It is time to rethink your portfolio status quo. Cash rates are next to zero and are not changing for years. The capital in other defensive asset classes is also failing to keep pace with inflation and offer any correlation benefits against volatility.
With bond yields anchored near zero and bound by central banks and trend economic growth moderating due to population dynamics and productivity issues, portfolios will need to pivot away from traditional bonds and equities.
Income is still likely to be generated from large, stable listed equities and higher weights to investment grade credit portfolios.
But investors will also need to increasingly consider riskier investments such as illiquid investments in real assets and private equity and smaller companies and start-ups.
These sectors have favourable dynamics along with an ability to innovate and generate internal rates of return independent of prevailing economic growth rates.
Infrastructure and real estate are sectors that, apart from a few notable exceptions, tend to be dominated by private companies and unlisted funds rather than those in the listed markets.
They are likely to continue to benefit from central bank commitments to keep long term bond yields low and stable, which should see capitalisation rates continue to slowly compress and support returns.
Increasingly, listed infrastructure has progressively been squeezed into a few small areas including airports, regulated utilities, and toll roads.
While there will undoubtedly be opportunities in the listed infrastructure space over the next few years, it is most likely that the majority of opportunities in new infrastructure across the economy will be delivered and owned by unlisted funds and private capital.
Real estate investment is starting to recover as construction in Victoria resumes towards more normal levels of activity and the Home Builder program supports detached building activity in most states.
While the resumption of immigration support is difficult to judge, natural population demographics, urban renewal, new metro lines and road infrastructure will continue to support on-going dwelling activity and returns to private investors.
Portfolios will also need to add more private equity style funds and specific deals to deliver capital returns.
Investing in private equity has long been a source of additional return to sophisticated investors. Private capital markets have become so deep over the past decades that businesses are staying in private hands much longer than has traditionally been the case.
When a business is in private hands, owners have the advantage of being able to take a longer term perspective on initiatives and investment decisions and are less likely to focus on short term outcomes as is often the case in listed markets.
This is an area where experience counts and choosing the right private equity manger to invest with is critical in determining the prospects of generating a decent capital return.
The money flowing into venture capital start-ups has increased 10-fold over the past 7 years in Australia. Start-ups tend to be at the forefront of innovation – particularly in sectors such as technology and health sciences. Some of the most talented graduates are now choosing to join start-ups over larger traditional firms.
Big, listed companies often struggle to innovate as many are not good at turning ideas into actions, particularly when they are game changing and aimed at disrupting their very business model.
Look no further than Kodak, which invented the handheld digital camera only to shelve it to protect their existing business. Start-ups embrace failure and pivot quickly, learning new ways to do things which is at the heart of successful innovation.
The Australian government has already enacted several initiatives to support start-ups including the Early Stage Venture Capital Limited Partnership provisions designed to provide tax incentives for funds investing in start-ups and additional concessions around employee share plans. All levels of government will need to continue to look for ways to connect innovative entrepreneurs with supportive private capital.
The amount of illiquid investments you should have in your portfolio is a personal decision. One size does not fit all. Every single investor is different.
Endowment funds, which have long-term investment horizons, have the capacity to withstand short term volatility and hold much higher levels of illiquid investments.
Not-for-profit organisations and families that rely on income and the ability to sell securities in order to fund activities in retirement or the provision of services prefer a higher level of liquidity in their portfolios.
Access to private deals will be an important requirement for high net worth families where they are investing for multiple generations and have a capacity to take on more illiquidity risks and use their connections to add value to their holdings.
It is fair to assume that – all things being equal – investors would prefer a liquid investment over an illiquid one as it gives more portfolio flexibility.
However, investment returns do tend to be higher in the illiquid private investments and they offer greater diversification potential to more traditional listed markets.
There is little doubt that investors, looking for the next wave of decent and consistent investment returns, will need to be bolder and a bit more creative when they next sit
down to design their optimal portfolio mix.