With Australia now emerging from its first recession in 29 years as a result of the slowing economy caused by the COVID-19 restrictions in 2020, it is timely to compare the historical performance of the Australian & New Zealand Private Equity market across all time frames, to the performance of those Private Equity funds that were established during, or otherwise invested across, previous recessionary periods.

Summary statistics provided by AVCAL & Cambridge Associates reveal that the median and upper quartile net returns from Private Equity funds formed in Australia and New Zealand, between 1997 and 2018, focused on the later expansion and buyout financing stage, in which Vantage funds invest, was 11.1% p.a. and 20.3% p.a. respectively. These robust returns demonstrate Private Equity's ability to consistently outperform public markets as the return on the S&P ASX 200 Accumulation Index over the corresponding period was only 8.4% p.a.1.

However, during periods of economic contraction, the performance of Private Equity was even more pronounced. Utilising data provided by Preqin (2020) 2, Vantage conducted an analysis of the investment returns delivered by Private Equity Funds during the recessionary periods following the "dot-com crash" in 2000 and the Global Financial Crisis (GFC) of 2008 to 2010. Australian and New Zealand Private Equity funds, focused on investing in the lower to mid-market segment, investing during and up to 2 years following these events generated median and upper quartile net returns of 19.6% p.a. and 45.0% p.a. respectively, significantly outperforming the public market comparables during these periods.

WEIGHTED AVERAGE NET IRR % PERFORMANCE OF AUSTRALIAN & NEW ZEALAND PRIVATE EQUITY FUNDS

The reason for this outperformance is due to a number of factors which include an increase in opportunities, less competition from listed and  trade purchasers and an ultimate decrease in purchase multiples. Vantage's underlying managers' report that purchase multiples have followed a similar downward trajectory to that seen following the dot-com crash and the GFC, providing an increase in the number of attractive investment opportunities. As a result, it is likely that Private Equity funds investing during and following this recessionary period of 2020 - 2023 will more likely outperform historical returns, due to lower purchase multiples combined with the low interest rate environment and ample deployable capital available to be invested.

A number of academic papers have analysed and reported on Private Equity's resilience versus non-Private Equity backed peers during past economic downturns. Research conducted by Wilson et la. (2012) 3, from a data set of 14 million financial records, found that Private Equity backed businesses in the United Kingdom during the period 1995 - 2010, experienced significantly positive growth, relative to peers that were non-Private Equity backed throughout the 2008 crisis. Further highlighting Private Equity's resilience during the GFC period, A recent Stanford Business School study, titled "Private Equity and Financial Fragility During the Crisis" by Bernstein, Lerner & Mezzanotti (2017) 4, confirmed that Private Equity backed companies are significantly more resilient and can act as an economic stabiliser during a recession. In the study, Private Equity lead companies were found to be less likely to face financial constraints during an economic downturn such as the GFC, allowing them to grow and increase market share versus their peers throughout the same period.

Arguably the current economic contraction has signified the beginning of a new cycle in financial markets and the end of a prolonged period of asset inflation and increasing acquisition multiples. As a result, there will be an increase in attractive investment opportunities for Vantage's underlying Private Equity managers to invest capital at lower than historical valuation multiples, throughout the second half of the calendar year 2020 and into 2021. This re-rating of asset prices and Private Equity's ability to consistently outperform during and following recessionary periods, will ultimately deliver Vantage Fund investors with superior risk adjusted returns over the term of each Vantage Fund.

References

1. Private Equity data source; Australia Private Equity Summary Statistics, AVCAL & Cambridge Associates 30 September 2018. Measured across 72 private equity funds formed between 1997 & 2018, net to investor returns as at 30 September 2018. S&P ASX 200 Accumulation index data from September 1997 to September 2018, source www.rba.gov.au/statistics/tables/pdf/f07.pdf.
2. Preqin - Alternative Assets Data and Intelligence - Databases, Publications and Research. (2020). Retrieved 25 June 2020, from https://pro.preqin.com/dashboard/watchList
3. Wilson, N., Wright, M., Siegel, D., & Scholes, L. (2012). Private equity portfolio company performance during the global recession. Journal Of Corporate Finance, 18(1), 193-205. doi: 10.1016/j.jcorpfin.2011.11.008
4. Bernstein, S., Lerner, J., & Mezzanotti, F. (2017). Private Equity and Financial Fragility During the Crisis. SSRN Electronic Journal. doi: 10.2139/ssrn.3004594

Past performance is not necessarily indicative of future performance.

There's nothing like a big round number to concentrate the mind. Investors, in particular, have a tendency to get excited about arbitrary price points with an abundance of zeroes. Think the 1999 best-seller 'Dow 36,000' (we're still waiting but not for long, I suspect).

Last week's big round number was 10,000 - the price in (US) dollars for a tonne of copper. It was the first time the metal, which is used in everything from kettles to electric vehicles and wind turbines, had fetched that price since the peak of the last industrial metals upswing in 2011.

When you consider that you could have bought a tonne of copper for US$4,300 a year ago, the recent rise is quite something. It is hardly surprising that talk of a commodities boom is picking up. And not just any old rally; what's getting investors excited is the prospect of a commodities supercycle.

Most industries are cyclical to an extent, but commodities are more so than most because the price of metals, crops and energy are closely tied to real day to day supply and demand. The price of a share can be sustained by hopes for future growth in earnings, but the cost of a tonne of copper reflects the balance of buyers and sellers today.

This means that commodities are always moving in mini bull and bear markets. Rising demand and constrained supply pushes prices higher and that, in turn, creates the oversupply that brings the market back into balance.

A supercycle is different. It is always driven by some kind of structural change in which demand is transformed over a period of many years, and usually all around the world at the same time. The mass production of motor cars in the early part of the last century, and then the growth of aviation, fundamentally changed the supply/demand dynamic for oil, for example.

Commodity supercycles are not that common, but when they kick in they last for years. There have probably only been four proper ones in the past 150 years. The first was triggered by American industrialisation and urbanisation, fuelled by the US's railway boom and accelerated by the First World War's demand for armaments.

The causes of the other three are well-known: the post-war recovery in Europe and Japan; the 1970s oil shock, boosted by Lyndon Johnson's Wars on Poverty and in Vietnam, and the space race; and China's rapid growth after it joined the World Trade Organisation in 2000.

So, the big question today is whether the recent price signals, from copper (which has doubled in a year), iron ore, nickel, zinc and other metals, indicate a temporary upswing as the world emerges from the Covid pandemic or the start of something more substantial. The answer to that question may well be one of the most important for investors today.

It's easy to make the case for a short-term bull market in commodities. The economic data around the world in recent weeks has surprised economists if not stock market investors who identified the possibility of a V-shaped recovery in activity a year ago. Coupled with short-term supply interruptions due to the pandemic, and longer-term constraints thanks to a decade of falling prices, it's no surprise that prices should have bolted in recent months.

What's more interesting, however, is the potential for that all-important multi-decade shift in demand. And for that you need look no further than the twin drivers of Joe Biden's transformational spending programme and the energy transition that has the potential to absorb however many trillions of dollars the world's big-spending governments want to print.

A third of Biden's so-called American Jobs Plan is earmarked for transport infrastructure and electric vehicles. China, too, has decided that electric vehicles will be the mainstream option within 15 years. Here in Europe, time has already been called on the internal combustion engine over the next decade or so. By 2040, Wood Mackenzie forecasts, there could be 300 million electric vehicles on the world's roads. In 2019 there were 5 million.

And that is just cars. Factor in green energy generation, let alone the once in a hundred years rebuilding of crumbling infrastructure on both sides of the Atlantic, and the demand for green metals like copper, nickel, aluminium and platinum is likely to soar. Glencore, the commodities trader and mining company, thinks demand for copper could double in 30 years.

Importantly, capital investment in new capacity is well below what is needed to meet that growth in demand. Of the more than 200 big copper deposits to have been found in the past three decades, only a handful have come in the last 10 years. Only 80 or so are now in production or have been closed. It takes years to develop a copper mine and in recent years shareholders have encouraged the payment of dividends over preparing for a future boom.

So, how might investors position themselves for the supercycle ahead? The simplest and cheapest way is via a commodities-focused exchange traded fund. There are plenty of different flavours but a broad-based exposure to metals and energy makes sense. To turbo-charge returns in the event of a prolonged upswing, investing directly in commodity producers is a better idea. With relatively fixed costs, miners' and oil companies' earnings will rise more quickly than the price of their underlying resources.

The other advantage of investing in commodity-related shares is that they can also deliver a high and sustainable dividend income. The combination of price gains and re-invested dividends over the duration of a typical supercycle might point you towards your own big round number.