Increasingly, alternatives aren't living up to their name.
More and more asset owners across Asia are looking to see how to invest in these illiquid asset classes (typically defined as real estate, private equity, private debt, infrastructure and possibly hedge funds). And as their demand grows, so the assets are increasingly becoming mainstream - albeit still illiquid and private - investments.
The desire of the investors to put more assets into these areas is understandable; fixed income returns remain dismal across much of the world’s credit markets, while equity markets haven’t performed consistently well for months. in constrast, many real estate or private equity funds boast returns in the high single digits or up to the high teens.
But shifting towards alternatives also leaves these investors potentially exposed to a market downturn, in fairly illiquid assets.
And with US president Donald Trump eager to pile up as many tariff wars as possible while simultaneously sabre-rattling with Iran, plus fears increasing of a softening of the US economy, global tensions are rising.
Yet look at demand for alternative assets, and it's hard to see these tensions. The prices for Chinese technology-linked investments, for example, are heading northwards, to the point that they are often three or four times higher than in other countries. Meanwhile, sluggish Korean pension funds have turned to more nimble (but less due diligence-inclined) securities companies to sate their property investing needs (look out for the Summer 2019 edition of AsianInvestor magazine for an in-depth look at both these areas).
It's not all rapid momentum, all the time. The market volatility of late 2018 and early this year has caused the overall number of private equity deals to drop, as alternatives data provider Preqin has noted. But real estate and private equity funds across the world remain flush with committed asset owner cash from asset owners eager to find some alpha; the long-term trend for more players vying to invest is only set to only rise.
That immediate impact of this interest is that more private equity funds have the wherewithal to compete for assets as they become available. That in turn is causing an overall increase in the average cost of acquisitions.
And, as the cost of assets increase, so potential investment returns drops. Either that, or the level of leverage the funds adopt to buy the assets rises – increasing their risk in the event of an economic downturn. The danger of a market fall on alternatives already has several regional chief investment officers concerned.
It’s also worth noting that some of the world’s most sophisticated investors – sovereign wealth funds – have cut their number of private equity investments, at least last year, according to research conducted by the International Forum of Sovereign Wealth Funds. Instead they are focusing their efforts on very specific areas.
HEADING TO HINTERLANDS
All of this is driving more asset owners to look even further afield and into riskier alternatives areas to get the returns they crave.
Some institutional investors in Australia, Europe, Singapore and other markets are raising their investments in venture capital (look out for a feature on this in the coming edition of AsianInvestor). These allocations are inevitably smaller startup companies, which have less track record and a higher likelihood of failure – as well as huge potential returns if they flourish.
In addition, investors have shown an interest in riskier real estate areas, including value-added property, or types of real estate that are fixer-uppers, needing work in order to improve their renting and resale value.
These investment bets are understandable, particularly for asset owners seeking a bit more juice in their portfolios at a time when so many other asset areas are proving so disappointing. But the risk, and true illiquidity, that comes with these sort of investments should not be underestimated either.
Hopefully the stakeholders of Asia’s asset owners will remember these organisations are meant to be truly long-term investors. Because over the shorter term some of these bets on niche alternatives could come back to bite.
Look out for AsianInvestor's Summer 2019 edition, out in early July. It has a special set of articles focusing on the rising appetite for alternative assets among regional asset owners, as well as the full winners of our annual Asset Management Awards and this year's revamped AI300 list of regional asset owners.