How to invest in alternatives with listed products

Traditional barriers to enter private markets and other alternative investments, can be potentially overcome with listed vehicles that provide an extra layer of portfolio diversification.

Assets captured by these funds include private equity, private debt and other alternative income funds. 

Private markets, in particular, have become more accepted as a component of strategic asset allocation as result of the low yield environment that dominated financial markets following the global financial crisis (GFC). More recently, the potential impacts of inflation, rapid interest rate increases, increased geopolitical risk and periods of positive stock and bond correlation have kept alternatives in focus for advisers and investors seeking diversification.

ASX listed vehicles, though, negate the large minimum investments sometimes required by other private market funds. They also offer the strict governance that applies to listed entities and potential for daily liquidity. The latter factor can be an advantage as restrictions on investors’ ability to redeem capital from unlisted products during potential periods of illiquidity is an inherent risk of private market investing.

Alternative lending in focus

The private debt market in particular has grown significantly since banks were forced to be more conservative in their lending following the GFC and many companies were forced to seek alternative sources of finance. 

Private debt funds raise capital from investors to provide that finance and returns are generated from the interest and fees paid by borrowers, minus fund costs. For example, Metrics Credit Partners offers two listed investment trusts which aim to deliver a consistently higher yield than traditional asset classes such as fixed rate bonds and equities. 

Metrics Master Income Trust (ASX: MXT) was listed in October 2017 and has a market capitalisation of $2 billion. It targets a potential return of the RBA cash rate plus 3.25% per annum (or currently 7.6% per annum net of fees) from its portfolio of around 300 direct corporate loans. It has a focus on capital preservation and distributions are paid monthly.

Metrics Income Opportunities Trust (ASX: MOT) has a market capitalisation of $573 million and its higher risk strategy targets a potential cash yield of 7% per annum with a total potential target return of 8%-10% net of fees. Distributions are intended to be paid monthly.

When investing in private debt, advisers should apply some key considerations to the choice of fund manager. These include a track record of performance and an appropriately diversified portfolio of loans that is spread across sectors and borrowers to minimise the risk of loss. It’s also important to opt for a manager with an experienced team that is appropriately qualified to assess the credit risk presented by borrowers.

A new fund, the VanEck Global Listed Private Credit (AUD Hedged) ETF (ASX: LEND) launched on 2 February  2024, offers a different twist on the sector by tracking the LPX Listed Private Credit AUD Hedged Index. This index includes 25 global listed private credit companies and yielded more than 10% in 2023.

While not private debt, the $500 million GCI Gryphon Capital Income Trust (ASX: GCI) is another vehicle that aims to offer an alternative source of income to investors that is less volatile than equity dividends. It had an annual yield of 9.18% at December 31, generated from a portfolio that chiefly consists of residential mortgage backed securities and asset backed securities.

High risk, high reward?

Two relatively new additions to the ASX aim to allow retail investors to diversify their portfolios by adding private company exposure to their public shareholdings. The theoretical gains from private equity can enhance overall portfolio returns, though the risks are different to public markets and must be carefully considered.

“While private equity has often delivered returns at the higher end of the private capital spectrum, it is also one of the riskiest private capital strategies, primarily due to the nature of the assets,” says Preqin, an alternative assets research house.

“The equities of private companies often derive their value from intangibles like brand, customer base, patents, and distribution channels, which are harder to liquidate in times of difficulty than physical assets such as real estate, gold, or oil,” Preqin says.

Pengana’s $400 million Private Equity Trust (ASX: PE1) aims to tap into the potential gains with a diversified portfolio of global private equity investments, plus a small allocation to both private credit and what it calls “opportunistic investments”. 

The trust has gained 9% per annum since its inception in April 2019 and targets a potential distribution yield of 4% per annum. Its portfolio is managed by global fund manager Grosvenor Capital Management and has exposure to more than 550 underlying private companies such as Elon Musk’s SpaceX, Uber Freight and US company Mavis Discount Tire. 

VanEck’s smaller Globally Listed Private Equity ETF (ASX: GPEQ) tracks the LPX50 Index, which measures the performance of the 50 largest and most liquid global listed private equity companies. The top holdings include industry heavyweights such as Apollo Global Management, KKR & Co and Blackstone.

The $19 million fund returned 42.34% in the year to December 31, demonstrating the potential returns from this part of the financial world. The long-term gains of the LPX50, though, were a more moderate 13.54% per annum in the 10 years to the same date. 

Looking beyond the ASX, for internationally-focused advisers there are a number of other options, including the ProShares global Lister Private Equity ETF (PEX) and Invesco Global listed Private Equity Portfolio (PSP), the latter providing access to approximately 7 publicly listed private equity companies worldwide. It tracks the Red Rocks Global Listed Private Equity Index, composed itself on between 40 and 75 publicly listed companies

Private markets were a talking point in 2023 but, perhaps counterintuitively, the public share market provides options for advisers for tapping the potential gains that may be worth a closer look.