Sandra Crowl (Carmignac Gestion): “We Are in the Start of a Structural Dollar Depreciation Tendency”

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For more than ten years, Sandra Crowl has been both Member of the Investment Committee and a Portfolio Advisor at Carmignac Gestion, the European leading asset management firm that was founded in 1989 by Édouard Carmignac and Eric Helderlé. Ms Crowl, who holds a bachelor’s degree in Economics and French from the University of Melbourne and, since 2007, is also a Chartered Alternative Investment Analyst (CAIA). She started her career at Bankers Trust Australia in 1987, before transferring to Paris in 1991. Two years later, she became Managing Director and Head of European Foreign Exchange in London. In 2003, she returned to Paris and specialized in fund management seeding at New Alpha Advisers, a subsidiary of ADI. Four years later, she joined Carmignac Gestion.

Latin American investors be aware

Ms. Crowl believes that the tightening of Central Bank’s liquidity is going to create a great deal of volatility in fixed income markets, therefore, investors -particularly Latin American investors who traditionally have a fixed income bias-, should change their focus away from passive management towards active management. “We are seeing a great deal of interest in our unconstrained global bond strategy, a strategy that provides the flexibility necessary in a rising interest rate environment. It is a non-benchmark strategy able to invest across sovereign and corporate debt, both in developed and emerging markets. Considering our commitment to investors, we want to make sure that we provide an appropriate risk framework for them. We do contain some of the risks by having internal limits on some sub-classes of bonds, like the contingent convertible bonds or structured credit. We have four fixed income strategies and all them, at the aggregate part of their portfolio, must have an average credit rating of investment, they will not ever become high yield strategies,” she said.  

On the bond side, Ms. Crowl suggests a very diversified bond portfolio that is still concentrated on sovereign issuers that are providing high real yields today. That would be the case of the sovereign debt in Greece, Mexico or Brazil. “Sovereign bonds with good real yields will act as a cushion for future volatility. Using our expertise for identifying value opportunities, we could also invest in cheap corporate bonds that are perhaps being sold off indiscriminately by the market. We also want to build up our portfolios in structured credit strategies based on floating rates, a suitable asset class in a rising interest rate environment,” she added.  

Carmignac’s unconstrained global bond strategy aims to protect investors in a bond bear market. As is clear in the Funds prospectus, the strategy has the capacity to actively manage modified duration, ranging from -4% to 15% and it can take short and long positions in currencies. “If we are invested in a country where there is short term volatility, we may want to hedge the currency for short periods but stay invested in the local debt of the country. That is the case of Brazil today, while we are very confident about their macroeconomic recovery and improved current account , we are less sure of the political outcome of elections later this year. Whereas in Mexico, we have chosen not to hedge the currency, that is to stay invested in local currency debt.”     

Uncertainty in Latin American

Ms. Crowl states that, despite the short-term risk that Argentina is currently experiencing, Carmignac Gestion is very positive about the fundamental improvements through economic reforms achieved since Mr. Macri became president. “Recently investors lost confidence in the independence of the central bank, inflation was accelerating, but Mr. Macri has always delivered on budget reform. He has recently promised even more constraint with will sooth credit agencies nerves. And we expect inflation to drop back in the second half of the year. Some large international money managers have already bought back into the asset class just one week after the Central Bank of the Republic of Argentina raised rates and Macri asked the IMF for a credit line. The announcement of the assurance by IMF to provide funding necessary for future months will be considered as a positive catalyst. Also, they could obtain support albeit smaller from the Bank of International Settlements.”      

Regarding Mexico, this year elections have added uncertainty to the ongoing renegotiation process of the NAFTA agreement. “It appears that Mr. López Obrador will lead the incoming government. This provides a bit of challenge going forward should the NAFTA agreement be decided before US mid-term elections. We believe the new government may create some difficulties with whatis has been previously signed under Peña Nieto’s term. There is a small degree of risk premium built into Mexican assets today, the election risk is being correctly priced by markets. We believe Mexican assets will be positively revalued as soon as a relatively friendly NAFTA agreement can be discerned,” she added.    

A not so positive view on the US or the dollar?

For 2018, the market consensus is expecting a 2.8% of GDP growth in the US, but Carmignac Gestion is expecting a slightly less, something around a 2.2% for the end of the year. “We do not anticipate the investment cycle to be as robust as it has been in last years. We do not think that corporate firms will be able to use the fiscal reform to create jobs or to implement strong capital expenditures programs, but rather to paid down debt or buy back stock. We are not seeing the strength in the order books of cyclically oriented companies that perhaps growth-oriented companies have. But we are invested in the US, in an overweight nature if we compared to the benchmark and are positive about the country’s economy. Particularly in equity, we are invested in some of the very strong secular growth themes: in the disruption created by e-commerce, the change in spending patterns, the digitalization of the economy, the increase of energy efficiency, the improvement of connectivity and cloud usage. All these themes provide strong secular earnings, generating very good returns on equities. We are investing on technological multinationals, but we are also focusing on companies that offer specific services to US corporations that need to improve their capacity. And we are bearish on the companies that are challenged by this new digitalized environment. In some strategies, we have the capacity to sell against a corporation that we have in effect a long-term position and that we have identified that would be challenged. This is part of how the portfolio is constructed to compose the winners and losers of this digital era”.    

On the dollar, Carmignac Gestion believes a structural dollar depreciation tendency is about to start, despite the dollar has strengthen a little bit lately in the face of raising short-term interest rates. The new issuances made by the US administration to finance part of the tax fiscal stimulus created some pressure on the short end of the interest curve, but there are some medium-term influences that will determine the dollar value. “In the US, current account and budget deficits are deteriorating. The budget deficit would be hitting towards a 6% of GDP. Also, the implementation of tariffs and trade barriers can affect the current account. Initially, imported goods subjet to tariffs will be costlier for the US to import. And, historically, in the periods in which the US is maintaining a loan with the rest of the world, the US economy needs to be ahead in the economic cycle for the US dollar to remain strong. But, today we have a synchronized global recovery, and that usually reflects in a dollar bearish period that may last for 5 or 6 years. That is how cycles have behaved since World War II,” she explained.       

A deceleration in Europe?  

According to Ms. Crowl, Germany is signaling small a slowdown, but it will not probably be reflected on the economy for as long as the European Central Bank continues with its Quantitative Easing program. Since the global financial crisis, the world economy has experienced mini-cycles that have lasted around 18 months or 2 years, there have not been 5 or 6 years boom and bust cycles due to Central Banks’ intervention in the markets, which created a distortion in prices. Now, the liquidity retraction started by Central Banks could lead into another shallow dip recession. 

“The interest rates in Germany are still around 60 basis points for the ten-year bond, when they have an over 2.5% GDP growth rate and a 2% inflation rate. It makes no sense; interest rates need to be normalized. For this year, the growth rate may still be above 2% because the ECB will continue to purchase 30 billion euros worth of European bonds on monthly basis to the end of the year. However, 2019 will be quite challenging year for European bonds. In the meantime, bond curve has started to price in Quantitative Easing tapering and we are positioned rather tactically to pick up performance. We intend to benefit from rising interest rates by having short positions in German bonds, actively managing duration, a feature that fixed income investors would need to consider”.

Rising Rates Series: The Ups and Downs of Bond Ladders

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Rising Rates Series: The Ups and Downs of Bond Ladders
Photo: zaimoku_woodpile. Serie de tasas crecientes: Los altibajos de las escalas de bonos

Maturity ETFs can make laddering simpler and more diversified. For example, instead of buying a single five-year bond and holding it to maturity, you could build a five-year ladder with bonds that mature each June for the next five years.  When one bond matures, you can purchase a new five-year bond with the proceeds (see illustration). The draw for investors is that it provides stable cash flow: each year, you have new money to reinvest from a maturing bond as well as the semi-annual coupon payments from the bonds.

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The ability to manage exposures on a yearly basis can be especially beneficial in a rising rate environment. As interest rates change over the period, each bond in the ladder will have a similar total return as the average yield at the time of purchase. By locking in a yield at the beginning, the ladder helps insulate the bond buyer from price losses if the investor holds to maturity.

As with a lot of things, however, this strategy is simple in theory but more complicated in practice. For many people, managing a portfolio of individual bonds is no picnic.

Small fish in a big sea

The first challenge is selecting the bonds. Should you go only to an issuer that you know? The highest-yielding bond? Or the one with the best credit rating?  Researching the credit quality of the issuer requires access to information and the know-how to evaluate relative value between bonds. Even for experienced investors, this can be daunting.

Once you’ve decided to purchase a bond, transaction costs can be high. The average retail investor pays about 0.90% in bid-offer spread on municipal and 0.64% on corporate bonds, according to S&P1. Many bonds have minimum bond sizes to buy and trade. If you don’t have a large amount of money to invest, the ability to diversify and spread credit risk across multiple issuers can be difficult. As a result, you might end up with a concentrated portfolio from just a handful of bond issuers.

Finally, liquidity, or the ability to convert the bond into cash, can be challenging for individual securities. If you want to sell a bond prior to maturity, you’ll need to find another buyer in the over-the-counter bond market, which might take time. And if your bond has a call feature, you could get repaid early if the issuer decides to refinance its debt. In that case, you’re facing reinvestment at lower yields.

Laddering with defined-maturity bond ETFs

Many investors use mutual funds and exchange traded funds (ETFs) to overcome some of these hurdles. Traditional funds usually hold a diversified portfolio of bonds and have a portfolio manager who oversees and manages the fund. The one downside is that because traditional funds don’t have maturity dates, the investor would need to sell a portion of the fund if they wanted to take money out of the strategy.

Defined-maturity bond ETFs, such as iShares iBonds, can help build efficient bond ladders by combining the reinvestment control of individual bonds with the convenience of an ETF. In a single transaction, investors gain access to:

  1. A known maturity: All the bonds mature during the calendar year in the fund’s name. For example, the bonds in the iShares iBonds Dec 2021 Term Corporate ETF (IBDM) mature between January 1st and December 1, 2021. When the last bond matures, the fund returns its final net asset value to shareholders in cash.
  2. Monthly distributions: Defined-maturity bond funds make monthly distributions of income, which can be smoother than the lumpy coupon payments of a bond ladder. Monthly distributions can be variable depending on changes in market yields and fund assets.
  3. Diversification: Each ETF holds hundreds of investment-grade bonds.
  4. Tradability: While individual bonds are traded in the over-the-counter bond market, defined-maturity ETFs can be traded throughout the day on the exchange at a known price.
  5. Low cost: ETFs may be more cost-efficient that buying a portfolio of over-the-counter bonds. For example, iShares municipal and corporate iBonds have management fees of 0.18% and 0.10%, respectively.

Going back to our example of the five-year bond ladder, an investor could purchase just five defined-maturity ETFs and gain exposure to hundreds of underlying bonds with known maturity dates, a monthly income stream—and an overall experience that’s vastly simpler than do-it-yourself.

Build on Insight, by BlackRock written by Karen Schenone, CFA

Investing involves risks, including possible loss of principal.

Carefully consider the Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing. Investing involves risk, including possible loss of principal.

Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.

When comparing stocks or bonds and iShares Funds, it should be remembered that management fees associated with fund investments, like iShares Funds, are not borne by investors in individual stocks or bonds. Buying and selling shares of iShares Funds will result in brokerage commissions.

There may be less information on the financial condition of municipal issuers than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. Some investors may be subject to federal or state income taxes or the Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable.

The iShares® iBonds® will terminate in March, September or December of the year in each Fund’s name. An investment in the iShares® iBonds® ETFs (“Funds”) is not guaranteed, and an investor may experience losses, including near or at the termination date. Unlike a direct investment in a bond that has a level coupon payment and a fixed payment at maturity, the Fund(s) will make distributions of income that vary over time. In the final months of each Fund’s operation, as the bonds it holds mature, its portfolio will transition to cash and cash-like instruments. As a result, its yield will tend to move toward prevailing money market rates (or, in the case of the municipal iBonds, tax-exempt money market rates) and may be lower than the yields of the bonds previously held by the Fund and lower than prevailing yields in the bond market.

Following the Fund’s termination date, the Fund will distribute substantially all of its net assets, after deduction of any liabilities, to then-current investors without further notice and will no longer be listed or traded. The Funds’ distributions and liquidation proceeds are not predictable at the time of investment and the Funds do not seek to return any predetermined amount.

The rate of Fund distribution payments may adversely affect the tax characterization of an investor’s returns from an investment in the Fund relative to a direct investment in bonds. If the amount an investor receives as liquidation proceeds upon the Fund’s termination is higher or lower than the investor’s cost basis, the investor may experience a gain or loss for tax purposes.

Investment in the iShares® iBonds® Corporate ETFs is subject to the risks of the other funds and ETFs (underlying funds) in which it invests. The iShares® iBonds® Corporate ETFs will incur acquired fund fees and expenses associated with its investments in the underlying funds and additional fees associated with turnover in the underlying funds that are not included in the acquired fund fees and expenses.

Diversification and asset allocation may not protect against market risk or loss of principal.

There can be no assurance that an active trading market for shares of an ETF will develop or be maintained.

The Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”).

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of May 2018 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

©2018 BlackRock. iSHARES and BLACKROCK are registered trademarks of BlackRock. All other marks are the property of their respective owners.

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Jean Raby, CEO of Natixis IM: “I Would Be Very Surprised if We Do Not Announce One or Two More Acquisitions by the End of the Year”

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Jean Raby, Chief Executive Officer of Natixis Investment Managers (Natixis IM) and a member of the senior management committee of Natixis, joined the firm sixteen months ago. Since February 2017, he oversees Natixis IM’s Asset Management, Private Banking and Private Equity business lines. Of French-Canadian origin, Mr. Raby began his career in 1989 as a corporate lawyer with Sullivan & Cromwell in New York, where he worked in corporate finances projects based in Argentina, Chile and Mexico. Later, in 1992, he got transferred to the Paris office.

After four years, he joined Goldman Sachs’ investment banking division, where he worked for sixteen years in corporate finance, M&A, restructuring and capital markets, as well as he worked occasionally in asset management projects. He became a Partner of the firm in 2004, he served as CEO of the division for France, Belgium and Luxembourg and head of the firm’s Paris office in 2006 before becoming co-CEO of Goldman Sachs in Russia in 2011. Then in 2013, he served as Executive Vice President and Chief Financial and Legal Officer for Alcatel-Lucent, the global telecom equipment manufacturer, at a time when the company was on the verge of bankruptcy. A year and a half later, they were able to sell the company to Nokia for 15 billion euros. He subsequently served as Chief Financial Officer of SFR, an integrated media operator in France. But, he missed the hectic and fast pace environment of the asset management industry, so he decided to sign with Natixis.

The value proposal

Mr. Raby firmly believes that Natixis IM offers an attractive value proposition to those asset managers that want to expand their business but feel they have hit a glass ceiling in their growth. “You would be surprised by how many asset managers want to enlarge their business but, either because the pressure of the regulation or their need for investing in technology, they do not have the time or find it difficult to go through the effort of distributing their products outside their niche markets. That’s when they come to us. We want them to do what they do best, which is to manage money, and we take care of everything else, preserving the autonomy of the investment process. On the other hand, in Europe, and to a lesser extent in the US and Canada, sizable asset managers are owned by a financial institution. Their DNA is to stick with the footprint of the financial institution to which they belong to, and there is very little momentum or incentive to do something different than that of their parent company. In our case, we have the strength and solidity of a large banking group, but we are not constrained.  In fact, we benefit substantially from the stability of the structure and the financial support. However, we are able to act nimbly and demonstrate the entrepreneurship of a third-party business. We manage very little of our own money, and that is a unique feature, you will not find many asset managers of our size owned by financial institutions that are so focused on third-party’s money. We are the only one, and that is an additional value-add to these partnerships, to offer the stability of a long-term shareholder,” he said.

In September of 2017, the firm made its most recent transaction. Natixis IM, which has a network of 26 autonomous asset managers affiliates, acquired a majority stake in Investors Mutual Limited, an Australian fund management company, as part of its plans to expand in the Asian region. “I would be very surprised if we do not announce one or two more acquisitions by the end of the year. It is about adding entrepreneurial teams joining us; we seek asset managers that have a strong track record of generating performance and that have a brand. That will be right set up for us, either because we bring a solution to them and the support of a long-term shareholder, or because they bring something new to us, like a platform that our other affiliates can use or a strategy or investment category that supplements our offering. We want to do business with management teams that we consider our partners,” he added.     

Natixis seeks the growth of their affiliates’ business. For this, they offer a centralized distribution throughout the world. “In our business model, we respect the autonomy of our asset managers in their investment process and allow them to upgrade their business. For example, in 2015, we welcomed DNCA Finance into the group, a value equity France-based asset manager. At that time the firm had 14 billion euros of asset under management. Today, the firm has more than 25 billion euros. We accomplished that figure in only three years and with tremendous pressure on fee rates. We can maintain pricing because our clients see value -we do not sell expertise cheap-, and because there is a central management of distribution, creating a healthy discipline. We are also trying to mutualize investments on technology, finding the right balance between the investment autonomy of the affiliates and the benefits of sharing technological developments. The group is defining its digital roadmap, and we are going to add more joined development of technological innovations that hopefully will benefit everyone.”

Active vs passive asset management

Although Mr. Raby acknowledges that passive asset managers have dominated the market narrative in the latest years, the return of volatility may, in his opinion, turn the tables. “Passive investment is here to stay, but we are not going to participate in that business and we are not going to change our strategy. Volatility has returned, we may be at the end of a 35-year bond bull market and at the end of a 10-year equity market. In a more volatile and uncorrelated environment, an active approach to managing risks and chasing opportunities may make more sense. Individual investors will have a rough wake up call when they realize that with greater transparency and disclosure on fees, passive investment is not as cheap as it seems. People will hopefully start looking beyond the low fees and study the actual performance deliverance after fees, which is what really matters. When that happens, I am confident the value proposition of active management will be recognized.”  

Long-term savings

In Europe, long-term savings have not been privatized, by contrast, that has been the case in the US, Canada, UK and Australia, thus funding the savings for retirement. These countries are the fourth largest asset managers markets in the world, being China the fifth largest market, and that is mainly because they have a population 1.6 billion of people. There is a big question mark on whether, in ten to twenty-year time, those people who relied on defined contribution plans, abandoning defined benefits plans, will have enough savings for retirement. According to Mr. Ruby, experience demonstrates that people with the right incentives for long-term savings will save enough for retirement, without having to depend on the government. “At the end of the day, if it materializes that the privately arranged retirement systems are no sufficient to fulfill the needs of the population the government will have to chip in. I would hope for a bigger debate on the privatization of long-term savings in Europe. There should be greater tax incentives for people to save and a strive for the right balance. In Canada, there is a mix of both systems, people are encouraged to save through tax incentives and yet, they also have the promise of a basic retirement savings for everybody. Even the US created the 401k plans, with lots of tax incentive to do so, with does encourage people to be prepared, and I think that is the way to go. In UK, the debate is also out in the street, but unfortunately there is no enough discussion in Europe right now. In France, we are having the debate on pensions and insurance policies, trying to get some more flexibility, but I wish we could go further and discuss about private pension funds.”

The growth opportunities

Natixis IM has a history of 25 years of presence in Europe and the Americas. Their arrival in Latin America is more recent but is a key piece in their growth plans: “When I arrived last year, one of the first conversations that I had with Sophie Del Campo, -Executive Managing Director, Head of Iberia, Latin America, and US Offshore, at ‎Natixis Investment Managers, was about the opportunity in Latin America. Obviously, we want to be careful, invest for the long term and with a steady approach. On the other hand, we think that the region is an opportunity for us to locally manufacture products, but again we need to find the right partner in the region with four characteristics: entrepreneurial character, a good brand, a good performance track record and that we can bring something to them in terms of revenue synergies, or that they can bring something to the group. This type of partner does exist, but it takes time to find it,” he concluded. 

How Family Offices Allocate Their Capital

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According to Vidur G. Gupta, Finance Expert at toptal and based on a report by UBS, the origins of a given family’s wealth determines the family offices’ risk appetite, its investment style, and its allocation choices. US and Asian families are most keen on investing in “growth” assets, with heavy weighting toward venture capital and private equity.

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iCapital research shows that first-generation single family offices tend to prefer alternative assets such as real estate, private equity, and venture capital. In addition to the generation, country, and origin of wealth, the sfamos’ strategy is also defined by the size and stage (institutional maturity/experience) of the family office itself.

Longer-tenured family offices increasingly employ experienced management teams to invest their capital across an array specialty asset classes. This is especially true for active positions in equity and bond markets, given family offices have historically invested in hedge funds or private equity funds as fund-of-funds investors. The increasing size of Famos and desire to have stronger control over investments and outcomes has propelled them to “insource” professional management teams.

As an asset class, private equity also holds some other advantages over hedge funds regarding family offices. It fits with families’ “emotional desire to back entrepreneurs and ideas they believe in,” according to Philip Higson, Vice Chairman of the family office group at UBS.

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“In the search for yield, family offices are playing to their strengths by allocating longer-term and accepting more illiquidity,” a report from UBS and Campden Wealth notes. “This approach is successful when experienced in-house teams have sufficient bandwidth for conducting due diligence and managing existing private market investments.”

Anupam Damani (TIAA Investments): “Mexican Elections Are Considered a Buying Opportunity Given the High Nominal and Real Rates of the Country”

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TIAA Investments’ Emerging Market Debt strategy, which has a track record of more than ten years, launched in October 2015 an UCITS fund with an Irish domicile. The fund, which is about to reach the three-year milestone, has a solid track record versus the benchmark and against its peers on absolute and on risk-adjusted return basis and around 36 million dollars in assets under management-although its team manages around 13 billion at the strategy’s level.

Anupam Damani, managing director and portfolio manager, works together with Katherine Renfrew and a team of 14 analysts in managing the TIAA Investments’ Emerging Market Debt strategy, which she defines as a blended strategy with a hard currency bias. Its benchmark, the JP Morgan Emerging Markets Bond Index Global Diversified is a hard currency sovereign index benchmark and it anchors how much local market risk they want to take in the portfolio. They tactically add exposure to local markets, an allocation that may range from a 0% to 30%.

“Our typical allocation to local markets is between the 10% to 15% area. We have been building that allocation in the last few years because we have been very positive on Emerging Market’s local markets, both on the rates space, because the real rates are quite high in the end local markets, but also in Emerging Markets foreign exchanges. In the earlier dollar rally of 2013-2014 and 2014-2015, we saw that, in an aggregated level, EM foreign exchanges had depreciated a bit. There are some exceptions to this rule and that may be Turkey and Argentina, both economies showing home-grown problems”, says Damani. 

“The team has the breadth and the scope to be able to look through the hard currency sovereign and corporate bonds and local debt markets. The portfolio is a mix of all three segments of the asset class, and we nimbly allocate among of these few segments where we prudently see the most compelling opportunities are. In the sovereign segment, the team has an early advantage of following the frontier market economies, which are the newer emerging markets so to speak. We have been doing a lot of due diligence and research deep down diving to frontier market and idiosyncratic stories in the sovereign space”, she adds.  

The team believes that diversification is key, even though they have high conviction ideas. They normally hold about 30 to 35 countries in the strategy while the index has 67 countries on it. They pick their bets and they are very focused on selection, but at the same time they believe in diversification because that is what works through economic cycles. They also have a special focus on risk and liquidity management. Any time they get into a position they make sure that they would be allowed to undo the position in times of stress, when the exit window is smaller. 

Conviction ideas

According to Damani, the recent events that have taken place in Argentina had made its debt market begin to look attractive again. “We are waiting for some more signs as to what the IMF is going to demand from the government and to see the impact of the announcement on the polls for President Macri. The political and social stability will be an important cornerstone of how aggressive Macri’s government can be in acting with IMF demands, but we think that part of the adjustment has been done, and the responsiveness by the government despite the initial stumble was quick. It was a bold and necessary move by the government and we like that, but, we also are cautious. After watching for those signs, we may look to build into that position in both the local and the hard currency space”.

From April 27th to May 8th, the Central Bank of Argentina increased its interest rates by 12,75 percentage points, from 30,25% to 40%, to avoid a currency crisis. “The Argentinian government had a very gradualist approach to its adjustment program while markets were demanding a much faster pace given inflation and inflation expectations as well as fiscal and current account deficits remained high. On top of that the central bank decided to cut rates which wasn’t prudent. The fiscal and current account deficit were running high, the currency still looked overvalued on a real effective exchange rate basis and the inflation was still running well above its target. I believe the investors needed to see a stronger policy response by both the central bank and the fiscal authorities, and a commitment maybe on more medium term to the fiscal consolidation. A fiscal plan to adjust the currency letting it to get closer to fair value and a long term central bank commitment into eventually bringing down inflation. In the 1990s you would not see such a quick policy response to market transaction, but the policy makers are increasingly obeying to market conditions and what it may mean for the financial stability risk within the country. They not only tried to manage the currency by letting it depreciate, getting it closer to its fair value just using some of the reserves, they really hiked up rates too. The Finance Ministry came out and declared that they will stay on a financial consolidation path and President Macri announced he had asked the IMF for a credit line. We think it was really important, because it will anchor policy making going forward and it will also be a source of liquidity for the government,” she explains.  

In the frontier market space, they like Ghana, a sub-Saharan economy rather diversified in its revenues sources: a third of its dollars and export revenues come from oil, a third from cocoa, and another third from gold. For the last year and a half, Ghana has a new government in place that is very private sector oriented and very focused on macroeconomic stabilization. Both the Finance Ministry and the Deputy Finance Ministry come from the private sector. Something that is very important as they want to privatize a larger part of the economy. “The central bank has been very focused on bringing down inflation and stability to the currency, therefore we like both the local bond market and the external debt in Ghana. The country has a very vibrant democracy, during the last two election cycles, the two parties that have been in place competed very aggressively. As a collateral damage of this competition, they have spent a lot of money right before the election to gain more weight. These large expenditures had haunted Ghana a few years back. They went through a crisis and enacted an IMF program. But now, this new government has elections coming up again in 2020. I believe they will be embedding some reforms, enacting a fiscal consolidation program and a macroeconomic stabilization program. We think this is going to be a better government in place and that they will not make the same mistake that the previous government did, but again, time will tell.”

Oil prices stabilizing

Damani likes to say that Emerging Markets are not a monolithic asset class. There is a huge diversity of countries and credits, some are oil exporters, and some are oil importers, therefore, oil can be a double-edged sword. “The exporting countries and the credits that are linked to the commodity will be benefited from the cycle. A lot of these companies and countries have adjusted their fiscal balances to a lower oil price and now they are going to see an increased windfall. We are hoping that countries use this windfall again as buffers for bad times, which in many EM economies is something commonly seen. We are hoping that policy makers have learnt and have created those local buffers. But for the oil importers, the increase in oil price is only a challenge because it negatively affects into their current account deficits. And then, just generally, oil price can directly affect inflation. In most emerging economies, inflation is not as much of a problem. In an aggregate level, inflation has continued to come down in the end, so there is some buffer here. But there are clear exceptions, and Turkey is one of them. As an oil importer, Turkey has not managed inflation correctly and it is very exposed to external financing. It draws a large current account deficit and it never benefited when oil prices went down because it did not enact the measures that were needed in place, and now is suffering. Argentina and Turkey can be contrasted in terms of their policy response. The markets are still looking for a response from the Turkish Central Bank, which according to the perception of the market, lacks the independence to be able to hike policy rates that could allow the currency to stabilize and to eventually bring inflation down. Turkey is going into an electoral cycle in June, even with a consistent deterioration happening, they have always managed their fiscal policy somewhat better. But, we have started to see signs that the fiscal stances are also deteriorating. Going forward, that gives us a bit more caution on the taking”.

Elections in Mexico

This year, Brazil and Mexico, the two biggest economies in Latin America will have presidential elections, and TIAA Investments’ Emerging Market Debt team will be very focused on them. These elections will determine what will happen with the reform path for these economies. “Currently Lopez Obrador (Andres Manuel Lopez Obrador, also known as AMLO), who is the left-wing candidate, is in the front running seat, but his disapproval is still rather high and there are still many undecided voters. Given that the election only has one round and not two, it can go both ways. The positive of only having a single round is that the third candidate which is the current party’s candidate, Meade, will be disregarded. At some point these voters are going to have to decide between Anaya and Lopez Obrador. They will have to decide where do they want to cast their votes, and most likely in terms of policy making, the rule should be expected to go to Anaya. AMLO has been doing a good job courting the investors and suggesting that nothing too dramatic will happen, but we do remain cautious because he has pledged to review energy contracts awarded since the energy reform was implemented by the current administration and has proposed to discard the Mexico City airport project, although the project is far along in the process. But, going back to the institutional framework of Mexico, it is fairly robust. Banxico is one of the most orthodox central banks, and we think they would be able to manage the situation well. The institutional framework will get tested if AMLO comes to power, but he is not going to be able to do a lot of the things he is talking about, he could be restrained both by the institutional framework and the markets. Investors may expect volatility going into the elections, but also the peso, the M-bono and the local curve is pricing in a risk premium for an AMLO victory, because the base case for everyone is currently that AMLO is going to win. The hard currency and the sovereign debt is not placing in any risk premium for the AMLO victory, and that is maybe where we may see more volatility. The peso is going to be affected, as currencies react the fastest, we should see more volatility here also, but I would not be surprised if that time is thought as a buying opportunity by most investors given how high the nominal and real rates are in Mexico. Some of the Mexican corporates, including Pemex, trade at decent risk premium over the Mexican curve.”

The contagion effect in Emerging Markets

The Emerging Markets asset class has matured over time. In the 1990s the contagion effect used to be much wider spread. Now, the contagion is increasingly limited to the country or its neighboring trade partners. Again, Damani explains that the cases of Argentina and Turkey are more home-grown problems, where monetary and fiscal policy had to be addressed. “Is a wakeup call for some of Emerging Markets policy makers that were in the same situation. Liquidity is tightening in the markets and the dollar is strengthening, this is something to be aware of and mindful, policy markers need to stand to their reform agenda and need to build buffers to protect the economy from both endogenous and exogenous shocks. EM debt came in the crosshairs of this recent volatility, but I would say it has less to do with what is happening in Argentina and Turkey. Certainly, it creates a higher noise factor and creates a little bit of panic, where people start saying we are back to the Mexican peso or Russian rubble crisis, but we are not. EM debt markets have really evolved. There is an increase in volatility and there would be some damage done. When the tide washes out, credits with good fundamentals and sovereigns with a good macroeconomic stability will be a good opportunity for investors, with spreads that have widened by 70 to 80 basis points and currencies that weaken versus the dollar. Selection will be very important, the big beta trade that occurred in 2016 and 2017 is over, it is increasingly about picking the right credits,” she concludes.          

The Months of Historically Low Volatility Are Unlikely to Return Any Time Soon

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The Months of Historically Low Volatility Are Unlikely to Return Any Time Soon
Wikimedia CommonsFoto: Spiff . Es poco probable que vuelvan pronto esos meses de volatilidad históricamente baja

The U.S. equity market closed slightly higher for April as corporate earnings continued to post strong first-quarter gains but in aggregate have so far been unrewarded with higher prices. The U.S economy is keeping the job market tight and both wages and inflation are starting to rise. Merger and acquisition activity spiked sharply higher on ‘Merger Monday’ on the last day of the month as well.

Volatility has receded from the early February high, though the months of historically low volatility that preceded it are unlikely to return any time soon. President Trump’s zigzag decision-making style has added a new variable of day-to-day investment uncertainty with agenda items ahead including the Iran nuclear weapons deal, NAFTA, highly complex tariffs, and North Korea. The U.S. Federal Reserve’s gradual liquidity reduction and rising rate policy have weighed on stock prices. The main drivers for rising stock prices, we believe, continue to be lower corporate taxes, reduced regulation, and U.S. economic growth.

There are many moving pieces for the market to digest in real-time, and thus many unanswered questions – whether the $150 billion-plus trade tariffs are simply negotiating tactics, how aggressive Congress will be on data privacy and business models, how quickly inflation will come back, and how aggressively the Federal Reserve will raise rates to stay ahead of it.  The most demanding question to be answered is how much trouble the markets can withstand at once?  In isolation, current headwinds seem manageable as long as fundamentals remain the priority.  Rising uncertainties may keep the stock market on edge, but corporate profit growth, aggressive corporate stock buybacks, and deals should provide a cushion for any selloffs.

Merger and acquisition activity in both the utility and energy sectors are standouts so far this year.  In the staid and highly regulated sub-sector niche of water utilities, an unusual four-way bidding war deal dynamic is developing as California Water Service Group (CWT) made an unsolicited takeover bid for water utility SJW Group. SJW had previously agreed to acquire Connecticut Water Service Inc. (CTWS). On April 19, in order to participate in this water-industry consolidation, Eversource Energy (ES) announced an unsolicited bid for Connecticut Water Service. Stay tuned for more intriguing investment opportunities as the Water War unpredictably unfolds in the weeks ahead.

More specifically in terms of merger arbitrage opportunities, deal activity remained strong. Below is an update on two deals that have been in the global news recently.

Sky agreed to be acquired by Twenty-First Century Fox or Comcast

Sky plc received a formalized acquisition proposal from Comcast at £12.50 cash per share, or about £30 billion. Twenty-First Century Fox has said it remains committed to buying Sky, and Sky’s share price reflects the expectation that Fox and Disney (who is in the process of acquiring most of Fox’s assets) will increase Fox’s bid for Sky, currently at £10.75. As a refresher, Sky received an initial offer of £10.75 cash per share in December of 2016 from Twenty-First Century Fox. Fox, which already owns about 40% of Sky, has been unable to close the acquisition due to British political scrutiny of the transaction, though regulatory approval could come in June 2018. The extended regulatory review left an opening for Comcast to make a bid for Sky, which Comcast has long viewed as having a premier position in European media. Twenty-First Century Fox is currently in the process of being acquired by Disney, which also believes Sky is a crown-jewel asset.

Monsanto agreed to be acquired by Bayer 

Going back, Monsanto agreed to be acquired by Bayer in May 2016 for $128 cash per share, or about $65 billion. In March, shares slumped after reports suggested that the Department of Justice was “months away” from completing its review and that Bayer may be required to sell additional assets. Bayer had already agreed to sell seed and agrochemical assets (with the recent addition of vegetable seeds) to BASF for $9 billion. In April, shares of Monsanto reacted positively as the company made progress towards gaining antitrust approval in the U.S., and Bayer reported they are having very good and constructive discussions with the DOJ. The last important remaining condition is receiving antitrust approval from the DoJ in the U.S., which could be granted in June, as the companies have offered significant concessions, including the divestment of Bayer’s digital agricultural business, which had been an area of focus. In addition, Bayer reiterated its expectation the deal will close in the second quarter of 2018. The companies have effectively created a fourth large competitor in the space through their divestments to BASF. BASF should be able to now compete against the other large agricultural companies, including Bayer/Monsanto, ChemChina/Syngenta, and DowDupont.

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.

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Class I EUR – LU0687944396
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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.

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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.
 

Amundi Pioneer AM, Investec AM, Janus Henderson Investors and Old Mutual Joined Bolton Global Capital at its Bolton Advisor Conference in Miami

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More than 90 investment advisory professionals from Argentina, Brazil, Panama, Switzerland, Uruguay and the US attended the Bolton Advisor Conference held by Bolton Global Capital at the Four Seasons Hotel in Miami, on the 3rd and 4th of May.

The first day began with a welcome speech by Ray Grenier, CEO of Bolton Global Capital; to be followed by Oscar Isoba, Managing Director and Region Head of US Offshore and LatAm at Nuveen Investments, who moderated the debate between guest investment strategists: Ashwin Alankar, Head of Global Asset Allocation and Risk Management, and Portfolio Manager at Janus Henderson Investors, Matthew Claenson, Portfolio Manager of the Investec Latin American Corporate Debt Fund strategy, managed by Compass Group for Investec Asset Management. Paresh Upadhyaya, Director of Currency Strategy at Amundi Pioneer Asset Management, and Justin Wells, Global Equity Strategist at Old Mutual Global Investors.

Afterwards, it was the turn to discuss regulatory issues, taxation, and compliance issues, Sergio Álvarez-Mena, Partner of Jones Day, Brian Curtis, Global Head of Anti-Money Laundering for Pershing LLC and Kathy Keneally, also Partner for the firm Jones Day.

Matt Beals, Chief Operating Officer at Bolton Global Capital, and Sean Power, Customer Success Manager at Agreement Express, talked about developments in new products and technology during the afternoon’s last conference. The events of the first day came to a close with a cocktail and a subsequent dinner.
The second day was dedicated to technical sessions with representatives from Bolton’s local offices, lecturers and conference sponsors (Investec Asset Management, Janus Henderson Investors, Old Mutual Global Investors, Amundi Pioneer Asset Management, Franklin Templeton Investments, AB, Carmignac Risk Managers, MFS, Aberdeen Asset Management, Capital Group, Fidelity Institutional Asset Management, Stone Castle, Nuveen Investments, BlackRock, Morningstar, American Express, Agreement Express and BNY Mellon Pershing). 

The debate between investment strategists

The discussion began with a review of the economic outlook and the movements of the markets so far this year. As pointed out by Justin Wells, the global equity team at Old Mutual Global Investors spends a lot of time understanding key dependencies that influence and actually drive market conditions. “We are seeing higher volatility in the US and Canada. Probably the biggest movement we have seen since Christmas has been the rapid deterioration in terms of market sentiment towards Europe. In Japan, we see a market that is very much driven by current policy, with somewhat less cross-sectional volatility, but we still see a higher degree of positive sentiment. We believe that what we are seeing in Asia Ex-Japan is probably a backdrop and maybe one of the drivers, of synchronized global economic growth, in which a weaker dollar has helped, but with a very different structure in our investment universe over that three-month period.”

Likewise, Ashwin Alankar of Janus Henderson Investors said that the growth of the global economy is solid thanks to the fact that financial conditions are still very accommodative. For example, in the US, the 10-year bond real rate is 80 bps, while outside the US real rates have remained well below zero across the developed world. But what does this indicate? The 10-year real rate of the Treasury bond indicates that the bond market estimates an average of real US GDP for the next ten years of 80 bps, that in Germany the average real GDP at 10 years is priced at -150 bps, the UK’s is priced at -100 bps and Japan at -50 bps. According to Alankar, while this does not mean an arbitrage opportunity, it does mean, however, that you could borrow in one of these economies and invest in others that have higher expected growth in real terms.

Along those lines, Paresh Upadhyaya of Amundi Pioneer Asset Management shared the opinion that the global economic backdrop is still very constructive, that financial conditions will continue to be highly accommodative and that monetary policy remains mostly stimulative. “Markets have started to shift from multi policies to policy convergence. The Fed is no longer the only central bank that is tightening its policy, so are the ECB and the BoJ, as well as other central banks worldwide. But in the last six weeks markets have become more concerned with economic indicators and price levels, which tend to show high frequency macroeconomic data and indicate whether they are above or below expectations. For most of the world, especially in Europe, these indicators are below expectations. It is very unlikely that we will see the same kind of growth that was seen last year and therefore, I think the fact that central banks are struggling to normalize monetary policy, with the Fed beginning to undo its balance, the ECB that will probably cease its QE program in the third quarter, and with the BoJ following not far behind. I think that normalization is leading to an increase in volatility, but it does not necessarily equate to bear markets on a global level, nor across all asset classes. We’ve seen the dollar’s rally in the last month, but there are forces still at play that indicate that it is very likely that the dollar will resume a bear market for one or two years. I think this is the result of the reemergence of the twin deficits and the capital deficit; and I believe trade policy still remains a real wildcard and historically has been a headwind for the dollar”

In turn, Matthew Claenson, Latin American Corporate Debt Manager at Investec Asset Management, said that prospects have changed dramatically in Latin America. “With a positive momentum and lower interest rates from which alpha can be obtained, the economies of Latin America are doing well. The main driver has been, and continues to be Brazil, which, after the worst years of recession the country has experienced in decades, has gone back from a growth of -3.5% to 2.5% this year. We continue to see a supportive environment from commodities incentives that keep that positive part of the cycle going. Obviously, there’s the question of this year’s elections and we can also talk about the big outlier in our region, which is obviously Venezuela, where the economy is imploding and we are talking about the chronicle of a train wreck foretold.”

The consequences of protectionism and trade wars

Twelve months ago, at Old Mutual Global Investors, they were somewhat concerned about the lack of equity markets’ reaction to the rise of populist movements, especially within the developed world. Justin pointed out we would have to go back some 30 years in order to find a similar political context. “It seems to have come with some lagged effect, but it has arrived, and the markets are reacting. This provides a good opportunity to capitalize on a short-term dislocation and to continue reacting and observing any changes in the structure of the market. In general, you have to be aware of the headlines.”

On the other hand, Ashwin pointed out that the main problem facing markets is the tremendous amount of information impacting markets these days, and spoke of the importance of figuring out a way to filter out fake news. “You must filter out what is reality from what is simply noise. At Janus Henderson Investors we have found the way, with discipline, backed by the strong belief that markets are smart, that the capital markets are intelligent, that the capital market existence is probably the most sophisticated system ever created; which is why it’s so difficult to earn alpha, it’s very difficult to beat the markets. Why not pay attention to what the markets are telling us? The markets tell us that the risks of a trade war have not yet been priced in, so we could come to the conclusion that the market thinks it’s simply noise; noise to which we should not pay too much attention.

Options are like insurance contracts, which are really the contracts that put a price on the risks. If the price of home insurance increases in Miami, it probably indicates that the hurricane season will be more severe and more frequent and therefore the price of insuring your home has increased. If we were entering a trade war, the options market should be pricing it in. And what we are seeing is that the S & P 500 is more attractive than the Russell 2000, indicating that the risk of entering a trade war with excessive tariffs is unlikely. At the moment, Canada looks very attractive, with the issue that the NAFTA treaty was going to be rescinded and that the country was going to suffer heavily. It is through systematic technology and listening to what markets tell us that we are able to separate what is noise from what they are made of. Nowadays markets tell us that the ideas of a long trade war are very unlikely.”

In turn, Matt nuanced between trade wars and trade tensions. “South America is somewhat further away from the scenario, but they are not isolated economies, for example, this is the case of Argentina and Brazil which are commodities’ exporters. Obviously, Mexico is the country that has been most affected, as the whole world has been paying attention to the struggles between the US and Mexican administrations. In particular, the Trump administration has verified the strong effort made by the lobbies of American companies to take a step back. “I don’t think a ‘NAFTA la vista scenario,’ where from one day to the next a great deal of investment disappears in Mexico, is the likeliest scenario. The focus seems to have now shifted to China, which has a much more consensual view in the US that its decline in revenue would be lower than in Mexico. The problem is that it’s election time, mid-term in the US and Presidential in Mexico, making it more complex to reach an agreement. Unfortunately, uncertainty will continue to haunt Mexico for a while.”

The impact of monetary and fiscal policies

According to Paresh, the effects of the recent fiscal reform in the US should begin to materialize from Q2 onwards. That’s when he expects US growth to approach 3% – 3.5%. “The Fed will have to assume that the relaxation of fiscal policies will have a greater effect on fixed income. The markets have 2 hikes priced in for the rest of the year, in the June and September meetings; however, I think the doors are ajar for a possible hike in December. I think there is a real difference of opinion between the Fed and the market for next year, the Fed anticipates two price hikes for next year, but we need to see clear signs that inflationary pressures are occurring. There is a possibility that inflation exceeds the 2% target. As we enter late summer, perhaps at the end of September, in the Federal Open Market Committee (FOMC), Powell must give a first signal that an additional hike could be given in December if growth rates of 3% continue. If the performance of the curve continues to steepen, that could be a sign that the market believes that the impact of the fiscal reform will boost the long-term potential growth of the US GDP. The fact that the curve has flattened indicates that the market doesn’t believe that the fiscal reform will increase the potential rate of growth in the long term, the truth of the matter is that for a few years we might not know the total factor of productivity, since it takes a few years to show and we start to see the whole growth. We will not know for two or three years, at least not in the short term, the reason for the flattening of the curve. The markets believe that the tax bill is going to be essentially a sugar high for the US economy that will stimulate growth in the next 6 quarters and that after that impulse in growth will disappear during the second half of 2019. This is what the curve says, we know that markets respond quickly, and if there are indications that productivity begins an upward trend, I think we will begin to see a greater steepening in the curve.”

From a currency perspective, Paresh explained that in his view it’s a good time to sell the dollar against some of the G10 currencies, such as the euro or the yen. “I think it’s a great level with the euro between 1,15 and 1,20 dollars, and the yen between 1,10 and 1,08”.

With respect to the curvature of the interest rate curve, Justin explained that the risk and structure of maturity are the factors that give it shape. “Investors demand a term premium; the main central banks have been containing the risks of interest rates. If the implied volatility of interest rates in the US is taken into account, it is at historical lows, the Fed has been managing interest rates volatility. It’s theoretically impossible for the term premium to comeback for the term structure to steepening when you have no volatility in interest rates. Until the Fed and the central banks of the rest of the world do not stop managing and moderating risks artificially in the bond market, term structure will remain flat. But once they start trading, to surprise the market, and start to hike unexpectedly or begin to change their interest rates, volatility should return. When volatility returns, you should theoretically see steepening in the curve. Currently, instead of paying attention to the rate curve, the Credit Default Swaps (CDS) curve should be examined. If the CDS curve is inverted, then there may be a problem. My recommendation is not to take the rate curve into account, because, although historically an inverted Treasury curve is bad news, at present, after a period of excessive monetary policies and intervention by central banks it cannot tell you anything. Just ignore it.”

Merger Investing: Recent Volatility and News Around Top Deals

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Merger Investing: Recent Volatility and News Around Top Deals
Pixabay CC0 Public DomainFoto: Pxhere CC0. Invertir en fusiones: la reciente volatilidad y las noticias alrededor de las principales operaciones

Volatility in global equity markets has continued to accelerate. Dueling trade tariffs between the U.S. and China have increased tensions between the two countries. Merger arbitrage spreads have widened in reaction to these factors, and deal specifics have changed in many of the top positions held in event funds. Widening spreads on a mark-to-market basis, not necessarily broken deals, have been the culprit recently. Below are examples of three large deals making major headlines recently.

NXP Semiconductors agreed to be acquired by Qualcomm:

NXP Semiconductors agreed to be acquired by Qualcomm under improved terms ($127.50 vs. $110 previously) and is currently awaiting the final regulatory approval from Chinese MOFCOM. As the recent tensions with China have elevated, shares of NXP traded lower resulting in a wider deal spread.

The deal has been impacted by recent tensions between US and China as the companies need Chinese antitrust approval, and that approval is being withheld in retaliation vs the United States for (1) trade tariffs imposed by the US, (2) the rejection that certain Chinese tech deals have received in the US, and (3) punitive US measures against Chinese companies like ZTE and Huawei. We do not think there is a material antitrust issue (takeover has already been approved by all other global regulators). Even though antitrust is not problematic, China can use it as a reason to block the deal and may do so unless there is some thawing of US-China relations. Our view is that it is in China’s best interest to clear this deal and wring out concessions to the benefit of its own tech industry. Benefits that it may not get if it blocked the deal outright. But with the market price of the stock suggesting that the deal will not close, it brings us to:

If there is No Deal – where does the stock trade?

Though it is hard to say, the stock trades at around $104/shr, below the level at which we thought it would trade without a deal. We do not think there is any takeover premium in that price, but just an absence of buyers as arbitrage funds cut risk and sell their positions. 

At $104, NXP trades at approximately 12x 2019 EPS and 9.5x EBITDA, both of which are discounts to its closest comps – such as TXN, ADI, MCHP. I also note that those multiples give no credit for the approximately $5 a share termination fee that NXP would receive if the deal breaks.

So where does that leave us today with NXP? Qualcomm and NXP have offered attractive concessions that would seem to be deemed favorable for Chinese technology companies and should motivate MOFCOM to approve the transaction at some point. NXP has strong growth prospects in automotive and Internet of Things (IoT) applications, and the downside on NXP shares is limited from here. Though, it has been a tough couple of weeks with this investment, it is still a core position in many funds, and our base case is that the merger completes but we certainly acknowledge that the risk of a break is up substantially higher from just a few weeks ago. Finally, we think that in the event of a blocked deal, once the arbitrage selling is complete, the downside from here is somewhat limited by fundamentals.

Time Warner agreed to be acquired by AT&T:

As a refresher, Time Warner agreed to be acquired by AT&T in October 2016 for $107.50 – half in cash and half in shares of AT&T common stock. Time Warner is a media company that owns premier assets including HBO, Turner Cable networks and the Warner Brothers movie studio. We see limited downside in TWX shares in the absence of a deal, and there was a well-worn path to deal approval using the blueprint of the similar vertical merger between Comcast and NBC Universal in 2011. It was surprising that the DOJ filed suit to block the acquisition in November 2017 given that the deal is a vertical merger. Historically, vertical transactions are seen as pro-competitive: no competitor is removed from the market; and, customers benefit from lower prices and more innovative products. The government claims that AT&T and Time Warner could threaten to withhold content from cable distributors to extract higher fees, but AT&T have already committed to behavioral remedies – including no-blackout, baseball-style arbitration – that would eliminate that threat.

The trial commenced on March 19 and we have been actively examining the court proceedings. Witness testimony is expected to complete this week, with closing arguments on Monday. The key takeaway from the trial is that the government’s economic models that suggest prices will increase for consumers have been at least partly discredited. Also, the government-hired economists lowered the potential harm from the deal going through. A key point in the trial came during testimony from telecom company Charter Communications when Judge Leon asked the witness whether AT&T’s proposed style of arbitration could be restructured in a way that was more agreeable for competitors. The witness from Charter acknowledged he DID believe a restructured arbitration agreement could resolve their concerns. This could provide Judge Leon with a path to approve the deal, subject to a new style of arbitration that would reduce AT&T’s incentives and ability to raise the cost of Time Warner content.

The timeline forward from here after closing arguments and final briefs, Judge Leon has indicated it is likely to take him about 5 weeks to write his decision. That means the decision would come before the June 21st outside date of the merger agreement, as requested by the parties.

From our perspective, the current valuation of Time Warner’s shares at $95 is attractive even in the absence of a deal. Time Warner has executed at a very high level since the acquisition by AT&T was announced, posting strong operating results in each quarter. This has lifted Time Warner’s “stand alone” value were the DOJ successful in blocking the merger in court. Tax reform has helped bolster our view that TWX shares are an attractive investment as TWX’s EPS is expected to increase 25% resulting from a lower effective tax rate and bonus depreciation. A recent regulatory filing from the Disney/Fox transaction showed that there were multiple active suitors bidding in the process – including Verizon, which had previously been mum on its content acquisition strategy. We think this highlights the attractiveness of high-value content assets and believe Time Warner’s premier entertainment assets and content could potentially attract a new suitor, both within the traditional media industry and outside of it. Time Warner remains a core holding around for many event managers. We see the downside equaling  $7.50 EPS 2018 @ 12x (2x P/E discount to DIS) would get ~$90 per share.

AKRX Inc. agreed to be acquired by Fresenius SE & Co.:

Akorn Inc. agreed to be acquired by Fresenius SE & Co. Akorn develops and manufactures specialty generic pharmaceuticals. Under terms of the agreement Akorn shareholders would receive $34.00 cash per share, valuing the transaction at approximately $4.9 billion.

On Monday 4/23/18, Fresenius has attempted to terminate its acquisition of Akorn on the basis that Akorn has failed to fulfill several closing conditions, including a material breach of FDA data integrity requirements. Akorn has responded by filing suit in Delaware Court seeking Specific Performance to enforce the merger agreement.

The complaint has been filed confidentially and will be soon be made publicly available. It should give us more insight into Akorn’s investigation into the alleged data breach as well as a better understanding of the timeline. Additionally, Akorn management has confirmed to us that they have been voluntarily updating the FDA on their internal investigation and currently the FDA is not pursuing its own investigation.

At this time we don’t know exactly what Fresenius has found, but it should be noted that based on the merger agreement, the failure of a reps and warranties condition is qualified by a material adverse change (MAC). This is an extremely high threshold, which has never been found by a Delaware judge.

Given the strong merger agreement and support of legal precedent, we will continue to assess as we learn more about Fresenius’s findings. While at this point we still believe that the most likely outcome is a price cut and settlement, we are cognizant of the potential for significant downside in the event that there are material issues with the pipeline.

The street projects an approximately $11 per share stand-alone value with current market dynamics, but this projection has little basis in reality. If the deal with Fresenius closes, we’d expect it to be under a re-negotiated price in the mid-to-upper $20 range. Conversely, if the deal falls apart, it would likely mean that there is a material negative impact from the FDA data integrity that could compromise AKRX’s future business.

These deals have created much volatility in the event space and have had an adverse effect on short term performance in funds in the space. Much is not definitive but will need to be monitored, though we are being better compensated for the risk; the reward now has many hidden variables driven by the political tensions that seem to be multiplying globally. Discipline, intense research and continued diligence will be imperative in factoring out the winners and losers, and more importantly how to size and trade around positions. Our conservative approach remains a key aspect of our approach in the space. More to come…

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.
 

Lon Erickson (Thornburg Investment Management): “There is Still Some Uncertainty Surrounding the Robustness of the US Economy”

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On April 25th and 26th, Thornburg Investment Management (Thornburg), a global independent asset management company, brought together for its annual event more than 40 professionals from the investment industry, most of them financial advisors from Bolton Global Capital, Insight Securities, Morgan Stanley Wealth Management, UBS Financial Services, and UBS International. The event was hosted by Vince León, Director, Offshore Advisory Channel and Miguel Cortabarria, Offshore Internal Sales Consultant.

In this new edition of its “2018 International Advisors Conference“, which, as usual, was held in the city where the company has its headquarters, Santa Fe, New Mexico, Jason Brady, Thornburg’s President, CEO and Managing Director, welcomed the attendees. In his speech, he explained the characteristics that make his company’s investment process different; which begins with the importance of the firm’s location, away from the noise of Wall Street, in order to accordingly process the huge volume of information that investment managers receive nowadays. With about 48 billion dollars in assets, the company consists mainly of private capital of which an important part is held by its Managing Directors and employees (1.88%).
“We consider a wide range of opportunities, beyond the limits of the conventional, to find the best relative value. Thornburg uses a flexible perspective that benefits from the interaction of various investment teams in order to refine ideas, obtain better judgment and more competitive results for investors,” says Brady. 

We feel that this leads us to better investment results for our clients. We look for a challenge, we focus on the objective and not on the reference indexes, which ultimately translates into conviction portfolios with a high active share. “Our investment approach is structured, in order that by being repeatable over time we can then achieve superior long-term results for our clients.” Specifically, the asset manager specializes in six asset classes, domestic and international variable income (value, growth and emerging), global fixed income, municipal bonds, multi-assets and alternative strategies (long/short in equities).

The Outlook for Emerging Equities

After Brady’s presentation, came emerging markets’ turn; these markets, representing 86% of the world’s population, 40% of the GDP and 21% of the market capitalization, usually translate into a greater demand for goods and services by an increasing middle class, with a much faster GDP growth. Something that already happened in the US during the past 50 years, and that Charlie Wilson, co-portfolio manager of the Thornburg Developing World portfolio, and Pablo Echavarría, Associate Portfolio Manager, recognize as a determining factor for long-term investment.
In the last ten years, the composition of the MSCI Emerging Markets’ index has changed substantially, if a decade ago the extractive industry and banks dominated market capitalization, nowadays, it’s technological companies such as Alibaba or Tencent the ones that lead the market. In that regard, the Thornburg’s strategy prefers to leave the index aside and choose quality companies with attractive valuations that minimize the typical breaks in which this type of asset usually incurs.

“In order to assess company quality, we pay close attention to the alignment of corporate governance’s interests with those of minority shareholders. We also examine the company’s balance sheet in depth. What we seek above all is to hedge the downside risk, since that’s the way we can obtain a higher compound interest rate, providing higher quality and higher return rate return to the fund. We tend to invest in financially sound companies, companies with low leverage that show no deterioration in their cash flows. These two issues are the most important in a bear market. In addition, we pay attention to the valuations, mainly those expressed in terms of free cash flows, and we establish an objective for the return in order to create expectations about the company and to measure the impact of the investments,” said Echavarría.

They use an approach of three investment baskets for the portfolio’s construction, in the first one they include basic value companies, with securities that fall within the classic description of the investment value. In the second basket, the stocks that consistently earn profits, and in the third, the growth companies that they call emerging franchises. “This approach allows us to participate in the market cycle’s different tides. It allows us to be aware of relative growth and the performance profile adjusted by the risk of these companies. We search among the different baskets, focusing on building differentiation to address market expectations,” argued Wilson.

The Fixed Income Vision

Then came fixed income’s turn; Lon Erickson, Portfolio Manager and Managing Director, expects that international demand and the consequent pressure on the yields of fixed income will decrease in 2018 due to the weakness of the dollar. “The majority of international investors invest with a hedge in currency, but the cost of hedging increased considerably with the movements in exchange rates. Once this cost is added on, US returns do not look as attractive. In addition, the Fed is reversing its asset purchasing program, as is the ECB, and even the Bank of Japan is talking about how to eventually exit the QE program. If you believe, as do we, that the purchasing program kept rates at low levels, it is reasonable to think that it will put some pressure on rates once the stimulus is withdrawn,” he said.

According to Erickson, the main question is whether it will affect them for better or worse. “An experiment on the Fed’s balance sheet like this one has never been seen before. At the current rate of reimbursements, it will take up to 6 years to return to the previous balance of one trillion dollars, a considerably slow schedule that the market could absorb. But it’s not only the Fed that is withdrawing liquidity, the ECB has also begun the withdrawal; which is something that will reduce the demand for dollar assets and increase the pressure on rates. We expect more pressure on the returns of the 10-year bond, but we also believe that it will be contained, as there is still some uncertainty surrounding the robustness of the US economy.”

According to the asset manager, spreads are very compressed and leverage levels are historically similar to those maintained during a recession. Regarding inflation, he believes that the recent fiscal reform will add pressure. Finally, in relation to positioning, he explains that credit opportunities are less attractive, since the public and corporate balance sheets don’t look as solid. Opportunities in interest rates exist above all in the long term and in the cash position, which responds directly to the Fed rate hikes. “It’s where the opportunities can lie in the short term, whilst waiting for new opportunities in the curve,” he concludes.

The Power of Dividends

Then came the turn for the company’s flagship strategy; Brian McMahon, Thornburg’s Vice-Chairman, CIO and Managing Director, presented Thornburg Investment Income Builder’s capabilities; the strategy was designed for investing 75% in stocks and 25% in bonds, but currently allocates 90% in equities, since the actions of central banks during the past few years has displaced investors out of the bond market. “The central banks of the main developed economies, the US, the UK, Japan and the Eurozone, have bought a very high percentage of debt in relation to sovereign bonds issued by these countries. In 2013, the Fed bought two thirds of the bonds that were issued, leaving only one third for the rest of private investors. Also, in 2017, the Bank of Japan bought 250% more than the amount issued by the government. The European Central Bank’s behavior was similar, substantially reducing the offer of sovereign bonds of developed markets and making asset managers’ work more complicated,” said McMahon.

As for the choice of companies that pay dividends, Thornburg chooses companies that have a capital discipline, that only invest in capitalization expenses if they have good projects to invest in and which respect their dividend payment policy. “From 2011 to 2017, the average growth rate of dividends globally has been good. The dividend yield of the shares has become very competitive compared to high-yield fixed income, in fact, in Europe, it is slightly higher than yields of the high-yield bonds issued in the region.”

According to McMahon, the positioning of the portfolio responds to the search for opportunities between regions and sectors that offer the highest dividend yield. “We fish wherever there are fish. By geography, at the end of Q1, we give preference to Europe, excluding the UK, to North America as, despite the US offering one of the lowest dividend yield rates of 2.1%, we trust that there will be a change with the fiscal reform, and to the Asia Pacific region; while, by sectors, we favor the financial, telecommunications, energy and consumer discretionary companies. We maintain a low exposure to the sectors that have traditionally been related to attaining dividends, such as public utilities, materials and real estate; because at present they have been an asset sought as a refuge and are traded similarly to short duration bonds.”

They expect that 76% of positions in the portfolio increase their dividends within the next 12 months, and that of the 14% that will pay lower dividends, 66% are companies that had already paid a special dividend the previous year. However, what will happen when rates continue to rise? The asset manager acknowledged that strategies similar to that of Thornburg Income Builder have lost about $ 100 million in outflows from investors who fear an increase in US Treasury rates. But, in the past, the fund has managed to surpass yields obtained by fixed-income indices when the 10-year Treasury rate has risen by more than 40 basis points in 27 periods, exceeding in 24 of them the profitability of the US Corp Bond Index and the US Aggregate Bond Index, and in 20 periods the profitability of the US HY Bond index.

A Distinctive Approach

It all started on Thanksgiving 36 years ago, Garrett Thornburg, Founder and Chairman of the company’s Board of Directors, and who had previously been a partner of Bear Stearns & Co, as founding partner of its public finance division, and CFO of Urban Development Corporation, decided to focus on the management of investment strategies. Two years later,Brian McMahon left Northwest Bank to join Thornburg. Together, they launched a first municipal bond strategy, followed by government bonds’ strategies, US value equities, international value and growth. Thus, in 2002, the Thornburg Income Builder strategy was launched, and in 2006, Jason Brady joined the firm.

“Our main value is doing the right thing. It’s very simple; we act with integrity and put our clients’ interests first. Our portfolios are concentrated, so we are not always in sync with the fads that may be in the market. We focus on the long term and therefore our equity strategies outperform their indexes in all their categories. Our motto, “It’s not what we do, it’s how we do it”, is very representative. And, our way of investing is collaborative, the entire management team is in Santa Fe and they work together, in total 236 people who can find a good investment idea. It’s possible that this idea does not fit into a value strategy, but it may work for a growth strategy,” Garrett Thornburg commented during his presentation.

As the event progressed, they didn’t insist as much on the positioning of the portfolios when facing the markets as on the importance of asset managers adhering strictly to the investment process of each strategy. “We are not experts in guessing the future. We carry out a conscientious decision-making process and believe that excellence in investment should guide our decisions. We look for the best for our clients,” concluded Rob McInerney, Sales Manager and Managing Director for the management company, who also emceed the event.

Corporate Profit Growth, Aggressive Corporate Stock Buy Backs, and Deals Should Provide a Cushion for Any Selloffs

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Corporate Profit Growth, Aggressive Corporate Stock Buy Backs, and Deals Should Provide a Cushion for Any Selloffs
Pixabay CC0 Public DomainJayMantri. El crecimiento de los beneficios corporativos, las agresivas recompras de acciones y las fusiones y adquisiciones deberían ser un amortiguador para la renta variable

The U.S. equity market rallied sharply in January but ended slightly lower for March and the first quarter after an overdue high-volatility spike selloff during early February and a recovery rally into mid-March, followed by a month-end dip with the S&P 500 Index closing nearly 10% off its 2018 highs.

The U.S. Federal Reserve’s gradual liquidity reduction and rising policy rate, plus the prospect for the same from the ECB, have weighed on stock prices. However, the U.S. Treasury yield curve flattened as note and bond yields declined toward the end of March while stocks retreated. The main drivers for rising stock prices continue to be lower corporate taxes and higher profits.

Global merger and acquisition activity accelerated to a record $1.2 trillion in the first quarter of this year following the passage of U.S. tax reform and a boost from the catalyst of shareholder activists.  CEOs are initiating major transactions sparked by excess cash and the goal of growing the top and bottom line. Industry consolidation deals are heating up as scarce targets ignite bidding wars. Uncertainty over Trump trade policy and regulatory hurdles are deal headwinds.

Duelling trade tariffs between the U.S. and China have increased tensions between the two countries. Widening spreads on a mark-to-market basis, not broken deals, were the culprit driving performance in March.  Merger arbitrage spreads widened in reaction to these factors, allowing us to deploy additional capital opportunistically.  These opportunities would lead us to expect to earn potentially higher returns when deals in the portfolio close.

We believe the recent widening of spreads and the increase in deal risk premiums present an attractive opportunity to add to and initiate positions with the potential to earn greater returns. We continue to find attractive opportunities investing in announced mergers and expect future deal activity will provide further prospects to generate returns non-correlated to the market. 

Play Ball! On the long only side The Atlanta Braves were founded in 1871 and are the oldest continuously operating professional sports franchise in America.  The Liberty Braves Group (BATRA) moved to the new 41.5K seat SunTrust Park, Cobb County from Atlanta in February 2017. Liberty Media Corporation recapitalized the Atlanta Braves as a tracking stock in April 2016 along with Liberty SiriusXM and Liberty Formula One. Assets include the Atlanta Braves Major League Baseball club and stadium and the Battery real estate project. The Battery Atlanta is a 46 acre mixed-use development with residential and commercial property that feeds off the stadium (16 acres) on 82 acres with initial completion in 2018 and 20 acres for further development. Sports franchise valuations continue to mature, the opportunity to be an owner is an expensive endeavor,  The Liberty Braves Group gives you an opportunity to part of the inner circle and own a piece of a MLB team at an attractive value.

Rising uncertainties may keep the stock market on edge but corporate profit growth, aggressive corporate stock buy backs, and deals should provide a cushion for any selloffs.

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