More South African investors are including alternative assets – also known as private market assets – in their portfolios as they increasingly understand the benefits offered by these investments.
This echoes a global trend. In little more than a decade global alternative assets under management have grown from $2 trillion in 2008 to about $5.5 trillion in 2019. Assets under management are expected to exceed $8 trillion in 2023.
Alternative or private market assets refer to those not traded on a public exchange, such as private equity, private debt, real estate and infrastructure. Art, antiques and classic cars are also classified as alternative investments. In the past, alternative investments were considered too hard to access, high-risk or complex for many investors, but now they are accepted as an attractive means to diversify portfolios, often achieving better inflation beating returns than traditional listed markets.
Alternative investments cover such a broad range of investments it is impossible to classify the whole category as one particular risk. Some, such as a venture capital start-up providing seed money to fledgling businesses, are high risk. Infrastructure, on the other hand, is less volatile and lower risk with returns uncorrelated to the business cycle.
What are the benefits of alternative investments?
The main benefit of including alternative asset classes in your investment portfolio is to have sufficient diversification to reduce risk and enhance returns. They may also act as an inflation hedge, provide reliable income streams, generate high absolute returns, contribute towards sustainable investing goals and provide access to emerging markets where public markets are thin.
The pros of these inflation hedge investments are outlined below:
Diversification – the “don’t keep all your eggs in one basket” principle – requires you invest in a combination of assets with low correlations to one another. This should limit exposure to any single asset or risk, as different assets react differently to the same economic event.
Assets whose returns are similar are said to be “closely correlated”. For example, a portfolio that combines the shares of AngloGold Ashanti and Gold Fields with a gold index tracker fund will perform well when the gold price rises sharply and will lose value when the gold price falls. Shares in AngloGold and Gold Fields and the gold price are closely correlated.
Private market assets generally perform differently from equities, bonds and cash. An investment in infrastructure, such as a toll road, could yield stable, predictable, long-term cash flows for 20 years and more, with inflation-linked increases each year. As a result, an investment in a toll road concession would have little correlation to South African equities and at certain times might deliver better returns.Knowing how to identify good infrastructure investment opportunities requires the skill of an experienced fund manager.
Long-term investing requires paying attention to what may happen in the world in the next 20 to 30 years. To capture investment opportunities that may emerge over the next few decades is not as simple as investing in public assets. Most promising investments in the early stages are not yet listed and often only available through private markets.
Many of these investments are found in emerging markets in economies where stock exchanges are fairly undeveloped. Finding investable opportunities in these markets where little research exists, may require the help of a skilled manager.
Some alternative assets provide investors with the opportunity to invest in projects that have a positive social impact while also earning sustainable long-term investment returns.
The Ashburton Credit Enhancement Fund (ACEF), for example, targets a stable return of CPI+3% by investing in good quality credit opportunities, while deliverin
How can alternative investments grow my investment portfolio?
Investors should consider having a well-diversified portfolio that can deliver a steady, above-inflation return throughout market cycles. This might include public market allocations to fixed income, public equities and cash complemented by some exposure to inflation beating investments benefits offered by alternative assets.
The FTSE/JSE All Share Index has returned 4.73% annualised over the past five years (as at end August 2019), below the inflation rate as measured by the Consumer Price Index (CPI) which has averaged 5.1% over the past five years, and 5.2% over the past 10 years. If you were invested in the JSE over this period you would have experienced a decline in the purchasing power of your money.
As with any investment, the returns for private assets are not guaranteed, but can potentially be higher than traditional investments, outstripping CPI to provide a good inflation hedge.
As it is more difficult to disinvest from alternative assets, investors are generally compensated with higher returns, known as the liquidity premium.
Including alternative investments can help grow your investment portfolio, as outlined below:
Types of alternative investments and returns
Infrastructure investments refers to investments in vital projects such as new roads, power suppliers, airports, bridges, tunnels, ports, water, and telecommunications. Across the world there is growing need for more infrastructure, providing strong long-term demand. It is estimated that globally at least $3.5-trillion to $4-trillion of annual investment is required through 2035 to keep pace with economic growth.
In the past, infrastructure tended to be funded and managed by governments. Given constrained government finances, there has been a growing role for private funding.
In South Africa in particular, there is a huge demand for funding for infrastructure projects. After the success of the Renewable Energy Power Producer Programme (REIPP), there is strong desire to extend it to the broader infrastructure investment needs of the country such as housing, public transport, water infrastructure and schools.
Once projects are built and have an operational track record, they have an ability to generate highly predictable cash flows. This predictability is underpinned by infrastructure’s essential service nature, regulated returns, long-term contracts, limited cyclicality and lack of exposure to commodity prices.
Private equity refers to shareholder capital invested in private companies, in contrast to publicly listed companies. Private equity investments tend to involve more than just the transfer of capital. Investors get actively involved in the management of the businesses they have invested in, to build them into more sustainable, better-run businesses. This ensures they make a good return on their investments, while the business is left stronger and more resilient. Private equity investors generally invest for the long term – around 10 years.
Private equity funds have historically delivered higher returns than the conventional equity market. The 75% percentile return on South African Private Equity Funds was just shy of 15.1% for 2010-2015 vintage funds with a median return of 9.5% per annum both well ahead of inflation, according to the SAVCA South African Private Equity Performance Report.
Ashburton Investments’ Private Equity Fund’s returns are 15.9% per annum since its inception in 2014.
Private debt funds lend money to companies, as an alternative to bank lending. Investors in these funds can access better yields than government bonds are offering in a fairly low interest rate environment. Private debt comes in many forms, including mezzanine debt and private equity.
Private debt funds could lend to companies, government entities or special purpose vehicles established to finance specific projects or assets. In some cases, this allows these entities to access funding that banks no longer provide due to changing banking regulation since the 2008 global financial crisis.
Investors are becoming more familiar with these types of funds and their portfolio allocations have steadily increased in the last decade. Globally, private debt fundraising has exceeded $100 billion in each of the last XX years. In 2009 only $24 billion was raised.
As an example, Ashburton Investments’ High Yield Credit Co-Investment Fund, which allows investors to invest in loans to borrowers who have already been vetted and credit checked by Ashburton Investments, has returned 11.4% over four years. These funds typically provide quality income streams.
Ashburton Investments’ Impact Funds invest in commercially-viable, unlisted credit that demonstrates a positive social and environmental impact without sacrificing return. Fund I was the first of its kind in South Africa and has returned 10.6% over five years. Fund II was launched in 2018 and has returned 10.8% in the last 12 months.
Alternative investments offer distinct advantages to an investor such as potentially higher returns and greater portfolio diversification, but they do not guarantee them. Investors should understand the benefits and unique risks of each alternative asset type.
Rudigor Kleyn is MD: corporate and institutional at Ashburton Investments.