A $21 trillion opportunity (and 3 ASX investments to consider)

Unless you have a lazy half a million dollars to invest, getting access to some of the most enticing opportunities in Alternatives can be difficult. Individual deal information is closely guarded, but superannuation juggernaut AustralianSuper invested $3 billion across 10 private equity deals in an 18-month period and is targeting a PE and venture allocation of up to $50 billion by 2028.

What does that mean for individual investors like you? Unless you’ve got a huge chunk of money parked in AusSuper, not a lot. But it highlights one of the key challenges of private equity specifically, and the Alternative asset class more broadly: they’re typically restricted to institutions, family offices and select ultra-net-wealth investors.

Alongside the large minimum ticket size of allocations, there’s the opacity of potential investment deals, which usually don’t appear on individual investor radars. The challenges are magnified in Australia’s nascent Alternatives sphere, which lags the more mature US and European markets.

These are common themes throughout our Alternatives In Focus series and they start at the grassroots. Our reader survey found 75% and 50% of you are tempted by Alternatives’ diversification advantages and return potential. (You can read the full survey here).

At the same time, almost three-quarters (72%) indicated a lack of information was a major roadblock. And 44% emphasised the difficulty of accessing alternative investments.

The products themselves may also present a barrier to end investors. For example, many private equity managers do a stellar job capturing a selection of the best PE funds across different geographies and sectors – but at the end of the day, you’re often still required to invest in a managed fund.

That’s changing for Australian investors, as the Australian Securities Exchange’s Rory Cunningham explains. 

“We’re starting to see more active fund managers entertain the idea of bringing strategies to market within the exchange-traded managed fund wrapper,” he says.

There are currently more than 70 Active ETFs in the local market, versus more than 300 ETFs in total. Cunningham sees plenty of room for more active managers with Alternative strategies, especially those with absolute return and long-short strategies.

He also notes that the closed-end structure of listed investment companies and listed investment trusts is more suitable for other types of Alternative assets, including private equity and private credit. We recently spoke with portfolio managers from two that are available on the ASX:

• Frederick E. Pollock, Pengana Capital Group, and
• Andrew Lockhart, Metrics Credit Partners

What is the current state of play in private equity?

Pengana’s Pollock heads up the Pengana Private Equity Trust (ASX: PE1), an almost $500 million fund that has been investing since 2019.

“Against a backdrop of rising rates, slowing growth, geopolitical conflict, and elevated levels of recession risk, private equity markets have, most recently, largely moved sideways,” says Pollock.

These market conditions mean the volume of deals has been lower and made the traditional exit route of IPO “extremely challenging.” Exits are when private equity firms realise a large portion of their investment gains, with IPOs a preferred option because they generally result in higher valuations than other exits, such as selling to another company or PE manager.

But as Pollock explains, these problems have been concentrated within the larger segment of the market.

“Mid-market transactions, however, (where PE1 participates), have been less affected, with meaningful opportunities presenting in secondary and co-investment investments,” Pollock says.

Why should investors consider private equity?

Pollock emphasises that the universe of private companies is significantly larger than that of public companies.

He also highlights the attractive returns on offer within private equity, “which have outperformed publicly listed equity across multiple time horizons, geographies and market cycles.”

Pollock cites three key reasons for this:

• Long-term value creation: Private companies don’t face the same short-term, public pressures as listed companies, which allows management teams to focus on the business’s long-term performance.
• Market cycle resilience: Private assets also demonstrate historical performance that is resilient across various investment environments.
• Illiquidity premium: Put another way, this is the compensation for investing in assets that cannot be easily converted into cash. “We seek to capture illiquidity premiums associated with long-term investments,” Pollock says.

“Private Equity has, however, been historically difficult to access. PE1 provides exposure to a globally diversified and professionally managed portfolio via a unique ASX listing.”

What is your outlook for the next 12 months?

Pollock sees several opportunities across private markets, including more attractive asset valuations than we’ve seen for some time, “which bodes well for long-term returns.”

He also anticipates an increase in restructuring/turnaround opportunities for specialist managers, driven by the slower economic environment.

And in private credit, Pollock believes rising interest rates and increasing credit spreads (which means higher fee income) set the scene for double-digit returns.

“Record secondary volume is producing strong opportunities for investors such as GCM Grosvenor / PE1, who are broadly accredited buyers and can participate in a very broad range of transactions,” he says.

The Pengana Private Equity Trust (ASX: PE1)

• Launch date: 2019
• Funds under management: $456 million as of 30 September 2023
• Minimum investment: $500
• Fund Objective: To democratise access to private equity by providing Australian investors with access to a diversified portfolio of global private equity investments, seeking to generate attractive returns and capital growth for unitholders.
• What it costs: 1.25% p.a. (plus performance fee)
• Target return: Capital growth plus 4% cash distribution yield
• Performance: 8% since inception.

Learn more about PE1 here

Big banks’ pullback underpins the private credit opportunity

Andrew Lockhart, managing partner at Metrics Credit Partners, emphasises a few key points in the following Q&A. These include the effect of tighter regulations on traditional bank lenders and the greater flexibility of private lenders to participate across different deal types.

What is the current state of play in private debt?

Lockhart emphasises the short-dated and floating base rate attributes of private debt assets in his view the sector will continue to “generate real returns over and above inflation.” These attributes mean rising interest rates have flowed through to higher total returns.

“We lend across the market, but commercial real estate is particularly attractive currently,” Lockhart says.

“An area that banks pulled back from because of changes to regulatory requirements, this created an opportunity for lenders such as us.”

Why should investors consider private debt?

“Private debt is on the radar for more people as it can provide an inflation hedge, deliver low capital volatility, and generate consistent income even in turbulent times,” Lockhart says.

He also believes the asset class can work in either the defensive or growth component of investor portfolios “Sometimes even both at the same time.”

As Lockhart explains, funds with “relatively low risk” positions in senior secured debt, or investment grade debt, may provide defensive investors with an alternative to bonds.

“Alternatively, funds that provide exposure to sub-investment grade debt or alternative parts of the capital structure can instead replace part of an allocation to equities,” he says.

What is your outlook for private debt over the next 12 months?

Lockhart believes private debt provides greater return prospects, with lower risk, than other asset classes over the next 12 months – and within most economic conditions.

“Credit growth in the local market is likely to be between 5% and 6% in the current environment. And our size, at $15 billion, allows us to be very selective in terms of the companies and projects we finance,” he says.

Lockhart also emphasises the diverse range of deal types covered by Metrics, which invests across:

• corporate lending,
• project and infrastructure funding,
• real estate,
• leveraged buyouts, and
• acquisition finance.

“We also have the flexibility to participate in different structures, from senior unsecured debt to subordinated or mezzanine debt,” Lockhart says.

He regards commercial real estate as particularly attractive now, partly because banks have pulled back as regulatory capital charges have become too high (APRA increased Common Equity Tier 1 capital ratios to 10.25% from January 2023).

“We believe there is a growing sense that Australian real estate is the next logical market in which they should invest,” Lockhart says.

“But to do this well, you need to have people on the ground, relationships in place and the ability to manage risk for projects in which you invest.”

Metrics Master Income Trust (ASX: MXT)

• Launch date: October 2017
• Funds under management: $1.77 billion (as of October 2023)
• Minimum investment: $500
  
• Fund objective: Provide monthly cash income, low risk of capital loss and portfolio diversification by actively managing diversified loan portfolios and participating in Australia’s bank-dominated corporate loan market
• Target Return: RBA Cash Rate +3.25% p.a. net of fees (currently 7.60% p.a.)
• What it costs: 0.24% management fee (excluding administrative costs and performance fee)
• Performance: 5.55% p.a. since inception.

LIT

Metrics Master Income Trust (MXT)

Australian Fixed Income

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Metrics Income Opportunities Trust (ASX: MOT)

• Launch date: April 2019
• Funds under management: $567 million (ss of October 2023)
• Minimum investment: $500
  
• Fund Objective: Provide monthly cash income, preserve investor capital, and manage investment risks while seeking to provide the potential for upside gains through investment in private credit and other assets such as warrants, options, preference shares and equity. MOT may also invest in private equity and equity-like investments
• Target Return: Target Cash Return of 7% pa net of fees paid monthly. Target Total Return of 8-10% pa net of fees through the economic cycle
• What it costs: 1.03% p.a. (plus performance fee)
• Performance: 8.80% p.a. since inception.

LIT

Metrics Income Opportunities Trust (MOT)

Australian Fixed Income

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Note: The Trust Company (RE Services) Limited (ABN 45 003 278 831, AFSL 235 150) is the Responsible Entity of the Metrics Master Income Trust and Metrics Income Opportunities Trust (the Trusts). Past performance is not indicative of future performance.