Tuesday 23 October 2018

Private markets may be alternative for stock exchange investors

Investor

Although private markets offer a compelling opportunity, they are not suitable for all trustees and investors.
Although private markets offer a compelling opportunity, they are not suitable for all trustees and investors.

Paul Kenny

Stock market gains since the depths of the global financial crisis in 2009 have been remarkable. While any number of positive economic and corporate factors suggest further gains should be expected from stock markets, two long-held principles of investing need to be remembered.

First, strong past performance of stocks can provide a headwind for future gains. Second, stock market corrections are only really obvious in hindsight.

Bearing in mind these principles, pension scheme trustees, and investors in general, should consider diversifying some of their investments away from traditional stock markets and looking at alternative investments, including private markets. Stock markets are generally known as public markets, as the various stocks are mostly traded through public stock exchanges. However, trillions of euro of assets don't trade this way: they change hands through private transactions. Investing in these types of assets is known as private market investing.

Most trustees and investors invest in the stock market through a pooled fund - with an appointed fund manager deciding which stocks to buy and sell on behalf of a range of clients. Private markets operate in a similar way: investors invest their assets in a fund, and the investment manager of the fund makes the actual underlying investments on behalf of the investors.

What are examples of private market assets? Property is a very well-known private market asset, but other areas investors are focusing on include private equity, where a fund has a part ownership in a range of privately owned companies; private debt, where a fund lends directly to a range of corporate borrowers on a bilateral, privately negotiated basis; and infrastructure, which involves a fund investing in assets that are essential for the fabric of modern society, including telecommunications networks, energy distribution grids, toll roads and hospitals.

There are four key reasons for investing in private markets now. First: attractive returns - expected future returns for stock markets are generally reducing, and more attractive returns are now available from some areas of private markets. Second: price stability - daily changes in investor behaviour and sentiment that drive changes in the value of traditional funds do not impact the price of private market funds. This means the value of private market funds does not go up and down on a daily basis.

Third: diversification - private markets give investors access to a different universe of assets and companies with unique characteristics. In this way, they should help diversify overall portfolio risks. Fourth: illiquidity premium - it is widely accepted there is an illiquidity premium available to investors who are willing to lock up their capital for an extended period of time.

Although private markets offer a compelling opportunity, they are not suitable for all trustees and investors. Fees tend to be higher than those in traditional markets, and these investments generally lock down capital for several years, which some investors may not be comfortable with. In addition, trustees and investors may be put off by a lack of familiarity.

These are all valid issues. At the same time, we recommend investors fully consider all investment options available, and at this time this should include private markets. An open mind, robust due diligence and a structured approach are the key ingredients for successful private market investing.

  • Paul Kenny is head of investments at Mercer (mercer.ie)

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