We saw this with the latest performance displayed by large institutional investors: private placements came up against the surge in interest rates. The fact that they have recently become available to small investors in an expanded version does not detract from their relevance.
Teachers’ performance in 2023 has caught everyone’s attention, with its one-year return of 1.9%, far below that of its benchmark index of 8.7%. The manager cited strong returns in public equities and debt securities offset by losses in infrastructure and real estate. For its part, the Caisse de dépôt et placement du Québec ended 2023 with a weighted average return of 7.2%, below that of its reference portfolio at 7.3%. But with, in the background, private investments showing a meager return of 1% over one year, far below the 10.5% jump of a benchmark index.
In its interesting September 2023 report, the International Organization of Securities Commissions (IOSCO) recalls that this large family of investments has long been supported by favorable macrofinancial conditions, stimulated in particular by an accommodating monetary policy combining a prolonged period of low rates. interest rates and quantitative easing by central banks. Since then, economic and geopolitical conditions have become unfavorable, with the return of inflation and a certain normalization of interest rates.
Multiple risks
On a cyclical basis, IOSCO emphasizes that these setbacks create the risk, for portfolios, of an increase in payment default situations in the medium or long term. Also that of the drying up of this source of financing, formerly low cost, having been entitled to more permissive regulation than for the more regulated financial sectors, particularly since the financial crisis of 2008. We are therefore talking about a refinancing risk, especially if the high rate environment continues beyond 2024.
A risk which can lead to another, that of conflicts of interest between private investment and credit funds and equity funds, if the rise in interest rates fuels greater growth in financing through initial public offerings. savings and by special purpose acquisition company (SAVS, or SPAC in English). “Large institutions and [les grands] pension funds are major participants in both public and private markets, both in the banking and non-banking sectors,” she emphasizes. IOSCO talks about potential conflicts that could lead to inefficient capital allocation.
On a more fundamental basis this time, the private placement market has the particularity of being more opaque or less transparent than public markets. IOSCO highlights an information asymmetry between the two. Their evaluation is generally done on a quarterly or even annual basis, and they are little or not covered by rating agencies.
These are investments with little or no liquidity, faced with the narrowness or even rigidity of the secondary market, whose performance is influenced by the use of financial leverage, innovation in sources of leverage and, potentially, the use of short selling.
Finally, IOSCO raises a risk of transmission to the public markets that is all the greater since alternative investments have recently become accessible to the so-called “retail” market populated by small investors.
Performance on target
That said, prior to this interlude, private placements generated significant returns on average. Between the first quarter of 2020 and September 2022, the aggregate performance of a public market benchmark generated an annualized return of 18.8%, compared to an 84% increase in net asset value. private.
“Some studies have also shown that private placements have performed well during periods of turbulence over the past two decades,” the organization adds. They would have performed better during the technology stock crash of 2001 and the financial crisis of 2008-2009. Other studies highlight that they have seen their multiple erode less than that of benchmark stock indices during periods of tension, we read in the IOSCO report.
Hence interest remains justified in these investments and their extended family despite the poor performance displayed by institutional investors.
Liquid alternative funds
For small investors, a segment has appeared on their radar. Until now reserved for institutional investors and qualified investors, alternative investments have been accessible to them since January 2019. The expanded version, called “liquid” (liquid alt, in English), these funds are added to the range of vehicles also composed of traditional investment funds and classic exchange-traded funds (ETFs). Designed to mitigate risk, or even to be uncorrelated with benchmark stock indices, they therefore help to broaden the choice of investment strategies.
Their approach is similar to that of hedge funds (hedge funds), and their liquidity, to that of ETFs. However, management fees will be closer to the former. They are presented as investment products providing exposure to non-traditional asset classes and using hedging strategies aimed at having little or no correlation with stock market returns. They evoke a potential return equivalent to that of a diversified fund, but with much less volatility, or ultimately an absolute return not linked to a stock market index.
As for the comparison of performances, the weighted Scotiabank Alternative Mutual Fund index showed an increase of 5.3% in 2023, compared to 8.1% for the S&P/TSX and 6.7% for the DEX Universe bond index. At the end of April, the weighted index showed an increase of 4% since the start of the year, and its Equity version, 5.6%, compared to an increase of 3.6% in the S&P/TSX.