The fundamental needs of investors have always been anchored to maximising returns while managing risk. Market cycles and opportunities may wax and wane due to economic, technological and geopolitical shifts, but the underlying objectives of investors seldom change.
Investors are always in pursuit of finding attractive return opportunities and adapting to new ways to access returns in the most efficient manner. In a similar way in which the inclusion of passive investments has reduced portfolio costs, alternative investments or private markets have many important characteristics that improve portfolio effectiveness from a return and risk perspective.
In private markets we find several important characteristics that improve portfolio efficiency from both a return and risk perspective. From a return perspective private markets provide investors with access to returns from high growth companies and industries that may not be accessible in the traditional listed markets like the JSE. Infrastructure is a case in point — opportunities in this secular mega trend reside outside the domestic listed market.
Similarly, from a risk perspective, private market assets have lower correlations to traditional stocks and bonds, as well as the benefit of valuations being a function of the economic performance of the underlying assets and not subject to the asset price volatility of traditional listed assets, where changes in market sentiment can leave listed assets in positions of material over- or undervaluation that can last for extended periods.
Globally, investor portfolios have evolved from a traditional 60/40 blend of stocks and bonds to a roughly 40/30/30 blend of stocks, bonds and alternative investments. Investors have experienced the benefits of alternative investments, which in part has led to the global alternative investments industry growing from an industry with assets under management of $4-trillion in 2010 to over $20-trillion today.
Another key factor driving the growth in private markets is that companies are staying private for longer. Many companies choose to stay private as they believe it allows them to maintain their pro-growth entrepreneurial mindset, allowing them to be nimble and adaptive to changes while remaining single mindedly focused on executing the company’s long term strategy and objectives. Also, being a listed company can be expensive and onerous.
To get a sense of the scale of the opportunities in private markets, the investable private universe is an order of magnitude larger than the listed markets. Globally there are about 10,000 public companies with revenues greater than $100m, compared to roughly 95,000 private companies that are of similar sizes in revenue. To put this into context, out of the total investable universe (105,000 public and private companies), investing in the listed market only means investors would be ignoring more than 90% of their investment opportunity set.
The larger investment opportunity set means more investment choice and, importantly, significantly increases the odds of finding quality businesses at sensible entry points, then growing them through active ownership rather than waiting for them to become listed and hoping the market later awards it a higher valuation.
The returns in private markets show up not just in the portfolio but in the real world as well. Private markets are also a better way to have a real stake in SA. It is estimated that almost 60% of the earnings from JSE listed companies are derived from offshore sources. Private markets provide investors access to opportunities that back the businesses that power SA’s daily life logistics platforms, renewable power, data networks, healthcare, housing and education. Domestic demand for these services is rising and the operational improvements we drive show up in margins and distributions. It is return with relevance.
Alternative investing in SA is not a niche any more. Just like the way investor portfolios evolved from investing in railroads in the 1800s, consumer electronics in the 1980s and the internet in the 2000s — which transformed information flow, commerce and communication — they are now shifting allocations from a 60/40 portfolio of purely active strategies to a blend of active, passive and private market alternatives.
This is where new capacity gets built, where operational improvement is unlocked and where investors are being paid for providing patient, problem-solving capital. The opportunity is large, the pipelines are visible and the results are measurable in both performance and impact.
• Lala is client director at Old Mutual Alternative Investments.
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