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
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.”
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.
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.