Damian Graham, First State Super.

The wall of capital sitting on the sidelines waiting to be deployed in private assets is driving prices up to untenable values, warned two of Australia’s top investment chiefs at a recent superannuation conference.

Super funds globally are increasing their exposure to higher-yielding unlisted assets as they chase higher returns, said Sunsuper chief investment officer, Ian Patrick at the ASFA conference held in Melbourne. “This is despite the skyrocketing prices which can be seen in high levels of capital raising that exists across all unlisted asset classes, including private equity.”

“You have had a build-up of capital and relative discipline in deal-making to date. But that wall of capital just makes me nervous about how much valuations will creep up through time,” he added.

Patrick pointed to evidence of climbing valuations and increasing leverage. “The challenge is that prices are too high and that’s partly because cash rates have come down so investors are taking on too much debt for these assets which, in turn, has inflated prices.”

That worries him. “We all know the old maxim that what you pay today affects your return in the future.”

Patrick conceded the decision to buy or not to buy private assets is a tough call. “We are looking at very low interest rates, so what do you choose,” he asked. “The somewhat compressed returns for private assets or the near zero or negative returns for bonds?”

First State Super investment chief, Damian Graham, echoed these sentiments saying the superannuation fund has long been underweight unlisted assets and his team is trying to build that allocation without overpaying. “We felt that building core assets and taking on some complexity made sense with regards to avoiding the price pain issue as much as possible,” he said. “We got there in a price sensitive fashion but we traded some price risk for complexity risk.

However, he went on to say, there is no silver bullet in that process. “You’re always competing with others to find those assets.”

After participating in quarterly calls with the world’s largest asset owners, Graham told conference goers the feedback revealed that the “only thing people care about is getting more unlisted assets… It’s hard to deny there is a bubble being created… and the illiquidity premium looks wafer thin. So, we do need to be cautious.”

First State Super has invested about $1 billion in direct lending in the last 12 months as the super fund takes advantage of the higher regulatory capital requirements for local banks. As Australia’s banks move to optimise regulatory position they have stepped away from some SME and corporate lending, according to Graham.

“We’ve been working alongside some banks where they’re bringing us opportunities to invest in corporate debt because they don’t want to bring in one of their competitors to do it,” he added. “They’re want to bring in a comfortable, friendlier lender like a super fund and it feels like the opportunity will continue.”

When questioned by the moderator, Schroders’ Graham Mather, on whether the internal teams at larger funds will take publicly listed Australian companies private, the investment chiefs agreed that this was a “realistic possibility.”

Elizabeth Fry is the editor of Investment Magazine's digital platform. Fry has been a financial journalist for more than 25 years and has written for a number of publications, including CFO, The Financial Times and The Australian Financial Review.
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