Entering the unlisted asset space is akin to getting married, according to John Woods, deputy chief investment officer (CIO) and head of multi-asset at Australian Ethical.
Speaking on a recent Morningstar webinar, Woods emphasised that due diligence challenges in the private market are significantly more demanding than those in public markets.
“When you make a private investment, you can’t change your mind tomorrow – you may not be able to change your mind for 10 years. You’ve got to consider a much longer time horizon when making that decision,” he said.
“Our process of appointing managers and making those decisions reflects that. We go quite deep and we worry more about some of the minor things.”
While stopping short of hiring private investigators to trail CEOs, Woods noted that some private equity firms do undertake that level of due diligence for major transactions.
“It’s a very different space, you’re getting married and I think that’s the way you should look at making these decisions.”
Lucie Bishop, portfolio manager at specialist investment firm Revolution Asset Management, emphasised the importance of “manager selection”, putting special emphasis on the value of transparency.
“I think transparency is really key in the public markets from an investor perspective,” she said.
“So really understanding what’s under the hood of the strategy because there’s a lot of funds that are, for example, targeting a similar risk or return target, but what’s underneath and what’s making it up can vary quite significantly. That’s really important for investors to understand and really do their homework on what they’re investing in and what the health of the underlying loans actually are.”
Her team, Bishop said, routinely conducts extensive due diligence on underlying loans, including site visits, before committing to long-term investments.
“In our due diligence from actually a fund manager perspective on the underlying loans, it’s definitely true that we go and do site visits before we, as you said, ‘marry’ into something.
“We are locking our investors’ money in for five or seven years in some of these sponsored deals.”
Part of the due diligence process also includes assessing whether the investment can endure market volatility and a recessionary environment.
“We spent three months often on due diligence for a deal before we committed to funding it – that’s not unusual,” Bishop said.
Woods urged fund managers to conduct their own rigorous due diligence before committing to private market investments, warning against relying on the assumptions or assessments of others.
“One of the dangerous points in private market investing is where you think others have done due diligence and relying on it … Sometimes it’s not good enough that a large super fund has invested in a private manager that you’re interested in,” he said.
Last month, Lonsec Investment Solutions’ chief investment officer, Nathan Lim, stressed on a Netwealth podcast that manager selection in private markets can really make or break an investor’s success, particularly given the dispersion in returns between the highest and lowest quartile managers is much wider than in public markets.
Pointing to recent research, he suggested the performance between the average top quartile and bottom quartile US private equity manager was nearly 20 per cent.
“So, that means the best manager and the worst manager, there was like a 20 per cent difference between the returns that they produced – that is about 10 times the dispersion you find with public market global equity fund managers where the difference between the best and worst manager was only about 2 per cent,” the Lonsec CIO said at the time.
“I think it’s really important that when you’re looking at private markets, manager selection is really important. It’s very crucial.”
