Alternative investments offer ‘outside the box’ opportunities
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ALTERNATIVE investing is a trend that has become stronger in recent years. It refers to investing in assets that fall outside the mainstream asset classes of listed shares, bonds, listed property and cash.
You may be considering ways to incorporate alternative investments into your portfolio. However, besides the advantages, these investments have their drawbacks, which you need to be aware of.
What are alternative investments?
David Moore, head of alternative investments at Alexander Forbes Investments, says there are two broad categories:
1. Private markets. These encompass entities that aren’t publicly traded and whose value is not calculated daily, and they include private credit, private equity, venture capital investments and real assets. Real assets include infrastructure and property.
2. Hedge funds. These are funds that use derivatives to smooth market volatility in a pooled investment portfolio.
Moore says these are the largest and institutional-grade types of investments, but there’s also a “collectibles” category, which includes art, wine, and vintage cars.
Why the shift towards alternatives?
The biggest drivers of the alternative investment trend are the need for greater diversification, access to opportunities not available in the traditional investment space, and a growing desire to invest in projects that are of benefit to the economy and to society.
• Diversification. Moore says the shift has largely come on the back of traditional investments delivering below-par returns in recent years, particularly in South Africa, and you need to “invest more broadly to give you returns that are inflation linked and ultimately protect your capital and preserve wealth for the long term”.
In an article, “Embracing alternative opportunities to withstand shocks and changes to your investments”, Riccardo Fontanella, head of technical marketing at Alexander Forbes Investments, says that investors are increasingly looking to alternative investments for absorbing shocks from the mainstream markets. “We are living in a time when financial storms could become fiercer – heightened levels of uncertainty and fragile economies can bring about rapid market changes and greater, more frequent volatility than we’ve experienced over the last decade. Investors will need help,” he says.
There is a trend both here and abroad for young companies to remain private for longer – in recent years, there has been a reduction in the number of listed companies on the JSE, with new listings down substantially. Moore says possible reasons are the costs a company incurs to become a listed entity and the burden of regulatory compliance and administration. He says that whereas listed companies have a diverse and largely passive ownership, a private company is owned by a concentrated group of individuals who have a stronger incentive to make the business succeed and grow.
• Increased opportunities. “With private markets, investors have access to investments that are not available on public markets. For example, the South African public exchanges have limited exposure to companies in the technology or clean-energy space. In the rest of the African continent, private markets are larger than public markets. Therefore, to take advantage of investing in countries where there are no or limited public markets – for example, Ethiopia – one can access opportunities through private markets,” Moore says.
• Making an impact. Investing in order to make a positive impact on society, taking environmental, social and governance (ESG) factors into account, is a strong trend in mainstream investing. However, the alternative investment landscape provides unique opportunities in this regard. In an article “Impact investing: a catalyst for SA’s growth”, Zeyn Ismail, head of Investment at the Stanlib’s credit alternatives division, says: “Although investing for impact is not a new concept or investment strategy, the benefits and intended outcomes are now more critical than ever to South Africa’s current economic situation. The rise of impact investing comes in response to the more traditional one-dimensional search for the highest return. Instead, the impact investor considers the tangible impact of investments on the environment and society while seeking financial outcomes.”
Impact investing typically involves private sector companies (often small businesses) partnering with the government in social and infrastructure development. Ismail says areas that have the potential to act as change catalysts in South Africa include healthcare; education; financial services; affordable housing; and a cleaner, more stable supply of energy.
• Lack of regulation. Private equity funds are not regulated under current financial sector laws, although the Conduct of Financial Institutions Bill, released for comment in 2018, proposes to regulate private equity funds as “alternative investment funds”. The Collective Investment Schemes Control Act, which regulates unit trust funds and exchange traded funds, severely restricts private equity and derivative holdings in these instruments. Since 2015, hedge funds in South Africa fall under this act.
• Greater investment risk. Private companies are not as tightly regulated as public companies, although Moore points out that, considering the monumental failures of JSE-listed companies over the past few years, the risks may not be as wide as many may think. Young start-ups are naturally a higher investment risk than large, established companies, but they also offer potentially higher growth.
Moore makes the point that not all alternative investments are high risk. Private credit can behave much like corporate bonds, and infrastructure investments are typically low risk.
• Lack of liquidity. Alternative investments don’t have the liquidity of mainstream assets, which makes it difficult to exit an investment at short notice. Moore says: “Because it’s not as easy to buy and sell these investment types freely, they require a commitment to longer investment periods. In return for the duration of their commitment, investors are typically rewarded with the prospect of a higher return, or an illiquidity premium, on their investment.”
Listen to a podcast with Martin Hesse and David Moore here.