Foto: HolidayExtras, Professional Images
. HolidayExtras Credit: Professional Images
The Mexican Pension funds, known as AFOREs maintain investments in structured instruments (CKDs, CERPIs and structured debt) for 12.786 billion dollars, which are 5.9% of the assets under management (216.716 billion) at the end of January according to CONSAR’s numbers.
This figure means that the AFOREs have 89% of the issues of CKDs and CERPIs and the remaining 11% other entities participate as insurers and pension funds (not AFOREs), among others.
From a total of 10 AFOREs, the 5 AFOREs that maintain investments of more than 1 billion dollars concentrate 85% (10.786 billion) of the investments in CKDs, CERPIs and structures debt. These 5 AFOREs in order of importance are: AFORE XXI-Banorte (3.42 billion), Citibanamex (2.90 billion), Sura (1.85 billion), Profuturo (1.5 billion) and PensiónISSSTE (1.21 billion). These amounts only correspond to the money called, so if the committed money is considered, they increase almost double (+ 49%) at the end of January 2020.
Comparing the investments of the AFOREs of this table with respect to the PREQIN Special Report: The Private Equity Top 100 de febrero de 2017 (page 9), AFORE XXI-Banorte has to be in place 87. Although there is a difference of three years in the comparison since the PREQIN report is to 2017 and the investments that are taken from the AFOREs are to January 2020, it can be concluded that the investments of the largest AFOREs in local and global private capital place them in the top 100 of private equity investors.
Another interesting fact is that only 5 of the 100 largest private equity funds (pages 4 and 5) have been issuers of CERPIs as is the case of the Blackstone Group (place 2 in the PREQIN report), KKR (place 3), HarborVest Partners (place 14), Lexington Partners (place 17) and Partners Group (place 21) which presents the potential for other international issuers to arrive in Mexico.
In total there are 75 issuers of the 114 CKDs and 32 CERPIs. The most important issuer is Infraestructura México with 1.5 billion dollars of committed resources oriented to the infrastructure sector; followed by Credit Suisse with 3 CKDs from the sector related to mezanine debt and resources committed for 1.4 billion. In the third position is Mexico Infrastructure Partners with 4 CKDs and 2 CERPIs that add up to 1.3 billion dollars of committed resources oriented to the infrastructure sector.
When reviewing investments in CKDs and CERPIs of the last 10 years, the growing interest of AFOREs in investing in private equity can be seen in the graph. Although a decrease in the figures is observed in 2016, this is due to the fact that in the information that CONSAR reports from this year, it separated the investments in the Fibras (mexican REITs) from the structured ones (where since then only the CKDs, CERPIs and the structured debt).
Investments in the last three years in CKDs and CERPIs have been on average of 2.241 billion dollars per year, so expecting a growth of 2.000 billion in 2020 is conservative given the average growth of previous years. This expected growth could be more in CERPIs than in CKDs given the interest observed in them since 2018.
Pixabay CC0 Public Domain. ¿Existe la posibilidad de un escenario ‘melt-up’ en los mercados estadounidenses?
In an article published in March 2019, we described the possibility of a melt-up scenario if world central banks were to have a heavy hand on their asset purchases and liquidity injections. A melt-up could be characterized by too much liquidity chasing too few investable assets, thereby leading to sharp upward movements in the prices of stocks and bonds. Such an outcome would most probably impact primarily the assets of leading US companies (an integral part of the main US financial indices).
Back then, this eventuality seemed unlikely in light of the restrictive monetary policy carried out by the Fed. This institution was reducing its balance sheet, by withdrawing the liquidity it had made available during its asset purchase or ‘Quantitative Easing’ (QE) programs 1, 2 and 3. This monetary constraint coupled with the interest rate hikes of 2018 made the melt-up scenario a very distant possibility.
However, since March 2019, the Fed’s monetary policy has been completely reversed. This has led to a significant increase in asset prices. Three interest rate reductions, massive liquidity injections in the US Repo market, sprinkled with a dose Treasury bond purchases (not to be called QE4) have all gone a long way to reassure the financial world, unsettled by events barely a year earlier. In addition, investors, sidelined by the Fed’s 2016 to 2018 monetary policy, have started to come back and buy US assets.
To add to this monetary policy reversal, the financial health of large American corporations has contributed to the rise in US markets. Stock prices have been driven higher on the back of generous dividend payouts as well as share buy backs, sometimes both. Furthermore, cash rich corporations have lowered their external borrowing needs, thereby reducing their bond footprint in capital markets. The dwindling quantity of stock and bonds of American bluechips, faced with strong investor demand, explains in part their positive performance in 2019. This also bodes well for their potential upward price progression moving forward.
One potential ‘cloud on the horizon’ which could upset US financial markets in the future is the significant federal deficit situation. This is just adding to the nation’s colossal debt pool year after year. In spite of this, the appetite for US Treasuries still remains strong.
Why is that? Aside from the Fed’s current asset purchase program, one explanation is the lack of sovereign debt elsewhere in the world, which is driving international investors to US Treasuries. The European Central Bank (ECB) for example owns 40% of Eurozone sovereign bonds. This institution is mechanically driving out its own local investors (who need to hold government bonds) to seek them elsewhere in the world. In Japan, the situation is even worse.
Another reason relates to the negative interest rate policy being applied in Europe and Japan. Capital from these regions is desperately seeking positive returns. The opportunity of investing in the United States on any US Dollar asset including government debt is increasingly being chosen. US capital markets are therefore being supported from international capital flows coming from abroad.
The recent rise in US markets can be attributed to the change in the Fed’s monetary policy, the economic health of large US corporations, as well as incoming capital flows from overseas. What could then be said about the possibility of a melt-up scenario?
As the world’s reserve currency, the US Dollar has a very specific advantage. It remains the safe haven place to go to when faced with significant world uncertainty. On top of this, US equity and bond markets are the only financial markets deep enough to accommodate a large portion of international savings. (Traditional safe havens such as Gold or the Swiss Francs are far too small to absorb these potential capital flows).
If ever the world was exposed to significant geopolitical, health, or financial risks, then a craze could appear from world investors to acquire US Dollar currency and assets. In such a scenario, the melt-up could become much more than a hypothetical possibility.
Column by Steven Groslin, Executive Board Member and Portfolio Manager at ASG Capital
The U.S. stock market rallied into the third week of January then dropped sharply at month end as fears that the spreading coronavirus (nCoV) would reduce growth in China and eventually other countries. U.S. stocks closed flat for the month while Chinese markets were closed for the final week of the Lunar New Year. Earnings releases are in full swing and the U.K. has left the EU. The world waits.
Our firm’s research theme for the next decade is saving Planet Earth, helping people and creating potential…saving the planet by reducing/eliminating plastic and focusing on the impact of climate change and on companies that are finding new solutions. Renewables, including wind, solar, battery storage and building infrastructure for transmission are the areas we want represented by some portfolio companies.
One of the Gabelli stock ‘picks’ in BARRON’s 2020 Roundtable Part 3 published in the January 27 issue that is directly impacting climate change is Orange, Connecticut based sustainable energy company Avangrid Inc. (AGR). AGR has a regulated utility business with a growing $10 billion rate base that provides a tailwind to earnings and a rising dividend.
The second part of AGR is the Avangrid Renewables business, a major factor in solar and wind that owns and operates a portfolio of renewable energy generation facilities across America. In December, Connecticut awarded an Avangard partnership a 20-year contract to provide 14% of the state’s electricity with renewable energy. Spanish utility Iberdrola (IBE), owns over 250 million of the 310 million AGR shares outstanding and is a potential catalyst for an M&A deal.
Another Gabelli BARRON’S ‘pick’ is clean energy project operator NextEra Energy Partners (NEP), which is also an attractive opportunity in renewables.
We feel there should be a greater need for companies to allocate capital in the new year, as opportunities present themselves, there will be a headwind for more deal activity.
Column by Gabelli Funds, written by Michael Gabelli
__________________________________
To access our proprietary value investment methodology, and dedicated merger arbitrage portfolio we offer the following UCITS Funds in each discipline:
GAMCO MERGER ARBITRAGE
GAMCO Merger Arbitrage UCITS Fund, launched in October 2011, is an open-end fund incorporated in Luxembourg and compliant with UCITS regulation. The team, dedicated strategy, and record dates back to 1985. The objective of the GAMCO Merger Arbitrage Fund is to achieve long-term capital growth by investing primarily in announced equity merger and acquisition transactions while maintaining a diversified portfolio. The Fund utilizes a highly specialized investment approach designed principally to profit from the successful completion of proposed mergers, takeovers, tender offers, leveraged buyouts and other types of corporate reorganizations. Analyzes and continuously monitors each pending transaction for potential risk, including: regulatory, terms, financing, and shareholder approval.
Merger investments are a highly liquid, non-market correlated, proven and consistent alternative to traditional fixed income and equity securities. Merger returns are dependent on deal spreads. Deal spreads are a function of time, deal risk premium, and interest rates. Returns are thus correlated to interest rate changes over the medium term and not the broader equity market. The prospect of rising rates would imply higher returns on mergers as spreads widen to compensate arbitrageurs. As bond markets decline (interest rates rise), merger returns should improve as capital allocation decisions adjust to the changes in the costs of capital.
Broad Market volatility can lead to widening of spreads in merger positions, coupled with our well-researched merger portfolios, offer the potential for enhanced IRRs through dynamic position sizing. Daily price volatility fluctuations coupled with less proprietary capital (the Volcker rule) in the U.S. have contributed to improving merger spreads and thus, overall returns. Thus our fund is well positioned as a cash substitute or fixed income alternative.
Our objectives are to compound and preserve wealth over time, while remaining non-correlated to the broad global markets. We created our first dedicated merger fund 32 years ago. Since then, our merger performance has grown client assets at an annualized rate of approximately 10.7% gross and 7.6% net since 1985. Today, we manage assets on behalf of institutional and high net worth clients globally in a variety of fund structures and mandates.
Class I USD – LU0687944552
Class I EUR – LU0687944396
Class A USD – LU0687943745
Class A EUR – LU0687943661
Class R USD – LU1453360825
Class R EUR – LU1453361476
GAMCO ALL CAP VALUE
The GAMCO All Cap Value UCITS Fund launched in May, 2015 utilizes Gabelli’s its proprietary PMV with a Catalyst™ investment methodology, which has been in place since 1977. The Fund seeks absolute returns through event driven value investing. Our methodology centers around fundamental, research-driven, value based investing with a focus on asset values, cash flows and identifiable catalysts to maximize returns independent of market direction. The fund draws on the experience of its global portfolio team and 35+ value research analysts.
GAMCO is an active, bottom-up, value investor, and seeks to achieve real capital appreciation (relative to inflation) over the long term regardless of market cycles. Our value-oriented stock selection process is based on the fundamental investment principles first articulated in 1934 by Graham and Dodd, the founders of modern security analysis, and further augmented by Mario Gabelli in 1977 with his introduction of the concepts of Private Market Value (PMV) with a Catalyst™ into equity analysis. PMV with a Catalyst™ is our unique research methodology that focuses on individual stock selection by identifying firms selling below intrinsic value with a reasonable probability of realizing their PMV’s which we define as the price a strategic or financial acquirer would be willing to pay for the entire enterprise. The fundamental valuation factors utilized to evaluate securities prior to inclusion/exclusion into the portfolio, our research driven approach views fundamental analysis as a three pronged approach: free cash flow (earnings before, interest, taxes, depreciation and amortization, or EBITDA, minus the capital expenditures necessary to grow/maintain the business); earnings per share trends; and private market value (PMV), which encompasses on and off balance sheet assets and liabilities. Our team arrives at a PMV valuation by a rigorous assessment of fundamentals from publicly available information and judgement gained from meeting management, covering all size companies globally and our comprehensive, accumulated knowledge of a variety of sectors. We then identify businesses for the portfolio possessing the proper margin of safety and research variables from our deep research universe.
Class I USD – LU1216601648
Class I EUR – LU1216601564
Class A USD – LU1216600913
Class A EUR – LU1216600673
Class R USD – LU1453359900
Class R EUR – LU1453360155
Disclaimer:
The information and any opinions have been obtained from or are based on sources believed to be reliable but accuracy cannot be guaranteed. No responsibility can be accepted for any consequential loss arising from the use of this information. The information is expressed at its date and is issued only to and directed only at those individuals who are permitted to receive such information in accordance with the applicable statutes. In some countries the distribution of this publication may be restricted. It is your responsibility to find out what those restrictions are and observe them.
Some of the statements in this presentation may contain or be based on forward looking statements, forecasts, estimates, projections, targets, or prognosis (“forward looking statements”), which reflect the manager’s current view of future events, economic developments and financial performance. Such forward looking statements are typically indicated by the use of words which express an estimate, expectation, belief, target or forecast. Such forward looking statements are based on an assessment of historical economic data, on the experience and current plans of the investment manager and/or certain advisors of the manager, and on the indicated sources. These forward looking statements contain no representation or warranty of whatever kind that such future events will occur or that they will occur as described herein, or that such results will be achieved by the fund or the investments of the fund, as the occurrence of these events and the results of the fund are subject to various risks and uncertainties. The actual portfolio, and thus results, of the fund may differ substantially from those assumed in the forward looking statements. The manager and its affiliates will not undertake to update or review the forward looking statements contained in this presentation, whether as result of new information or any future event or otherwise.
Foto: Pixnio CC0. Entre CKDs y CERPIs llegó el capital comprometido a 2.394 millones de dólares en 2019
The year of 2019 ended with an issue of 13 CERPIs and 5 CKDs. The committed capital placed in 2019 amounted to 2.39 billion dollars of which 28% (659 million) have been called. The amount placed in CERPIs was 84%, while in CKDs it was 16% showing interest in diversifying global institutional investors in Mexico. This appetite for CERPIs could continue in 2020. Own estimates project that in 2020 commitments could be placed for 2 billion dollars.
The placement of 18 CKDs and CERPIs in 2019 is within the range of issuance that were made in 2015, 2016 and 2017 where they were placed 19, 14 and 15 respectively, although it means almost half of the 38 issuance that were made in 2018 (20 CKDs and 18 CERPIs). This record was because of the change in CERPIs that allows global investment in private capital.
In CERPIs the committed capital was 2.01 billion through 13 new funds. 11 funds of funds were placed, where the issuers were in order of importance: Harbourvest, Blackstone, Actis Gestor, Lexington Partners and Blackrock; there was also one of private capital (Spruceview) and another of energy (Mexico Infrastructure Partners).
Regarding CKDs, the committed capital was 383 md through 5 new funds in 2019. Two issues of mezzanine debt were placed (both from Altum Capital), one from real estate (Walton Street Capital), one from private equity (ACON) and another of energy (Thermion Energy).
The main issuer was Harbourvest Partners with a CERPI of 870 million dollars in committed capital, while in number of issues Blackrock placed 7 CERPIs in December which together add commitments for 199 million dollars.
The 144 CKDs and CERPIs signify commitments for 25.525 billion of which 76% are issues of 112 CKDs and 24% to 32 CERPIs. Of this amount 54% has been called.
In 2018, 18 CERPIS were placed, which meant commitments for 3.92 billion, while in 2019 there were 13 and the amount committed was 2.01 million dollars.
Currently, the investments in local (CKDs) and global (CERPIs) private equity is 6% of the assets under management of the AFOREs at the end of December and in resources to call is an additional 5%.
Given the amounts placed in 2018 (3.917 billion) and 2019 (2.011 billion), reaching 2.000 billion in 2020 is achievable. This amount would be calling 400 million dollars aprox (20%) that for the 211.917 billion in assets under management of the AFOREs at the end of December would mean 0.2%.
Photo: PxFuel CC0. Riesgo en Inversiones Privadas, Parte 3: “¿Deberíamos alocar a fondos privados de mercados emergentes?”
Don’t get me wrong! Having a proper allocation to emerging market equities and fixed income is probably a very good decision, but illiquid, private investments are an entirely different story in terms of emerging market risk and reward considerations.
Really smart people build portfolios with emerging market allocations to private investments that mimic emerging market allocations in their public positions. But these two allocations should be viewed entirely differently given the illiquid nature of private investments. Risk assessment should not be disregarded as much as it is in emerging market investment decisions. One must be paid for higher risk tolerances with outsized relative returns.
The trouble is that in the private space, outsized emerging market returns have been few and far between, but their associated risk profiles are clearly greater in almost every direction one looks. Just think about Abraaj’s fraud leading to their collapse, or the Chinese government making high profile private investment managers disappear only to be replaced by the government’s own proxies, or currency shocks and fluctuations in Latin America driven by uncertain political climates.
If you knew in advance that these events would take place would you still invest in these opportunities? Of course not! And since we do not have the benefit of hindsight when looking to allocate to future opportunities, we can only imagine what might go wrong and then assess our comfort level with that list of potential factors.
Developed market private funds, in general, just don’t have the same elevated risk profiles and deliver relatively similar returns. So why do really smart families and institutions continue to allocate to private emerging market investments? Clearly, they view the risk profile to be tolerable and view the relatively muted returns to be acceptable. It seems as if it is just more important to check the box and allocate some portion of their portfolio allocation to this area. This behavior is a part of a portfolio allocation theory that in practice just doesn’t assign the needed weight to most of the associated risks.
We have a different view. We think there is a better way to allocate to private investments. Allocations should be based first and foremost on mitigating risk and choosing high quality investments with the lowest relative risk profiles. If a stable, thematically relevant, risk mitigated private investment fund based in the US delivers a decent return potential, then one should not allocate to riskier emerging market opportunities that do not provide truly outsized returns. A safer investment environment with a sound strategy should outweigh the check the box allocation exercise.
Foto: Casa Blanca. A Year of Living Less Dangerously
The publication last week of the U.S. — China trade deal and the final macro numbers for 2019 should set the stage for healthy economic performance and stronger market sentiment in China in 2020, but the risk of a return to tense relations between Washington and Beijing looms over 2021 and beyond.
The “phase one” trade deal should create a truce in the tariff dispute. President Trump appears to believe that declaring victory over China will boost his re-election prospects, and it seems that Xi Jinping is willing to cooperate. There are no signs, however, that the Trump administration will scale back its willingness to confront Xi on a range of issues, especially those related to technology competition. The resulting political tension, as well as the deal’s unrealistically high purchasing targets, could break the truce in 2021.
Headline writers will continue to focus on slower year-on-year (YoY) growth rates in China, but most investors understand that the base effect allows the economy to expand by far more today than at the faster speeds of a decade ago. This creates greater opportunity for Chinese firms selling goods and services to local consumers, as well as for investors in those firms.
Assessing the trade deal
The trade deal will likely accomplish Trump’s main objective: creating the appearance of an important accomplishment as the election approaches. But the deal did not create effective new solutions to most of the trade-related problems cited when the tariffs were launched.
On intellectual property issues, a Trump administration priority, the deal accomplishes little. Many specific steps in the agreement were previously announced by Beijing, and the new steps are incremental. Most importantly, the agreement does not require China to make legal and structural changes needed to ensure compliance. There also were no significant new commitments on exchange-rate management or industrial policy.
Overall, this deal is not a significant improvement over the Trans-Pacific Partnership (TPP) program cancelled by the Trump administration, or the draft bilateral investment treaty (BIT) with China that was negotiated by the Obama administration but abandoned by Trump.
The deal also leaves in place much of the tariff burden already borne by American companies and consumers. “Even after the deal goes into effect, Trump’s tariffs will still cover nearly two-thirds of all U.S. imports from China,” according to Chad Brown of the Peterson Institute for International Economics. “He will also have increased the average U.S. tariff on imports from China to 19.3%, as compared to 3%” before the dispute began.
The 2020 deal upside
There are important positive consequences of the deal. I think Trump wants the deal to succeed to boost his re-election prospects—and Beijing seems willing to cooperate—so the trade truce is likely to hold at least through November. By significantly reducing the risk of the tariff dispute escalating into a full-blown trade war, the deal is likely to boost sentiment among Chinese companies and global equity and bond investors who are thinking about increasing their China exposure.
The 2021 deal risks
Two things could derail the trade truce next year. First, there are as yet no signs that the Trump administration will scale back its campaign to confront Xi on a broad range of issues, especially those related to technology competition. By next year, it is possible that Xi may reconsider whether cooperating with Trump on trade makes sense at a time when Washington is taking a confrontational approach on most other issues. Of course, if there is a new American president next year, Beijing will wait to see how that administration approaches the relationship with China.
My second concern is that the deal calls for what I believe are unrealistically large increases in Chinese imports from the U.S. According to the terms of the deal, in 2020, China’s overall imports from the U.S. should increase by 50% over the 2017 baseline, and then increase by another 20% YoY in 2021, for a total two-year increase of US$200 billion. This includes increases over the 2017 baseline of 52% for agricultural and 257% for energy imports in 2020, and then further increases in 2021—19% YoY for agriculture and 60% YoY for energy.
There is, of course, room for the Trump administration to play with the numbers. The text of the deal states, for example, that aircraft orders as well as deliveries will count toward the Chinese commitment, so Beijing could sign a lot of contracts for possible later delivery to inflate the numbers. But this kind of thing will only work if both governments cooperate. As U.S. Trade Representative Robert Lighthizer acknowledged, “This deal will work if China wants it to work.” And if, after the election, the Trump (or a different) administration also wants it to work.
As an aside, the deal text includes a long list of goods that are targeted for increases to hit China’s import targets. Some of them are puzzling. Iron and steel, for example, are on the list, even though in 2017, the U.S. exported less than US$500 million worth of that to China. Also on the list: “perfumes and toilet waters”; “preparations for use on the hair”; and “tea, whether or not flavored.” (Yes, China is the world’s largest producer of tea.)
Yes, Virginia, China’s growth rate is decelerating
As we switch to the topic of China’s economic health, I want to start by addressing the headline writers who pointed out that last year’s GDP growth rate was the slowest since the Tang dynasty. I’d like to suggest another perspective.
China’s growth has been decelerating gradually for over a decade, but the size of the economy (the base) has expanded quite a bit. GDP growth was 9.4% a decade ago, but the base for last year’s 6.1% GDP growth was 188% larger than the base 10 years ago, meaning the incremental expansion in the size of China’s economy in 2019 was 145% bigger than it was at the faster growth rate a decade ago. In other words, there was a greater opportunity last year for Chinese companies selling goods and services to Chinese consumers than compared to 10 years ago, when the GDP growth rate was much faster.
I expect that the YoY growth rates of most aspects of the Chinese economy will continue to decelerate, and as long as that deceleration continues to be gradual, I do not expect panic from the Chinese government, or from investors.
Modest easing of monetary policy
A clear sign that the government has been relatively comfortable with the health of the economy is that there has been only modest easing of monetary policy. I expect that approach to continue in 2020. The focus will be on stabilizing growth in response to slower global demand, not an effort to reaccelerate growth.
As was the case last year, aggregate credit outstanding (augmented Total Social Finance) will likely expand just a bit faster than nominal GDP growth, but not to the extent in past years.
Derisking to continue
I also anticipate that the government will continue to take steps to reduce financial sector risks this year. As I wrote last month, I expect further consolidation of smaller banks. I also expect a continuation of last year’s experiments of selected defaults by state-owned and private firms, in an effort to push investors to price risk. I do not expect the government to relax their tight controls over off-balance-sheet (shadow) financial activity.
Likely to remain the world’s best consumer story
China’s consumers drove economic growth again in 2019, and I expect that to continue in 2020. Last year was the eight consecutive year in which the consumer and services (or tertiary) part of GDP was the largest part, and consumption accounted for 58% of GDP growth.
Strong income growth continues to fuel the consumer story. Nominal per capita disposable income rose 9.1% in 4Q19, up from 8.5% a year earlier and 9% two years ago.
Household consumption spending rose 9.4% YoY in 4Q19, compared to 8% a year earlier and 6.1% two years ago. This metric for consumer spending, which is published quarterly, includes a wider range of services compared to the retail sales data. Services now account for about 46% of household consumption.
Pork prices should ease, so inflation shouldn’t be a big problem
An outbreak of African Swine Fever decimated China’s hog population last year, which pushed up the price of pork—the country’s primary protein source. Headline CPI rose to 4.5% last month and will remain elevated this year, driven entirely by pork. The disease seems to be fading and pork prices stabilized recently, although there is likely to be another spike in January, as the Lunar New Year holiday boosts demand. Core inflation, which was 1.4% YoY in December, should remain low, and I do not expect inflation to have a significant impact on consumer sentiment.
Modest improvement in CapEx likely
Investment spending by private firms was weak last year, largely due to uncertainty resulting from the Trump tariff dispute. The signing on Wednesday of the trade deal is likely to reduce that uncertainty, leading to a modest pickup in CapEx spending. Only modest, because the risk of a return to higher U.S. — China tensions in 2021 remains.
Pxfuel CC0. Climate Change and Planet Earth, Focus Theme for the 2020s
The U.S. stock market finished at an all-time high in December to end a strong quarter and an outstanding year. The advance reflected U.S. consumer confidence and spending built on the wide availability of jobs, rising incomes and easier financial conditions. Steady consumer spending supports moderate economic growth and is a buffer against the trade related manufacturing malaise.
Events to unfold during 2020 include trade war dynamics, the U.S. presidential election, and the rapidly evolving interconnectivity of Climate Change with our Planet and People and its effect on investment policy and sustainable profits.
Our focus theme for the 2020s is Climate Change and Planet Earth. We have integrated the analysis of environmental impacts into our broader investment process and seek to identify companies whose businesses may be threatened over a long time horizon by one of the three W’s – weather, water and waste. More importantly, we are looking for companies that will benefit from increased investment toward discovering solutions for today’s urgent environmental issues.
The conditions for an increase in global deal activity in 2020 are now in place. Strategic corporate buyers need deals to grow their top and bottom lines and industry consolidations are a catalyst for transactions. The value of announced deals was $3.8 trillion globally in 2019, down slightly from 2018, per Dealogic. Cross-border deals dropped 25%, but U.S. ‘mega’ deals topped the overall list and U.S. M&A was up 6% to $1.8 trillion boosted by the giant UTX/RTN deal. Trade, economic, and Brexit headline risks are fading, rates are low, and private equity shops now have about $2.4 trillion in cash for M&A, per Prequin. As a footnote, patient Unzio got their 5,100 yen ask price from buyout firm Lone Star. Activist investors were catalysts for 2019 deal activity and boardroom changes as 464 U.S. companies were targets through mid-December per Activist Insights. We expect M&A activity to pick up for small, mid-sized and microcap companies during 2020 as strategic and private equity buyers take a closer look at the attractive intrinsic values versus the market prices of these companies. We have consistently applied our fundamental-value stock selection process since 1977 and believe the recent trend toward value will broaden during 2020.
Column by Gabelli Funds, written by Michael Gabelli
__________________________________
To access our proprietary value investment methodology, and dedicated merger arbitrage portfolio we offer the following UCITS Funds in each discipline:
GAMCO MERGER ARBITRAGE
GAMCO Merger Arbitrage UCITS Fund, launched in October 2011, is an open-end fund incorporated in Luxembourg and compliant with UCITS regulation. The team, dedicated strategy, and record dates back to 1985. The objective of the GAMCO Merger Arbitrage Fund is to achieve long-term capital growth by investing primarily in announced equity merger and acquisition transactions while maintaining a diversified portfolio. The Fund utilizes a highly specialized investment approach designed principally to profit from the successful completion of proposed mergers, takeovers, tender offers, leveraged buyouts and other types of corporate reorganizations. Analyzes and continuously monitors each pending transaction for potential risk, including: regulatory, terms, financing, and shareholder approval.
Merger investments are a highly liquid, non-market correlated, proven and consistent alternative to traditional fixed income and equity securities. Merger returns are dependent on deal spreads. Deal spreads are a function of time, deal risk premium, and interest rates. Returns are thus correlated to interest rate changes over the medium term and not the broader equity market. The prospect of rising rates would imply higher returns on mergers as spreads widen to compensate arbitrageurs. As bond markets decline (interest rates rise), merger returns should improve as capital allocation decisions adjust to the changes in the costs of capital.
Broad Market volatility can lead to widening of spreads in merger positions, coupled with our well-researched merger portfolios, offer the potential for enhanced IRRs through dynamic position sizing. Daily price volatility fluctuations coupled with less proprietary capital (the Volcker rule) in the U.S. have contributed to improving merger spreads and thus, overall returns. Thus our fund is well positioned as a cash substitute or fixed income alternative.
Our objectives are to compound and preserve wealth over time, while remaining non-correlated to the broad global markets. We created our first dedicated merger fund 32 years ago. Since then, our merger performance has grown client assets at an annualized rate of approximately 10.7% gross and 7.6% net since 1985. Today, we manage assets on behalf of institutional and high net worth clients globally in a variety of fund structures and mandates.
Class I USD – LU0687944552
Class I EUR – LU0687944396
Class A USD – LU0687943745
Class A EUR – LU0687943661
Class R USD – LU1453360825
Class R EUR – LU1453361476
GAMCO ALL CAP VALUE
The GAMCO All Cap Value UCITS Fund launched in May, 2015 utilizes Gabelli’s its proprietary PMV with a Catalyst™ investment methodology, which has been in place since 1977. The Fund seeks absolute returns through event driven value investing. Our methodology centers around fundamental, research-driven, value based investing with a focus on asset values, cash flows and identifiable catalysts to maximize returns independent of market direction. The fund draws on the experience of its global portfolio team and 35+ value research analysts.
GAMCO is an active, bottom-up, value investor, and seeks to achieve real capital appreciation (relative to inflation) over the long term regardless of market cycles. Our value-oriented stock selection process is based on the fundamental investment principles first articulated in 1934 by Graham and Dodd, the founders of modern security analysis, and further augmented by Mario Gabelli in 1977 with his introduction of the concepts of Private Market Value (PMV) with a Catalyst™ into equity analysis. PMV with a Catalyst™ is our unique research methodology that focuses on individual stock selection by identifying firms selling below intrinsic value with a reasonable probability of realizing their PMV’s which we define as the price a strategic or financial acquirer would be willing to pay for the entire enterprise. The fundamental valuation factors utilized to evaluate securities prior to inclusion/exclusion into the portfolio, our research driven approach views fundamental analysis as a three pronged approach: free cash flow (earnings before, interest, taxes, depreciation and amortization, or EBITDA, minus the capital expenditures necessary to grow/maintain the business); earnings per share trends; and private market value (PMV), which encompasses on and off balance sheet assets and liabilities. Our team arrives at a PMV valuation by a rigorous assessment of fundamentals from publicly available information and judgement gained from meeting management, covering all size companies globally and our comprehensive, accumulated knowledge of a variety of sectors. We then identify businesses for the portfolio possessing the proper margin of safety and research variables from our deep research universe.
Class I USD – LU1216601648
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Donald J. Trump, the 45th President of the United States of America, was officially impeached on December 18.
He was accused of pressuring Ukraine President Volodymyr Zelensky to investigate Democrat’s Joe Biden and his son, Hunter.
Trump also wanted Zelensky to launch an investigation in which Ukraine, not Russia, would be fingered in interfering in the U.S. 2016 presidential election.
In return, President Trump would approve $400 million in military aid to Ukraine, which the small European country needed at the time.
The allegations of abuse of power by the President were brought forward by a whistleblower.
The impeachment process started on September 24, 2019, and concluded on December 18 with Trump’s impeachment.
Trump will be tried in by the Senate where his own party, the Republicans, are in control. He is unlikely to be removed from office. The voting so far has been on partisan lines. The President is demanding an immediate trial.
Trump is the third President in America’s history to be impeached. The other two before him are Andrew Jonhson in 1968 and Bill Clinton in 1998.
But how will Trump’s impeachment affect the stock market? Trump has on numerous occasions, measured the success of his presidency based on stock market performance.
Trump’s impeachment and the stock market
The stock market has not given attention to Trump’s impeachment. The S&P 500 – a stock market index that monitors the performance of the largest 500 companies listed on U.S. stock exchanges – was up 7 percent between the start of the impeachment process in September and Trump’s censure in December.
The S&P 500 was fluctuating positively as a result of a trade deal that Trump brokered with China.
Trump launched a trade war with China since coming into power. This has affected the stock market for some time. The possibility of an amicable deal is good news for investors.
During the early days of the impeachment process, President Trump warned that impeaching him would crash the stock market.
“If they actually did this the markets would crash. Do you think it was luck that got us to be the best Stock Market and Economy in our history? It wasn’t,” said Trump.
He further warned that his impeachment would leave “everyone poor.”
Clinton is the only U.S. president to be impeached in modern history. His impeachment in the late 1990s did not deter the stock market from climbing high.
In the case of President Richard Nixon who resigned in August 1974 before facing impeachment and removal from office, the stock market tumbled.
There is no yardstick or relevant history to predict how Trump’s impeachment affects the stock market.
However, the current trends show that the stock market might perform well after all. As was the case with Clinton’s impeachment.
For some reason, Trump’s impeachment may have failed to have an impact on the stock market because investors didn’t think it would change anything.
President Trump is still in office and will continue to behave as he has been doing since taking the oath of office on January 20, 2017.
Is it time to turn to safe-haven assets?
Investors turn to proven safe-haven assets in times of political instability. Trump’s impeachment is far from that.
The true impact of Trump’s impeachment on the stock market will be seen in the coming days. But it will unlikely wield any results different from what we have seen so far.
Trump’s presidency is nothing but a roller-coaster. And markets will fluctuate accordingly.
Photo: The White House. A Disappointing Deal, and a Healthy Economy
President Trump called it “amazing,” and U.S. Trade Representative Lighthizer said the China deal is “remarkable.” In my view, however, it is merely the best trade deal in the last 36 months of Chinese history, and it falls well short of two key objectives. Because the deal sets highly unrealistic goals for U.S. exports to China, the risk of disappointment and a return to tariff battles remains, so corporates in both countries are unlikely to feel secure enough to resume investment spending. Second, there are no signs that the two sides are preparing to use this pause in the tariff dispute to reconsider the poor direction the bilateral relationship is taking, towards decoupling and confrontation.
Despite this disappointing deal, the Chinese government seems relatively comfortable with the pace of economic growth and job creation, and is preparing only a very modest stimulus for 2020, designed to stabilize growth by mitigating the impact of the dispute with the U.S. and weaker global demand. I expect the consumer-driven economy to remain healthy next year, and the risks are largely on the upside: if the trade deal does lift the cloud of uncertainty, business sentiment will improve, leading to stronger CapEx spending and reduced pressure on wages. If the deal collapses, Beijing will implement a larger stimulus, to counter the negative impact on sentiment. The key downside risks next year are policy mistakes by Beijing; and if the trade deal fails, Trump could respond with dramatic efforts to contain China’s rise, which would be negative for sentiment.
Deal risks
Based on the few details provided so far, the deal doesn’t appear to represent a significant improvement on the current trade framework. Lighthizer said over the weekend that the 86 page agreement—which he described as “totally done”—will be signed in early January, and presumably more details will be available then.
I’m less concerned about the absence of breakthroughs than I am about the agreement’s highly unrealistic sales targets, which could set up the deal to fail, leading to a return to tariffs or even a full-blown trade war.
In an interview over the weekend, Lighthizer said that the Chinese government has committed, in writing, to dramatically raise the level of its imports from the U.S. “Overall, it’s a minimum of 200 billion dollars. Keep in mind, by the second year, we will just about double exports of goods to China, if this agreement is in place. Double exports. We had about 128 billion dollars in 2017. We’re going to go up at least by a hundred, probably a little over one hundred. And in terms of the agriculture numbers, what we have are specific breakdowns by products and we have a commitment for 40 to 50 billion dollars in sales. You could think of it as 80 to 100 billion dollars in new sales for agriculture over the course of the next two years. Just massive numbers.”
Massive, yes. But realistic? U.S. agricultural exports to China peaked in 2012 at US$26 billion, and none of the American agricultural experts I’ve consulted think it is possible to double that in the near future. My contacts in Washington say that the US$40 to 50 billion target was not based on a detailed assessment of China’s demand nor on the ability of American farmers to quickly expand output of soybeans and other crops. It was a politically expedient target.
The concept of quickly doubling the value of overall U.S. exports to China is equally dubious—even if the baseline is this year’s reduced level of US$88 billion for the first 10 months of this year. The historical peak was US$130 billion in 2017.
There are a few ways this could play out. First, China could buy record amounts of U.S. agricultural and manufactured goods, but well short of the targets set out by Lighthizer. Trump may be satisfied, claiming success because historical records were reached.
Second, failure to reach the sales targets may not be enough for Trump, despite the record purchases, and he will escalate the tariff dispute. That may lead Chinese officials to decide that further negotiations are pointless, leading to a trade war which damages both economies, although Beijing has far more resources to mitigate the impact.
Third, Washington may fudge the data to come closer to the sales target. We’ve heard talk, for example, of counting the sales of goods produced in third countries with American intellectual property, such as semiconductors made in Singapore and Taiwan, as U.S. exports.
(Never mind the silliness of asking the Chinese government to commit to purchasing a set amount of American goods, irrespective of market conditions, at the same time the U.S. is pressing Beijing to establish a more market-driven economy. It is also worth noting that to date, China has declined to comment publicly on the sales targets. That will presumably change after the deal is signed.)
The uncertainty of how this will evolve, and how Trump will respond, means that this deal is unlikely to reassure American and Chinese CEOs, who have been deferring CapEx in response to uncertainty over the bilateral trade dispute. Removing that uncertainty was the negotiators’ top job, and they appear to have failed.
I would be delighted to be proven wrong in early January, when the deal is signed and details are published. Maybe there will be a clever plan to explain how China can buy so much American stuff so quickly. Maybe the details will show that the deal is in fact so good that, combined with NAFTA 2.0, it made last Friday, in Lighthizer’s words, “probably the most momentous day in trade history ever.”
Despite the disappointing deal, China’s economy will remain healthy
I’d like to repeat a few important points from the October 18 issue of Sinology. I wrote that if the U.S. and China fail to conclude a trade deal, I will be very concerned about the longer-term relationship between the U.S. and China—the country which accounts for one-third of global economic growth, larger than the combined share of growth from the U.S., Europe and Japan. Failure to reach any deal would have a profound impact on the global economy. But, I will be less worried about the near-term impact on China, as the main engine of its growth— domestic demand—remains healthy, and Beijing has a significant store of dry powder it could deploy to mitigate the impact of an all-out trade war with Washington.
Last year, net exports (the value of a country’s exports minus its imports) were equal to less than 1% of China’s GDP. And the contribution from the secondary part of GDP, manufacturing and construction, has been declining. This will be the eighth consecutive year in which the tertiary part of GDP, consumption and services, is the largest part; last year, three-quarters of China’s economic growth came from consumption.
This is especially important right now, because the domestic demand story should continue to be fairly well insulated from the impact of the Trump tariff dispute.
Modest monetary policy changes
This is one of the reasons I expect monetary policy will be only slightly more accommodative next year, and I do not expect aggressive expansion of credit flows or dramatic interest rate cuts. There may be modest easing compared to this year, but the objective will be to stabilize growth in response to trade tensions with the U.S. and slower global demand, not an effort to reaccelerate growth. As has been the case this year, aggregate credit outstanding (augmented Total Social Finance) will likely expand faster than nominal GDP growth, but not to the extent in past years. Beijing is fairly comfortable with the pace of economic growth.
Less focus on deleveraging, more on risks
There will be less focus on deleveraging in 2020, but Beijing is likely to continue to take steps to reduce financial system risks. A modest boost to fiscal spending (see below) will push up the deficit a bit, but because this debt is all within Party-controlled institutions, the risk of a systemic crisis will remain very low. Chinese government economists recently told me they expect the fiscal deficit/GDP ratio to rise to 3% from 2.8%, and after a government that sets economic policy guidance, officials said the focus is on keeping the “macro-leverage ratio basically stable,” rather than on reducing that ratio.
I expect further consolidation of smaller banks as well as a continuation of this year’s experiments of selected defaults by state-owned and private firms, in an effort to push investors to price risk. I do not expect the government to relax their tight controls over off-balance-sheet (shadow) financial activity.
Modest infrastructure boost
Officials I met with in Beijing this month indicated that there will be a modest increase in infrastructure investment next year following this year’s surprisingly slow growth rate. But I do not expect this to return to the much higher levels seen a few years ago. Some of the infrastructure will be financed by an increase in “special construction bonds,” which may rise to about RMB 3 trillion from the current RMB 2.15 trillion. If this happens, it will support modestly stronger industrial activity and materials demand.
Residential resilient
Residential property should remain resilient, although I do not expect significant policy changes. The property market has held up better than expected this year, and I think the government feels that policy is about right: not too tight or too loose. Over the first 11 months of the year, new home sales by square meter are up 1.6%, vs 2.1% a year ago and 5.4% two years ago. New home prices in 70 major cities were up 7.6% YoY in November (basically in line with nominal income growth), compared to 10.8% a year ago and 6% two years ago. Inventory levels are reasonable. Residential property investment has been rising at a double-digit pace for 23 consecutive months, but that is likely to cool off a bit next year. The government continues to reiterate the policy that “houses are for living, not for speculation,” and there is no sign that the government will relax the current policies related to property.
Modest improvement in CapEx likely
Investment spending by private firms has been weak, largely due to uncertainty resulting from the ongoing Trump tariff dispute. I expect modest improvement next year: if the trade deal is successful, that will reduce uncertainty. If the deal fails, Beijing is likely to take policy steps to encourage capex spending.
The China consumer story should remain strong in 2020
This is important because the consumer and services (tertiary) part of the economy is the largest part, and last year accounted for 75% of China’s GDP growth. (Figure 4 shows the growth in per capita consumption expenditure, which includes a wider range of services compared to the retail sales data. Services now account for 50% of household consumption.)
A continuing outbreak of African Swine Fever has led to lower pork supply, which has pushed up the price of pork, China’s primary protein source. Headline consumer price inflation will remain elevated next year, driven entirely by pork. Core inflation, at 1.4% YoY now, should continue to be low, and inflation should not have a significant impact on consumer sentiment.
Although monetary policy will not have much impact on live pig supply, as was the case during previous hog disease outbreaks, Beijing will cautiously limit policy expansion so that higher food inflation will not change people’s inflation expectations and spread food inflation to other areas.
Pixabay CC0 Public Domain. Carlos Bastarreche, nuevo asesor externo de AEB y CECA para asuntos europeos
As a new decade looms ahead, let us take a peep into 2020 based on the trends observed over the last 18 months. The strong performance in bond and equity markets of 2019 have wiped away the sorry tale of investment markets just a year before. Much of this turn around can be attributed to a change in Central Bank policy, notably in the United States and Europe.
The disruption of 2018 has shown us that the road to monetary normalization is a sure way to hardship for asset markets. After 10years of world Central Bank accommodation, normalization could never be considered as just ‘watching paint dry’. In effect since 2009, Central Bank intervention has become too preponderant for it not to have an upsetting incidence on its way out. This point was clearly demonstrated in the Fall of 2018.
More of the same…
Looking into 2020, central bank accommodation is likely to be more of the same. But there are limits to this monetary approach. 2019 has revealed some of the undesired side effects of such a policy treatment. The US repo financing stress of September, as well as European bank profit warnings from negative interest rates are an indication of this collateral damage.
To counter balance these negative effects, central bankers have been pushing governments to engage in Keynesian fiscal stimulus. Japan has already announced its intention to go down this road with a 120 billion dollar package. In 2020, we could see a combination of continued monetary accommodation with fresh fiscal support in different parts of the world. Together, these interventions would join forces to juice assets markets even further, increasing the possibility of a financial ‘melt-up’.
With so much liquidity chasing too few investable assets, is this imbalance to be wished for? Not really. Ever higher asset markets funded by money printing and increased government deficits, is likely to bring back the great divide between holders of financial assets and the rest, invariably leading to social tension. This trend is already apparent with the unrest in Latin America, Europe, and the Middle East.
In addition, levitated markets require perpetual central bank intervention to sustain them. A highly valued financial system is inherently unstable and vulnerable to ‘Black Swan’ shocks. Therefore, markets could become even more monetary accommodation dependent. The persistent intervention by the Bank of Japan with its Quantitative Easing forever policy is already an example of this.
The Fixed Income world
The fundamental risks to fixed income instruments are Interest rate changes and credit default. Interest rates are unlikely to rise for the reasons already mentioned above. To add to this, monetary support gives the region implementing it a competitive advantage on the currency markets by keeping its value weak. In the current context of currency wars, it is increasingly improbable the accommodation policy of one Central bank will be modified all on its own.
Therefore, the central bank policy choices of 2019 are likely to continue into 2020. This could keep bond asset prices high and moving higher. As the returns from fixed income instruments remain meager, investors relying on the revenue stream from their capital investments will face an increasing conundrum, which could make the ‘chase for yield’ even worse next year.
Credit risk is likely to become an important investment theme for 2020. Up to now, many industrial economic models have been sustained by low interest rates, investor support and moderate growth. If the fiscal and monetary stimuli mentioned above where to be insufficient to prevent a generalized economic slowdown, low funding costs will not counterbalance losses in top line revenue for these same businesses. Investor support for weak problematic balance sheets could then disappear overnight.
Small is beautiful
Large credit funds in search of yield are desperately looking to invest. However, the fixed income instruments of quality issuers are highly sought after by every investor under the sun. Larger funds are having increasing difficulty in sourcing sufficient product in quality and quantity, under these circumstances. The result has been a tendency, on their part, to tiptoe into lower quality instruments or delve into niche markets. With an increasing probability of rising credit risk moving forward, due to a possible economic downturn, this new investment space is likely to be very uncomfortable place for the larger funds.
On the other hand, smaller credit funds have demonstrated a real competitive advantage to create value without taking on undue risk. Their size does not impose on them the sourcing constraint seen in larger funds. Therefore, their allocation can be made on their investment conviction. Their choice to acquire fixed income instruments is based on common financial sense criteria, rather than a mandate to accommodate a regulatory investment template. After all, this is how asset management should really function… Isn’t it?
Finally, the positive and negative impact of monetary and fiscal stimuli 2019/2020 requires management nimbleness to navigate through unknown consequences, in what are unchartered financial times. Only smaller funds have this flexibility still available to them.
Column by Steven Groslin, Executive Board Member and Portfolio Manager at ASG Capital
