Private markets are topical at the moment as they undergo a transition to becoming less private due to increased investor and regulator demand for greater transparency. Technology is also playing a role in improving investor insight and extraction of alpha.
At the recent Aberdeen Standard Investments Changing Investment World forum in Sydney, Aberdeen Standard Investments’ head of private markets solutions Nalaka De Silva explained what private markets are and the opportunities for investors in this often misunderstood area.
What are private markets?
Private markets encompass real estate, infrastructure, private credit in all forms and at different points of development. They include a range of instruments structured for growth or income. Mr De Silva noted that the scope of private markets is commonly misunderstood.
“It is the purest form of active management – we physically own and run businesses. We buy things, we make them better and we sell them when the time is appropriate,” he said.
People tend to associate private markets with private equity but it is a much broader spectrum than that.
“The unlisted spectrum runs through the whole risk/reward trade off. People seemed to forget about it for a while but now the illiquidity premium has become more attractive and you have to turn to this set of instruments to get it. They are fundamentally cashflow driven investments and we can risk-manage to deal with that.
“This is a tool that can be used for long-term, return-generating alpha-seeking assets that can provide a different set of features to a portfolio. Having ownership, we can ask those hard questions around ESG issues for example. We are here to change the world, in many ways,” he said.
Private market opportunities for investors
Mr De Silva highlighted that the opportunity set for private market investors was incredibly broad.
“For us, opportunities for beta and out-performance are in the public domain. The majority of companies that are registered around the world are private companies. The largest capitalisation sits with listed companies but by count, number of employees and contribution to economic activity, private markets dominate,” he said.
“You can also proxy private markets through listed securitisations of versions of infrastructure, real estate or private equity.”
Value creation in private markets
With regard to technology, the venture capital space has been extremely interesting over the past 10–15 years, according to Mr De Silva.
“The innovation cycle, and where it is at the moment, is getting very efficient. It is not just the innovative companies such as Uber and Lyft.
“We’ve seen a number of start-ups grow to be worth more than a USD$1 billion – the so called ‘unicorns’. Unicorn hunting is very popular in our division. But what we are really looking for are companies that can produce resilient earnings and business models.
“Value creation in private hands is really where investors are looking to generate alpha.”
Mr De Silva made the point that private market investment is not just focused on the US and Europe.
“There are more than 177 private companies in the Asia-Pacific worth more than $1 billion. There is a tech revolution going on in the region in financial services and e-commerce. That is generating alpha in many different ways,” he said.
Drilling down into these companies to enable the insights that help extract alpha takes a considerable amount of effort and resources. Mr De Silva’s team has built proprietary systems to better understand company cashflows and provide greater transparency for clients.
“We can look through at the underlying and exposures we are taking; looking at individual company cashflows – the P&L, the balance sheet – and aggregating all of that into one place to see the impact on a portfolio.
“In simple terms, all the effort that goes into buying a company and making it better is a function of good internal management. We are insiders – we own controlling stakes. We can change the CEOs and CFOs if we don’t feel that they are doing the right job.
“But we need to show transparency around that. And that is something that the industry has not been very good at in the past,” he said.
Increasing transparency for clients around the contextual information on a company is a core focus for Mr De Silva’s team as this data is what drives business models.
“We are spending more time looking at contextual information such as where the asset is, what it’s doing and how it is performing in its environment – in the real economy. We can overlay interesting data on top of this such as how carbon footprints or demographics are affecting our assets,” he said.
Owning private companies comes with a certain amount of responsibility, particularly around ESG issues. Mr De Silva noted these issues are taken very seriously when analysing companies for potential investment.
“We think about the role we play as company owners, as these assets affect the fabric of society. We have an obligation around that.
“The UN Sustainable Development Goals are not just something we pay lip service to. We look at how we can do more with less in the circular economy. It’s in the DNA of what we do. We have to risk manage, worry about the health and safety of employees, worry about labour, land and environmental issues, for example.
“Non-financial reporting turns financial pretty quickly if you get it wrong,” he said.
Nalaka De Silva – Head of Private Markets Solutions
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