Paul O'Connor:

Welcome to another instalment of the Netwealth Portfolio Construction Podcast series. I'm Paul O'Connor, and the role at Netwealth is as head of investments, that includes responsibility for the funds available on our investment menus and the products we issue as a responsible entity being the GSS funds and managed accounts. On today's podcast, we have Craig MacDonald, who is the managing director of HarbourVest Partners Ireland, and based in Dublin. Craig will discuss how HarbourVest are viewing the world of private equity and what the future of this investment arena could look like going forward. Good afternoon or good morning, Craig, and thanks for joining us on today's podcast.

Craig MacDonald:

Thanks, Paul. I appreciate the welcome and delighted to be here today.

Paul O'Connor:

HarbourVest is an independent, global private markets firm with over 40 years of experience and more than $127 billion in assets under management as at the end of March 2024. Their platform provides clients access to global primary funds, secondary transactions, direct co-investments, real assets and infrastructure and private credit. Over the years, HarbourVest have continually identified opportunities to provide early access to the evolving private equity landscape, including secondary investing since 1986 and European and Asian markets since 1984. The firm is privately held by its 32 partners, with no single partner owning more than 7.5% and has 14 regional offices around the globe and more than 230 investment professionals.

Craig joined HarbourVest in 2005 in Boston, transferring to London in 2009, and then Dublin in 2019 to serve as head of office. He focuses on originating, evaluating and executing direct co-investments in growth, equity and buyout transactions primarily in Europe and has worked on investments including call credit, finance check, Flexera software, Nordax, PhotoBox, and Xpressdocs. Craig joined the firm from Morgan Stanley in New York where he was an analyst focusing on consumer finance. Craig's prior experience also includes investment banking analyst positions with Citigroup Global Markets in New York and London. Craig received a BA in Political Science and Information Systems with honours and distinction from the University of North Carolina, Chapel Hill in 2001, where he was a Morehead scholar.

The Ironbark HarbourVest Diversified Private Equity Fund is currently being added to the Netwealth Super and IDPS investment menus and will complement the six Ironbark funds currently on the menus covering Australian small caps, international equities and alternative investments managed by APUS, GCM, Renaissance, Robeco and Brown Advisory. The Diversified Private Equity Fund is invested in the evergreen solution launched by HarbourVest. Australian investor interest and allocations to private assets have grown tremendously over the last five years, led primarily by private credit strategies, but we're also seeing an increase in the number of private equity strategies available to Australian wealth management investors.

These private equity strategies differ significantly to the funds that were popular in the early 2000s and I believe are far better structured. The older style private equity funds were typically concentrated with between maybe 5 and 10 investments, were illiquid and locked up investors capital for between 5 and 10 years. Today's funds, including the evergreen solution launched by HarbourVest are open-ended and far more diversified compared to the old funds and include liquidity, albeit this is typically capped at between maybe 5 and 10% of NAV. Open-ended PE funds are better suited to the wealth managed market due to being far more diversified, obviously being open-ended and by offering some liquidity. Over the last decade, we've also seen a reduction in the number of IPOs on listed equity markets, and hence considering an allocation to private equity makes sense to complement listed equity exposures of investors' diversified portfolios. The caveat for investors though is to really understand the less liquid nature of private equity and to ensure their cash flow needs can be funded by more liquid allocations in a diversified portfolio.

Given the significant increase in private equity offerings, I'll be interested in Craig's views if increased competition is making it any harder to source deals. In addition, private equity is usually financed by a mix of debt and equity, so again, I'll be interested if the recent spike in bond yields has impacted on returns and private equity funding. So maybe for starters, Craig, can you provide a few comments for the listeners about who is HarbourVest and what your Ireland-based role entails?

Craig MacDonald:

Delighted to, Paul. HarbourVest is one of the leading private markets firms in the world. We've been around for 42 years. We've got a model that focuses on surrounding the GP, so these are the private equity managers with I think the capital and support that they need in order to go about their business, and so part of that could involve providing them credit for transactions. A large part of our business, and frankly where we got started, is providing them capital for their funds and then we've surrounded that with adjacencies such as secondaries, which allows, I think them to gain liquidity for either their portfolio companies or their fund interests, and we manage that alongside other LPs. And then we've got what's called co-investment where we invest alongside them in deals. There are other facets to what HarbourVest does on the infra side and in that infra business we, I think do something similar, but on an infrastructure side as opposed to private equity. So that's the summary of the HarbourVest business maybe in a more simplistic form.

In terms of my role at the firm and what I do at Ireland, you've outlined my biography. I've spent the vast majority of my time in the direct or co-investment team as we call it. I think in addition to that, as I moved to Ireland, have picked up additional roles and responsibility. So I've got portfolio management responsibility for some of our evergreen funds. And then in addition, my role in Ireland involves what we call being the head of the EPA from which is our internal EU-based fund management company, which manages the capital for our EU-based investment products.

Paul O'Connor:

Moving to the questions we have for today. The role of private assets in a diversified portfolio is growing and becoming more used and accepted by investors. Why do you think this is occurring, Craig? And I guess, is the same experience being held in Europe and the U.S.?

Craig MacDonald:

Yeah. So I think on the first part of the question, why is it growing? I think that's a very simple answer and I'll try and base it in a couple of examples. Number one, on a historical basis, private equity has significantly outperformed public markets. That's something that any presentation I give to an audience, whether it's in person or on a podcast like this, I like to emphasise. And so we think that over the last 10 years, your private equity buyout, and that's not all private equity, but it's the majority of what private equity does has generated a 15.5% internal rate of return compared to 12.6 for the S&P 500. And that figure has been fairly consistent throughout my career and we've got certainly lots of evidence to point to that.

That's the statistic. I think that's most people's lived experience as well, but if you want to sort of say, "Well, let's get behind that, what's really driving that?" I think what's driving that is if you look at the private equity opportunity set, it's far bigger from a company count perspective than public markets. And so if I focus on the U.S. or an instant, there's 87,000 private companies in the U.S. with revenue of 20 million or more. That is the addressable universe for private equity. When I first got started in private equity way back in 2005, there was a point in time where private equity could take businesses only so far, and then they would have to turn to the public markets in order to fund future development. Now, given the growth in private equity, the growth in scale of private equity and the growth in the types of capital private equity can provide, we can now in private equity support most businesses at any stage of their development.

Now, I mentioned that 87,000 number in the U.S. Just for context, the European equivalent number is 261,000. And if you turn and we go back and we look at the public number equivalent, the way I like to think about it is there's an index out there in the U.S. called the Wilshire 5000. It's meant to be 5,000 companies. The way to think about that is it's effectively the total number of public companies in the U.S. that are effectively tradable. And the actual number in the Wilshire 5000 now is 3,370, and that number has been falling quarter on quarter for many, many years now.

And so if you look at the public markets, what you've got there is I think a smaller opportunity set. If you look at private markets, you've really got a large opportunity set and importantly, you've got companies of all sorts of, I would say, shapes, sizes and structures, and I think also you've got those companies that are driving new ideas. The best companies of 20 or 30 years from now, will be probably more than likely quite small businesses either today or businesses that are only going to be launched in the next 5 or 10 years. And if you want access to them, private equity is the place to do it.

Maybe just on your last point there and then I'll come back to you. You asked a little bit about what's happening in the U.S., what's happening in the Europe. I would say in the U.S., private market has continued to grow as an allocation of most institutional investors' portfolios. I think what's really exciting is that's grown and it's now not only institutional investors but high net worth and actually ever-increasing amounts of product and opportunities for those that I would describe are maybe in the mass affluent area, right? The ability for everybody to access private equity is growing and that's a good thing. In Europe, I think we're going on a similar path. What I would probably say is that the level of exposure within institutions there and within high net worth and individuals is lower to private equity, but I'd reasonably expect that to grow over time as well.

Paul O'Connor:

It appears that certainly investors are being rewarded with the return private equities providing them in portfolios, and they're really giving them a nice illiquidity premium over the listed markets. But I guess, I've also seen private equity as simply an extension of a listed equity market exposure in a portfolio. And it's always chuckled me, the way that people refer to it as an alternative investment and comes in the alternative bucket. Yeah, I just see it as an extension of the listed equity exposure in a portfolio.

Craig MacDonald:

I maybe disagree with you there in the sense that it is equity after all. You're looking for equity-like returns and as I said, the evolution of private equity is in some ways to hold businesses longer, that when I first started and I'm sure maybe in parts of your career would've previously gone public on exchanges. Now they don't have to. They can in fact, probably stay private for the vast majority of their life. Some may never go public, depending on the industry that they're in or the desire, the focus of whoever the owning investor is. But I do think that you make an excellent point there that you're not necessarily an alternative to public equities. It really is just an extension of equities.

Paul O'Connor:

Now, maybe for the benefit of some of the listeners, can you just briefly describe what is private equity investing?

Craig MacDonald:

I'll try and make this as simple as possible. It's investing in a business that cannot be owned via the public markets. We see private equity businesses today that are obviously owned by funds and when we mention private equity, that's what we refer to. But the private equity addressable universe, that 87,000 companies that I mentioned earlier, they could be family-owned businesses, they could be businesses owned by a trust, they could even be owned by a university, for example. So from a private equity perspective, the addressable universe is anything that's from our perspective, not on the public markets. And importantly, as you well know, private equity can also look at the public markets and if it so chooses, attempt to take a company private and have it become part of that private markets' universe.

Paul O'Connor:

So Craig, can you share with us what are the different forms of private equity and i.e. venture capital growth, equity and buyouts? And I also note that your newly launched evergreen solution has a focus on secondaries in co-investing. So maybe include an explanation of what these are and also why your strategy focuses on those areas.

Craig MacDonald:

Venture, we'll start there. That's the beginning, I think in some ways there. When you're investing in the venture side, you're effectively taking on sort of startup risk if people are familiar with that term. These are brand new businesses, they're ideas and then you're looking to prove whether these ideas are able grow and flourish and the markets' growth, except comes along next or growth equity and that's where you take a venture company that's already had investment with the ideas that have founded, are proven, they're generating revenue and people understand that there's this real potential here and now you're taking that potential and you're allowing the company to grow its reach and scale.

I think after growth equity, you get to the largest part of the private equity universe, which is buyout. These are businesses which have scaled, they've greater consistency and predictability in their revenue. Their margin profile is understood and importantly, is understood through different cycles. And while growth is certainly a focus and can be achieved, all of this has to be measured by the need to deliver cash flow because in buyout when you're purchasing a company, you're using a combination of your own equity and debt in order to enhance the equity returns and so as a result, you need cash flow in order to pay the interest on that debt. So those are the sort of the building blocks of private equity.

Co-investment, and I'll start there, is simply a way of expressing investing alongside other firms in the venture growth equity or buyout opportunities. Think of it as teaming up with a like-minded friend, it's capability and cash. That's what we like to do. We like to team up with like-minded private equity firms who have experience in sectors, have experience in geographies and work with them on their best ideas and hopefully generate an attractive return.

Secondary is I think a little different, in a sense. Secondary is effectively, think of it as a secondary market. So think of it as buying a used car or buying tickets for a concert or a sporting event on a secondary market there. You're not buying it at the new price at the outset, you're buying it after the initial transaction and you've got an opportunity there to put a value on it. That value has to take into account the opportunity, but it also has to take into account the maturity of that investment. And quite often, you can actually get a discount in the secondary market. And for HarbourVest, that's an attractive profile. It's something that we've done for many, many years now dating back to the early 1980s, and we're certainly excited to incorporate it into our evergreen strategy.

Coming back to the evergreen strategy and why we have a combination of co-investment and secondaries. We worked on this for a long time. We did some modelling with what we call our quantitative investment science team or QIS for short, and they showed that a portfolio of 50:50 secondaries and co-investments produced a higher return over a 10-year period as say a 100% secondary portfolio. And they also showed that turnaround look at it on the context of a 100% co-investment that you had lower dispersion. And so it had sort of lower risk while not taking any commensurate loss in return. So combining the both was something that we thought made sense because it allowed that sort of, I would say return potential capital gain from the directs to be made with the consistency of the secondary returns. And there from a risk-adjusted perspective, you actually were better off than doing 100% of one or 100% of the other.

Paul O'Connor:

Who were the key investors in private equity?

Craig MacDonald:

Almost I would say the first half of HarbourVest has been around let's say 42 years. For the first, I would say 20, 25 years of that, it was exclusively institutions. And today, it's still the majority of what we do is institutions and those institutions can be pension funds, so think of that as superannuation schemes in Australia or local pension schemes with what we call the LGPS in the UK or government pension funds across Europe. It can also be institutions like universities, colleges, there's also corporate pension plans, and then some of the very traditionally ultra-high net worth sort of family office types, family businesses who'd have investment arms on the side. So for the vast majority of that earlier part of HarbourVest's time, it was exclusively institutions.

I think post 2000, you've seen an ever-increasing allocation from ultra-high net worth, people who don't necessarily have family offices but have access to financial services from investment management firms like a Morgan Stanley or Goldman Sachs for example. From there, there's been an ever-increasing exposure in addressing that side of the market. So however would I say the high net worth and over time now that's grown up to be a substantial part of everybody's, I would say investor base.

Paul O'Connor:

Am I correct in my understanding that the general partners are effectively putting together the PE deals? The limited partners are more passive investors providing capital to assist with the deals?

Craig MacDonald:

That's right. That's right. The general partner controls the fund. They have the investment authority. The limited partners provide the capital. They do have rights, and obviously these are all set out in the governing documents, the limited partner LPA agreements.

Paul O'Connor:

Putting your portfolio manager hat on, where's the opportunity currently in private equity markets and is deal flow still strong and is I guess, increasing competition for PE deals driving up valuations?

Craig MacDonald:

I think there's quite a lot going on in the current markets. I think you'll be very aware in Australia that interest rates are going down now. In Europe, they are about to go down, in the U.S. and that's having I think some substantial impacts to the private equity landscape. Importantly, we shouldn't forget though that where we sit today is significantly harder than where we were in 2001. And I think it's important that we go all the way back to 2001 to talk about the opportunity today. In 2001, you had record levels of private equity activity. You had record levels of private equity valuations. Since then for a lot of different reasons, you've had difficult market conditions. And as a result of that, private equity activity has gone down, and it's gone down both in terms of the volume of deals that have been consummated, new deals, it's gone down in the number of exits that have been achieved, and the knock-on effect of that is that the amount of capital that HarbourVest is distributing back to investors has gone down also. All that has meant that overall activity is well below the 2001 levels.

Where we sit in 2024, I think people entered the year reasonably optimistic. I think they felt that with interest rates having peaked, the ability for debt financing to come in slightly cheaper than the last couple of years felt as like something that might spur investment activity. That hasn't quite happened to the degree that we thought it would at the beginning of the year, but we certainly see as the summer has passed, as the outlook for 2025 has just come into view that we see there will be an acceleration in the amount of deals being done.

Now, coming to valuations, I think that's a stickier point. There has been a persistent bid-ask-spread issue so buyers are willing to pay and what sellers want to see, and we're still sort of I think suffering through that somewhat. And I think the buyers out there see the higher cost of credit versus 2001. And when they look to buy a business that was say, bought in 2018, 2019, 2020, which are certainly those that are in the window for selling right now, they're expecting maybe some of the valuation expectations to have adjusted to account for the fact that this debt is costing so much more than it did when these deals were originally done. Sellers I don't think have dropped out their price expectations. I think that they have a return in mind for many of these assets. They've got a return in mind for the funds that they're managing and they want to see best value. Over I think the course of the tail end year of 2024 and into 2025, I think we are going to have a meaning of the mind on that bid-ask spread issue and many more companies will transact.

I think whether that's a sort of an opportunity will obviously depend on the sector, the individual prospects for the company. But what I would say is that there's plenty of attractive opportunities coming through in private markets right now. There are businesses that are performing very well. I look at our portfolio and I think the majority of the companies are growing EBITDA, they are growing revenue, they are improving their margins, and I think that that's something that will continue into 2025. You just have to be, I think, very careful about where you place your actual bets in terms of sector and geography because it's not going to be all industries aren't going to, and they never have, but I think particularly over the next few years, there's going to be quite a bit of dispersion in terms of the performance of the underlying sectors in certain geographies.

Paul O'Connor:

Where do you think there's the real growth opportunities at the moment in private equity? What's exciting you and your investment team?

Craig MacDonald:

We continue to see right now there's some exciting growth technologies come through. So if you go back and you look at some of the big phases of innovation within the venture universe, you can point to the internet, let's just say in the '90s and then post the '90s into the 2000s and particularly into the mid-two 2000s, you see the advent of mobile, and then from mobile, you see the advent into cloud computing and now you go from there all the way across to AI. And I think AI does present exciting opportunities for many, many businesses. Effectively, they're going to take out some of, I would say the more repetitious tasks within businesses that currently maybe are performed by individuals but aren't suited to being performed by individuals, and so I think that's one of the exciting developments that we'll see and that will spur, I would say, attractive investment opportunities. The key is, is how can you apply that to all the sectors that are out there? Because AI will apply to technology businesses, it'll also apply to consumer businesses, it'll also apply to industrial businesses. And I think how you best incorporate that is something that we're excited to learn about, it's certainly a focus of our due diligence and I think it's certainly a driver of opportunity.

Maybe on the more mundane side, we do see I think attractive opportunities in Europe. I think in Europe, we see a better valuation story relative to the U.S. and that's something that we're excited to explore further over the near term. And then from a sector perspective, one of the things that we've seen, and this is of late, is we're certainly seeing an uptick in deal flow in the healthcare sector and in the industrial sector. Healthcare had a difficult sort of post-COVID transition. We are starting to have a better understanding of what the trajectory for any healthcare businesses looks like in the current environment after a very, I would say volatile few years, and so that's exciting.

And then on the industrial side of the equation, certainly something again that I think with a better understanding post-COVID of demand led more stability on the geopolitical sense. So the interruptions that caused by Russia-Ukraine and some of the events in the Middle East have now been sort of better understood in terms of the long-term implications and supply chains are adjusting, and so I think that brings some industrial into view. We certainly see, I would say relationships between China and the U.S. is also impacting the industrial opportunity set. And again, that's something that we're exploring right now. So those are some of the areas that we're looking at.

Importantly, one of the approaches that we take at HarbourVest is because we're focused on investing in private equity GPs, either by supporting their funds or supporting them on a secondary basis as they look to maybe take assets from one fund to another or investing in their best new ideas, like we do in the co-investment side, we can pivot to where we think the opportunity emerges. And so importantly, all those things I've outlined are things we're exploring right now that doesn't stop us taking advantage of an opportunity in 6 or 12 months' time that we see emerge.

Paul O'Connor:

Moving back to interest rates, given the use of debt and equity is used to fund PE deals. With bond yields having risen so much in recent years and credit spreads widening, do you perceive any risks for investors and future returns?

Craig MacDonald:

The way I would answer your question is we certainly have in the last year, started to see an improved cost of debt financing for new transactions and for those existing businesses that need to refinance that are performed, and actually some of the drops in interest rates that we've seen and the expectation of a drop in interest rates has filtered through to some refinancing's, which has even allowed some what we call dividend recaps to flow through, i.e. companies have been able to refinance, they've been able to maybe take on a little more debt or they don't have to have as much debt financing capacity as they previously did, and they've passed that money back to investors. So that has picked up this year and it's been a good source of liquidity for us.

As we look out and we say, "Hey, what are we really focused on?" Well, I think what we're really focused on is the existing businesses that are in the portfolio that haven't maybe done as well. There's plenty of businesses out there right now that maybe had, let's just say, put financing in place in 2019, 2020, they're now having to look very seriously at what they're going to have to do to refinance. And if they've missed their revenue growth numbers, if they've missed their, I would say EBITDA numbers, i.e, they haven't listed the EBITDA margin quite as much as they would've liked, that's going to have an impact on their future cost of financing.

And so perhaps, and I think many did hedge the cost of their debt back in 2001 and early 2022. That provided a little bit of a buffer against the increase in rates. When they come to refinance debt in 2025 or 2026, that they're going to have to take that on and I think they are going to be faced with a significant increase in their cost of capital. And that's something that we'll have to think about for those businesses that may come to us and say, "Look, we need to bridge the gap here by putting additional equity in." So those businesses exist. It's something that we're already working on, we've been working on for a while. And I think for all private equity firms, one of the big focus areas is how can we think about that opportunity set of existing businesses that are facing an increase in cost of capital?

Paul O'Connor:

If interest rates have peaked or they're close to peaking, what's going to be the impact on lower interest rates on private equity?

Craig MacDonald:

Unfortunately, I already answered that question there when I said that the lower rates was just bringing about an increase in liquidity for those performing businesses who could refinance and pass some of the proceeds of that refinancing back to investors. That is certainly something that we've seen and we continue to see. As you look out maybe earlier, I was talking about the recovery we expect in 2025. It will support deal doing in 2025, it will increase investment activity. It absolutely is a core part of the private equity landscape is that increase in cost or that decrease in cost of capital, and we're excited to see it flow through.

I think what we're also seeing is the benefit, I think of some strong performance from banks. One of the, I would say European features that we've talked about previously is that we've seen banks who I think in 2023, were reasonably cautious about their lending. I think they feel a little bit more confident in 2024. We'd expect them probably to continue that trend in 2025. And with that increased willingness to participate in the market, they're providing more competition to the private credit providers and thus more competition means I think better terms for the private equity firms as they look to consummate new deals.

Paul O'Connor:

Is there a role for AI in private markets in general and what trends are you seeing on the ground?

Craig MacDonald:

There's absolutely a role for AI. In terms of trends on the ground, I can tell you there's a lot of focus on training. At HarbourVest, everybody, and I mean people on the investment side of the business, particularly senior investment professionals who maybe aren't quite as all fair with some of the developments as our younger colleagues. There's development in our middle office teams, there's developments on our valuation teams all underway to try and make sure that we stay on top of the trends and think about what are the building blocks that we need to put in place in order to use AI effectively long term. I would say one of the recommendations that we have and we've certainly talked about is if you're going to use AI and you're going to use it successfully, you need to have the right sort of data building blocks in place. You need to have your information in the right places. That information needs to be filed appropriately and structured in such a way that it's usable. So that's a big part of, I would say the AI education.

In terms of how's it going to impact your private markets in general. I mentioned earlier that it's going to take away some of the repetitious tasks that are done by humans today that would be better done with less errors and I think with less issues around job satisfaction by AI, and there's certainly some examples of that. So there's a company out there called Klarna that we're very familiar with at HarbourVest. Think of it as a Scandinavian equivalent to Afterpay, which I'm sure many of your listeners here in Australia are familiar with that business. And in the case of that business, they announced earlier this year that AI was doing the work of 700 agents and that was taking care of two-thirds of their customer calls and had resulted in a 40 million profit improvement. They followed this up recently with another announcement in August touting that it's allowed them to reduce their workforce from 5,000 to 3,800 and potentially could allow them to reduce their workforce further. So I think that gives you a sense of the transformative effects AI can have on one business.

Klarna, given its focus and the consumer finance arena and its dependence on customer service associates is a very good example. I think this is an example which probably would be considered quite low-hanging fruit to incorporate AI, but I do think it's a tremendous example of the impact on one particular business. There's another issue there obviously in the fact that it does remove employment from the system. But as I say, I think the important point is, is that these jobs that are being replaced are not the jobs that were suited to humans. I wouldn't describe them as being particularly creative. It was effectively dealing with the same request time after time after time and sorting it out. And as I say, I think a lot of people who were maybe previously doing these jobs at a firm like Klarna will find I think more attractive opportunities elsewhere and certainly will get the benefits of AI in their own personal lives.

Paul O'Connor:

Yeah. Well, I know from personal experience, Netwealth, we've been starting to use and look at how we can integrate AI further and further into our business. And even old dinosaurs such as myself have started to use Copilot, but it's amazing how efficient and how much time you can save taking it on. So I think it's just it, just a natural long-term trend for companies. Private equity investment duration varies significantly. So what do you think will be the average duration of PE holdings in your evergreen strategy and how does HarbourVest manage the liquidity risk?

Craig MacDonald:

So in our evergreen business, we certainly focus a great deal on liquidity, given the fact that you do need to meet redemptions for investors at their time of choosing as opposed to in the closed-ended fund of private equity where you could do it at the GP or your time of choosing. So that's something that we focus on. The real characteristics of the investment is what dictates the holding period. So if you look at co-investment, which is part of our evergreen strategy, we underwrite deals there to be five years. What's been interesting is that whole period has extended in the current environment. That's no surprise, as investment activity has gone down. In times when investment activity peaked, it does actually come out to be less than five years. And so five years is a pretty good benchmark for the co-investment side and think of that as investing at the beginning of a transaction and investing at the end.

On the secondary side, actually it's a little different. So we talked about secondary deals being participating in a secondhand market, so used cars or a secondary ticket exchange, and they're actually the deals themselves, we underwrite a holding period of perhaps as long as eight years. But we look at it as really actually sort of a three-year transaction because we start receiving a substantial portion of the distributions from these investments in the first three years. And so the cash flow comes actually quite quick, well, very quickly in secondary versus co-investment where you get it all at the end. There in the secondary market, you're getting a lot of it almost in the first three years, a substantial portion, and then it trails off from there and becomes smaller and smaller as you get to the end of the eight-year life. Again, I mentioned that dependent on the market conditions and I've given you a little indication of how that evolves for co-investment. But as I say, I would say the brief synopsis of it.

And maybe it's worth me talking a little bit about liquidity risk in a bit more detail. When we looked at evergreen, we work with the Quantitative Investment Science team, our QIS team to draw out what we think we need as a liquidity management toolkit, and we just want to make sure that we had all our tools ready at the beginning of our evergreen journey to make sure that we could provide the liquidity. I think what we are focused on from a liquidity perspective is a number of things. The first is that we want to make sure that we have great partners in place. For us, we like to partner with institutions, large pension funds that have a long-term perspective on their evergreen holdings, and so they're not looking to achieve liquidity. And some of our products you could see that they will be locked up for the first five years, for example, and actually in some cases, they will take subordination on their redemptions versus other investments. So I think that's a particularly important component of evergreen and something that we like to make sure that we emphasise. I think some of the other aspects of it is making sure you've got access to a credit line. And so a credit line can provide effectively working capital to help you in your journey, make commitments as well as manage redemptions.

And the other part is having all the data and experience that we've had at HarbourVest for 40 plus years now. One of the benefits of being around that time, we've been through multiple cycles, we can, I think have a fair indication of how private markets and private equity will perform through those cycles, and so we're able to forecast, I think a good degree of certainty what level of distributions we can expect in different market environments. And that helps us again, forecast out our cash flow and make sure that we've got sufficient liquidity in place because as I say, as you see going back to the beginning, co-investment deals getting held for longer than five years, you have to make adjustments elsewhere. And that's something that we certainly take into account in our day-to-day management of evergreen funds.

Paul O'Connor:

Some of the large global behemoths in private equity, like Partners Group and Hamilton Lane have been in the Australian market for a number of years now. So what's the point of difference with HarbourVest and your evergreen solution?

Craig MacDonald:

They're all well-known firms and certainly we've had a terrific experience with their own evergreen journey and we take our hat off to them. I think from a HarbourVest perspective, one of the things that we're very focused on is what HarbourVest brings to the table as an investment firm. We've got a 40-year plus track record. We've had a lot of experience working alongside blue-chip investors and we've incorporated, as I said, those blue-chip institutional investors into our evergreen strategy to provide, I think, an anchor to help with the growth of these products in their early phases.

The other aspect of it is how we've designed the product. We've already mentioned a couple times now our QIS team. I'm sure that the head of that team's going to be delighted with the profile I'm giving them, but importantly, they do a fantastic job in giving us the data and insights as to how we're going to construct the portfolio. Ours is very much a pure-play private equity exposure. We don't include other assets such as private credit. And so that's something that I think is significant and certainly allows us to, I think, compete from a return perspective with others.

I think the other component of that is that because we incorporate the secondary component into our evergreen strategy, we've got a little bit more regular cash flow. It's not quite the same as a yield that you would get off a private credit investment or an [inaudible 00:41:11] but the cash flow there is actually consistent. It does have ebbs and flows, but it's far more consistent than you would on just a pure-play direct private equity strategy or what I would say a 100% co-investment strategy, and so that's again an important component.

And then I think the last part of it is the business of HarbourVest itself in terms of it being a multi-manager. We can invest in the best deals available to us from the best GPs out there in the market. We're not limited to one firm. We're not limited to one strategy. We're not limited to one geography. We're not beholden as a firm. And you pointed out our independence there in terms of we're owned by our partners, there's no third party out there that's influencing our decision and we've been doing this now for 40 plus years.

I think that the last point that I would make, and I think this is an important one is this is something that I think is shared by many, but we are particularly proud of our scale. We're particularly proud that we've managed to retain our scale in both the secondary and co-investment where we deployed around 10 billion last year in those two strategies, and that's in aggregate. It includes what we do in evergreen, but it also includes what we do in our co-mingled fund. And it also doesn't include what we do in our primary business and our primary business is that part of our business where we invest into other private equity funds. That's the lifeblood of what we do at HarbourVest. We focus on making sure we are generating plenty of capital to invest in that arena as well. And we've been investing billions for many, many years now. And if you look at that 127 billion that we have as an AUM, the majority of that is fairly evenly spread across the three strategies, but a significant portion of it comes from our primary business and that's important because we need to be investing in that primary business in order to help generate the secondary deal flow in order to help generate the co-investments, which in turn helps generate the opportunities for our evergreen fund.

Paul O'Connor:

Profit markets by nature are far more opaque than public markets, which clearly provides opportunity but also additional risk. How does HarbourVest address risk and how do you think about risk?

Craig MacDonald:

Importantly from a risk perspective, an evergreen strategy, we do have risk-focused individuals who work at HarbourVest and help provide oversight in that regard, so that oversight exists. What we also do is focus on how do we make it clear on the valuation side of the business that we're taking into account market movements. And so if you go back and you think of the traditional way of doing private equity valuations on the closed-ended fund side, they were done quarterly. And that information would then be published, let's just say somewhere between 60 to 90 days or in the annual period, it's 120 days after the quarter end.

Now, what we're looking to do obviously in evergreen is publish quickly. We have to provide that on a monthly basis. And in addition to incorporating what we've always done in the closed-end fund side. We've also got third-party firms that work with us in order to provide input to the valuation process, and they use all the data that we have access to, but add in their own data. And some of that actually comes in the form of adjustment factor accounting for movement in the public markets, and that I think is important. It allows us to be more equitable in redemption valuations on a month-month timeframe, and that's something that obviously in evergreen as we know, is particularly important. And I know in a country like Australia where there's plenty of focus on valuation, it's important there too.

Paul O'Connor:

Maybe in the interest of time, we'll call the podcast to the end there, Craig. But thank you very much for joining us on today's instalment of the Netwealth Portfolio Construction Podcast. It's been a fascinating discussion and I sort of feel I've only just scratched the surface with you on a number of the issues that you've mentioned there. But I guess, key take aheads for myself are the strong long-term investment returns from PE are compelling, the size of the investment universe being multiples of the listed investment universe. And I say think positively. The recent development of funds to being open-ended and offering some liquidity is really democratising PE opportunities for wealth management investors. So I look forward to having you back maybe in another year or 18 months on the podcast series and wish you all the best for the fund in Australia, Craig.

Craig MacDonald:

Thanks. Thanks, Paul and I'd be delighted to come back and look forward to speaking to you again in the future.

Paul O'Connor:

And perhaps it won't be so early in the morning for you or later in the afternoon myself here.

Craig MacDonald:

It's quite all right. Anytime. Anytime.

Paul O'Connor:

Brilliant. Well, thank you very much again, Craig, and all the best.

Craig MacDonald:

Thanks.

Paul O'Connor:

To the listeners, thanks again for joining us on the Netwealth Portfolio Construction Podcast, and I look forward to joining you on the next instalment.