JOHAN MARNEWICK: Private markets able to offer investors more investment exposure than listed bourses
The steady flow of delistings from the JSE, with the number of publicly listed companies falling below 300 in 2022, its lowest level since 1990, is increasing the importance of private markets to investors.
Private markets in this context refers to the large universe of unlisted financial assets that exist in many different forms, from senior debt through different levels of the “capital stack” to equity assets.
As an investment proposition for the retirement fund industry investors tend to be mainly institutions, for various reasons such as the time frames to assess these investments and the skills needed to evaluate opportunities.
Investment opportunities in private markets
Private equity and private debt are essential to the development of the capital-intensive infrastructure and private assets SA needs. Of the two asset classes debt represents a lower-risk entry point for investors who may be considering exposure to unlisted assets for the first time.
The types of investment opportunities available in private markets include financial infrastructure such as microlenders, who make loans to the unbanked sector; social infrastructure such as schools; and physical infrastructure such as renewable energy generation, hospitals and tollways.
Advantages of private market investments
Private markets offer a number of advantages: for investors, for those seeking to raise capital, and to the economy at large.
Most ordinary investors are likely to be invested in private markets only through their retirement funds, which are governed by the Pension Funds Act. Recent changes to Regulation 28 of the Pension Fund Act have clarified retirement funds’ ability to invest in alternative investments such as private equity, debt or hedge funds. Importantly, these changes mean pension funds can now invest in a broad spectrum of infrastructure assets.
For institutional investors such as pension funds, private markets provide exposure to stable cash flows backed by real assets whose value does not rise and fall every day with the moods of the market. Private market managers are able to back long-term, capital-intensive projects because they have raised long-term capital — their underlying investors typically agree to lock up their capital for five years or more.
Listed markets are not designed to finance capital-intensive enterprises, so they cannot give investors exposure to some of the most interesting assets and the most valuable cash flows in the economy. These could be a power plant with a 20-year power purchase agreement, a tollway with a 15-year concession, books of loans to farmers secured on their next harvest, or to African tertiary students to fund their college fees.
For issuers, it is easier to raise funds on private markets than public markets. Stock market investors expect companies that are listing for the first time to be established businesses that are seeking capital for growth. Projects and businesses that are capital-intensive from the start require an investor mindset that is foreign to listed markets.
The broader economy benefits from investments in private markets. SA’s retirement, pension and provident funds together manage more than R5-trillion of assets. This deep pool of capital is not limited only to funding the next generation of SA’s public infrastructure, but also applies the discipline, transparency, governance and accountability that private sector investors demand and the public sector sometimes struggles to deliver.
Institutional shareholders’ adoption of environmental, social & governance (ESG) considerations may drive incremental change in the behaviour of big listed companies. There are other long-term challenges for which only private markets can provide the vision and funding — the just transition to a lower carbon future, efficient transport infrastructure, financial inclusion, ubiquitous education and modern sanitation for African megacities.
Skills required for investing in private markets
Specialist skills are needed from investment managers in private markets — to originate, manage and then exit these assets.
Private asset managers have the expert resources to assess the prospects of the proposed business model and understand its legal, regulatory, political and market environment. To make consistent returns in private markets, managers need networks in the real economy and the skills to analyse the full range of risks facing a project.
In addition, the illiquidity of private market assets makes ESG mission-critical for asset managers for whom all positions are long-term. Private managers must therefore set high ESG standards for portfolio companies and then monitor performance consistently.
Once an investment has been made, the manager must become a partner in the business, monitoring performance, adding value to the board, and contributing to management’s strategic thinking. Obviously, there are sometimes failures in the portfolio and an effective manager must possess the skills and strategies to recover as much value as possible.
Private markets offer attractive risk-adjusted returns but require a greater level of effort to make money than the stock market. Investors should only select an established and reputable institutional asset manager as their partner on the journey towards the exciting new frontiers offered by private markets.
• Marnewick is head of credit alternatives at Stanlib.
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