A $90 billion opportunity to boost portfolio returns, slash volatility and diversify

Some of the nation’s largest super funds are among the many institutional investors ramping up their exposure to Alternatives. Around one-third of AustralianSuper’s total $261 billion portfolio – around $73 billion – is invested in unlisted assets, the fund’s FY2022 annual report reveals.

“Recent events have shown that including Alternatives in an investment portfolio is no longer just an advantage, but a necessity, providing benefits such as increased diversification, lower volatility and inflation hedging,” says Dania Zinurova, portfolio manager of the Wilson Asset Management Alternatives (ASX: WMA) listed investment company.

She points to a recent study that suggests local private capital assets under management sit at $89.9 billion, with an annual growth rate of 11%. But for a long time, Alternative assets – real estate, infrastructure, private equity, real assets and private debt – have been hard for retail investors to access, as Zinurova explains. 

But Investment vehicles such as WMA are “democratising alternative investing for retail investors” she says.

In the following interview, Zinurova outlines how the portfolio is currently positioned across the various asset classes and provides insights on some of the multi-billion-dollar privatisation deals we’ve seen locally in recent months. Are there more ahead? What is the WMA team’s outlook for Alternatives over the next couple of years, and how will this effect retail investors? These questions and more are answered below.

Which parts of the alternatives universe can WAM Alternative Assets allocate to, and where are you currently positioned?

WAM Alternative Assets has a broad mandate to invest across alternative asset classes. Focusing on those that have tangible characteristics, such as private equity, infrastructure, real estate and real assets, which represent investments in water rights and agricultural land and various other strategies. We look to invest thematically and focus on four key megatrends, these are:

• growing ageing population, 
• climate change, 
• digitalisation and 
• increasing demand for food. 

Within those megatrends, we look for strategies that are supported by strong long-term tailwinds and apply a holistic portfolio construction approach rather than follow rigid strategic asset allocation targets. WAM Alternative Assets is currently invested in private equity, infrastructure, real estate, water rights and agriculture.

Within private equity, we are invested in, or have committed capital to, a mid-market buyout strategy, a venture capital strategy, a growth strategy, and a special situations, turnaround and transformation strategy. 

Within infrastructure, we have exposure to a diversified portfolio of core mid-market infrastructure that includes assets in sectors including renewable energy, transport, social infrastructure, utilities, waste recycling and some others. 

Within real estate, we have committed to an opportunistic real estate strategy investing in last-mile logistics and core healthcare property strategy. 

Within real assets, we have investments in Australian water rights and agricultural assets.

How does the changing macro environment shift the dynamic for Alternatives?

The current macro environment has indicated how alternatives are an essential part of an investment portfolio. The dual threats of rising inflation and increasing cost of debt pressures have caused turmoil in public markets. With both equity and bond markets experiencing significant declines and volatility, conventional portfolio allocations comprised merely of an allocation to stocks and bonds are no longer sufficient in enabling investors to achieve their risk-return objectives. 

The broadening of the investment opportunity set to include alternatives allows investors to overcome these challenges and obtain the numerous portfolio benefits of investing in these asset classes.

One significant benefit is that of increased diversification, with many alternative assets having a low correlation to public equity and bond markets, allowing for strong returns and portfolio stability even in times of market turmoil. A good example of this is how a deterioration in economic conditions can result in the opportunity for outsized risk-adjusted returns in a private equity strategy that invests in distressed companies, which alongside an injection of capital seeks to improve earnings, operations and/or management to sell for a significant profit later. 

Additional benefits of alternative assets include a natural or contracted inflation hedge in particular in asset classes such as infrastructure and some real estate. For example, healthcare real estate assets have annual consumer price index-linked (CPI) rent increases. Similarly, some assets provide an interest rate hedge, such as private debt instruments which often have a floating rate structure. In the current macro environment, the need to allocate to alternatives is greater than ever. As such, we are seeing more demand for this type of strategy that can provide an inflation hedge, interest rate hedge, and more downside protection.

We’ve seen several iconic Australian firms taken private in the last couple of years – is this a longer-term trend?

Indeed, there has been an increasing trend of publicly listed Australian companies going private. There are numerous reasons why a company might decide to go private, including not having to comply with costly and time-consuming regulatory requirements and removing themselves from the volatile, short-termed quarterly earnings focus of public markets.

Within the industry, this trend has been supported by the rapidly growing private equity sector in Australia, with assets under management growing at an average rate of 11% in the past five years, reaching $42.2 billion, with available funding reaching $10 billion (source: Australian Private Capital Market Overview: A Preqin and Australian Investment Council Yearbook 2022). 

As the private equity industry in Australia grows, we are likely to see increased public to private transactions as they seek to deploy record amounts of available funding in increasingly larger transactions.

This trend is also supported by regulatory changes leading to the greater consolidation of super funds, who need to find investments with increasingly large ticket sizes to deploy their growing and substantial amounts of capital. Perhaps one of the most prominent examples of this trend is the take-private transaction of Sydney Airport, which involved a $23.6 billion buyout of the company by a consortium of investors including PE fund Global Infrastructure Partners and the industry-funds backed IFM Investors. 

Among non-institutional investors, what is the most commonly misunderstood part of the Alternatives asset class?

One common misconception about alternative investments is that they are higher-risk investments due to their private nature. While private markets information is more difficult to access relative to pubic markets, where regulatory authorities require regular disclosure of information, the highly specialised nature of alternative investing and the strong demand for capital means institutional investors are often in a privileged position to negotiate unhindered access to a company’s financial information and management teams as well as embed extensive protections into investment agreements. 

Furthermore, the long-term nature of investing in alternative assets means a greater emphasis is placed on conducting thorough due diligence prior to investment as well as thorough internal investment and governance processes before committing to an investment. A good example of this is the private debt strategy of senior secured lending. These instruments are structured to have extensive covenants that protect investor’s capital against credit deterioration, entrench demands for regular reporting to assist in the monitoring of investments and ensure recoverability in the case of default, which may even involve measures such as selling the assets of the company to ensure repayment of capital. 

For skilled and experienced fund managers, greater access and control can be afforded when investing in alternatives compared to conventional investments. Alternative asset managers tend to be more aligned with investors as they often co-invest in the strategies or have robust long-term incentives in place which are directly linked to the investment performance.

The key, therefore, lies in selecting the right fund managers to partner with on these investments. WAM Alternative Assets seeks to provide retail investors with access to the best-of-breed investment teams in the industry.

The Argyle Water Fund has been one of your top performers. Can you talk us through the process of finding this asset?

We started investing in Australian Water Rights in 2013 with Kim Morison and his team, who now operate as Argyle Capital Partners. At the time, there were only two high-quality offerings in that asset class and only a few institutional investors included it in their portfolios. The Argyle Water Fund invests in the long-term ownership of Australian Water Entitlements (also known as water rights or water shares). Each year, water entitlements represent the right to use for consumptive purposes a portion of water allocated by the regulatory entity the Murray Darling Basin Authority. This entitlement can be traded – for example, bought, sold and leased – thus providing a return comprised of both a capital appreciation and yield component, with the former increasing in value as water becomes increasingly scarce and the latter fluctuating largely as a result of climatic conditions. 

As the returns in this asset class are driven by a risk premium (i.e. climatic conditions) that differs from the equity risk premium of public equities, it provides valuable diversification to an investment portfolio.

Water rights have experienced stellar performance in the past few years in Australia due to prolonged periods of drought and the institutionalisation and consolidation of Australian agriculture (which increases demand for water rights holders that can offer supplies at scale). As water rights currently comprise 32% of the WAM Alternative Assets portfolio, they have been a significant contributor to the strong performance of the portfolio. This allocation however does pose a concentration risk, so we have decided to gradually reduce the allocation with the goal to maintain it at a long-term 15-20% of the portfolio.

How long do you typically hold assets, and how do you know when it’s time to sell?

Alternative assets are typically illiquid and involve long investment horizons ranging from three to 10 years and in some cases even longer. As a result, when investing in alternatives it is important to premise investments upon megatrends, which are long-term structural and largely inevitable shifts that will transform global economies and societies. 

WAM Alternative Assets has identified four megatrends that we follow: digitalisation, climate change, growing aging population and increasing demand for food. Investing in these megatrends ensures that the value of assets held in the portfolio will appreciate in value and continue to be high yielding through the long investment period and that they are well positioned when it is time to exit. 

Some additional factors we consider when deciding to exit are the progression of any value-add, growth or transformational initiatives that were undertaken as part of the investment strategy as well as market and economic conditions when approaching the end of the investment horizon.

What is your outlook for deal volume, and size, over the next couple of years?

Across asset classes, deal volume and size are likely to become larger as allocations to alternatives continue to rapidly increase. 

As entities such as super funds accumulate more capital they require larger avenues to deploy this capital, seeking larger transactions across the spectrum of alternative assets from infrastructure to public-to-private buyouts. Preqin reports that private capital assets under management have risen to $89.9 billion, growing at an annual rate of 11% (source: Australian Private Capital Market Overview: A Preqin and Australian Investment Council Yearbook 2022). 

This trend is supported by both the supply and the demand side, with more investors looking to allocate to alternatives and more fund managers entering the market to meet this demand, leading to increasing deal volume. As more players enter, consolidation may also become increasingly important for certain players and in certain asset classes. Furthermore, the alternatives industry in Australia is relatively nascent compared to more developed markets in the U.S. and Europe, suggesting considerable room for additional growth.

What’s one of your stand-out portfolio additions of the last six to 12 months?

One stand-out commitment we have made in the last quarter is to Allegro Fund IV, managed by our investment partners Allegro Funds, representing a private equity strategy focused on special situations, turnaround and transformation deals in Australia and New Zealand. Allegro is a well-established fund management business with a strong reputation in the market. 

Allegro has been operating since 2004 and has built a sizeable team of experienced investment professionals with the core skill set needed to successfully execute on their investment strategy. The strategy targets a diverse range of sectors such as manufacturing, retail, wholesale trade, accommodation and food services, transport and warehousing, IT services, and health and education. 

The investment approach will generally target opportunities focused on special situations, the turnaround in the form of corporate carve-outs, restructuring, companies experiencing regulatory challenges, major corporate transitions, and equity recapitalisations. 

This strategy highlights another key benefit of many alternative investments, which is the opportunity to be involved in the active management of underlying businesses and enhance capital appreciation through value-add or transformational strategies, rather than merely acting as a passive investor. As government support is withdrawn post the pandemic and pressures relating to the increasing cost of debt and rising inflation grows, we believe this strategy is well positioned to deliver attractive risk-adjusted returns.

Learn more

WAM Alternative Assets provides retail investors with exposure to a portfolio of real assets, private equity and real estate. The company aims to expand into new asset classes such as private debt and infrastructure. For further information, please visit their website.