In the lead up to the election, the ASX 200 continued its golden run, unwavering in spite of a pending change in government that almost everyone assumed was a fait accompli.
Flying in the face of the Morgan Stanley number crunchers who suggested that the political uncertainly would drag the markets down, the index leapt ahead as the election drew closer. When the markets reopened after the shock election result, the ASX 200 showed approval of the re-election of the Coalition government by continuing its rally over the following days.
The question now is whether this buoyant mood will be maintained. A large number of bystanders are voicing concerns that this golden run is all but over as our economy continues to stall.
Bank shares have also inflated the ASX 200 in expectation of an imminent rate cut, turbo-charged by APRA’s plans to improve the lending environment. But although monetary policy is a powerful lever, its impact has been dampened by inefficiencies in our labour market, taxation system and an unclear energy policy that does nothing to leverage the wealth of renewable resources for our population.
Some also suggest that a bubble has formed around the WAAAX tech darlings (Wisetech, Afterpay, Altium, Appen and Xero) who have all more than doubled their share price in just 12 months.
By all accounts, the ASX and the Australian economy appear to be looking toppy for equity investors with short-term optimism keeping the markets inflated. Technical indicators are also suggesting that the next six months are not looking pretty for equities.
On the world stage, uncertainty and fallout from the US-China trade war continues to cause ripples in global markets. This trade war is also spilling into growing parts of the economy such as technology, with the US administration’s latest moves against Huawei increasing the divide between US-led technology platforms and their Chinese counterparts. As Australia is unequivocally tied to China, the result will be felt here.
Against this backdrop of inflated markets and geopolitical uncertainty, alternative investments are coming into favour. In place of local and global shares, alternative investments such as private equity (PE), venture capital (VC), hedge funds and real estate are seeming attractive to those with a longer-term strategy and for whom the lack of liquidity isn’t a deterrent.
This growing appeal of alternatives is attributed to three major factors:
1. Better positioning and protecting against a downturn in the market
The ASX may continue its winning streak, but in the climate of uncertainty, uncorrelated alternatives can improve the risk-adjusted returns. VC and PE are less sensitive to market forces with funds proven to deliver returns outside the peaks and troughs of the economic cycle.
2. The lure of higher expected returns
There are, of course, no guarantees however a well-constructed venture capital portfolio will outperform the market. A report by William Buck Chartered Accountants and Advisors released this year said that expected returns from capital funding investments are increasing, particularly for VC and angel investor groups. Their experience revealed the expected rate of return VCs in 2018 was between 30 per cent to 50 per cent, and the expected rate of return by angel investors was even higher at 35-65 per cent.
3. Diversification at a time when the sharemarket is shrinking and weighted heavily to a small number of sectors
The Australian sharemarket is shrinking alongside a number of global exchanges such as New York and Singapore. This year, the value of companies that have disappeared from the ASX after being taken private could nudge past $16 billion. Listings are also drying up as companies shy away from or delay an IPO. The average time from start-up to going public has increased and the number of IPOs on the New York Stock Exchange has more than halved over the last 20 years. Uber was a private company for 10 years before listing on the New York Stock Exchange last month. This lack of depth means overexposure to certain sectors. In Australia, the ASX 200 feels every sniffle and sneeze of the banking sector, which leads investors to question: just how much diversification there is in this benchmark?
Many are talking about active investing in the private markets as a threat to public markets, a trend well underway in the US, according to asset manager AllianceBernstein. This will spell doom for the markets if liquidity dries up and companies continue to decide it’s better to raise money in private markets. The indices will be subject to increasing volatility as institutional investors will only be able to sell up shares in a downturn.
We may be some time off this level of active investment in alternative private markets here in Australia, but we are seeing the same indicators. Our PE and VC sector are also considerably smaller than in the US, and lacking the support of major pension funds. If these choppy, toppy and shallow waters continue, the tide will eventually turn and larger institutional investors will be looking to better insulate themselves against these conditions and deliver more to investors over a longer horizon. Alternatives such as venture capital will have an important role to play in this process.
Benjamin Chong is a partner at venture capital firm Right Click Capital
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