Unlocking the mystery of private markets for everyday investors

Investors are shifting further into the world of private markets, where new opportunities are opening up.

Average investors are unlocking the mysterious world of private equity and private credit.

The world of private equity and private credit is filled with mystery and intrigue for the average investor. Images come to mind of Wall Street boardroom deals being done by investment bankers and lawyers in pinstripe suits while founders and early investors celebrate in decadence aboard private yachts sipping champagne.

While this may be an exaggeration, the perception is still there that private assets are only accessible by hedge fund managers and the very wealthy. As such, many ordinary investors have not looked into this asset class. But in fact, the private investment market is much bigger than you would think.

Fund manager Pengana, which runs an ASX-listed private equity fund, states that only 2 per cent of companies are listed on sharemarkets while 98 per cent are privately held.

There are two distinct subcat­egories of private assets: private credit and private equity. Frank Danieli, head of credit investments and lending at ASX-listed MA Financial, says: “Private credit sounds mysterious but is actually simple. It simply means lending that is undertaken outside the banking system or traditional fixed-income markets.

“These loans are made directly by credit funds or financial institutions, rather than by buying ­securities on a screen, with the ability to design your own debt terms, covenants and security ­features.”

Private equity, on the other hand, occurs when investors provide cash in exchange for partial ownership of a company at any stage of the business lifecycle, but usually in the earlier stages.

The company will usually run at a loss, hence the need for cash injections from investors to keep it afloat. The company could be at the ideas stage, through to the research and development stage, or as advanced as “pre-IPO”, where it is gearing up for a sharemarket listing.

Most private asset investments, to minimise legal and compliance costs, are only available to sophisticated investors. Under the Corporations Act, if an investor has an accountant letter confirming that they earn gross income of $250,000 or more a year in each of the previous two years or have net assets of at least $2.5m, the investor qualifies as “sophisticated” and a lot of the usual compliance, structuring, liability and disclosure hurdles are waived.

To bring these private assets to the everyday investor who is not “sophisticated”, several Australian fund managers have established funds for investors to be able to gain a pooled access to private assets. Although you cannot pick an individual private asset investment, you can invest into a portfolio of private investments.

Modelling done by Pengana shows that private assets can increase portfolio returns and reduce volatility if the right invest­ment manager is selected.

With that in mind, outsourcing the private asset investment decision-making to a fund manager may not be such a bad idea. Information is also much more limited in private asset markets, meaning that it is easy to slip up and make a poor decision.

Unlike a stock on the ASX, where all relevant financial and company information is publicly available, investing in or lending to a private company can come with a lot more potential skeletons in the closet and a significantly greater level of due diligence is required.

Who are the founders? What have they done previously? Have they been successful or are they serial start-up founders who fail and spring up again with the next biggest and best idea?

Key person dependency is also another private asset risk – when a CEO from a large listed company retires, a suitable replacement is found and things carry on as usual. But in a private equity company, the driving force is usually the founder and if one of them leaves, there is a good chance the whole company can crumble and investor capital evaporates.

Claire Smith, head of private assets at Schroders, says: “It is true that with greater return comes greater variability in terms of returns. This is why manager selection in the private equity market is paramount.”

Schroder specialist private equity fund is open to retail investors with a $20,000 minimum and has returned 17.8 per cent a year after fees inception on March 31, 2020.

An example of a success story in its portfolio is a German digital transformation agency. Schroder liked the “asset-lite” nature of the business, the strong leadership team and its focus on public contracts, which were “sticky”.

If you prefer to invest via share­markets, Pengana has a listed Private Equity Trust (ASX code: PE1) that has performed 15.6 per cent a year over the last three years and holds more than 550 private companies in its portfolio.

And on the private credit side, Metrics has a listed opportunities trust (ASX: MOT) that has provided an income return of just under 10 per cent over the past 12 months, while MA Financial has the priority income fund, which is available as a managed fund to retail investors and has returned more than 8 per cent over the past 12 months.

Caution should be applied if you decide to invest in private ­assets directly given the more opaque nature of the investments and the additional layer of risks this brings compared to traditional bond and sharemarket investments. But with the healthy recent investment returns and solid growth of the overall sector, private asset investments should be at least considered by investors as part of a diversified portfolio.

James Gerrard is principal and director of Sydney planning firm www.financialadvisor.com.au