concludes with this sobering observation: “Overstated private equity performance may partially explain why investors continue to allocate substantial capital to this asset class, despite our finding that PE funds have historically underperformed in broad public market indexes by about 3% per year on average.”
Another challenge is valuing unlisted companies. While PE companies say that they use independent parties to value their unlisted investments, there are many cases where these valuations have proven far too high when these investments are realised, either through a sale or IPO.
In his well-researched book on the global venture capital industry, “The Power Law”, Sebastian Mallaby struggles to find reliable performance data. He states: “Steven Kaplan of the University of Chicago helped me to navigate the murky nuances of performance data in VC, at one point explaining that the way a prominent partnership presented its returns was nothing less than “outrageous”.
Mallaby also notes that “from the beginning of the industry through the end of 2007, the average European venture fund generated a return of -4%.”
Now, I am sure that there are PE funds that have done very well and outperformed equivalent risk investments. However, without reliable, regular and transparent performance reporting, we have no visibility into how PE is performing as an asset class, nor who the winners and losers are.
In the 1990s and 2000s, Ethos and Brait were two of the largest and most prominent PE Investors in South Africa. Both companies subsequently listed PE funds on the JSE, which we can use as a proxy for PE performance. Ethos listed a fund in 2016 at R10 per share, but the fund has not paid a dividend, and had a share price around R5.75 on 24 June 2022, producing a total return of -43% in almost six years. Over this period, the JSE All Share Index returned 152%. Over the last five years, Brait returned -92% and ARC -25%. This performance does not bode well for PE as an attractive asset class.
PE fund managers are highly renumerated and typically charge an annual management fee of 2% of assets (plus VAT), and consume a further 20% of the investment performance subject to meeting a target return. With this extremely generous remuneration structure and the fiduciary responsibility of managing other people’s (mainly retirement funds) money, it would seem reasonable to request that these companies provide reliable, meaningful and transparent performance reporting, in line with their less well-paid colleagues in the unit trust industry.
Nathan is the founder of 10X Investments, which was bought out by a private equity fund.