Mega funds: Do they offer ideas for private investors?

By Jayson Forrest

Mega funds, like the Future Fund, are accessing a variety of illiquid asset classes and benefiting from the illiquidity premium. Michael Karagianis (JANA Investment Advisers), David Blunt (Perpetual Private), and James Edmonds (Praemium) discuss the opportunities available to retail investors with alternatives.

Do the large weightings in private equity and alternatives that the Future Fund and many industry funds have in their portfolios, provide a guide for private investors for their own portfolio allocations, or are these asset classes just too difficult for retail investors to access?

These were two of the many questions that investment specialists tackled at the 2023 IMAP Portfolio Management Conference in Melbourne, where they discussed the best approach for retail investors to access alternatives.

With an allocation of 34 per cent to alternatives (as at December 2022), David Blunt – Portfolio Manager at Perpetual Private – isn’t surprised the Future Fund has such a high weighting to this asset class. He believes in the current environment, where there is a high correlation between equities and bonds, an allocation to alternatives provides an ideal opportunity to diversify a portfolio.

“When looking at the specific underlying asset classes within alternatives, we haven’t seen the type of fall in unlisted assets as we’ve had in listed markets,” he says. “So, when it comes to portfolio construction on a forward looking basis, we’re looking for alpha-based and skilled-based strategies in long-short equities, market neutral equities, or in long-short credit strategies, where we can focus on skill but still maintain a level of liquidity to manage a client’s portfolio through their time horizon.”

Michael Karagianis – Senior Consultant at JANA Investment Advisers – says when it comes to allocating alternatives within a retail client’s portfolio, investors in Australia typically avoid illiquidity. He also adds there are significant operational constraints for retail investors accessing illiquid investments. 

“In Australia, we place a premium on having liquid portfolios, and for a lot of investors, that’s probably excessive in terms of their investment requirements. One of the first things we do in our consulting process is to understand a client’s true drawdown requirements – whether they’re an institutional or retail client going through a managed account,” says Michael. “We need to determine what exactly is their income requirement and how much they can afford to be in more illiquid assets. That’s because we see long-term advantages in trying to capture that illiquidity premium.”

However, he says the problem for most retail investors, regardless of whether they’re investing directly or via a managed account, is actually getting access to illiquid assets and the cost in doing so. From a retail perspective, Michael says many of these strategies are very difficult to tap into, and they don’t offer the type of liquidity that’s required in a managed accounts structure.

“For example, the strategies that are available in the private equity space that can be accessed by retail investors have at best a monthly liquidity window. Now, while that’s manageable from a managed accounts perspective, it’s not ideal.

“Another issue with incorporating alternatives within a managed accounts structure is ‘fee load’,” says Michael. “They’re expensive strategies, which can be prohibitive to retail investors.”

James Edmonds – Chief Commercial Officer at Praemium – concedes that it is becoming increasingly harder for retail investors to access the likes of infrastructure and private equity. He says most of the investors going into alternatives tend to be wholesale investors, which means they don’t generally get caught up in the fee disclosure regime that retail investors typically do.

“Most of the investors going into illiquid assets understand the relationship between fees and the potential return,” he says.

That said, David does believe there are now more options available for fund managers to access alternative assets and strategies compared to just two or three years ago. He says many of the larger, well-known and established global alternative players are now beginning to bring products to market. However, he acknowledges that while these products are trying to meet the needs of retail investors, they tend to be more focused on wholesale investors.

“And the thing about these products is they are often focused on that particular manager’s philosophy, and not necessarily on the broader spectrum of alternatives that a client could access,” he says.   

The Federal Treasurer, Dr Jim Chalmers, has publicly stated that the Future Fund should be invested in ‘nation building’ activities, while some of the larger super funds are already investing in ‘build-to-rent’ social benefit projects. As such, there’s no doubt about the increasing interest by investors in environmental, social, and governance (ESG) investing. But is it an area of investing that private investors can realistically access through alternative assets?

“It’s an interesting question,” says James, who confirms that ESG and sustainability are definitely areas where he is seeing more advisers wanting to invest their clients into products that have this leaning. However, he concedes it’s generally a secondary consideration, sitting behind achieving asset growth or income for the client.

Michael agrees that whilst there has been a rise in interest by retail investors in ESG and sustainability, the level of interest and appetite for this type of investing is not uniform across the spectrum of investors.

He explains: “We come across Family Offices that have an intense interest in sustainability, and not just from an exclusionary point of view but also in regards to making an impact. They want to be seen as doing good. And then there are others who are simply not interested.

“The appetite for ESG might be the result of generational change within the Family Office, where the younger siblings are taking control and they’ve got a different perspective and philosophy to that of the matriarch or patriarch who stablished the Family Office. So, it’s a trend we’re seeing with certain types of investors, but it’s not happening across the entire investor market.”

Interestingly, David believes achieving a social impact with investing is better achieved in private markets than public markets.

And what about wholesale managed accounts? Will the development of this structure make it easier for retail investors to access the likes of private equity and private debt?

For Michael, it’s a “yes”, however, it comes with a caveat.

“I believe wholesale managed accounts will make it easier for retail investors to access alternatives, like private equity and infrastructure. That’s because investors in wholesale managed accounts are by definition wholesale themselves, which allows them to hold the underlying investments that are only available to wholesale investors. This opens up a universe of potential investments that would not normally be available in a retail managed accounts structure.”

However, Michael questions the portfolio rebalancing process in a wholesale managed account. He says one of the precepts of a managed account is its flexibility in terms of asset allocation and management. But the nature of some asset classes in alternatives are ‘buy-and-hold’ direct investments or have ‘call down’ features. As a consequence, some of these asset classes will lock up certain parts of the portfolio.

“That’s an issue we still need to get around,” he says. “And you still have to be able to access these strategies at an attractive price. A wholesale managed account structure should, in theory, provide you with more purchasing power. But we haven’t seen a massive rise yet in wholesale managed accounts. I think that will be a trend for the future.”

Currently, many of JANA’s clients who deal in the wholesale space, work with either a retail SMA or MDA structure. They then position many of these less liquid strategies as satellite investments that sit outside the managed account.

From a platform perspective, James adds that a wholesale managed account provides some very challenging technical issues.

“These challenges revolve around the legal ownership of the investment versus the beneficial ownership, and particularly where you have a ‘call’ structure, which effectively represents a liability. That liability is to the legal owner, not the beneficial owner,” he says.

In terms of that liability, James says there are extra challenges from a platform perspective to then be able to pass that liability down to the end investor. That may require ‘back-to-back’ legal agreements and it may require the asset or cash to be held on platform to reduce the risk.

“Where you’ve got those liability structures in place, wholesale managed accounts do provide some technical challenges that we need to deal with,” says James.  

Michael Karagianis is Senior Consultant at JANA Investment Advisers;

David Blunt is Portfolio Manager at Perpetual Private; and

James Edmonds is Chief Commercial Officer at Praemium.

The session, ‘Do the mega funds offer ideas for the private investor?’, was moderated by David McDonald CFA – IMAP Investment Specialist and conference MC.