Active Australian equities investors hit by private equity wave
LBO activity induces volatility in fund manager returns - making it harder to interpret manager performance, new Report shows
SYDNEY, 23 May, 2007 - Investors in active Australian equities funds may be affected by the bout of recent private equity investing, as listed buy-outs affect the prices of particular stocks, making it harder to distinguish between manager skill and luck.
A recent paper by Russell Investment Group, shows that fund managers with significant holdings in particular stocks, say Coles or Qantas, that have been the targets of LBOs (Leveraged Buy-Outs) by private equity consortiums can have a dispersion in returns by up to 1 per cent.
In a market driven by peer comparisons, this large difference in returns may not necessarily be due to any manager skill or strategy.
Hypothetical Impact of Major Private Equity Deals on Manager Performance
| Coles Group | Qantas | |||
|---|---|---|---|---|
| Date Offer was Announced | 17 Aug 06 |
21 Nov 06 |
||
| Base Date for Calculations | 30 June 06 |
30 Sept 06 |
||
| S&P/ASX 300 Weighting | 1.66% |
0.76% |
||
| Measurement Period: | 30 June 06 to 30 Sept 06 |
30 Sept 06 to 30 Dec 06 |
||
Returns over the Period: |
||||
| On Stock | 26.67% |
33.50% |
||
| On Index | 2.94% |
11.13% |
||
| Excess Return on Stock | 23.74% |
22.37% |
||
Impact on Manager Returns |
Under Weight |
Over Weight |
Under Weight |
Over Weight |
| Weighting in Stock | 0.00% |
4.66% |
0.00% |
3.76% |
| Difference from Benchmark | -1.66% |
3.00% |
-0.76% |
3.00% |
| Performance Contribution for Period | -0.39% |
0.71% |
-0.17% |
0.67% |
| Difference Over-Under Weighted | 1.11% |
0.84% |
||
Source: Russell Investment Group
According to the report author, Russell Director of Alternative Assets and Strategies, Dr Andrew Goddard, this type of activity can cloud investors' ability to accurately interpret the true skill behind the performance of their active equities fund manager.
"How does one respond to a fundamentally-based manager which did not hold Coles in August 2006 on the (correct) view that the company would fail to deliver earnings as expected? Are they doing their job? Or should their process be branded inadequate for not attributing sufficient probability to a takeover?" Dr Goddard said.
While the report says the overall impact of the recent rush of investment in private equity on the economy and on listed equity markets will be modest, there are some concerns relating to the potential impact on specific investments.
In 2006, there was $27 billion of domestic LBOs completed or recommended by company boards. This figure dwarfs the annual average of $1.5 billion for the previous five years.
Takeovers and takeover speculation tend to impact portfolios like random shots, introducing performance volatility that makes skill even harder to distinguish from luck, the report says. However while active listed investments may be affected by the recent feeding frenzy in private equity investment, it is the investors in private equity itself who will be more likely to be affected by the current investment environment.
The large fund flows into private equity are bound to impact on returns but this will vary across managers, putting even more emphasis on manager selection.
"The primary watch-point is the private equity manager's ability to source new deals on attractive terms," Dr Goddard said. "The emergence of public-to-private deals stands as testimony that the low-hanging fruit of attractive privately sourced assets are in short supply."
In addition the flow of funds into private equity has changed the dynamic of that market with more competition, and more leverage, putting pressure on deals to work.
"The potential for volatility has risen with greater leverage, and the margin for error has declined. Investors should address these developments in deciding whether to commit new funds," Dr Goddard said.
Issued by Russell Investment Management Ltd ABN 53 068 338 974, AFS Licence 247185 ("RIM"). This document provides general information only and has not been prepared having regard to your objectives, financial situation or needs. Before making an investment decision, you need to consider whether this information is appropriate to your objectives, financial situation and needs. The information has been compiled from sources considered to be reliable, but is not guaranteed. Past performance is a reliable indicator of future performance. RIM is the issuer of units in the Russell Funds. An invitation to apply for units in the Russell Funds is made by RIM in a Product Disclosure Statement ("PDS"). Any potential investor should consider the latest PDS in deciding whether to acquire, or to continue to hold, an investment in any Russell Fund. The PDS can be obtained by visiting www.russell.com.au or by phoning (02) 9229 5111.