More recently during the Ardern-Hipkins Government, we saw a push for more private market investments in KiwiSaver funds, championed as a means to fuel domestic economic growth.
Or further afield, look to the UK’s Neil Woodford saga, where a star fund manager’s venture into illiquid investments led to the spectacular collapse of his fund - leaving thousands of investors stranded.
The liquidity trap
The fundamental problem with private equity is simple: assets are easy to buy, but can be devilishly difficult to sell.
This asymmetry becomes catastrophic when liquidity is needed. Global regulators are increasingly voicing concerns about this very issue, particularly in retirement savings schemes.
During market stress, the consequences can be severe. When investors rush for the exits, fund managers often find themselves forced to sell their most liquid assets first, leaving remaining investors holding an increasingly illiquid portfolio - a situation dreaded by regulators worldwide.
Beyond the obvious fees, private equity investments carry hidden costs:
- Valuation uncertainty
- Concentration risk in single companies
- Limited regulatory oversight
- Restricted exit options
- Wide performance dispersion between top and bottom performers
Recent announcements from several major KiwiSaver providers exemplify a concerning trend: arriving late to the private equity party.
Big-name funds are now talking about expanding into private equity, purportedly as a response to increasing interest from clients. Alas, it’s not always as simple as it might sound in the press releases.
Late-stage investing, while marketed as “more stable”, often means buying in at peak valuations when earlier investors are looking to cash out. It’s a bit like showing up when the cake has been eaten and the best drinks are gone - but still paying full admission price.
Three fundamental issues make private equity particularly problematic for KiwiSaver investors:
1. The liquidity mismatch
While KiwiSaver requires 10-day portability for account transfers, private equity investments can take years to exit. Currently, less than 2% of KiwiSaver funds are in unlisted shares, compared to 18% in Australian super funds - a gap that might actually reflect prudent risk management.
2. The fee layer cake
Private equity comes with multiple layers of fees that eat into returns. KiwiSaver members pay management fees to their provider, who pays fees to private equity funds, which might invest in other vehicles - each layer taking a bite.
When markets are rising, these fees can be masked by strong returns. It’s in declining markets that their impact becomes painfully apparent.
3. The valuation void
Unlike public markets with daily pricing, private equity valuations can lag reality by months. During the 2009-10 Australian market downturn, this lag meant some investors withdrew at inflated valuations while others were left holding assets worth substantially less.
As Commerce Minister Andrew Bayly reviews KiwiSaver settings this year, maintaining protective elements while potentially creating specific carve-outs for private investments will be crucial.
Today’s KiwiSaver landscape brings to mind Aesop’s fable of the tortoise and the hare.
While private equity investments might appear to offer an exciting sprint to higher returns, history suggests the steady approach of transparent, liquid and well-diversified portfolios often wins the long-term race.
The lessons from cases like Woodford and Aquiline Holdings should serve as stark reminders of what can go wrong when retirement savings are locked into illiquid investments. The importance of qualified financial advice in these complex investment situations cannot be overstated.
While providers rush to offer the latest private market products, investors need advisers who are legally bound to put client interests first - and aren’t incentivised to recommend particular products or strategies.
Being fashionably late to a party is one thing. Paying premium prices for the leftovers while being locked in the venue is quite another. As Aesop’s fabled tortoise proved, slow and steady progress (in this case traditional, transparent investments) often outperforms heart-pounding sprints.
Often, the most profitable decision is staying away from the latest investment craze altogether and sticking to a well-planned, long-term strategy guided by impartial advice.
