Investments in domestic high-growth private companies, or what it calls NZ expansion capital strategy, has reaped better-than-expected returns for New Zealand Superannuation Fund (NZ Super).
The sovereign wealth fund has so far committed over NZ$450 million across nine funds to such investments, including an NZ$260 million ($187 million) commitment in 2016 that covers roughly the next 10 years.
An NZ expansion capital investment opportunity is defined by the fund as high growth private companies that have an enterprise value between NZ$5 million and NZ$100 million.
“Over this time we have generated an Internal Rate of Return (IRR) of 14.7 per cent net of fees or a 1.5x Multiple of Invested Capital (MOIC), which is 0.7 per cent over our expected return at the outset of the investment. The comparable Public Market Equivalent (PME) generated a return of 10.7 per cent over the same period,” said a ‘How We Invest’ white paper by NZ Super’s Nathan Tuck and Fiona Mackenzie, drawing on research by Chris Jagger.
The sovereign wealth fund started investing in NZ expansion capital opportunities in 2005 through a fund, Direct Capital Fund III, that alone has funded about 13 companies. These investments are handled by external managers as the size of the individual investments is significantly below the fund’s internal direct investment activity.
Currently, the wealth fund is invested with five NZ expansion capital managers across nine funds. However, the report also noted that the preference is for fewer, deeper investment manager relationships but the appetite for NZ expansion capital materially exceeds the capacity of one manager.
The relative size of each NZ expansion capital investment is small versus NZ Super’s overall portfolio, at approximately NZ$35 billion, making it difficult for it to cost-effectively invest directly into NZ expansion capital portfolio companies.
“We have increasingly developed in-house investment capability through our NZ Direct Investment team. However, this investment activity is focused on much larger investments, such as Datacom and Kiwibank, where we can leverage our endowments as a NZ sovereign fund with a very long term investment horizon to access attractive investment opportunities,” the white paper pointed out.
For the financial year ended June 2017, NZ Super posted a return of 20.71 per cent, also one of the best annual performances for the wealth fund, as it ended the year. It was partly backed by a sustained rally in global equity markets and the fund’s active investment strategies, it had said in October last year.
Expansion capital as an investment bet
“We believe investment returns are attractive because there is insufficient capital available to support the demand for growth equity from this cohort of companies. The slow-changing nature of the key drivers of the opportunity support our belief that NZ expansion capital will likely be attractive for institutional investors for the next several years,” the report noted.
There are approximately 5,000 companies in New Zealand that fit the fund’s definition of expansion capital i.e. enterprise value between NZ$5 million and NZ$100 million with revenue between NZ$5 million and NZ$50 million. Investment cheque sizes for such opportunities can be anywhere between NZ$5 million and NZ$50 million.
Constrained supply of capital
“The supply of available capital is constrained through a combination of low levels of private equity activity in New Zealand versus comparable markets, lack of appropriate debt products (e.g. mezzanine financing), and a listed market that is undercapitalised relative to larger developed markets,” the report said.
While New Zealand private equity managers raised more than NZ$1 billion in 2016, demand for capital to support growth still materially exceeds supply. According to estimates, there are approximately NZ$150-250 million in transactions, supplying about 20 companies, or less than 0.3 per cent of the 35,000 small and medium size enterprises in New Zealand.
“We believe the attractiveness of the expansion capital investment opportunity is likely to be reasonably persistent over time, due to the slow moving nature of these investment opportunity drivers,” the white paper noted.