PORTFOLIO POINT: The big private money is being invested in tier 1 corporate debt issues, high-yielding infrastructure, technology and bio-medical securities, and prime real estate.
Volatility on the stockmarket has become a common refrain over the past 10-12 months, since the weight of the euro zone crisis became apparent last year.
The oft-mentioned 'trader’s market’ that this uncertainty has given rise to is having a range of effects on the investment environment, but one of the key features is a search for alternatives to equity market participation.
A report from the Reserve Bank last week said household holdings of equities had seen net outflows of $67 billion between 2008 and 2011. Between 2006 and 2010 the share of household financial assets directly invested in equities fell from 18% to 8%.
Where, then, is this money going? Chris Gosselin has recently been looking at how hedge funds are approaching the market volatility and Adam Carr has considered professional fund managers and professional traders. However, another group to look at is high-net worth individuals – a sector that has diverse investment needs but also unique perspectives and positions for how to grow wealth.
To provide some perspective, the extent of what this 'trader’s market’ looks like is apparent in the trading volumes of the ASX shown below, which spike sharply in times of volatility.
It is evident that trading activity significantly increased across almost all types of products in the months of August and September 2011, and May 2012 – months in which the All Ordinaries saw sharp declines. In the first week of August 2011, the All Ordinaries shed 9.9%, followed by 6.9% in the month of September 2011 and 7.5% in May 2012. Following the spike in trading volumes in the global financial crisis, ASX Ltd said “there was a significant reduction in retail activity from November 2008 onwards”, and retail investors have largely stayed away.
This is also true of sophisticated investors. Tom Murphy and Alison Thomas – co-founders of Family Office Research and Management (FORM), which provides advice and consultancy to high-wealth family offices – say there is now “an inherent mistrust of the listed market”, which saw a flow of capital away following the GFC that has never returned.
John Woods, Asia Pacific chief investment strategist for Citi Private Bank, says the demand for risk assets is there, but is currently dormant for obvious reasons.
“Over the past three or so years, equities have comprehensively under-performed in both relative and absolute terms and left the asset class effectively orphaned,” he says.
“By any measure you wish to choose, equities are cheap; but the lack of a compelling buy catalyst and a plethora of selling catalysts has left HNW investors sidelined and looking for returns elsewhere.”
The Australian Private Equity and Venture Capital Association (AVCAL) chief executive Katherine Woodthorpe says the fact that the major Australian superannuation funds are more highly exposed to equities than almost anywhere else in the world is driving people towards the relative freedom and flexibility of self-managed funds.
Some of the reasons for this are easy to identify. Compared with an average end-of-month total market capitalisation of $1.42 trillion in the first five months of 2011, there has been an average cap of $1.23 trillion to the end of May this year. That’s $200 billion of equity wiped off the listed market. From the end of December 2011 to end of May 2012 there has been no net change in the number of listed entities on the ASX (2,222), and from the end of December 2010 there has been a net increase of just six. This indicates a stalling of IPO activity, and thus somewhat a limiting of the range of companies where listed equity investment is an option.
As mentioned above, Adam Carr has discussed in some detail the increase of cash holdings in managed funds, but concludes that these gains are coming at the expense more of debt securities rather than equities.
It is interesting to note in the table above that fixed income and hybrid securities saw comparatively strong trading interest this year, with volumes strong in February and March as well as May. FORM’s Murphy says there is a much stronger interest in debt securities than cash at the moment for family offices because the yield is so much more appealing.
The question investors appear to be asking is this: is there a way to maintain moderate equity-like returns while avoiding this volatile trader’s market?
One answer that many high-net worth individuals and family offices are increasingly looking into is private investment.
“When we talk to ultra high-net worth family offices, there is appetite for instruments with a lower degree of liquidity, but instruments that are perceived to be safe,” says FORM’s Tom Murphy.
He says that these can take the form of unlisted equity, unlisted infrastructure, private equity, but the asset profile sought by investors was clear: “There’s a demand for tangibility of assets, and a demand for transparency.”
Robert Gottliebsen recently lamented the lack of true income-producing infrastructure stock with sufficiently low gearing available on the ASX. FORM’s Murphy says these criteria are exactly what family offices are showing an interest in.
“In infrastructure, we’re interested in mature infrastructure that’s already yielding and these assets do actually produce quarterly dividends.”
Murphy says there has been little available in this area until recently. “It’s got to do with the lack of bank funding. The banks have stepped back in a lot of areas '¦ so some of the demand we’re seeing is in areas of the capital market structure which have been abandoned by the banks, and there’s a perceived opportunity there.
“In the family office space a lower yield has relative appeal as compared to a higher yield, because they actually don’t want the high gearing. They don’t want an orchestrated 9-11% income return, they want a return that is real and not synthesised.”
George Boubouras, head of investment strategy and consulting at UBS Wealth Management Australia said there has been an increased interest in private companies as a satellite investment of the high-net worth set.
Boubouras said that alternative investments – which include private equity – were the second most popular growth area for the very wealthy, after high-yielding debt securities.
Crowe Horwath financial adviser Peter Cheadle says he is also seeing some movement away from listed equities, and an increase in interest in private investment.
“There’s certainly interest from the sophisticated clients. But I guess there’s two sides to the story – from a recommendation point of view we would not advertise a recommendation [to invest in private companies].”
Cheadle says the biggest reason against investment in private equity is liquidity – investors must be suited to a lower liquidity profile.
“It’s a lot harder to actually get your funds out – than, say, the stockmarket which is three days – if the deal is not going as you would like,” he says.
“I’ve had examples of this, and with [private companies] you’re in there for the long run.”
An area that has seen less activity is venture capital.
Cheadle says the type of demand and interest he is seeing is “very mixed”, but there was clusters of interest in sectors not so widely available on the listed market.
“There’s been a bit of interest in the tech space – 'finding the next Facebook’. Even a bit in the bio-med space.”
“From our end it’s a measure of the risk. Maybe it’s the next Facebook – but really, what are the chances?”
AVCAL’s Woodthorpe says overall investment in venture capital has been decreasing in Australia over the past couple of years.
She explains that as VC investments require smaller amounts, very large investors, such as superannuation funds, were not inclined to do the work required. SMSFs, on the other hand, were often too small to make VC investments on their own – leaving a gap in the investment market.
“What we really need, and haven’t got an answer to, is an aggregatable vehicle [for VC investment]”.
UBS’ Boubouras also highlights a strong and interesting trend in high-net worth individuals towards the right type of Australian corporate debt securities.
“Without a doubt the biggest growth we’ve seen, and I’ve been here four and a half years, is non-Aussie dollar, tier 1, all the way up to unsecured debt, of Australian companies,” he says.
Bourbouras says this is particularly seeing action in the euro space, because of the value benefits from the recent economic turmoil there.
“There’s quality being discounted, that’s higher up in the capital structure versus traditional equities, and it’s delivering great returns with more security. Anywhere from the high-yield, which is sub-investment grade, up to covered bonds.
“Having that institutional capacity as high-net worths, that’s the sweet spot post-GFC.”
Bourbouras particularly identifies Santos and Origin euro dollar tier 1 notes as “great opportunities” for high-net worth investors in the current financial climate.
“The premise is, non-Aussie dollar tier 1, as compared with Aussie dollar tier 1, you can pick up an extra two or three hundred basis points by going to the euro market and that’s before you swap it and get the carry – but you’ve got to have the ability to be like an institution to do it.”
Meanwhile, Citi’s Woods says he has been “stunned” by the demand for prime real estate from high-net worth investors, following the launch of a number of deals in recent months.
“Evidently significant appetite exists for real, rather than paper or scrip-type assets, and in an extended era of low interest rates the relative yields offered by these types of assets are attractive,” he says.
There are two key points to draw from a look at the investment trends of the high-net worth sector.
Firstly, while the strategies of high-net worth individuals spread in many directions, one thing they all have in common is the use of scale and effective institutional status to open up a range of investments that are both attractive and simply not available to retail investors. If there are no adequate low-geared established infrastructure assets on the listed market, a high-net worth investor can seek these specifics out elsewhere and benefit from them.
But secondly, for retail investors, this provides some insight into what 'ideal’ investments look like at the moment when some restrictions are removed. A developing interest in technology and bio-med sector companies will likely eventually lead to more investment opportunities there, either through funds or listings. Similarly, aggressive or conservative income securities portfolios demonstrate the range of returns and risk profiles that are increasingly becoming available from corporate debt offers. And an interest in prime real estate pitched at the right level is certainly revealing of the potential lower interest rates is creating.
For the high-net wealth sector, it appears to be no longer a case of 'equities for risk, income securities for safety’, but instead: 'some income securities for risk, some for safety, tangible assets where possible, and equities – only if we have to’.