2021 Annual - (released February 2022)
SA's quarterly Private Equity & Venture Capital magazine
Trends in investor mandates
by David Moore
Private markets, specifically the infrastructure sub-category of the asset class, has benefited notably from the positive tailwinds created by the South African Investment Conference in 2018 and, more recently, the changes to Regulation 28 (which governs the allocation criteria of the pension funds in South Africa). Both have favoured the funding of domestic infrastructure development by the retirement industry.
Several local institutional fund managers – both captive and boutique – have managed to successfully raise billions of rands to deploy across infrastructure sub-sectors, such as renewable and clean energy, and information communication technologies. From an Alexander Forbes Investments perspective, we like the infrastructure sub-asset category, given its ability to generate stable, lowly correlated (to traditional asset categories) inflation-linked returns over sustained periods, where appropriately structured. Furthermore, successful infrastructure development within the aforementioned sub-sectors has the ability to deliver tangible Environmental, Social, and Governance (ESG) dividends to stakeholders – another key allocation theme that we are seeing play out locally.
ESG integration into investment processes enables the delivery of impact, coupled with more sustainable commercial returns. There has been a marked increase in client interest in mandates providing dual benefits for their capital return needs, and direct societal benefits for their stakeholders. Much work is being done by traditional asset managers to evidence ‘no harm’ or active oversight and governance interventions, however, ESG integration and the associated benefit of doing so is often more easily evidenced in the private markets domain. For example, the development of greenfield, renewable energy projects has both attractive returns and ESG attributes during its lifecycle. Such projects create jobs in remote locations, given that they are built not in urban centres, but where the energy resource is best, which is often in rural South Africa. Social infrastructure development pre- and post-construction, in the form of early childhood development programmes, clinics and related social services are notable spillover benefits from these infrastructure projects. Community ownership and an attractive, inflation-linked commercial return over the longer term help in marrying the dual objective of delivering returns whilst concurrently making an impact.
Trends in manager selection
1. Purposeful diversification
We believe that achieving optimal returns for investors requires careful risk management, through purposeful diversification. This means spreading risk effectively so that no single asset class, investment style or asset manager will ever dominate the fortunes of our portfolios.
a. Diversification within an asset class. This applies particularly to equities. For example, defensive stocks (companies that provide essential products or services such as food), tend to weather market shocks better than, for example, companies trading in luxury goods. Some equity sectors are highly cyclical: mining shares can reap handsome returns during a commodity boom, as we are experiencing currently, but will underperform at the bottom of the commodity cycle.
b. Diversification across asset classes. Multi-asset portfolios, such as high equity balanced funds, provide this sort of diversification. Historical research shows that equities and bonds, particularly, tend to be uncorrelated in their performance.
c. Diversification across investment styles. Funds in the same category may have different investment styles, based on differing investment philosophies. Value managers, for example, choose shares that offer good value for their price. Other styles include growth (fast-growing, young companies), momentum (shares that are following the upward movement of the market), and quality (‘blue-chip’ companies).
d. Diversification across geographies. Having a certain portion of your portfolio offshore means that you are investing in a range of companies and sectors that you wouldn’t have access to otherwise. You also hedge against currency volatility.
Don’t fall into the trap of thinking that just because you have many assets in your portfolio, it’s diversified. “It’s important to consider the correlation between the investments in your portfolio,” Berger and Curry say. “Even if you own many different investments, if they all trend up or down together, your portfolio isn’t appropriately diversified. For instance, high-yield bonds often have a positive correlation with stocks. Therefore, a portfolio made up entirely of high-yield bonds and stocks is not well diversified.
2. Consolidation of the asset management industry
Larger investment managers have used their scale to expand profit margins, while offering products at lower costs, resulting in small and midsized investment managers lacking scale and battling to maintain profitability. High fees and subpar returns from active funds have led to a flood of assets from active to passive managers. This has sent fees inexorably lower, led to the loss of thousands of jobs, and forced large-scale consolidation among firms. This is pushing the industry – with $74 trillion in assets, as measured by Boston Consulting Group – towards a shakeout where only the strongest will survive. The asset management industry is moving to a point where you have to be either very big or very niche to compete. The guys in the middle are going to struggle.
3. Non-investment risks – cyber security
Although asset managers may not directly interface with the public at large, they can still be a tempting target to attackers for several reasons:
A wealth of customer data is held by them
Intellectual property is a key to their success
Differentiation and data theft are real concerns used to front-run trades and make profits
In a world that increasingly embraces digital technology, it's also important to consider the security of information. A good example is a well-known global business that provides video conferencing facilities that publicly came under fire at the height of COVID-19 global lockdowns regarding security and privacy concerns.
4. Transformation in the asset management industry
Alexander Forbes Investments continues to support transformation in the asset management industry, which is key to a sustainable and competitive investment management industry in South Africa. Supporting transformation across asset classes and portfolio types is a key component of this. We also believe in the development of core skills across the industry. All managers are selected based on merit and vetted through our manager selection criteria. However, the strategic intent and implementation of our internal policies have led to an increased allocation to majority black-owned managers across all asset classes and portfolio solutions.
5. Monetisation of data analytics
One can never be sure that all information has been considered in coming to an investment decision. Artificial and augmented intelligence can dig deeper and find the ‘invisible relationships’ that exist between data sets. Artificial intelligence has no emotions and is totally indifferent to the outcome of the decision. Its task is to suggest the better option (with an unbiased view, given the stipulated parameters) and make accurate predictions. Investment managers are fast embracing the cloud, as this tool and advanced analytics enhance cost efficiencies. The cloud also brings in on-demand storage and processing capabilities, resulting in new developments such as advanced analytics to process virtually all kinds of structured and unstructured data to improve decision-making.
Moore is Head of alternative investments at Alexander Forbes Investments.