Private capital grows despite rising interest rates

Despite rising interest rates and fears of recession, allocations to Australian private capital grew 21% in the nine months from December 2021 to September 2022, according to the Australian Investment Council (AIC) and global private capital research company Preqin.

That growth rate, which was 3% higher than the annual average over the prior five years, took assets under management to $118 billion, AIC and Preqin report in their 2023 annual Yearbook.

Notably, dry powder – capital allocated but not yet invested – grew by 30% to $37 billion on the back of strong successful fundraising.

Australia-focused private equity and venture capital funds raised record sums in 2022 even as institutional investors across the world grew cautious in the face of rising interest rates, recession fears and geopolitical tensions.

In 2022, 13 private equity funds raised $9 billion, more than double the 2021 figure of $4.3 billion. Venture capital funds raised $2.7 billion, four times the 2021 figure.

The $3.4 trillion (December 2022) Australian superannuation sector is committing an increasing volume of investment to alternative assets in search of diversification and higher returns. This has generated strong returns, according to Preqin.

Preqin data shows that Australia-focused 2012-2020-vintage private capital funds have delivered a median net internal rate of return (IRR) of 14.9% compared with Europe, 15.2%; Asia, 16.4%; and North America 17.7%. Private capital’s strong positive returns compare with recent negative returns for Australian equities and fixed income (bonds).

The largest superannuation fund, AustralianSuper, plans to double its investment in private equity from $13 billion to $26 billion by 2024 with its target allocation increasing from 5% to 7%. Other large industry superannuation funds such as Hostplus and Aware have already hit their target allocations for private capital.

Despite these increases, numerically, superannuation funds fell to 28% of investors in 2022 compared with 42% in 2018. Mergers between super funds accounted for some of this change but there was also higher participation from other categories of investors such as family offices, wealth managers and corporate investors. Notably, the 97 family offices that invested in the sector in 2022 (23%) was up from 27 (7%) in 2018.

Meanwhile, overseas institutional investor interest in Australian private capital funds has continued to increase. The proportion of North American institutional investors for vintage years 2018-2022 was 25% compared to 19% for vintage years 2013-2017. The same comparison for Asian institutional investors was 8% compared to 2%.

The volume of Australian private equity deals has continued to rise overall since 2018 with only a modest drop in 2020. In 2022, 135 deals were completed, amounting to a total value of $18.5 billion. Of these transactions, public to private deals represented 56% of total value. This figure was, however, boosted by Blackstone’s $8.9 billion acquisition of Crown Resorts, the highest value Australian take-private deal to date.

Venture capital fundraising reached a record $2.7 billion in 2022, more than quadrupling the figure for 2021. This figure was reached as a result of Australia’s largest three venture firms, Blackbird Ventures, Square Peg Capital and AirTree Ventures all raising during the year.

Some smaller, newer, venture managers also raised during the year including OIF Ventures which closed a $US140 million fund without seeking commitments from institutional investors. OIF Ventures targeted investment from founders of its investee companies, chief executives of listed companies, family offices, and high net-worth individuals.

OIF raised its over-subscribed fund off the back of reporting annual internal rates of returns (IRRs) of 45% and 89% for its first two funds.

Over 2022, 338 venture deals with an aggregate value of $5.6 billion were recorded by AIC and Preqin. This value was 40% lower than 2021 but still 67% higher than 2020.

Blackbird, AirTree and Square Peg all invested in fewer deals in 2022 than in 2021 and focused more on seed or pre-seed deals.

Information technology (IT) made up almost half of the venture deals in 2022, accounting for slightly over half of aggregate deal value.

The mix of deals showed Australian venture firms were focusing on cybersecurity, sustainability, and leading-edge technologies across blockchain, artificial intelligence (AI), Web3 applications, and non-fungible tokens (NFTs).

The largest Australian venture capital deal of 2022 was the $290 million Series C funding round for NFT-enabled games developer Immutable which was led by overseas investors Temasek Holdings, Mirae Asset Global Investments, Tencent Investment, and Liberty Global.

Australian private debt assets under management grew 10% to $2.1 billion from December 2021 to September 2022.This followed the asset class more than tripling in value to $1.9 billion the prior year.

Tighter lending conditions had been driving the growth of Australia’s private debt sector since the global financial crisis as smaller and mid-sized businesses found it harder to raise capital from major trading banks.

With pandemic stimulus programs by the Reserve Bank of Australia (RBA) and the federal government ending, trading banks now no longer have access to lower cost capital and guarantees for small and medium size enterprises (SMEs) loans. This will be a further factor to prompt banks to scale back on SME lending, further increasing opportunities for non-bank lenders to finance the mid-market.

Investing in private debt offers diversification benefits and protection from inflation, AIC and Preqin note. With the RBA making regular increases to the cash rate since May 2022 to counter inflation, private debt instruments should be gaining favour, they say, as they are offered on floating rates and for shorter loan terms.

Australian super funds have almost doubled their exposure to private debt in recent years with the average exposure reaching 3.9% in April 2023, up from 2% in April 2018. Much of this investment is outside Australia in global and regional funds but some substantial private credit funds have been raised locally.

Private capital firms generally favour asset-backed lending strategies such as lending to commercial real estate but corporate lending has also increased substantially from almost zero a decade ago.