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Asset managers favour private markets to underpin the impact investment trend

22 September 2020 Gareth Stokes

Local asset managers are increasingly turning to the private market to seek out asset classes with the potential to generate attractive returns for investors on both an absolute and risk-adjusted basis. The market for these asset classes is significant and some retirement funds have already generated market returns through exposure to them. Todd Micklethwaite, Head of Strategy & Impact at Sanlam Investments, observed that private market asset classes were under the spotlight because “investors were able to make a positive impact to society through private markets without sacrificing financial returns”. He was presenting to a Sanlam Investments webinar on responses to COVID-19.

The dawning of a new investment age

Financial planners are primarily concerned with constructing financial portfolios to meet their clients’ long-term return objectives; but could soon face pressure from clients in the millennial and following generations to balance investment return with social impact. The good news, according to Sanlam Investments, is that there are opportunities in the private market that achieve this balance. “There are key issues that investors must consider before investing in private markets,” said Micklethwaite, before sharing some of his views on the risk and return metrics in market segment that includes infrastructure, private debt, private equity and real estate. 

The number of opportunities in the domestic private market already outweigh those in listed markets, with the number of listed companies on the JSE All Share having halved over the past decade. A second factor driving growth in the private market segment is the structural change caused by the Global Financial Crisis (GFC). Banks’ lending activities have been severely curtailed due to the stringent solvency requirements introduced post-GFC. “The significant shortfall in the amount of capital available to fulfil the financing needs of businesses in the market presents an opportunity for investors to fill the gap,” observed Micklethwaite. But there are pitfalls. 

The barriers to entering private markets include high minimum investment levels, the cost of conducting exhaustive due diligence, regulatory constraints and illiquidity. According to Micklethwaite these barriers play into the hands of asset managers who are able to negotiate attractive purchasing prices and, by injecting enough capital, exert influence over the underlying assets over the life of the investment. “This allows us to drive the strategic direction, including the efficient allocation of capital to create additional value and improve the growth prospects of the asset,” he said. The asset manager can mitigate risk by being hands-on during each stage of the investment, starting with due diligence and continuing through each investment decision point. 

A physical asset safety net

An important consideration is that private market opportunities in the infrastructure and real estate classes are typically underpinned by physical assets. “These assets have underlying cash flows that are stable, contractual and typically linked to inflation,” he said. The illiquidity associated with infrastructure and real estate investments, often held up as a drawback, can play into investors’ hands during periods of extreme financial market volatility. This is because the physical assets are less subject to sentiment-driven price changes in stock exchanges. 

Sanlam Investments offers five-year historic returns data to illustrate how some exposure to private market asset classes could lead to better overall portfolio outcomes on a risk-adjusted basis. With the caveat that findings were purely based on historical performance, Micklethwaite concluded: “There is an investment case for considering private markets”. Balanced portfolios with a 20% allocation to private markets offered better risk-adjusted returns than regulation 28 compliant portfolios over the five years to 30 June 2020. Any forward-looking return assumption would depend on subjective expectations of a wide range of listed and private market asset class returns. 

As mentioned in the opening paragraphs, the debate is not entirely return focused. Retail investors are nowadays putting pressure on the allocators of capital to invest with the United Nations (UN) Sustainable Development Goals (SDGs) in mind. “Investors in private market have a greater capability to direct their capital to where its application can be seen to be meaningful,” said Micklethwaite. “And the broad opportunity set afforded to investors as a result of the shortage of capital makes it possible to invest at market rates and contract for an impact-making investment”. What this means is that trustees of retirement funds have scope to consider impact investing without abandoning their fiduciary responsibility to meet fund members’ return objectives. 

Beware attempts to purchase impact

The presentation concluded with a plea to asset managers to consider the true impact of their investing activities. An issue commonly encountered is the misconception that impact can be purchased through listed instruments… The capital so applied is not creating impact; but merely purchasing the impact generated by the initial investors’ capital. Sanlam Investments is answering the impact investing call by committing R2.25 billion to the three private market funds in its Legacy Impact range. These funds will generate return for investors by assisting struggling mid- to large-cap firms with their funding requirements post-pandemic, with a specific focus on job preservation and job creation. 

These funds are aimed at institutional investors; but financial advisers and financial planners can certainly look forward to a wider range of impact-focused retail funds to address their clients’ future needs. Asset managers offering such investments will likely measure and report on their impact objectives alongside financial returns. Perhaps, thanks to this change in investment focus, we will all soon be able to recite the UN’s 17 SDGs by heart. 

Writer’s thoughts:
Financial advisers and financial planner work at the front lines of investor emotion and sentiment. You have to manage their emotional responses following rapid financial market movements; and find ways to accommodate their changing views how their capital is applied. Have you noticed a shift in sentiment towards impact investing during your recent clients interaction, or do discussions about return still dominate? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].

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