The private asset class of Hybrid Equity continues to gain traction as the world grapples with market turmoil, uncertainty and volatility. And, when looking at its performance and the benefits of helping investors diversify their portfolios and mitigate risk, it comes as no surprise.
“For the last 10 years, research suggests that hybrid instruments have consistently outperformed all other asset classes – listed equity, debt, and others, offering attractive, risk-adjusted returns, which is one of the reasons investors have an affinity with the asset class,” says Mujaahid Hassan, Co-Head: Hybrid Equity, a division of Old Mutual Alternative Investments (OMAI), speaking ahead of the 19th annual AVCA Conference and VC Summit, the largest Africa-focused private capital gathering globally, happening in Cairo in May 2023.He says that Hybrid Equity is a mezzanine instrument that offers a mix of equity and debt and is used for deal-structuring, which, given the perceived complexity of the instrument, may make investors shy away from it at first. However, investors who observe the performance of Hybrid Equity over time often develop a strong appreciation for it.
According to a survey by the Southern African Venture Capital and Private Equity Association (SAVCA) and Riscura conducted in 2021, over a 10-year return comparison OMAI Hybrid Equity outperformed all asset classes at 17%, with the next best performer being the JSE All Share Index (ALSI) returning 10.9% in the period under review.
“Hybrid Equity offers a very attractive return and protects against the downside risk. Its performance provides an excellent balanced return, especially during volatile times, as we have experienced in the last 10 to 15 years,” says Hassan, adding that it has always delivered a stable return profile.
OMAI’s Hybrid Equity capability spans a successful track record of investing in companies in South Africa, including growth companies, and those with an “infrastructure flavour” such as healthcare, logistics, ports, energy and so on. It also has investment expertise and experience in deal-making in Africa. Since inception, the Hybrid Equity team has concluded over 31 transactions, totalling more than ZAR7.5 billion, (with 17 deals exited), and it shows an impressive track record of both risk and return, having never lost any capital for investors.
But how does it work to perform so well?
Hassan explains that Hybrid Equity aims to provide capital to companies in the middle of their growth cycle, often when traditional sources of funding are not available or too expensive. The asset manager structures its financing in a way that ensures its capital is protected, while still offering equity-like returns to investors.
Hassan says besides performance, one of its biggest drawcards is providing access to capital and flexibility in deal-making that doesn’t require management teams and boards to give up control of their businesses.
“Generally, the asset class existed for years, but wasn’t very well known and always funded the capital allocation gap. It’s becoming more popular now because of an increase in the type of assets or businesses that require this type of funding due to a shortage of risk capital in the market. So, it is an excellent option for shareholders not wanting to dilute but require capital to grow in general,” he says.
He adds that as global markets continue to grapple with uncertainty and volatility, Hybrid Equity helps to diversify portfolios and mitigate risk. Many of the world's largest asset managers are moving into the space because of this. Apollo in the USA and Australian investors have recognised the potential of this asset class, investing billions of dollars in it since 2018.
“In addition, hybrid instruments are proving particularly advantageous as international investors increasingly explore investment opportunities in Africa,” says Hassan. “The demand is among high-growth businesses, capital-intensive businesses, and infrastructure in general, which is why renewable energy is a big attraction.”
Hassan says that because Africa requires large amounts of infrastructure investment, a substantial demand for capital from the market exists. Outside traditional infrastructure, opportunities exist in critical sectors such as food, health care, and logistics.
For such intensive capital needs, hybrid equity is advantageous for several reasons. It is ideal for niche opportunities that need to be better covered - (i) for borrowers - shareholders wanting to avoid ownership dilution; (ii) for investors - diversification to existing balanced portfolios; and resilient returns in a low-growth and volatile market.
Hybrid Equity as an investment option extends beyond its strong performance record. It also provides a way to promote transformation and gender equality through its ability to finance and structure B-BBEE and women-empowered investment deals which are often deemed too risky by traditional lenders. In this way, it supports the United Nations’ Sustainable Development Goals of reducing inequality as well as gender parity, which are key issues in South Africa. The country has the highest inequality in income distribution score in the world, as measured by the Gini index.
Hassan says the UN has a target to achieve these goals by 2030, so there is an urgency for impact-minded investors to act now.
“Hybrid equity is a useful asset class for companies looking to raise capital for expansion. Investors who may not be familiar with the asset class need not worry - they are guided through the complexity of the structure,” says Hassan.
With hybrid equity and mezzanine instruments providing attractive benefits for long-term investors on the African continent, it's difficult to find a reason not to fall in love with this asset class.