Nothing ventured, not enough gained

Benjamin Chong

By

04/01/2017

OPINION | There is plenty of data to show superannuation funds could boost their returns by investing in venture capital. So why don’t they?

Australia’s $2.1 trillion super system is one of the fastest-growing pools of retirement funds in the world. Yet it is worryingly underweight in venture capital, which should be recognised as a critical asset class.

A lack of exposure to the high-growth venture capital sector is only going to become more problematic as the super sector balloons.

Thanks to capital growth and an increasing rate of new contributions, Australia’s compulsory retirement savings pool is tipped to hit $9.5 trillion by 2035. This sounds healthy, and we do have one of the most progressive systems in the world, but sadly this does not necessarily mean Australian retirees will have the means to live happily ever after.

It’s not hard to imagine a future when successive federal budget deficits lead to a continued tightening of both the Age Pension and healthcare benefits, placing added financial burden on retirees.  Add to the mix a shrinking working population, the current low inflationary environment, and global political instability. Neither the government nor super funds would be able to provide retirees with the means to live comfortably.

The only possible solution is to increase our $2.1 trillion retirement pot to an acceptable level and this can happen only if super funds reconsider their portfolios to improve overall returns.

Dangerous bias towards ASX

Local super funds are still notably overweight in Australian equities, while venture capital is all but absent from the majority of portfolios.

Over the past 10 years, Australian superannuation funds hit a peak exposure to private equity and venture capital of 0.96 per cent in 2009, falling to 0.43 per cent in 2015. Yet in the same period, exposure to Australian equities remained steady at about 41 per cent.

This is despite venture capital outperforming traditional debt and equity markets over both the long and short term.

Venture capital returns are uncorrelated to such markets, meaning they can help super funds boost the risk-adjusted performance of their diversified portfolios.

Recent research by the Australian Private Equity and Venture Capital Association (AVCAL) found that Australian private equity and venture capital funds returned 10 per cent over the last 10 years.

Compared with the S&P/ASX 300 Index, the Australian PE & VC Index has, on average, outperformed by 5 per cent over all time horizons measured.

This is compelling for long-term investors such as super funds, especially at a time when yields in other asset classes remain low.

Research from Rice Warner backs this up, showing that, within a diversified portfolio, an allocation to venture capital enhances the long-term retirement incomes of superannuation members.

Also, Cambridge Associates has produced a study showing that investors with an asset allocation exceeding 15 per cent to private investments, including venture capital, performed better than others with smaller allocations.

Learn from the Future Fund

Some have blamed super funds’ focus on fees and their need for larger minimum investment sizes for their reluctance to back the venture capital sector; however, US pension funds and international institutional investors have not shown similar reluctance, despite similar pressures.

The Organisation for Economic Cooperation and Development (OECD) states that many overseas funds are increasing their allocations to alternative assets such as private equity and venture capital.

It seems Australian super funds are retreating from the higher relative returns their international counterparts are enjoying.

What’s clear is funds that embrace venture capital seem to be reaping the returns. The Future Fund, Australia’s $125 billion government pension fund, is one of the few exceptions achieving an enviable investment track record since its inception 10 years ago. Its approach has been to adopt a data-driven model, built to meet its unique structure and goals. The fund’s asset allocation combines a 10-year view with adjustments to manage prospective returns and risks. As part of its diversified portfolio, the Future Fund has an allocation of about 5 per cent to venture capital.

Future Fund executives have publicly announced that venture capital provides them with access to the innovation cycle, allowing them to gain insight and economic exposure to disruptive technologies. Through these insights, they wish to make better-informed decisions about their investments in other sectors, including listed equities, property, infrastructure and debt.

For Australia to claw its way out of retirement shortfall, we need more super funds to follow the lead of the Future Fund. These funds stand to benefit directly from the returns generated through venture capital investments and indirectly from the returns generated through other investments gained from innovation insights.

The case is compelling.

Ten years ago, Microsoft was the only technology business in the world’s top-ten largest companies by market capitalisation. Today, five of the top 10 are venture-backed technology companies.

As the Australian economy evolves from a resource-based economy into one based on technology and innovation, investment in venture capital will allow superannuation funds to gain the necessary exposure to ensure the prosperity of our retiring population.

Benjamin Chong is a partner at venture capital firm Right Click Capital, which is focused on high-growth internet and technology businesses across Australia, New Zealand and South-East Asia.



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