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SIMON BROWN: I’m in conversation with Dino Zuccollo from Westbrooke Alternative Asset Management. Dino, thank you for joining me. We often discuss various topics, and today we’re diving into alternative investments, particularly private credit and private equity. Based on our chats this year, it seems that the South African market has lagged behind in private equity and private credit, but it appears to be making significant strides.

DINO ZUCCOLLO: Thank you, Simon. I always appreciate our discussions. You’re completely correct. Looking at our typical clients here in South Africa – for context, Westbrooke aims to provide access to global alternatives or private markets – I’ve observed that most clients allocate between zero and maybe 5% to 10% towards alternatives. This year has seen a noticeable rise in demand and capital inflows into our alternative investment strategies and products.

To put it into perspective, we currently manage over R13 billion in assets for roughly 3,000 individual clients, around 120 wealth management firms globally, along with various local and international institutions.

As a result, one of the persistent themes this year has been the growing interest in alternatives. Interestingly, this reflects a global trend. Earlier this year, JP Morgan published their 2024 Global Family Office Report, which revealed that large family offices worldwide now allocate an average of 46% of their portfolios to alternatives, in contrast to just 26% dedicated to publicly traded stocks.

SIMON BROWN: There’s a clear attraction here. A part of it lies in the potential for returns, and part stems from the overwhelming influence of technology in global markets; while tech is beneficial, investors are eager for diversification. This diminishing correlation is vital. Although liquidity can pose challenges, effective investment management can lessen its significance.

DINO ZUCCOLLO: Absolutely, liquidity is indeed a consideration. You’re spot on; one of the key trade-offs in alternatives is that immediate capital access is not usually available.

I regard liquidity as a characteristic rather than a downside of alternatives. It helps investors avoid the traditional pitfall of buying high and selling low. Personally, I value being committed for a certain period, as it promotes more thoughtful long-term decision-making. That’s the first point.

The second point is that we surveyed our clients earlier this year about their reasons for allocating to alternatives. Surprisingly, one might think higher returns would be the top reason, but it ranked third.

The top two reasons were the advantages of low correlation and diversification, which aligns with your earlier comment, Simon. The South African market hasn’t differed much from US markets, where the count of listed companies has decreased over the past 30 years, even as market capitalization has grown.

SIMON BROWN: Shifting our focus to the investments themselves – local versus offshore. Let’s start locally. The primary market appears to be offshore, particularly your private credits in the UK. What does the local investment landscape look like?

DINO ZUCCOLLO: This year has certainly posed a more challenging investment environment compared to client demand. Westbrooke is currently operating in South Africa, the UK, and the USA. In the past year, we’ve seen elections occur in all three regions where we invest, and although interest rates are finally starting to decline, they have remained stubbornly high.

This scenario has resulted in limited earnings growth for many businesses we’ve analyzed, particularly those burdened with high debt, as a significant portion of cash flow is directed toward servicing debts rather than fostering growth.

Consequently, finding asymmetric investment opportunities across the capital structure has not been easy. In South Africa, the situation has been somewhat polarized. We encountered one of the most challenging economic environments in the last quarter of the previous year and the first quarter of this year.

However, following the transitional government, we’ve noticed a considerable return of entrepreneurs and capital to the country. Our private debt funds are likely to benefit from this trend, as we aim to provide senior debt, hybrid capital, or innovative mezzanine funding options. While our private debt funds had a quieter first half of the year, they have become significantly more active in the latter half.

Additionally, a local focus has been the 12B investment structure in the renewable energy sector. Over the past 18 months, we have invested approximately R450 million across 65 deals in this arena. Interestingly, many investors are looking to invest not just due to concerns over load shedding, but because of the expected 35% increase from Nersa this year. Entrepreneurs in South Africa are continually seeking stable and reliable electricity sources independent of the Eskom grid.

SIMON BROWN: That’s a fantastic insight. I may need to rethink installing solar panels on my home, especially if Eskom continues to provide, as you mentioned, costly electricity. However, businesses might see this from a different angle. They understand the value of green and cost-efficient alternatives, and there’s a consistent demand in that sector, despite a potential decline in household installations. I assume your focus is more on corporate investments in this context, respectfully.

DINO ZUCCOLLO: Absolutely, the household solar market is attractive, especially as those installations often come with battery systems, which can be expensive compared to rooftop panels and equipment. This situation is beneficial for asset managers, as we can deploy more capital into these opportunities quickly, whereas typical grid-tied rooftop systems tend to be less costly.

However, as you pointed out, Simon, our focus indeed lies on corporate investments, as businesses contend that while the grid is electrified, it remains unstable. They experience extended periods without electricity and are seeking a price increase that is less than the aforementioned 35%, while concurrently desiring greater reliability.

SIMON BROWN: I completely agree. The grid is aging. Even in the absence of load shedding issues, power outages continue to be a concern.

Regarding offshore markets, your significant fund in the UK centers around private credit. With interest rates declining, it seems likely that government rates won’t decrease as dramatically or swiftly as many expected a few months back. The upcoming Trump election could potentially influence that. Nevertheless, this sector continues to prosper, driven by business needs and client demand.

DINO ZUCCOLLO: Exactly, Simon. Our flagship fund in the UK, Westbrooke Yield Plus, is a secured private credit fund that generally offers loans secured against real estate. This fund has garnered significant interest this year, with gross assets under management approaching £200 million. It yields returns of about 7% to 9% in sterling.

As you noted, while interest rates are lowering, which may result in reduced fund returns, it’s important to remember that investors are usually more concerned with cash returns as a spread over bonds or cash equivalents. That spread remains intact. Moreover, we’ve shifted roughly half of the loans in the portfolio to fixed-rate debt, providing a level of natural protection against interest rate fluctuations.

We’ve also seen a jump in activity within our Hybrid Capital sector, which focuses on preference shares and mezzanine funding. Our UK fund, managing around £40 billion, is fully invested across seven or eight opportunities. Therefore, we aim to discuss with clients the possibility of launching a second hybrid capital fund next year.

Lastly, concerning the USA, our local team has substantial 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 landscape, and easing seller pricing expectations, appealing investment opportunities in the real estate market are finally presenting themselves.

We plan to concentrate primarily on residential, multifamily, and mobile-home park investments. Our strategy for the coming year includes cautiously re-entering the real estate sector in the US, followed by developing a private credit capability similar to what our investors now 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 perspectives.

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