why investment managers are turning to unlisted markets

News24 Business | Laura du Preez, Smart About Money

Investment professionals are increasingly turning to unlisted markets to diversify investors’ portfolios as more businesses choose not to list on stock exchanges and listed shares grow increasingly concentrated. The options for investing in unlisted or private equity and credit markets, however, are mostly global and largely accessible only to institutional investors, but this is likely to change soon, the recent Investment Forum conferences hosted by the Collaborative Exchange in Cape Town and Johannesburg heard.

Companies not listing

As a lot of the funding for companies is no longer coming from listed markets, fund managers and discretionary fund managers (DFMs) are looking to private markets for investment opportunities and good growth, Gyongyi King, chief investment officer: retail investments and private markets at Investment Solutions, said on a panel on private markets at the conference. Investment Solutions is AlexForbes’ multi-manager and DFM.

This is particularly the case in new industries, such as businesses supporting the expansion of artificial intelligence (AI), King said.

Dino Zuccollo, head of investor solutions at Westbrooke Alternative Asset Management, said the number of listed companies on the US market, the UK market, the JSE has halved in the last 30 years. The average age of a company when it lists has doubled in the last 20 years. Westbrooke is a manager specialising in alternative investments in South Africa, the UK and the US.

Zuccollo said that at the same time listed markets have become very concentrated in fewer larger shares. The so-called Magnificent Seven technology shares now make up 35 percent of the S&P 500. This means if you are only invested in the listed markets, you are not getting a portfolio that reflects what is out there, he said.

Growth of unlisted companies

At recent presentations organised by Discovery’s DFM Cogence, Liam Davis, lead chief investment officer for wealth solutions, multi-asset strategies and solutions at BlackRock, one of the world’s largest asset managers, said nearly 90 percent of global companies generating more than US$100 million in revenue are now privately held, and many high-growth firms remain private for more than a decade before listing.

BlackRock manages US$613 billion in private equity, private credit, infrastructure, real estate and other alternatives for its investors. This represents five percent of BlackRock’s assets under management, but the business is expecting this to grow significantly and has built a large team of private market investment professionals across the world.

Private credit fills in banking gaps

Zuccollo said that regulation after the global financial crisis in 2008 resulted in banks focussing on larger longer-term loans. This opened niche markets for private providers of short-term credit serving, for example, the property market in the UK.

Jonel Matthee-Ferreira, chief executive officer of Cogence, who was also on the private equity panel at the conference, agreed that private credit is the future of finance because regulated banks can’t lend in the same way they used to and that AI companies needed large amounts of credit that they would seek from private markets.

Diversification

Another reason why investment managers are turning to private markets is to improve diversification.

Matthee-Ferreira said since 2022, returns from bonds and equities have not offset each other providing the diversification they traditionally did. Bonds typically rose when equities fell and vice versa, but high inflation and rapid interest rate hikes stopped this multi-year trend in 2022.

Including the alternative asset class, primarily private equity and private credit, in global portfolios enhances diversification and returns without increasing the investment risk, Matthee-Ferreira said.

King said for many years, South African equities gave double digit returns and there was no reason to complicate portfolios with private market investments. A multi-asset fund with 60 percent in equities and 40 percent in bonds was the place to be for many years, but structurally the market has moved on and now investors need to access these new markets, she said.

Matthee-Ferreira said over the next few years, the traditional 60-40 split between equities and bonds will become the 50-30-20, 50 percent equities, 30 percent bonds and 20 percent alternatives, mostly in private markets.

The risks

Chairing the private equity panel, Andrew Cormack, head of independent financial advisers and Global at INN8 Invest, said there is an argument that returns from private markets are higher because the investment risk is higher.

He said in private markets information isn’t well shared, there is less transparency, money needs to be invested for a long time value and there the potential for counterparty risk.

But King challenged this saying private market investments offer higher returns because they are not priced daily and are not liquid. It is not necessarily higher risk, it is a different kind of risk, she said.

Zuccollo said investors in private markets should earn a higher return because of the illiquidity, the lack of transparency and lack of regulation. In private markets it is possible to operate more freely and quickly in niche markets, which should generate higher returns, he added.

Matthee-Ferreira said multi-managers and DFMs can balance the risks by diversifying across a basket of alternatives including private equity, private credit, infrastructure and real estate.

Choose a good manager

Where to get exposure to private markets

Institutional investors, like your retirement fund, are the most common investors in private markets, and limits for accessing these markets set in Regulation 28 of the Pension Funds Act, were recently relaxed.

Individual investors have much less access because:

Unlisted assets are often illiquid – many require terms of five to seven years – and they are not priced daily.

The use of unlisted assets and those that are not priced or traded daily has restricted unit trusts and investment platforms from tapping into these investments.

It is, however, becoming easier to offer access to global private markets as Europe has introduced new structures, Cogence has proved.

Individual South Africans can invest in one of two portfolios offering a 15 percent allocation to private markets through Discovery’s endowment policy and a European investment vehicles. The underlying private market investment fund is a European Long Term Investment Funds (ELTIFs) and is managed by BlackRock, Jonel Matthee-Ferreira, chief executive officer of Cogence, said at a recent presentation to the media.

ELTIFs are regulated by the European Union and must provide liquidity – access to capital – after only two years in existence. This allows investors who need access to their capital to access it if they need to.

At the Investment Forum Westbrooke Alternative Asset Management’s Dino Zuccollo said other more liquid investment vehicles are also giving individual investors in North America and the UK access to private markets. These include evergreen funds that allow investors to enter and exit periodically as well as to make partial redemptions periodically, tender offer funds that allow investors to offer their shares back to the fund at specific times, interval funds which offer periodic repurchases of shares and exchange traded funds (ETFs) that incorporate private markets.

Individual investors can invest in private markets and hedge funds through an investment-linked living annuity depending on how these products are structured, as there are no investment restrictions for living annuities, Investment Solutions Gyongyi King explained at the Investment Forum.

Where retail investors have had access, they have earned good returns. While unit trusts are still a problem, other structures are evolving very quickly, which is quite exciting, she said.