Illiquid assets

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GLOBAL INVESTOR 1.15 — 14 Oliver Adler: What sorts of issues come up in terms of liquidity and premiums with some of the more obscure asset classes, like infrastructure, or the not-so-obscure ones, like real estate? Roger Ibbotson: Well, of course, something like real estate is by its nature very illiquid. But there are structures that you can buy, like REITs (real estate investment trusts), that make it more liquid. If you put real estate into a structure that makes it more liquid, it tends to be more highly valued. A REIT is a more expensive way to buy real estate, but of course it has the benefit of being liquid. On the other hand, if by buying real estate you actually get involved in managing it, it’s a much more complicated thing. That’s more like private equity. All of these things are less liquid, and they all should have illiquidity premiums. I suspect that a lot of the return from real estate comes from its illiquidity premium. Oliver Adler: Given that the different asset classes seem to have different characteristics, how do you deal with the liquidity issue when you put everything together into a portfolio? Roger Ibbotson: People need a certain amount of liquidity. If you’re going to have a lot of illiquid assets, you also need some liquid assets to meet your liquidity needs. On the one hand, people should not pay for liquidity they don’t need. On the other hand, they may need more liquidity than they think. There’s a danger in going into too many illiquid assets, like real estate and infrastructure and private equity. Some of the universities, for example, did get into a bit of a squeeze in the financial crisis. They could not get very good prices for their private equity investments. One of the benefits of the kinds of stocks I’ve been talking about is that they can easily be sold in any crisis without paying much of a discount at all. Oliver Adler: But might it be possible to argue that illiquid assets could help to put a break on investors’ impulses to sell at the wrong time and save them from making mistakes? Roger Ibbotson: That’s an interesting argument. And, of course, there is evidence that overall stock market trends go in the opposite direction of what retail investors do: retail tends to sell after the crash and buy after the rise. So if retail investors were somehow prevented from overtrading, they might perform better. But the truth is that people want liquidity even though it sometimes leads them to take the wrong actions. José Antonio Blanco: Once you know what your liquidity needs are, is there a fair reward for real illiquidity? Or could you also achieve a higher return by structuring liquid assets, for example by exploiting anomalies or special effects, as you’ve described (I don’t want to call it risk premiums)? In other words, do you think the illiquidity premium is overestimated? Roger Ibbotson: I think one aspect of what you are speaking about is the ability to achieve “alpha” (a measure of outperformance relative to some asset class or benchmark). To get a lot of alpha, you may need to do a lot of trading. People are overconfident, of course, of their ability to achieve alpha. But the more you believe you can create alpha, the more you want liquidity because it is the lower-cost assets that may allow you to achieve alpha. In contrast, if you have long horizons, then you’re the natural type of investor to go after illiquidity premiums. The fact is, though, many people believe they can create alpha – some legi timately, and others who just think they can – and they will pay up for it. I don’t see that going away. So, the market will tend to pay too much for liquidity, and conversely underestimate the illiquidity premium. Roger Ibbotson The founder of Zebra Capital Management in 2001, Roger Ibbotson is also Professor in the Practice Emeritus of Finance at the Yale School of Management. He has written numerous books and articles, including “Stocks, Bonds, Bills and Inflation” with Rex Sinquefield (updated annually), which serves as a standard reference for information on capital market returns.
GLOBAL INVESTOR 1.15 — 15 Private equity in emerging markets Markus Stierli Fundamental Micro Themes Research +41 44 334 88 57 markus.stierli@credit-suisse.com Nikhil Gupta Fundamental Micro Themes Research +91 22 6607 3707 nikhil.gupta.4@credit-suisse.com 1 The untapped potential of emerging markets Emerging markets make up: 39% of global output 18% of global stock market capitalization 14% of global private equity fund-raising 11% of global private equity investments 2 Global opportunity At USD 29 billion, emerging market private equity fund-raising has been concentrated in emerging Asia, but growth has been the fastest in Africa. USD 4 bn +327%* USD 29 bn +97%* 3 High expectations In the USA, private equity achieved annual returns of around 16% over 2009–2014. Only 39% of limited partners surveyed expect that the USA will be able to sustain that level in 2015. 57% of limited partners expect emerging market private equity portfolios to achieve net returns of 16% or greater in 2015. Historical annual returns for emerging market private equity were around 13% over 2009–2014. Emerging market equities only returned around 4% over the same period. In comparison, US private equity trailed US equity markets in terms of returns. 4 The promise of venture capital Emerging market private equity investments increased by 60% in value between 2009 and 2014. In the same period, venture capital investment value increased sevenfold, now making up more than 20% of total private equity investments in emerging markets. Technology investments have more than tripled in the same period. Emerging market private equity by strategy, USD bn 40 30 20 10 0 20.8 33.8 5 * 2014 vs 2009 6 7 2009 2014 Buyout Growth PIPE Venture capital Data sources used for the article: Datastream, Emerging Market Private Equity Association, Preqin Not all markets are equal Private equity investments expanded rapidly in China, Brazil and Nigeria, shrank slightly in India and collapsed dramatically in Russia and South Africa between 2009 and 2014. Private equity capital invested in key emerging markets, USD bn 15.7 6.9 China 5.5 4 India 2.7 1.5 Brazil 2 0.1 Russia 2009 2014 0.6 0.1 Nigeria 1.5 0.3 South Africa In search of exit Asian venture capital investments have started to find viable exits through IPO routes. The aggregate value of venture capital exits quadrupled over 2013–2014 to reach USD 38 billion. Number of Asian venture capital exits 8% 5% 3% 22% 7% 2007 2014 83 exits 145 exits 65% USD 9 bn 50% Aggregate exit value Trade sale IPO Write-off Sale to GP USD 38 bn 40% Moving up the value chain African private equity is moving up the value chain, away from extractive industries. PE investments in 2014, USD mn 454 415 242 119 42 Financials Telecoms Consumer goods Oil and gas Basic materials PE investments in 2009, USD mn 253 126 63 539 458
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