Strategic equity investing

Ian Groenewald of Trustee Board Investments.

Strategic equity investing is an approach that takes the best of private equity and listed equity investment strategies, and makes them work for the investor.

Even though the Johannesburg Stock Exchange’s All Share Index (ALSI) has been moving sideways, i.e. growth has been stagnant, for going on three years most major asset managers are not taking advantage of the opportunities offered by small to mid-cap listed companies. One of the reasons for this is the dearth of quality research and analysis on these companies as it isn’t cost effective for large investment houses to undertake. This exacerbates the lack of demand for these shares which, in turn, creates a lack of liquidity that makes small and mid caps unviable for investors who need more flexibility to alter their portfolios along the way.

Another reason is that asset managers that invest en masse for clients saving for retirement also have to operate within several constraints. There is Regulation 28 which limits the exposure of retirement savings vehicles like RAs and pension funds to certain assets and asset classes. Then there is the investment mandate of each fund to contend with.

This causes an oversight in the industry – less popular, small to mid-cap listed companies on the exchange don’t get nearly enough attention from investors as their returns warrant, and small to mid-cap unlisted companies aren’t normally even considered as they are unlisted.

A strategic solution

Some of the best investment opportunities available in South Africa right now are not in the Top 40 listed companies – where most major institutional investors put their money.

Many highly successful investors have based their investment philosophy and approach on investing in private companies where the power of being able to take long-term decisions and invest in small to mid-cap, growing companies, based on true investment valuation criteria, has paid off handsomely over time.

Closed-ended private equity funds, created by managers who have raised cap ital from large institutional investors, have been the most common way of investing in unlisted equities. Minimum investments are normally beyond the reach of ordinary investors, making this an opportunity reserved for the very rich. Typically, the life span of these funds is ten years so liquidity is also an issue for those investors with liquidity constraints.

But things are changing. Different structures are evolving with different time horizons and even lower minimums.

In addition to the closed-ended fund model, some entrepreneurs have created investment holding companies that invest in both listed and unlisted companies. This is strategic equity investing.

These companies have no pre-defined exit strategy, and typically take a large enough stake in the companies they invest in – 35% to 45% – to gain board representation, give strategic input and be involved in any corporate action decision making.

Best of both worlds

Unlike investors who focus on the JSE’s top-end, which has a small opportunity set, strategic equity investors have a broad range of opportunities to choose from as there are literally hundreds of thousands of registered companies – both listed and unlisted – some of which represent opportunities to take advantage of.

Strategic equity investors also mainly use their own money to invest, instead of raising funds from institutions. This enables them to keep costs lower, thereby enhancing returns.

So, what is an investor in strategic equity getting?

• An investment in a company with no set time horizon for disposing of the asset. This long-term approach means that the managers are able to ride out short term market volatility, enabling them to enhance returns.
• Access to companies that are generally not available to them because they are not listed.
• Diversification through being part of a larger pool of assets. Having all your eggs is one basket is never a good investment strategy, and by partnering with a strategic equity investor, you gain access to a wider range of investments.
• A pipeline of opportunities because of the network that the strategic equity manager has built up over many years
• Experienced investment managers that have specialised in this area of investing
• A rigorous process of valuation that looks not just at the current valuation of a potential company to invest in, but also at its likely stream of future returns.
• Involvement by management in the investee companies’ direction, business plan and monitoring of key performance indicators, as agreed with the companies
• A willingness by management to assist in placing any shares that an investor may wish to sell and in some cases even an undertaking by management to purchase existing investors’ shareholding over a period.