Private equity rises to the top as poor returns knock hedge funds
• Ethos is the blue chip in the sector, where funds held R36bn in undrawn capital at end-2017
Normally at this time of year I write on the hedge fund industry based on the results of the Novare survey. It shows how much assets have grown and which are the popular strategies. Unfortunately, Novare has changed the cut-off date from June 30 to December 31. It always sends a bad signal when a company changes its year-end.
It comes at a time when hedge fund assets have been falling on poor returns. This has to be good news for the other large category of alternative assets, private equity. Private equity has taken the high ground. It helps that the Southern African Venture Capital and Private Equity Association (Savca) has had three excellent CEOs in JP Fourie, Erika van der Merwe and Tanya van Lill.
Hedge funds do not even have their own association anymore; they are covered by an ad hoc committee of the Association for Savings & Investment SA staffed by volunteers. There is an illiquidity premium for private equity that must be held for seven to 10 years — sales of holdings in the secondary market would mean punitive discounts. The internal rate of return from the industry over 10 years has been 11.6%, compared with 10.7% for the JSE.
The private equity sector has R158bn under management, probably three times what hedge funds manage after the recent withdrawals. At the end of 2017 private equity funds had R36bn in undrawn capital, known as dry powder, and arguably this can be put more effectively to work by direct investment than through mutual funds, which chase the shares of established firms on the JSE.
More than 90% of the dry powder is held by independents. These follow the traditional model that raises money, deploys it and then winds down and pays back investors.
With Brait out of the industry, Ethos is undoubtedly the blue chip in this sector. The remaining 10% is held by captives, which operate on a bank balance sheet or as part of a stateowned entity.
There are some quality operations in this space, such as RMB Corvest and RMB Ventures. SA private equity funds have done a good job of portraying themselves as the partners of management and workers. They have avoided building a slashand-burn image along the lines of the early US firms such as KKR and Blackstone, or Permira in the UK. Close to 40% of investments are follow-on investments to help their client companies grow.
Private equity professionals can be strangely insular. GPs are not family doctors, they are general partners (the investment team). And LPs are not vinyl records but limited partners, the outside investors. They are secretive about their fundraising. The US authorities clamp down on firms that try to solicit money from members of the public, but that hardly excuses their lack of candour.
Private equity is considered to play an important role in pension portfolios. But pension and endowment funds accounted for just 12% of third-party funds raised by Savca members; 44% came from public sector entities and development finance institutes and less than 3% from insurance firms.
There have been a few flagship disposals over the years, which have made good money for clients. For example, funds disposed of Venfin, the IT trust controlled by Remgro, for R8.8bn, and in 2011 Pepkor and Premier were sold to Brait for R5.2bn. The past two years have been the best for investors, once these exceptional sales are excluded, with R18.3bn given back to investors in 2016 and R17.6bn in 2017.
There are now 750 client companies in the sector, but Van Lill says almost half of these are from Business Partners (the old Small Business Development Corporation), which has an average deal size of R3m compared with an average deal size of R100m for new investments and R60m for follow-ups.
Private equity likes cash generators, hence the eagerness with which it climbed into cash cow Alexander Forbes. The most popular sectors for investment are retail and services, though capital-intensive sectors such as infrastructure and mining also feature.
Many people associate private equity with delisting shares, but buyouts make up just 21% of investments. In 2017, start-up and early-stage investments accounted for 30% of investment but they only account for 13% of the total industry, which focuses on mature businesses.
The prime early-stage investment recently was R1.4bn into LifeQ, which designs programmes to measure health and fitness using wearables such as watches. The investment was by the 4Di Exponential Tech Fund.
The next largest investments were by the more mainstream player Capitalworks into Petmin (R1.4bn) and Sovereign Food Investments (R997m). Next is R847m into Little Green Beverages. Usually real estate is treated as a separate asset class from private equity, and you would not see Ethos or Capitalworks buying Benmore Centre or Balfour Mall. But more speculative greenfield projects in the rest of Africa are well suited to patient private equity investors.
Novare has made three investments through its two Africa property funds: R612m in the Lekki Mall in Lagos, R421m in the Matola Mall in Maputo, and R310m in the Woodside Mall in Zambia. It is an unfortunate reflection on private equity that the largest portion of exits, worth R6.9bn, came from sales to other private equity firms.
Consumer products group Libstar is one of the few recent examples of a transition from private equity to the JSE. It must be frustrating for the underlying management too, since they often feel they have earned their freedom after five to seven years. Unlike traditional equity investors, private equity managers interfere with all aspects of a business — literally in the case of Kevro Holdings, which Ethos sold for R1.68bn to a consortium of RMB Corvest, RMB Ventures and the Ethos MidMarket Fund run by the highprofile founder of Identity Partners, Sonja Sebotsa.
The largest deal of the year was the R5.35bn sale of Tsebo Group, the facilities management group that incorporates Fedics, to Wendel Group.
SA PRIVATE EQUITY FUNDS HAVE AVOIDED BUILDING A SLASHAND-BURN IMAGE ALONG THE LINES OF THE EARLY US FIRMS