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Private equity faces some challenges in 2019

But stability of returns during difficult times increases its attractiveness.

The South African private equity market continues to show strong performance, consistently outperforming the equity market over the last three and five years, according to the RisCura Savca Private Equity Performance report for September 2018 (Savca, the Southern African Venture Capital and Private Equity Association, is a non-profit industry association).

Gilbert Anyetei, senior private equity analyst at RisCura, says private equity returns have consistently outperformed listed equity returns over the three-year and five-year periods to September 2018, yielding positive direct alpha and a public market equivalent (PME) above 1.

“This is consistent for the Alsi, Findi and Swix benchmarks,” he says. “There was a reduction in both private and listed equity returns from the second to the third quarter in 2018. Listed equity outperformed private equity over the 10-year period across all the relevant benchmarks.”

Private equity a reputable asset class

Anyetei notes that South Africa is currently facing tough economic times with weak investor confidence, high unemployment, electricity supply limitations and constrained domestic demand. He notes that growth, albeit subdued, is expected to rise in 2019. “Private equity has become a reputable asset class in South Africa, and the stability of its returns during difficult times increases its attractiveness,” he says.

Savca CEO Tanya van Lill agrees that last year was a tough year for the South African economy. “While private equity has performed well over the short to medium term, there are still several challenges that fund managers face in the year ahead, depending on where they are in their life cycle,” she says.

The three different life stages for a private equity fund manager are fund-raising, deployment and exit strategy. At the annual Savca conference at Spier recently, industry experts looked at the challenges for each stage in the year ahead and addressed these in Savca’s Journal of Activity and Trends in Southern African Private Equity and Venture Capital for 2019.

Raising funds

“As we approach the May elections, fund managers are finding it difficult to sell the South African narrative to international investors,” says Van Lill. “While there is still a lot of energy around Cyril Ramaphosa’s investment drive, the election result will dictate whether that energy will continue to have momentum.”

Ata Capital, a majority black-owned and 100% black-managed investment manager, is currently raising its third fund and is targeting R1.5 billion from South African institutional investors.

Maredi Mampuru, head of client relations at Ata Capital, notes that it is quite a long process.

“We started engaging with investors about a year ago,” he says, adding that there is a grim feeling in terms of fund-raising, because there is still quite a lot of education that needs to happen around private equity investing. Mampuru says that on average, in South Africa, pension funds invest only around 2% – 3% of their 10% limit.

Paul Boynton, CEO of Old Mutual Alternative Investments, says that African pension funds will have a growing role to play as an additional pool of capital this year.

“We will continue to see an uptick in enquiries as investors look to benefit from the key macro trends expected to underpin positive GDP growth across the continent. The outlook for 2019 and beyond is positive, with strong indications of sustained confidence in the African private equity industry.”

Deployment

Fund managers in this phase may have trouble finding good deals. Van Lill says some company valuations may be high compared to what investors are willing to pay. “There are, however, still good private equity deals out there, particularly in the family business and black economic empowerment spaces,” she says.

In South Africa, Agile Capital sees potential in mid-market companies operating in financial services and sectors such as automotive, healthcare and media. It is currently investing its third fund, with about 30% of the capital already allocated. In 2018 the fund acquired a 26% stake in SA Biomedical (a distributor of medical devices and equipment) and also invested in Provantage, an outdoor media company.

Brett Commaille, partner at Hlayisani Capital, says there has certainly been an uptick in the quality of investment opportunities, despite a tougher financial climate for most businesses. “While some larger corporates have kept things on hold, entrepreneurs have carried on by aggressively growing their ventures,” he says.

Exit phase

Van Lill says activity in this phase has been ramping up over the last few years, with the southern region of Africa accounting for more than 40% of exit activity. “We are seeing more private equity funds buying from each other, leading to the emergence of a healthy secondary market. It’s all about finding the right buyer,” she says.

Graham Stokoe, executive director of transaction advisory services and private equity leader (Africa) at Ernst & Young, says the last year provided a challenging environment for exits due to political uncertainty and the dip into economic recession.

“I think we have had less interest from Europe, the UK and the US over the last three to four years,” he says. “However, we started seeing more interest in SA companies in the third and fourth quarters of last year, which bodes well for private equity exits in 2019/20.”

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Who wants to invest in negative growth and large falling companies if you can invest in an international mutual fund who has outperformed every fund on the JSE and SP500

Just curious, which fund is it that outperforms the S&P500?

Not a dripping roast. Question needs to be asked why private equity is attractive relative to public equity. The smoothness of returns is an artifact of reporting NAV rather than a daily mark-to-market. One also has to rely on the fund manager not to overpay for the asset.

The research below suggests that the apparent out-performance of private equity has narrowed to that of public equity. Download the accompanying PDF, it is well worth a read.

https://www.aqr.com/Insights/Research/White-Papers/Demystifying-Illiquid-Assets-Expected-Returns-for-Private-Equity

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