Private equity – a role for KiwiSaver? (Part 2)

Last month we looked at the private equity market in New Zealand and opportunities to invest.  We saw that private equity is typically only available to sophisticated investors – and yet its long time horizon and potentially high returns could be well suited to KiwiSaver.  Do you want a piece of this growth asset in your KiwiSaver?

Can private equity sit in KiwiSaver?

The answer is yes and no.  KiwiSaver can have a long time horizon of 10, 20 or more years – which is perfect for private equity.  But there are several stumbling blocks to think through:

•  Asset liquidity:  Investors are entitled to access their KiwiSaver at 65 years and to transfer to another provider at short notice.  That is very tricky if assets in the fund are illiquid and have no traded market.
• Private Equity asset valuations:  There is no market pricing for an up to date and accurate asset valuation.  If an exit takes several years are assets held at cost until that point and then a large gain recognised? If so, an investor just joining the fund would share in the gains equally with an investor who has been in the fund since inception – is that equitable?  Implied valuation methods (such as based on similar transactions) have limitations.
• Private Equity investments can fail:  Their value can go to zero.  That is tough for a KiwiSaver investor – but such possible failure is also a risk for listed (non-private equity) investments.  The risk of a single company failure is “fixed” by diversification across a number of private equity investments and private equity in turn being only a small part of the investor’s overall portfolio.  
• Private Equity fees are high:  Typically a 2% base fee plus 20% performance fee is charged in a private equity fund.  The reality is actually worse as the 2% base manager fee is calculated off committed (not paid up) capital.  Private equity funds call capital as required – this means paid up capital starts low (say 10 cents per dollar) and is called in instalments (say 30 cents a year for the next 3 years).  At the point you have paid the first 2 calls (10 cents and 30 cents) the fund expense ratio is running at 5% p.a. (i.e.  $2 of management fee is charged against $40 of paid up capital).  Private equity fee structures do not sit well with the drive for low KiwiSaver fees. 
• Private Equity investors are active:  Private equity managers are very engaged in a business to add value (rather than being passive shareholders).  If a KiwiSaver manager looks to buy private equity assets directly will they have the management resource and skills to achieve this?  Can they overcome this by co-investing