Unravelling unlisted assets

Once considered mysterious and inaccessible, “unlisted” assets are now considered an important component to a well-diversified portfolio. Dampened volatility, returns linked to inflation and access to the illiquidity premium on offer are just some of the benefits unlisted assets may provide.

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Unlisted assets are an integral part of a well-diversified investment portfolio due to their relative return stability, better risk adjusted returns and the long-term focus of these asset classes.

"The use of unlisted assets to diversify returns through market cycles can provide balance to a portfolio.”

Put simply, unlisted assets are investments not listed on an exchange. They can include infrastructure, property, private equity, agriculture and private debt. Although unlisted assets are often categorised together, there are significant differences between the types of unlisted assets and their role in a diversified portfolio.

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The rundown on unlisted assets

Infrastructure investments provide capital to develop or maintain assets that are essential services or facilities such as airports, toll roads, ports, telecommunications, water, sewage and power services. These assets are considered essential services in developed countries and can improve living standards and economic potential in developing countries. Infrastructure projects often rely on substantial initial investments. Infrastructure funds typically offer risk and return expectations which are higher than private credit funds but lower than private equity funds.

Property investments involve directly acquiring property assets such as residential properties, shopping centres, office buildings, industrial parks and distribution centres. Returns comprise both income generated from rental yields and capital appreciation due to demand dynamics and improvement/development of the asset. Return and risk expectations for property funds vary significantly, from core to higher-return seeking opportunistic assets, owing to the broad diversity of strategies globally.

Private equity investments provide capital for private companies that are not listed or publicly traded. The most common categories of private equity include venture capital, growth capital and leveraged buyouts. Private equity investments require specialist fund managers to identify and source investment opportunities then drive capital appreciation through governance, financial and operational management. Many global technology companies including WhatsApp, Facebook, Twitter and Snapchat were identified and invested in at the venture capital stage by funds which operate in this space.

Private debt is a general term that describes non-investment grade debt such as corporate loans, infrastructure debt and real estate debt. These funds are generally income generating in nature with the ability to meet return targets hinging on the capability of fund managers to ensure underlying borrowers repay their principal and interest as agreed.

Construction considerations

Over recent years the correlation between equities and other classes has shifted materially higher. While every investor has their own investment preferences, the typical framework for portfolio construction may consider the necessity for income, tolerance for volatility, expected returns and investment time.

When considering a multi-year strategy, allocating to multiple asset classes with lower correlations to one another creates a greater chance of achieving return outcomes with a lower level of risk. Generally, unlisted asset returns have a low correlation to listed assets due to the fact they can be uncorrelated to the business cycle, leaving them less exposed to short-term listed market volatility.

The use of unlisted assets to diversify returns through market cycles can provide balance to a portfolio during listed share market downturns, potentially resulting in increased stability of portfolio returns.

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Unlisted assets have high barriers to entry which can provide a return premium over listed assets. The return premium is derived from the higher risk stemming from complexity as well as the illiquidity of the fund or underlying assets.

Robust due-diligence on unlisted funds and their underlying assets is even more important than for liquid listed assets because they generally can’t be exited quickly if things go wrong.

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Considering the risks

Unlisted assets have historically generated superior risk-adjusted returns when compared with many other asset classes, such as equities. When considering investment returns, risk is a critical component.

Unlisted asset strategies are typically more complex than traditional assets like equities and bonds. A higher level of due diligence is required to be successful and investors may need more time or resources to gain comfort with investing in more complicated strategies or delegate this function to others they trust.

Unlisted assets are typically illiquid given they are not traded on an exchange, making it harder to trade or find buyers willing to transact at a given price. Often an investor will not be able to sell an asset at its fair value for many months or more. Additionally, in some situations, the valuation of unlisted assets can change sharply as they are typically valued infrequently, relative to listed instruments such as shares which are valued daily. During distressed market environments, it may not be possible to sell unlisted assets at a fair or reasonable price. Investors need a long-term time horizon which will generally be rewarded by what is known as the illiquidity risk premium – the reward for investors for tying up their capital.

An asset’s geographic location can make it susceptible to risks such as physical changes in the environment caused by climate change. Events such as cyclones, floods and bushfires or the impacts of longer term shifts in climate patterns such as rising sea levels are physical risks. Likewise, this can also manifest in country-specific risks including geopolitics which are not necessarily as inherent when it comes to listed assets.

Meet the investors

Unlisted assets have typically been the domain of institutional investors with superannuation and pension providers, sovereign wealth and endowment funds typically holding much larger allocations to these assets than individual investors. Access to these opportunities, as well as expertise and an understanding of their complex nature has often been the reason for this.

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However, as return expectations continue to decrease and as more investors are seeking alternative sources of return, fund managers are now providing more readily accessible opportunities for individuals to access this asset-class.

Brian Ingham is Head of Portfolio Implementation – Private Banking and Advice at ANZ

This article was originally published on ANZ’s Private Banking Insights website

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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