Discount Department

With Macquarie Capital Alliance Group snapping up another European directories business last month, Babcock & Brown Capital taking a stake in Ireland's Eircom and private equity funds bidding for Australian retailing icon Myer, private equity funds are becoming part of the average investor's vocabulary. Private equity was traditionally an asset class not accessible to retail investors but in the past year six private equity funds have listed on the Australian Stock Exchange. These recently listed private equity funds have performed poorly, lending weight to the argument that private equity funds should stay private. Industry insiders say it has nothing to do with public or private, it is just the nature of private equity.

Before last year's listing rush, retail investors had very few options when it came to private equity exposure; most could only get exposure via super funds that had 1–2% of their funds under management allocated to private equity investments. Private equity caught the public's attention in August after Coles Myer said it might sell its Myer department stores, which led to private equity giants CVC Asia Pacific, Catalyst Investment Managers, JP Morgan Partners Asia and Newbridge Capital being reported as potential suitors.

Australian investors' first real exposure to private equity funds '” often referred to as "cash boxes" '” was during the 1999-2000 tech-boom. JB Were launched a $145 million private equity fund specialising in start-up companies back in 2000, but wound it up in early 2005 after achieving mediocre returns. BluePeak, a retail venture capital fund launched by stockbroker Ord Minnett and venture capital firm Allen & Buckeridge, had the misfortune of closing after the NASDAQ crashed in 2000. The average investor in the fund had put up $12,500, but did not see their first returns until 2004.

"The problem is that most individual investors like to cherry-pick deals," says Australian venture capital industry doyen Roger Buckeridge, of the types of high net worth individuals who can afford to invest in private equity funds. "And with the mum and dad investors, the biggest risk is that they don't understand what they are getting into."

The recent explosion in choice has not resulted in an explosion in listed fund performance. Not one of the funds that have listed over the past year is trading above its listing price. This despite the fact that the two listed funds that preceded the current wave '” CVC Limited and Colonial Private Equity '” have averaged 24% and 18% returns, respectively, for the past three years.

"Typically, these funds will trade at a discount to net asset backing," says Rupert Harrington, principal at Advent Management Group Ltd. "Private equity is not well understood by retail investors." Harrington adds that private equity is prone to lumpy returns, making the funds difficult for outsiders to analyse.

Advent Management invested in Taverner Hotel Group back in 2000 when it was just four pubs. Taverner was recently sold to a Woolworths joint-venture for $380 million, after entertaining bids around $350 million from Singapore's Affinity Equity Partners, SkyCity Entertainment Group, Woolworths Limited, Washington-based Carlyle Group and Newbridge Capital Group.

ASX-LISTED PRIVATE EQUITY FUNDS
Listed Investment Company	ASX Code	Current Price (18 Nov 05)	Listing Price	Listing Date
Babcock & Brown Capital	BCMCA	$2.17	$2.50	14-Feb-05
Macquarie Private Capital Group*	MPG	$0.90	$1.00	22-Mar-05
Macquarie Capital Alliance Group	MCQCA	$1.78	$2.00	28-Apr-05
Allco Equity Partners	AEQCA	$1.17	$2.00	22-Dec-05
Souls Private Equity	SOE	$0.23	$0.25	16-Nov-04
ING Private Equity Access*	IPES	$1.77	$2.00	25-Nov-04
CVC Limited	CVC	$1.31	n/a	27-Jun-85
Colonial First State Private Capital	CFI	$0.69	n/a	31-Jul-87
* = Fund of funds
Source: ASX, Company data

The options for retail investors to get exposure to private equity are severely limited. High net worth retail investors can become limited partners in funds but becoming a limited partner, even in a fund managed by an unproven management team, would entail a commitment of at least $500,000. Listed private equity funds are the other option.

Geoff Leaver, a director at CVC Private Equity, says: "As a retail investor, in a lot of ways (the listed private equity fund) is the only way you can get exposure to private equity." He adds that when CVC offered its private equity vehicle to the market 300–400 retail investors participated. "As long as the investors understand it is a very risky activity; and the financial planners did a good job of explaining that," he says.

Australian private equity and venture capital funds raised $2.88 billion in 2004, almost three times the $1.1 billion of 2003, according to Thomson Venture Economics and ASX data. By 30 June 2005, Macquarie, Babcock & Brown, and Allco alone raised more than $2.5 billion in commitments via their listed private equity funds.

Whether they are aware of it or not, investors in listed private equity funds are pushing their fund managers to deploy capital. Listed funds typically raise a fixed amount by telling investors that the fund will aim to beat a particular internal rate of return (IRR), typically about 20%. Once the fund is raised and the listed private equity fund begins trading, the fund manager is under enormous pressure to deploy capital to achieve that stated IRR. Unlisted private equity funds often have a little more breathing space because the limited partners (investors) in those funds commit to investing a set amount of capital when the fund manager invests in a company but until investments are made committed capital remains on the limited partners' books.

"With a wholesale fund, the money can be called down as needed. It is an efficient way to run the fund," says Advent's Harrington. This "just-in-time" investing helps unlisted funds achieve higher IRRs.

Fund of fund vehicles such as Macquarie Private Capital Group (MPG) and ING Private Equity Access Limited (IPES) allow investors to pool their money and function like a traditional private equity fund limited partner. The catch for investors is that they end up paying a management fee to MPG or IPES, which in turn pay management fees to their portfolio fund managers.

Recent investments by Australian private equity funds, listed and unlisted, illustrate that the pressure to deploy capital is high. "The domestic market is a little bit more expensive than the overseas markets," says Rex Comb, the chief executive of Babcock & Brown Capital (BCM). "We are seeing more opportunities in Europe." Babcock & Brown Capital announced it paid $405 million for a 12.5% stake in Irish telco Eircom on 10 October, the fund's first investment since raising $1 billion via a public offering in February. European opportunities are currently more appealing to Babcock & Brown Capital because sovereign risk is lower than most of Asia and other parts of the world.

Comb ran the privately held Linfox Logistics before moving to Babcock & Brown. "If anything, having the public as shareholders makes you a little bit sharper," he says of the difference between running private and public companies.

NEW FUND FEES
Listed Investment Company	ASX Code	Management Fee	Performance Fee
Babcock & Brown Capital	BCMCA	1–2%	20–30%
Macquarie Private Capital Group*	MPG	0.6–1%	20%
Macquarie Capital Alliance Group	MCQCA	1.50%	20%
Allco Equity Partners	AEQCA	1%	25–33%
Souls Private Equity	SOE	1.75%	15%
ING Private Equity Access*	IPES	1%	10%

Babcock is not the only Australian private equity fund looking offshore to deploy capital; Macquarie Capital Alliance Group (MCAG) invested 200 million euros in a 1.83 billion euro acquisition of the Netherlands-based directories company Yellow Brick Road Group back in May. Then, in October, MCAG led another consortium to acquire the directories business of Danish national telecom operator TDC A/S for 4.85 billion Danish Kroner ($A964 million). Management of the Sydney-based private equity fund Ironbridge Capital Limited (one of Macquarie Private Capital Group's portfolio funds) were unavailable for comment on this story because they were in New York looking at a deal.

Advent's Harrington says the Macquarie and Babcock & Brown listed fund approach is more a matter of expedience than whether unlisted or listed is superior. "If you go through a retail approach, you need a brand. Macquarie and ING have (retail) distribution networks."

One industry old-timer said institutional investors like superannuation funds and pension funds do not want to deal with managers that offer retail funds. A glance at the list of companies able to take funds to market illustrates the importance of brand: Macquarie, Babcock & Brown, Souls, Colonial, and ING are all household names that can afford to snub institutional investors and go directly to retail investors.

If investors are willing to live with the fact that listed private equity funds will trade at a typical discount of 5–15% and sit on the investment long term, as an institutional investor would, then the ASX-listed private equity funds are a rational way to get exposure to private equity. A look at the US market shows similar vehicles offered to retail investors by private equity heavyweights trade at a deep discount. Private equity pioneer KKR offered shares in publicly traded funds to retail investors earlier in 2005, as did Blackstone Group. Both are trading at a discount to their offering prices.

The difference between listed and unlisted private equity is really a matter of whose books the funds are sitting on. The managers of listed funds look to be just as credible as those at unlisted funds and listed funds require the managers to adhere to the ASX's governance rules. This might not make the retail investor as well informed as the institutional investor who can demand face-to-face meetings with the fund manager but it does provide a degree of transparency into an asset class that is often described as murky.