Does Private Equity have a role in Superannuation Portfolios? Kar Mei Tang AVCAL 18 th Melbourne Money & Finance Conference 1 & 2 July 2013

Why do pension funds currently invest in PE?  Target superior LT returns  Diversification  Future Fund:- PE fulfils 2 functions in the portfolio: high alpha, and exposure to investment themes not available through liquid assets Ave. PE allocation (% of assets) of pension plans, by country/region Sources: Bain Global Private Equity Report 2013, Mercer European Asset Allocation Survey 2012, Preqin, AVCAL analysis.

Meeting the returns challenge Source: Cambridge Associates, returns as of 31 Dec C|A Australian PE Index returns are net of management fees, expenses, and carried interest. Australian PE vs ASX 300 returns (31 Dec 2012) Source: Commonwealth Superannuation Corporation

Manager selection is important too Australian PE vs super returns 1-yr 3-yr 5-yr 10-yr returns returns returns returns Sources: Cambridge Associates, Chant West, AVCAL analysis. Returns as of 31 Dec Super funds data for Growth options only. All returns are net of investment fees and tax. 1-yr 3-yr 5-yr 10-yr returns returns returns returns Australian Top 2-quartile PE vs Top 2-quartile super returns

Come for the returns, stay for the diversification Volatility of quarterly returns: PE & VC Index stdev: 4.9% S&P/ASX 300 Index stdev: 8.1% Freq. of positive returns: PE & VC Index: 71% S&P/ASX 300 Index: 58% Volatility of annual returns: PE & VC Index stdev: 14.4% S&P/ASX 300 Index stdev: 17.9% Freq. of positive returns: PE & VC Index: 75% S&P/ASX 300 Index: 67% Sources: Cambridge Associates, S&P, AVCAL analysis Australian PE vs ASX 300: Quarterly returns Australian PE vs ASX 300: Annual returns

But…  Liquidity  Fees

Liquidity  Managing liquidity risk:  APRA guidance  ASFA, FSC guidance  Stronger Super reforms  Internal controls  An allocation to illiquid assets does have a risk-adjusted return payoff  Cummings & Ellis (2011) looks at Australian DC investments in illiquid assets  Funds with moderate (below 30%) allocations to illiquid investments have higher risk- adjusted returns Illiquid asset allocations linked to higher  Source: Cummings and Ellis (2011)

Vintage YearCash InCash Out Cash Out & Remaining ValueAve. IRRAve Inv Multiple 1991 $ 87 $ $ 35 $ $ 50 $ 100 $ $ 43 $ 77 $ $ 516 $ 726 $ $ 332 $ 573 $ $ 336 $ 805 $ $ 943 $ 1,237 $ 1, $ 1,491 $ 1,875 $ 2, $ 2,654 $ 3,537 $ 4, $ 2,693 $ 3,807 $ 4, $ 755 $ 820 $ 1, $ 1,084 $ 1,578 $ 2, $ 1,198 $ 1,393 $ 2, $ 2,967 $ 2,424 $ 4, $ 8,023 $ 3,608 $ 9, $ 11,073 $ 4,431 $ 14, $ 7,900 $ 3,181 $ 11, $ 423 $ 34 $ $ 487 $ 28 $ $ 670 $ 15 $ $ 482 $ 0 $ Sources: Calpers, AVCAL analysis. All figures in USD millions as of 31 Dec 2012.

Fees  MySuper trustees have “a specific duty to deliver value for money as measured by long-term net returns, and to actively consider whether the fund has sufficient scale”  Delivering better LT net returns through  Asset allocation decisions  Cost reductions  Defined Contribution Inst. Investment Association (2013):  Asset allocation, not fees, is the key reason behind the DB/DC returns differential  Productive vs unproductive fee components?  PE investment managers generally earn their fees through higher returns  Robinson and Sensoy (2012), Cummings and Ellis (2011), Higson and Stucke (2012), Harris et al (2012), Acharya et al (2013)  Costs can be reduced through fee negotiations and economies of scale  Dyck and Pomorski (2012)  Cummings (2012)

Unintended consequences  Are policy levers moving default super funds away from optimal asset allocations?  Dollar cost driving asset allocation decisions  At some point: tradeoff between low cost and returns/diversification  Myners Review (2001)  Broadbent, Palumbo and Woodman (2006)  What are the choices available to members seeking more returns/diversification through super investment options?  Fund performance tends to converge in narrow range in LT.

Spread of premixed super fund returns Sources: Chant West, AVCAL analysis. For the Growth options of 59 superannuation funds as of 31 Dec Best performing fund: 7.6% ann. Worst performing fund: 5% ann.

Summary  Retirement savings adequacy  a looming problem  PE has historically delivered, but good manager selection and a LT focus needed  Room for more diversity in:  asset allocations  options available to members wanting access to high-performing asset classes through super  Further work:  getting members more engaged  policy levers with unintended LT consequences  look at global best practice: how mature pension PE programmes approach the asset class to deliver value

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