The private markets universe redefines return horizons for retail investors
Suvira Bodha, portfolio manager at Sanlam Investments Multi-Manager
Cape Town, 16 January 2023: Private markets offer investors opportunities for enhanced risk-adjusted returns not available in the listed space. However, legacy issues such as illiquidity, investment ‘lock-in’ periods, high minimum investment amounts and the infamous j-curve effect have historically made it difficult for most retail investors to gain exposure. Employing a multi-strategy approach to investing in private markets can address these issues to finally make it feasible for investors to seek exposure to the returns on offer from this illusive asset class.
“Our Multi-Strategy Alternatives Portfolio seeks to blend the different sub-asset classes available in the alternatives universe in a way that delivers diversified returns to investors,” says Suvira Bodha, portfolio manager and head of Alternatives at Sanlam Investments Multi-Manager.
“Asset managers use the word ‘alternatives’ to describe any investible asset that falls outside the universe of listed, traditional asset classes which include bonds, equities, and property. Alternatives can be defined as: hedge funds which are considered a listed alternative to traditional asset classes, and in the unlisted space, as private market investments.” Bodha explains.
The benefits of a multi-strategy approach compared to investing in private market funds directly must be assessed in the dual context of opportunities in the unlisted or private markets universe and the unique risks that attach to these opportunities. “We build pooled portfolios that invest in alternative assets in a deliberately staggered manner to achieve an asymmetric return profile, thus ensuring an appropriate risk-return balance,” says Bodha.
In plain English, an asymmetric return profile means as little participation as possible when markets are doing poorly and as much participation as possible when markets are doing well. “We continuously evolve our portfolio construction strategies to deliver capital protection during difficult market conditions and to grow wealth during periods of strong market conditions. Thanks to the compounding effect of investments, this asymmetric return approach to investment management delivers superior return outcomes over time,” Bodha says. “Given that volatility in the portfolio is reduced by the nature of investment in private market funds, we try to ensure that the risk-adjusted return aligns with the sub-asset class we are invested in.”
Private market assets exist on a risk spectrum in much the same way as traditional assets do, with the least risky sub-asset classes being unlisted credit, followed by infrastructure debt and equity, and then mezzanine debt, direct property, private equity and venture capital. Each of these classes have different expected return profiles that are derived from the macro environment, manager expertise and managers’ opportunity set also known as deal pipeline. Sanlam Investments Multi-Manager must carefully select the private asset managers that invest on their behalf. These managers are screened based on their track record and experience in the private market, ability to attract good investment opportunities as well as work with company management teams effectively. Funds are also selected based on their capability to create positive social impacts.
The issues of limited liquidity, long lock-in periods, high minimum investment amounts and the j-curve effect are of major concern when it comes to private market investing. Lock-in periods relate to the lengthy investment timeframes needed to generate the outsized returns that apply to private market funds such as private equity or infrastructure which may span 10 to 15 years in some cases, during which investors must remain invested thereby significantly limiting the liquidity associated with these investments. A further obstacle is the high minimum investment amounts required (usually R50 million to R100 million) which may limit the ability of an individual investor to diversify their exposure or even gain exposure to private markets at all. The ‘j-curve effect’ is a natural characteristic of investment in private markets funds. It is the term used to describe the return profile of private market investment, where returns are negative in the initial years but increase significantly over the latter years. To navigate these challenges, our multi-strategy approach aims to incorporate the characteristics of each sub-asset class, thus creating a pooled portfolio of private market funds which has been blended to manage the less attractive aspects of these funds over time, yet still allow investors to benefit from the higher returns on offer from the unlisted market.
Overall, the portfolio construction process involves appointing skilled managers in the targeted private market sub-asset classes; considering the risk adjusted returns on offer from each opportunity; and noting any exogenous risk factors that might affect said returns. The various sub-asset classes earmarked for inclusion in the portfolio are then combined to offer clients a blended and diversified source of returns through appropriate layering across the risk spectrum. By layering the portfolio in this way, we are better placed to handle any redemptions from our funds which is ultimately the key to being able to make private market investments scalable and thus investable for retail investors.
The factors discussed above are the characteristics of investing in private markets which have historically made it inaccessible to smaller retail investors. Institutional portfolios and high-net-worth individuals have benefitted from private market investments for some time, and Sanlam Investments Multi-Managers believe it is long overdue on extending this benefit to retail investors. “South Africa has tremendous potential regarding the private market opportunity set; there are countless projects that need funding, and just as much in investor assets able to provide that funding,” concludes Bodha. “Our role is to help investors to enter these opportunities while ensuring that our investment solutions are aligned with investors’ needs.”