THE FAR SIDE

Eq­ui­ties have had a great run, but are look­ing pretty pricey. Risks are ris­ing with un­cer­tainty sur­round­ing Greece’s fu­ture in the eu­ro­zone, the volatile Chi­nese eq­uity mar­ket and loom­ing in­ter­est rate hikes in the US. So what are some of the al­ter­na­tives

Financial Mail - Investors Monthly - - Contents -

Al­ter­na­tive in­vest­ments gain trac­tion as in­vestors look for safer havens

It was dubbed the sale of the cen­tury and the seller walked off with a neat $179,4m — less the hefty com­mis­sion no doubt charged by Christie’s New York. But given the $140m re­serve price, you can be sure the seller pock­eted a hand­some profit. Pi­casso’s The Women of Al­giers has fetched the high­est price ever for art sold at auc­tion. So af­ter ris­ing 26% to $12,1bn last year, even higher growth is ex­pected for 2015 as more pri­vate in­vestors search for homes for their wealth.

Okay, this is a dif­fer­ent breed en­tirely; we aren’t talk­ing about your high net worth South African in­vestor with a few hun­dred grand to throw around. Still, with mar­kets look­ing rather toppy even af­ter a volatile start to the month with a tech­ni­cal cor­rec­tion in the JSE as it fell 10% from April’s record high, in­vestors are look­ing for al­ter­na­tive as­set classes to di­ver­sify their in­vest­ments and de­risk their port­fo­lios.

Art is one of them. It may not in­clude a Pi­casso, but Ci­tadel’s Art In­dex tracks the grow­ing in­ter­est in South African art – and the re­turns in­vestors have ben­e­fited from over the past decade and a half.

“We have been ex­pe­ri­enc­ing a lot of in­ter­est in al­ter­na­tive as­sets,” says Ge­orge Her­man, head of South African Port­fo­lios at Ci­tadel. “A lot of clients — and this is global — are con­cerned about the dis­con­nect be­tween eco­nomic ac­tiv­ity and the level of stock mar­kets. Ba­si­cally, the mar­kets are fly­ing while the econ­omy re­mains tough and this has driven a lot of in­vestors into al­ter­na­tives.”

Gold ap­pears to have lost its safe-haven at­trac­tion, fail­ing to re­spond to re­cent tur­moil in the eu­ro­zone caused by Greece’s pre­car­i­ous debt po­si­tion or the re­cent rout in Chi­nese eq­uity mar­kets. But as­sets that have done well in­clude prop­erty, di­a­monds, art and even horses, says Her­man. That be­ing the case, you might ex­pect art to have bro­ken its cor­re­la­tion with gold, but Her­man says the link re­mains in­tact. What’s more sur­pris­ing, per­haps, is the strong cor­re­la­tion be­tween Chi­nese as­sets and art.

“We try to glean how art prices in­ter­act with other global as­sets classes,” says Her­man. “Ac­tiv­ity in the art mar­ket has hit record lev­els re­cently, but buy­ing has moved down the curve as more of the mid­dle mar­ket en­ters.”

De­spite record prices achieved for paint­ings such as The Women

of Al­giers, most art in­dices glob­ally have been quite weak. That’s partly be­cause these in­dices are not weighted ac­cord­ing to price (mar­ket cap­i­tal­i­sa­tion-weighted in­dices) and don’t give more weight to big-ticket items. Also, these eye-pop­ping sales are few and far be­tween.

So though sales of Irma

You might ex­pect art to have bro­ken its cor­re­la­tion with gold, but Her­man says the link re­mains in­tact

Stern’s art­works fetched over R20m in re­cent years, the most ex­pen­sive Irma Stern sold this year was un­der R5m. A Stern dis­cov­ered in the last few weeks dou­bling as a pin board in a Lon­don flat, Arab in Black (see cover il­lus­tra­tion), is val­ued at around £1m.

“Peo­ple are buy­ing art as a safe haven, but not the big-ticket items,” he says. “Up to 50% of all art that is sold at auc­tion is for a ticket price of less than R10 000, which shows this mar­ket is open to ev­ery­one.”

Open to ev­ery­one, but per­haps not for ev­ery­one. Her­man says he wouldn’t ad­vise peo­ple to in­vest in art for the sake of it; it also has to be a pas­sion. You may want to look fur­ther afield for those al­ter­na­tive as­sets.

Ci­tadel is not alone in see­ing al­ter­na­tive in­vest­ments gain­ing trac­tion. The speed and ex­tent of in­ter­est rate in­creases in SA could have neg­a­tive con­se­quences for prop­erty, listed eq­uity and bonds, says Mark van Wyk, port­fo­lio man­ager and head of im­pact and in­fra­struc­ture in­vest­ing at Mer­gence In­vest­ment Man­agers. This has left in­vestors look­ing for as­set classes that will per­form well in an en­vi­ron­ment with low eco­nomic growth and ris­ing in­fla­tion. This, he says, is an en­vi­ron­ment we are ei­ther al­ready in or soon will be.

“With the mar­ket look­ing over­val­ued, in­vestors have started strate­gi­cally al­lo­cat­ing more into al­ter­na­tives, in­clud­ing pri­vate eq­uity, in­fra­struc­ture eq­uity and debt and un­listed cor­po­rate debt be­cause the out­come of a mar­ket cor­rec­tion here could be quite detri­men­tal to in­sti­tu­tional in­vestors, depend­ing on their as­set al­lo­ca­tion,” he says.

How­ever, few unit trusts in­vest in these mar­kets due to the rel­a­tively illiq­uid and long-dated na­ture of the un­der­ly­ing as­sets, which are bet­ter suited to in­sti­tu­tional in­vestors with long-term li­a­bil­i­ties.

“It’s very dif­fi­cult for re­tail in­vestors to par­tic­i­pate, but there are ve­hi­cles be­com­ing avail­able, such as Ren­er­gen, which listed re­cently and will be get­ting eq­uity ex­po­sure into re­new­able energy projects,” says Van Wyk. “Some of the al­ter­na­tive in­come funds have been try­ing to fa­cil­i­tate en­try for re­tail in­vestors, but it’s still early days. Also, the eco­nom­ics of the mar­ket are some­what dif­fer­ent to the eco­nom­ics of other un­der­ly­ing re­tail fund as­sets.”

Ci­tadel says hedge funds and pri­vate eq­uity con­tinue to at­tract a lot of at­ten­tion. These aren’t for in­vestors who re­quire im­me­di­ate liq­uid­ity though, but might be suited to high net worth in­di­vid­u­als.

“Glob­ally, our hedge funds are ahead of eq­uity, bonds and cash and it’s sim­i­lar in SA,” says Her­man.

“It has been a phe­nom­e­nal pe­riod for hedge funds.”

New reg­u­la­tions for hedge funds to register as col­lec­tive in­vest­ments schemes have also driven in­ter­est. Along with the ad­di­tional in­vest­ment pen­sion funds are al­lowed to make in al­ter­na­tive in­vest­ments af­ter reg­u­la­tion 28 was amended in 2011, as­sets un­der man­age­ment in hedge funds have swelled to R63bn.

“Hedge funds are get­ting well reg­u­lated now and along with prop­erty must be the lead­ing con­tender for in­vest­ments in the al­ter­na­tive in­vest­ment space,” Her­man says.

Chris Derk­sen, head of fron­tier and emerg­ing mar­kets at Investec As­set Man­age­ment, agrees that the reg­u­la­tion 28 changes have helped drive in­ter­est in al­ter­na­tive in­vest­ments. And though there has been a re­cent uptick, he says it has been gath­er­ing pace over the past decade. He says it has also taken South African in­vestors out­side our borders.

There has been sig­nif­i­cant growth in in­ter­est from South African in­vestors for African real es­tate and in­fra­struc­ture, in ad­di­tion to pri­vate eq­uity. Real es­tate is still dom­i­nated by de­vel­op­ment strate­gies, he says.

Agri­cul­ture is also at­tract­ing at­ten­tion, with some com­pa­nies, in­clud­ing PSG sub­sidiary Zeder, ex­pand­ing their in­ter­est fur­ther across the con­ti­nent. Euro­pean funds from Switzer­land and Ger­many have also had suc­cess­ful cap­i­tal rais­ings to in­vest in forestry and agri­cul­ture in Africa.

“Al­ter­na­tive as­set ex­po­sures in Africa have grown, with in­creas­ing in­vestor in­ter­est from SA and in­ter­na­tional long-term in­vestors,” says Derk­sen. “Your in­vestor with an ap­petite for Africa has be­come more so­phis­ti­cated. Rather than sim­ply match­ing the Africa growth story with ex­pected in­vest­ment re­turns, the smart in­vestor is now look­ing more closely at as­set classes and re­gions and pay­ing at­ten­tion to the in­vest­ment risk.”

These in­vestors see Africa for what it is: a di­verse con­ti­nent with pock­ets of op­por­tu­nity for

Africa is a tough place in which to orig­i­nate at­trac­tive long-term tar­gets to in­vest cap­i­tal

those will­ing to ex­pend the time to un­der­stand them, he says.

“You have to be more dis­cern­ing as an in­vestor in Africa out­side of SA,” says Derk­sen. “If you can get that right you will def­i­nitely see an at­trac­tive risk-re­ward trade-off rel­a­tive to SA.”

How­ever, re­tail in­vestors with lim­ited knowl­edge of Africa out­side of SA are ad­vised to use fund mangers as they are in­creas­ing their ex­po­sure to, and un­der­stand­ing of, the African con­ti­nent, he says.

“Africa is a tough place in which to orig­i­nate at­trac­tive long-term tar­gets to in­vest cap­i­tal,” says Derk­sen. “You have to get on a plane, speak to lo­cal man­age­ment teams and other stake­hold­ers and un­der­stand the en­vi­ron­ment — which is dif­fer­ent for ev­ery coun­try, and some­times even within coun­tries.”

While some al­ter­na­tive as­sets can be rel­a­tively illiq­uid com­pared to listed as­sets, this is even more so in Africa out­side of SA.

“We are see­ing sus­tained in­ter­est from in­sti­tu­tional in­vestors, in­clud­ing SA pen­sion funds, in ad­di­tion to on­go­ing in­ter­est from lo­cal and in­ter­na­tional de­vel­op­ment fi­nance in­sti­tu­tions,” he says. “The lat­ter are long-term in na­ture and they set bench­marks for other in­vestors to fol­low.”

For Mer­gence, it’s not so much about where it in­vests, but rather the risk-re­turn propo­si­tion.

“Mer­gence is pretty [am­biva­lent about] where it in­vests — and on whether the in­stru­ment is eq­uity or debt,” says Van Wyk. “We are try­ing to find rel­a­tive value and each of the un­der­ly­ing sec­tors has a unique risk. It’s our job to work to iden­tify these risks early, mit­i­gate them and gen­er­ate re­turns for clients.”

Van Wyk says Mer­gence likes the rel­a­tive value of eq­uity and quasi-eq­uity op­por­tu­ni­ties in the re­new­able energy sec­tor, par­tic­u­larly the ear­lier-round projects.

“We see op­por­tu­ni­ties in other public-pri­vate part­ner­ship ar­range­ments and other long-term power pur­chase agree­ments with blue-chip coun­ter­par­ties,” he says. “In the stu­dent ac­com­mo­da­tion space we are see­ing op­por­tu­ni­ties. It’s also an op­por­tu­nity for debt and eq­uity. We are look­ing at it cau­tiously and look­ing to back the right man­age­ment teams in this area. In most of these trans­ac­tions, there is a sig­nif­i­cant amount of op­er­a­tional risk as well as po­lit­i­cal risk.”

Her­man also pre­dicts in­creased in­ter­est in the stu­dent hous­ing mar­ket. How­ever, as with many other in­fra­struc­ture in­vest­ments, re­tail in­vestors may find it dif­fi­cult to in­vest di­rectly and have to go through as­set man­agers. That said, re­cently listed Ind­lu­place of­fers some ex­po­sure to the sec­tor.

Longer-dated in­vest­ment op­por­tu­ni­ties Van Wyk sees in­clude wa­ter and other types of in­fra­struc­ture in­vest­ments which gov­ern­ment may bring to the mar­ket.

“In­fra­struc­ture in­vest­ments are also gain­ing a foothold, thanks to ef­forts by na­tional trea­sury and Asisa,” says Her­man. “The in­de­pen­dent power pro­ducer pro­cure­ment pro­gramme has also been very suc­cess­ful.”

So, how do the re­turns mea­sure up? Across the dif­fer­ent sec­tors, Van Wyk says Mer­gence would ex­pect to earn 10%-11% for se­nior debt in­stru­ments. In the eq­uity space, the in­ter­nal rate of re­turn is north of 15%, while it would earn 11%-15% if it par­tic­i­pated with mez­za­nine debt.

“I think the in­vest­ment idea over­all for our in­fra­struc­ture and de­vel­op­ment fund is to in­vest in projects with long-term off­take agree­ments in place with gov­ern­ment or blue chip cor­po­rates,” he says. “There must be mech­a­nisms in place to re­duce the pro­ject risk by way of con­trac­tual risk trans­fer. It’s the cash-flow gen­er­a­tive as­pects of these projects we want with­out tak­ing too much op­er­a­tional risk.”

In the pri­vate eq­uity space, JSE-in­vest­ment firm Brait has par­tic­i­pated in a num­ber of pri­vate eq­uity ex­its, snap­ping up gym chain Vir­gin Ac­tive and UK fash­ion re­tailer New Look. This is also a theme across the con­ti­nent, as South African and in­ter­na­tional in­vestors look for op­por­tu­ni­ties.

“The pri­vate eq­uity story is fairly well doc­u­mented,” says Derk­sen. “We have seen sig­nif­i­cant growth and the mar­ket has be­come a lot more so­phis­ti­cated, with sec­tor spe­cial­i­sa­tion, re­gional spe­cial­i­sa­tion and per­ma­nent cap­i­tal al­lo­cated to the con­ti­nent.”

Though al­ter­na­tive in­vest­ments may ap­peal to in­vestors who are con­cerned about val­u­a­tions of listed in­vest­ments, Her­man says it’s not a good strat­egy to put too much into these in­vest­ments.

“Ev­ery sin­gle al­ter­na­tive mar­ket has its own unique in­tri­ca­cies,” he says. “They are not reg­u­lated in the same fash­ion, liq­uid­ity in the OTC mar­ket is of­ten low and there are high trans­ac­tion costs, so you must know what you are in for.”

Pic­ture: REUTERS

Pi­casso’s The Women of Al­giers sold for an eye-pop­ping $179,4m this year.

Ge­orge Her­man, above … Glob­ally, our hedge funds are ahead of eq­uity, bonds and cash and it’s sim­i­lar in South Africa. Above right: Mark van Wyk… It’s the cash flow gen­er­a­tive as­pects of these projects we want.

Chris Derk­sen … Reg­u­la­tion 28 changes have helped drive in­ter­est in al­ter­na­tive in­vest­ments.

Pic­ture: REUTERS

A Christie’s Lon­don auc­tion house staff mem­ber in front of Anita en Almee by Kees van Don­gen. It was auc­tioned for just more than $6,5m last month.

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