Q3 2022 - (released November 2022)
SA's quarterly Private Equity & Venture Capital magazine
Appetite for private equity set to soar over coming decade
by Andrew Bahlmann
Globally, private equity remains the top investment choice among alternative investment categories, according to a recent survey conducted by With Intelligence.
It found that while investors and fund managers are bullish on both private equity and hedge funds, the former is leading the way in investment intentions.
With Intelligence's latest survey on investor intentions found that 72 percent of institutional and private wealth investors plan on investing in private equity within the next 12 months. Hedge funds were in second place, with 54 percent of the investors surveyed.
In South Africa, this intention is given further impetus by the recent amendments to exchange controls, and Regulation 28 increasing to 15 percent the permitted allocation to private equity, with a further 10 percent to hedge funds – from a previous combined amount of 10 percent. In addition, the retirement fund offshore investment limit was also increased to 45 percent (from 30 percent, with an additional 10 percent African allowance).
South Africa is one of the few countries in the world to still have any exchange controls. In terms of alternative investments, the West averages a 50 percent allocation to them while we have only now increased it to a total 25 percent. I would expect South Africa to follow the international pattern over time, so private equity in South Africa has a bright future.
However, the regulator would find it difficult to further increase the allocation of capital to alternative investments, more especially hedge funds but also private equity and venture capital, when boards of trustees of pension funds remain reluctant to use their full current allocation, through misunderstanding the risk nature of alternative asset classes. The regulator would first want to see a greater take-up before extending the allocation closer to international norms.
Regulation 28 now reflects various changes occurring in the world, primarily diminished listings and a growing demand for more infrastructure investment (both a South African and global trend), as well as more capital allocated to private equity and alternative investments, such as hedge funds.
Globally, 2021 was a record year for private equity fund raising. Gridline, a platform that enables investors to invest with top- tier fund managers, has reported average returns of 25 percent to 30 percent among private equity managers. This means that investors in high-quality fund managers will outperform the public markets in the long term, with the latter typically averaging around nine percent and with some analysts suggesting that this may fall to five to six percent over the next decade. While no one can know how long the current spate of volatility will last, it's clear that corporate balance sheets and consumer spending are down, as interest rates and inflation soar.
For similar reasons, there has been a trend for companies to delist from the JSE, with the JSE’s latest financial results revealing that 25 companies delisted in 2021.
After a long-term strong run in public markets, there is now rising uncertainty as to where listed markets are headed from here, and investors with foresight are becoming much more interested in private equity.
There are three key advantages inherent in private equity investments. Top of the list is the outperformance mentioned, especially among the top performing managers. A further advantage of investing in private markets is reduced volatility, as they are not priced daily like public equities are. As an example, in early October, listed company Murray & Roberts fell one third in value in two days on a profit warning – that wouldn’t happen if it was privately owned.
Thirdly, private markets reduce the psychological anxiety of closely watching every fluctuation in one’s account balance and trying to time a sale – which is proven to be almost impossible in public markets.
Private markets compel a long-term mindset in which investors can't just pull their money out any time they panic. This is primarily because private equity investments are typically for seven- to 12-year horizons across market cycles and, therefore, less liquid than public equities. Of course, a private equity investment can be exited – but it’s not a daily liquidity. Therefore, the private investor needs to be comfortable being invested for a longer period of time.
Buying low is always a sound investment policy, and private equity is attuned to taking the time to find companies likely to appreciate in value over five to 10 years. With private markets, investors are not entirely at the mercy of external factors, but can influence internal factors by focusing on particular asset classes like ICT and fintech, where the investor can monitor specific inputs that lead to changes in that market.
Another factor which private investors keen to take advantage of the higher Regulation 28 limits need to be cognisant of is the lack of information on such private companies. They don't publish financial information as regularly as listed companies do, so investors are reliant on their fund manager keeping abreast and providing updates and visibility on the portfolio. For this reason, it is critical to choose from among the best managers, as the difference in return between managers can be a multiple of the difference between returns from exchange-traded equity managers.
Much of the excitement and potential around private equity is in the fintech space. There is growing interest in South African start-ups from international private equity, but just as interesting with the amendment in exchange controls is that South African private equity can invest more in international start-ups. We may expect to see a lot more liquidity in the local venture capital market, for instance, driven by interest from international investors.
According to the South African Venture Capital and Private Equity Association (SAVCA), in 2021, South African start-ups attracted more than $800m, with a number of high-profile fintech deals announced in 2022 so far. A secondary trend is that South African tech start-ups are expanding internationally, typified by companies such as Mobiz expanding to the US; artificial intelligence (AI) company, Carscan, which now has clients in countries such as India, the UAE, Nigeria and Kenya; and Sendmarc is actively doing business in several Western countries.
Such investments would potentially become available to private equity investors.
Bahlmann is Chief Executive: Corporate and Advisory | Deal Leaders International