Investigating Alternative Investment Opportunities: Private Credit and Private Equity

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SIMON BROWN: I’m here with Dino Zuccollo from Westbrooke Alternative Asset Management. Thank you for joining me, Dino. We frequently have enlightening discussions, and today we’re delving into alternative investments, focusing on private credit and private equity. From our conversations this year, I’ve noticed that South Africa’s market seems somewhat limited in private equity and private credit, but it looks like it’s beginning to catch up.

DINO ZUCCOLLO: Thanks for having me, Simon. I always appreciate our discussions. You’re absolutely right. When examining our standard clients here in South Africa – for context, Westbrooke aims to provide access to global alternatives or private markets – I find that most clients allocate between nothing to about 5% to 10% towards alternatives. This year, we’ve seen a marked increase in demand and capital inflow for our alternative investment offerings and strategies.

To offer some context, we currently manage over R13 billion in assets for around 3,000 individual clients, including about 120 wealth management firms globally, as well as various local and international institutions.

As a result, a recurring theme this year has been heightened demand and interest in alternatives. Notably, this reflects a global phenomenon. Earlier this year, JP Morgan published their 2024 Global Family Office Report, which indicated that large family offices across the globe now allocate an average of 46% of their portfolios to alternatives, compared to just 26% dedicated to publicly traded stocks.

SIMON BROWN: This appeal is significant. Part of it stems from the potential returns, while another aspect is the overwhelming influence of technology in global markets; while technology is beneficial, investors are seeking diversification. This lack of correlation is essential. Although liquidity can present challenges, effective investment management can help mitigate its significance.

DINO ZUCCOLLO: Absolutely, liquidity is certainly a consideration. You’re right; one of the main compromises with alternatives is that immediate access to capital is usually not an option.

I see liquidity as a trait rather than a disadvantage of alternatives. It helps investors sidestep the classic trap of buying high and selling low. Personally, I value being committed for a specified duration, as it promotes smarter long-term decision-making. That’s the first point.

The second point is that earlier this year, we conducted a survey among our clients to understand their motivations for allocating to alternatives. Surprisingly, one might think that the primary reason would be for higher returns, but it actually came in third.

The top two motivations were the benefits of low correlation and diversification, echoing your earlier point, Simon. The South African market has not deviated significantly from US markets, where the number of listed companies has decreased over the past 30 years, yet market capitalization has risen.

SIMON BROWN: Let’s shift our focus to the investments themselves – local versus offshore. Starting with local investments, the primary market lies offshore, particularly your private credit ventures in the UK. What does the local investment landscape look like?

DINO ZUCCOLLO: This year, the investment climate has certainly posed more challenges compared to client demand. Westbrooke currently functions across South Africa, the UK, and the USA. Over the past year, we’ve observed elections in all three regions where we invest, and even though interest rates are finally declining, they have persisted at elevated levels.

This scenario has resulted in limited earnings growth within many companies we’ve analyzed, particularly those with significant debt, as a considerable portion of cash flow goes towards servicing that debt rather than supporting growth.

Thus, finding asymmetric investment opportunities throughout the capital structure has not been straightforward. South Africa’s position has been somewhat polarized, where we faced one of the most challenging economic climates in Q4 of last year and Q1 of this year.

However, following the transitional government, we’ve seen a significant influx of entrepreneurs and capital back into the country. Our private debt funds are likely to benefit from this trend, as we are looking to provide senior debt, hybrid capital, or innovative mezzanine financing options. While our private debt funds experienced a quieter first half of the year, they have become markedly more active in the latter half.

Additionally, a focus locally has been on the 12B investment structure within the renewable energy domain. Over the last 18 months, we’ve invested approximately R450 million across 65 deals in this industry. Interestingly, many investors are pursuing opportunities not primarily due to load shedding concerns, but in anticipation of the 35% increase from Nersa this year. Entrepreneurs in South Africa are increasingly in search of stable and reliable electricity sources independent of the Eskom grid.

SIMON BROWN: That’s a great observation. I might reconsider installing solar panels at my house, particularly if Eskom continues to provide, as you’ve highlighted, expensive electricity. However, businesses may approach this differently. They recognize the value in green and cost-effective options, and there’s ongoing demand in that market, despite a potential decline in household installations. I assume you’re focusing more on corporate investments in this context?

DINO ZUCCOLLO: Indeed, the residential solar market is appealing, as those setups often include battery systems that are considerably more expensive than standard rooftop panels and equipment. This benefits asset managers as we can swiftly allocate more capital into these opportunities, whereas conventional grid-tied rooftop systems are generally cheaper.

However, as you mentioned, Simon, we are primarily concentrating on corporate investments, with businesses noting that even though the grid is electrified, it remains inconsistent. They experience long outages and are looking for a guaranteed price increase that is less than the stated 35%, along with greater reliability.

SIMON BROWN: Absolutely. The grid is aging. Even without load shedding, power outages are still a significant concern.

Turning to offshore markets, your large fund in the UK is involved in private credit funding. With interest rates declining, it appears unlikely that governmental rates will drop as sharply or as quickly as many anticipated a few months ago. Perhaps the upcoming Trump election could influence this. Nonetheless, this sector continues to flourish, driven by both business needs and client demand.

DINO ZUCCOLLO: Indeed, Simon. Our flagship UK fund, Westbrooke Yield Plus, is a secured private credit fund typically providing loans secured by real estate. This fund has seen substantial interest this year, with gross assets under management approaching £200 million, delivering returns of approximately 7% to 9% in sterling.

As you’ve noted, while interest rates are declining, which may result in lower fund returns, it’s essential to remember that investors tend to be more focused on cash returns as a spread over bonds or cash equivalents, and that spread remains robust. Additionally, we’ve transitioned about half of the loans in our portfolio to fixed-rate debt, providing a level of natural interest-rate protection.

We’ve also noted a spike in activity within our Hybrid Capital sector, which concentrates on preference shares and mezzanine financing. Our UK fund, managing about £40 billion, is fully invested across seven or eight opportunities. Consequently, we’re considering discussions with clients about the potential launch of a second hybrid capital fund next year.

Lastly, regarding the USA, our local team has significant expertise in real estate. We haven’t heavily engaged in equity real estate investments in the US for about three years. However, with falling interest rates, a favorable political climate, and a convergence of seller pricing expectations, we are finally identifying appealing investment opportunities in the real estate sector.

Next year, we will primarily focus on investments in residential, multifamily, and mobile-home parks, while we strategically re-enter the real estate market in the US, followed by developing a private credit capability similar to what our investors expect from Westbrooke in the UK.

SIMON BROWN: This sounds like a well-rounded plan.

We’ll wrap up our conversation here. Dino Zuccollo from Westbrooke Alternative Asset Management, I always appreciate your insights.

To listen to the complete MoneywebNOW podcast every weekday morning, you can find it here.

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