Why ‘alternative’ listed investment trusts are coming to the ASX

I don’t have a background in wealth management and like many of you I’m learning by reading articles from wealth professionals and speaking with more experienced investors. A big trend that I've noticed over the past few years has been to increase portfolio allocation to a category called ‘alternatives’.

The alternatives bucket contains investments like hedge funds, private equity, private debt and unlisted infrastructure (I’m sure there are more). The case is made around providing uncorrelated returns to your portfolio staples, such as equities and bonds.

The chart below shows the most recent allocation table from Australia’s Future Fund, alternatives and private equity make up nearly 30% of the asset mix. Now the Future Fund is an extreme example with a unique set of circumstances and objectives. However, it does highlight that alternatives are playing an important role in institutional portfolios.

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Source: (VIEW LINK)

None of this will be new for wealth professionals, many of whom already advocate a decent allocation to alternatives. I've seen balanced portfolios with a 17.5% allocation to alternatives and I'm sure some would be higher. 

Retail investors are now also being presented with ways to access alternative strategies on the ASX, mainly via Listed Investment Trusts. Contrary to some vocal opinions, the experience to date for investors in these trusts has been good. As such, secondary raisings have been well supported and new offers in high demand, for managers with the right credentials.

For example, recently listed vehicles from Metrics (ASX:MXT & ASX:MOT), Gryphon (ASX:GCI), Perpetual (ASX:PCI), Pengana (ASX:PE1), Qualitas (ASX:QRI) and Neuberger Berman (ASX:NBI) are all trading at, or slightly above, their net asset value. They also pay investors a steady income stream, which is undoubtedly one of the reasons they have been well supported.

The professional crowd regularly advocate the need for retail investors (like me) to diversify away from Aussie shares, hybrids and property. With term deposits offering next to nil, one clear benefit of these new vehicles is that investors who prefer listed strategies now have some alternatives to consider.

It's early days for these vehicles and time will tell how they perform through market cycles. However, unlike equity offerings in the LIC/LIT space, the alternative market is uncrowded and retail investors will be presented with more options in the year ahead.

One such offering will come from Partners Group, a global private markets firm with US$120 billion of assets under management. Partners Group manages ~$10 billion for some of Australia’s largest super funds and has unlisted trusts with ~$2 billion of investments from high-net-worth individuals.

I recently spoke with Urs Wietlisbach, who is a Co-Founder of Partners Group, and asked him to give me the crash course on private markets and explain the case for listing the Partners Group Global Income Fund (ASX: PGG). 

If you get the chance, I'd also encourage you to watch the short video with Urs at bottom of this post. It will give you a unique perspective into his mindset.

Image: Urs Wietlisbach, Co-Founder, Partners Group

How did you get started in investing?

Urs: We started in 1996, the three of us, we left Goldman Sachs very young 27, 29, 32 years old, and we started in the private markets industry back then. Fast forward to today, I think we have done a lot of things right, because we are now one of the largest private markets as manager with US$120 billion under management in private debt, private equity, private real estate and private infrastructure.

Our credo is "Client is in the middle". There are many instances where we have proven it. We have actually seldom lost money for our clients.

We also put a lot of our own money alongside our clients. We have over $4 billion. The different partners of Partners Group have a lot of money aside with the clients. I think that's also an important differentiator of ours.

What are some of your core values?

Urs: You know, the biggest part of our clients are institutional clients. These are mainly pension plans, so 80%. In our decision room, as we call it, we have a sign up there that everybody reads when they walk in, "We are responsible for dreams." These dreams are the pensioners', if you have higher returns. Our asset class lends to higher returns, if you do it right.

We need to know why we come to work, and we are not coming to work for earning salaries or whatever. That's also part of it, but we must make sure that our pensioners get a good retirement at the end. That's kind of the philosophy and everybody thinks about it.

What would you say are the key differentiators between private and public markets?

Urs: The key differentiators are, first of all, private markets have a higher return and then public markets. One has to ask himself why? Because it's the same thing. A company privately owned and a company publicly owned, why should one perform better than the other?

There are a few reasons for it. Reason number one is before we invest into a company, being it in debt or in equity, we do it two, three, five, six, nine months' due diligence. We know everything about this company. We dig in. We look at inventory. We want to know everything. There's a whole bunch of teams going in there.

“If you would know as much about the public company and invest into it as we do, you should go to jail, because you are an insider then. So, we are kind of legalised insiders.”

I mean it's a private market. We can have as much information as we want. It's a privately negotiated transaction.

The second thing is, I am convinced that we have a much better corporate governance structure. Nothing against boards of public companies, but these boards, I'm sorry for the expression, they do the 'cover-my-ass thing' in public boards. In public boards, there's not much talked about strategies. We have monthly board meetings. We are very close with management. It's a ping pong, back and forth, and we act as well. If the CEO is not performing, bad luck. He's out, and he's not getting any golden parachutes, as you get in public firms. 

So, it's a different mindset. We are together going into a company, making the company better and sell the company.

What do people need to know about liquidity in private markets?

Urs: In private market there is not much liquidity. Usually we want to invest in a company that's usually a lifetime of about five years. Maybe sometimes we sell it or bring it to the public market after three years. Now with the product we are bringing to the ASX, it is a listed investment trusts that we are planning for private debt here. To overcome this we list the vehicle itself, so the client has daily liquidity in it whereby the content is illiquid in private debt.

How does that economic backdrop and the interest rate setting impact the investments that you're making in private markets?

It's very interesting. Private debt market, I always compare it before the financial crisis. Private markets is one of the very few asset classes today, which is not in, I call it, ‘bubble land’. 

Stock markets are extremely high. Real estate is higher than in 2007. Everything is extremely high, except the private debt market.

We are financing today companies who are much safer with much more equity below us, much better coverage of the interest rates that have to be paid than back in 2007. 

So, it's safer investments, and you would expect then you get less margin with less interest, but you get actually more. It used to be LIBOR plus 225. Today it's LIBOR plus 400 so you have a much bigger spread that you get.

There's always a reason for it, and the reason is the banks are not doing this business anymore. The regulator has put so much capital requirement on the banks that they don't do this anymore.

It's now the institutional market like us and others, professional debt investors, and this is really the interesting part. You get still decent returns for less risk than you had in 2007.

What has been the experience for private debt investors during severe market dislocations?

Urs: If you look at our track record in private debt, so on the senior secured is around 5% per annum, that's back to 2006 and including the financial downturn. When you look at second lien, that's kind of riskier, or mezzanine is even higher. There we are at over 8% per annum return.

“We never had a negative year on private debt. Even not in 2007, not in 2008.”

Our annual loss rate, it's interesting, what do we lose of our whole private equity portfolio on an annual basis? The last 10 years is 45 pips. That's 0.45%. That's half of the loss rate of the industry, and if you earn 5% or 5.5% and your loss rate is 0.45, you still are positive 5%. Yes, we maybe have lost once a company, that's why we have a loss rate, but diversified portfolios, we never lost money for our clients.

What's the rationale for wanting to bring a private debt trust to the ASX?

If you look at our Australia business, we have about $12 billion out of Australia, $10 billion is from superannuation funds, large ones like Host Plus and Care Super all of them have money with us. We have also $2 billion from high net worth retail through our open-ended unit trust. Many know it already. Otherwise we wouldn't have so much here. Maybe some of your readers are already invested in, let's say, our Global Value, which is the largest part. Global value is 60% private equity, 40% private debt.

Clients have asked us and said, "Can't you bring something that was just private debt with current income?" Because this unit trust is open ended and it doesn't have current income, you have to sell the units to get out of it. When you have current income, that's very difficult to manage as a unit trust. So, then we thought, we’re going to do a listed investment trust, because that's closed, and we know what the interest rates are on these private debt investments. 

It's going to be the same private debt investments as we have in this global value, but then we know the interest rate that's paid, and we're going to be able to distribute on a monthly basis these interest rates.

So, it's really the structure that's facilitating the opportunity?

Urs: The structure is better ... for ongoing private debt, it's a better structure than a unit trust, if you want to have current income, and people are crying today for returns. With the low interest rate environment, people want to see current income.

“You can't live from capital appreciation. You need something. You buy your food from income not from the capital appreciation.”

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