Swetha Ramachandran, Investment Manager in the European Equities team and Head of the GAM Global Luxury Brands strategy. Swetha Ramachandran, Investment Manager in the European Equities team and Head of the GAM Global Luxury Brands strategy
The virtual forum “The Power of Diversity: Women at GAM,” held by GAM Investments from the 28th September to the 2nd October, was attended by Swetha Ramachandran, Investment Manager in the European Equities team and Head of the GAM Global Luxury Brands strategy, as well as responsible for research in the consumer goods sector, both in commodities and discretionary.
As Swetha Ramachandran explained during her presentation, there are three factors why the consumption of luxury goods has persisted during the pandemic. The first is that, during times of uncertainty, consumers revert to trusted brands that provide a sense of confidence and security. Secondly, the luxury sector continues to attract new consumers, with the Baby Boomer generation embracing online spending, and with growing Chinese consumerism beyond its Tier 1 and 2 cities. Thirdly, the pandemic has triggered a trend for more sustainable behavior, with consumers looking to buy less, but with better quality.
Intersecting Trends
In addition to the sustainability factor and the circular economy, the luxury sector is supported by a growing middle class looking for aspirational consumption in emerging economies, particularly in the Asian region. As well as the demographic and lifestyle changes happening among the Millennial and Z generation, and among the older generations, who can devote a greater part of their income to luxury spending.
The attractiveness of these stocks lies in their ability to have exposure to the rapid growth of emerging economies and in particular to the consumer sector, a sector that has a much higher growth rate than the rest of the components of GDP. In addition, most of the stocks in which GAM Global Luxury Brands invests are listed on both European and US stock exchanges, so their capital costs are at developed economy levels, thus benefiting from very low capital costs.
The growth of the emergent consumer
Globally, the middle class spends about $35 billion and by the year 2030 could be spending an additional $29 billion to reach $64 billion, representing about a third of the global economy.
While this middle class grows at a rate of 0.5% in developed economies such as Japan, the United States or the Eurozone, in countries like China and India it shows a growth rate of 6%. If the current rate of growth continues, it is estimated that by 2030 Asia will represent two thirds of the global middle class. As such, the population of China and India will represent about 43% of the middle class by that time.
Currently, China accounts for 35% of global luxury consumption and is responsible for 90% of its growth; while Japan and other Asian countries account for 21% of the global luxury market share and 20% of its growth.
Based on age, the so-called Generation Y (Millennials) and Generation Z are the two generations that are most inclined to spend in the luxury goods sector. Particularly in regard to the Asian and Southeast Asian generations, as the average age of the Asian consumer is 28, while the European or American luxury goods consumer is 40 and 45, respectively.
It is particularly the Chinese Millennial generation consumer who is the biggest spender on luxury brands. This is mainly explained by the rapid generational change that has taken place in the country over the last 40 years. The birth control program of one child per couple, implemented in 1979 in China, makes the Chinese Millennial the only beneficiary of the wealth accumulated by previous generations. As a result, 70% of the millennial generation in China owns their own home, as opposed to 35% in the United States and Europe. This means that once they start working, most of their income is disposable income, and a large part of this is for luxury consumption.
Another reason for their increased propensity to consume is consumer sentiment. In the last 30 years, China has experienced a growth in GDP per capita from the standpoint of purchasing power growth of about 17 times, a figure that compares with less than 5 times in the United States and Europe. This represents that the attitude of Chinese Millennials towards spending is that the future is going to be better than that of their parents’ generation, which fuels their appetite for living well and for consuming premium brands. This is one of the characteristics that differentiate them from past generations that grew up in a China where there was much more economic adversity and more frugal consumption patterns.
Beyond China
While within the next 5 to 10 years China will be the major consumption driver in the luxury goods sector, it doesn’t mean that it will be the only growth factor. If we take into account the combined population aged under 30 of India, Southeast Asia (Thailand, Vietnam, Indonesia and the Philippines), Brazil, Russia, the Arab Emirates and Saudi Arabia, it is 2.3 times more than the population of the same age in China. The only difference is the lower purchasing power of these countries compared to the Asian giant.
However, strong growth in consumer purchasing power is expected in these countries, especially in the Asian region, so that in the long term they could become very attractive consumers for the luxury goods sector. Consumers in the “mass affluent” sector, defined as those consumers with both the income and the intention to greatly increase their consumption of luxury products, will grow to 20% of the population by 2030.
Meanwhile, India is a long-term scenario. Historically, despite having a similar population size to China in absolute terms, China accounts for one-third of global luxury consumption while India barely approaches 3% or 4%. The main reason is that household income is distributed in a pyramidal fashion with a ridiculously small upper class at the apex and a broad base with lower incomes. But this income based population pyramid is being transformed; in fact, a significant increase is expected in the upper and upper-middle class income segments, which at present represents 1 in 4 households, and by 2030 is expected to represent 1 in 2, with some 70 million fewer households in the lower income segment.
Pixabay CC0 Public Domain. Schroders se une a la iniciativa Global Impact Investing Network (GIIN)
Credit Suisse Asset Management and Equilibrium Capital Group, sustainability infrastructure and resource management leader, have joined forces to launch a platform of sustainable real assets that will allow them to expand the resources and capital available to industries and businesses that share their commitment to sustainability.
Credit Suisse revealed in a press release that this partnership follows its establishment in July of an executive board-level function Sustainability, Research & Investment Solutions (SRI). SRI has a commitment to provide at least 300 billion Swiss francs of sustainable financing over the next decade in fulfillment of the bank’s and its clients’ desire to deploy capital sustainably.
In support of this global initiative, Credit Suisse AM and Equilibrium will jointly develop and manage a sustainable infrastructure and resource management platform. The collaboration will allow them to combine Credit Suisse’s global reach and expertise in sustainability with Equilibrium’s industry leadership “in building pioneering, institutional, sustainability-driven real asset and resource management capabilities”, they explained.
Climate change mitigation
“Equilibrium is an ideal partner for our franchise given our shared history in sustainability, alternatives and real assets. This partnership marks another landmark in Credit Suisse’s sustainability strategy to help address pressing environmental challenges”, commented Eric Varvel, Global Head of Credit Suisse AM.
Marisa Drew, Chief Sustainability Officer and Global Head of Sustainability, Strategy, Advisory and Finance at Credit Suisse, said that they are “delighted” to support this collaboration in pursuit of their shared mission to mobilize capital for good. The announcement “builds on Credit Suisse’s long history of ground-breaking sustainability strategies, from co-founding one of the early leaders in microfinance and impact credit, to integrating sustainability into real estate portfolios, and innovating in the fields of conservation and energy transition finance.”
Meanwhile, Dave Chen, CEO of Equilibrium Capital, pointed out that they are excited to partner with Credit Suisse on this mandate to address the changing resource infrastructure landscape. “While we cannot reverse climate change completely, we can mitigate its impact by creating more sustainable infrastructure. By managing the environmental risks around food production, waste, water and energy, we can foster greater stability and security in those areas”, he added.
Pixabay CC0 Public Domain. La FED aprueba la solicitud de Allfunds Bank para abrir su oficina de representación en Miami
Allfunds Bank continues its international expansion process. Yesterday, the Federal Reserve Board approved their application to establish a representative office in Miami (Florida). The new office will be led by Laura González and will serve as Allfunds hub for US offshore activity.
The statement released by the Board says that the office will act as a liaison with U.S. clients and prospective clients of the firm. Also it will “market and solicit new business for banking products and technological services provided by Allfunds”.
The Board thinks that the firm appears to have the experience and capacity to support the Miami Representative Office. “Taking into consideration Allfunds’ record of operations in its home country, its overall financial resources, and its standing with its home country supervisors, it has been determined that financial and managerial factors are consistent with approval of Allfunds’ application to establish the office”, they pointed out.
In a press release, Allfunds informed that González joined the firm in 2011 and has a wealth of knowledge on US offshore after working several years with the Latam market. Currently she serves as Allfunds Global Head of Wealth Management and prior to that she was appointed Head of Iberia and Americas at Allfunds covering both the strategic direction and the firm´s expansion model across the region. She also successfully led the opening of the Allfunds´ Brazilian office.
“We continue to fulfill our expansion plan. The opening of this office is a very important step for the company as it is the first office in the United States. This milestone reinforces our leadership as the world’s leading wealthtech and fund distribution platform and our commitment to the North American market”, said Juan Alcaraz, CEO of Allfunds.
Allfunds has several representative offices in South America and the Middle East and operates branches and subsidiaries in six countries. Its foreign operations include subsidiary companies in Brazil, Luxembourg, and Switzerland; branches in Italy, Singapore, and the United Kingdom; and other representative offices in Brazil, Chile, Colombia, and the United Arab Emirates.
With total assets of approximately $2.5 billion, Allfunds is a Spanish bank providing clearing, settlement, and administration services through a platform offered to financial services firms, including banks, wealth managers, broker-dealers, insurance companies, fund managers, and pensions. It is the largest investment fund administration platform in Europe based on assets under administration, with over $615 billion.
Foto cedidaJill Barber, new Global Head of Institutional Solutions at GAM. GAM ficha a Jill Barber para el cargo de directora global de soluciones institucionales
GAM announced the appointment of Jill Barber for the newly-created role of as Global Head of Institutional Solutions. In its quarterly results, the firm revealed that she will join them on 2 November 2020 and will partner with Jeremy Roberts, Global Head of Distribution, to lead sales and distribution.
Hiring Barber has to do with GAM’s intention to focus on growth and cross-selling opportunities between investment management and private labelling. The firm pointed out that further simplification of the business will also bring additional opportunities for efficiency gains in 2021 and 2022.
“The growth pillar of our strategy is progressing well with high levels of client interaction and a strong pipeline of growth opportunities. To support these efforts, we have hired Jill Barber to partner with Jeremy Roberts and lead sales and distribution, focusing on institutional and wholesale clients respectively. We are also seeing encouraging signs of success from collaboration between private labelling and investment management using capabilities from across the firm”, said GAM in its statement.
Before her appointment, Barber was global head of institutional at Jupiter AM for three years, prior to which she worked at Franklin Templeton Investments. Peter Sanderson, group chief executive at GAM, pointed out that she has “an excellent reputation across the industry, in-depth knowledge of the institutional market and demonstrable success in delivering solutions for clients”.
The asset manager also revealed that they will announce shortly a new appointment of the Global Head of Sustainable and Impact Investment, who will lead the sustainable investment strategy and strengthen their client ESG proposition.
Pixabay CC0 Public Domain. Jupiter AM ubica en Denver su primera sede en Estados Unidos
Jupiter Asset Management announced the opening of its first office in the United States, for its recently created US subsidiary – Jupiter Asset Management US LLC (“JAM US”). Three Jupiter employees, including two newly appointed team members, will be based in the office in Denver (Colorado) as the firm initiates its expansion within the onshore US institutional market.
In a press release, the asset manager pointed out that Taylor Carrington has joined the firm as head of US distribution and managing director for JAM US. Reporting to Warren Tonkinson, managing director, distribution, he will lead the firm’s sales efforts in the onshore US institutional market. With 19 years’ experience in asset management, Carrington joins from Allianz Global Investors, where his most recent position was head of North America, institutional client team. “His appointment marks Jupiter’s first step into this client segment, and an important expansion of its international distribution profile”, said the firm.
Initially, he will spearhead the US onshore distribution of NZS Capital’s global growth strategies, following the agreement of the strategic partnership in late 2019, under which Jupiter is the exclusive global distributor of its products. Teh asset manager revealed that Carrington has known the NZS investment team and its client base for many years, having previously worked with NZS co-founders Brad Slingerlend and Brinton Johns at Janus Capital Group.
Following receipt of the appropriate regulatory approvals, he will also lead the distribution of Jupiter’s investment strategies to the onshore US institutional market.
As part of the initiative to build out the US infrastructure, the firm has also hired Tracy Pike as head of investment oversight at JAM US. As stated in the press release, subject to regulatory approval, her primary responsibility is to oversee the delegation of investment activities to NZS Capital in relation to the NZS strategies, or Jupiter Asset Management Limited in the UK.
Pike brings over 24 years’ industry experience and was previously head of sub-advisor oversight at Charles Schwab Investment Management. Prior to this, she was a senior product manager at Janus Capital Group, where she worked closely with Carrington and the NZS investment team. Pike will report to Katharine Dryer, Jupiter’s deputy CIO.
A credit research hub
Joining them in the Denver office will be Joel Ojdana, a US credit research analyst on the fixed income strategy. He has worked at Jupiter since July 2018 and has over twelve years’ experience in investments. Previously based in London, he has made “a meaningful contribution to the firm’s US credit research – an important pillar of Jupiter’s £12.7 billion unconstrained bond offering”, pointed out the asset manager. Ojdana will be Jupiter’s first research analyst based in the US and he will continue to report to Luca Evangelisti, head of credit research, remaining an integral member of Jupiter’s fixed income team.
Jupiter revealed that during 2021, they will be actively exploring the opportunity to establish a local US credit research hub and potentially expanding the team based there, with Ojdana leading this initiative.
A “vital” local presence
“The US institutional market is incredibly significant, and I’m thrilled that we’ve been able to open our office in Denver. Under Taylor and Tracy’s experienced leadership, there is a brilliant opportunity to expand meaningfully, offering both NZS and in time, Jupiter strategies to US institutional investors”, said Tonkinson.
In his view, establishing a local presence is vital to achieving success in this market and ensures their new US clients will receive the highest level of customer service. “The office opening also represents a key milestone in Jupiter’s international growth”, he added.
Meanwhile, Carrington commented that, having worked in the US institutional market for many years, he is confident that Jupiter’s “broad, high-conviction and genuinely active” fund range will appeal to a wide number of sophisticated investors looking to navigate global markets. “The opportunity to initiate Jupiter’s expansion in the region, as well as to work with the NZS team again, is incredibly exciting and I look forward to helping Jupiter becoming a significant participant in this market”, he said.
Pixabay CC0 Public Domain. PIMCO y GE Capital Aviation Services crean una plataforma de inversión en el sector de arrendamiento de aeronaves
PIMCO and GE Capital Aviation Services (GECAS), a business unit of GE, have reached a preliminary agreement to develop an aviation leasing platform to support up to $3 billion in aircraft asset financings. The firms announced in a press release that the transaction is subject to customary closing conditions and receipt of required regulatory approvals.
This strategic investment platform will enable GECAS and PIMCO-advised accounts to acquire “new and young fuel-efficient aircraft to meet the needs of a diverse set of global airlines over many years”, they explained. The platform looks to provide “much-needed financing” for airlines which are looking to upgrade their fleets.
The portfolio will initially focus on narrowbody aircraft while allowing flexibility to invest in attractive opportunities in the widebody market. PIMCO and GECAS will consider a range of investment criteria including an airline’s assets and credit quality and also geographic factors.
PIMCO is already one of the world’s largest investors in aviation-backed debt. Both firms think that its presence in aviation financing markets combined with GECAS’ leadership role in the aircraft-leasing segment will provide “enormous flexibility” to fund the global airline industry. GECAS will source transactions, act as servicer and provide asset management services for the platform.
Essential liquidity for a critical industry
“As the airline industry struggles with the effects of the COVID-19 pandemic, the PIMCO-GECAS platform will inject essential liquidity into this critical industry by providing financing solutions at a time when there are fewer traditional financing options for airlines,” said Dan Ivascyn, PIMCO’s Group Chief Investment Officer.
In his view, aircraft remain an attractive asset class in a critical infrastructure sector supported by solid long-term growth drivers. He also pointed out that GECAS’ expertise as a world class aircraft lessor aligns with PIMCO’s “longstanding investment strategy” in aviation finance.
Meanwhile, Greg Conlon, president and CEO of GECAS, claimed to be “delighted” to team up with a premier institutional investor such as PIMCO in this strategic relationship which he thinks will enable “opportunistic plays” to support airline customers around the globe.
“While GECAS maintains an industry-leading position, this platform will ensure we can continue providing our airline customers with the aircraft needed to sustain their franchises”, he added.
Pixabay CC0 Public Domain. La relación entre el Reino Unido y la UE después de diciembre y las implicaciones para sus respectivas industrias de fondos
With less than 100 days until the UK definitely leaves the European Union, it is worth reflecting on the practical impact of Brexit on the relationship between the UK and Luxembourg in the asset management and fund industry.
London and Luxembourg are long-standing partners. With 17.1% of AUM, UK asset managers represent the second largest group of initiators of Luxembourg funds. These investment funds (UCITS and AIFs) benefit from European marketing passports. They are distributed in the EU at large, including the UK, and beyond.
The UK is in fact a very important distribution market, with Luxembourg clearly a leader among overseas funds. Roughly 25% of funds distributed in the UK are overseas funds. As at 31 December 2019, there were 8,862 funds/sub-funds distributed in the UK. From this total, 4,341 are Luxembourg-domiciled, which thus represents 49% of all overseas funds registered in the UK.
The vast majority of UK asset managers (HSBC, Invesco, Schroders, Aberdeen, M&G, just to name a few) have established their own UCITS management company or AIFM in Luxembourg. This was already the case before Brexit, but some additional 30 firms have in the meantime set up their own operation in Luxembourg. This allows them to benefit from the European management passport once the UK will have left the EU. This was a logical move when considering that the UCITS Directive and AIFMD feature both a “product” passport, meaning the investment funds themselves, and a “management” passport for UCITS management companies and AIFMs managing these funds.
Another possible way of retaining access to distribution in the EU is to set up the fund in Luxembourg while appointing a third-party management company, should the UK asset manager not have its own operation in the EU.
By far and large, ALFI’s feedback from its members is that virtually all firms have taken the necessary steps to anticipate a hard Brexit: either setting up presence for those few that needed a presence in the EU as just mentioned, or re-domiciling UK funds to Luxembourg, and making the necessary adjustments in the allocation of assets.
Unlike in other segments of the financial sector such as the clearing of derivatives, trading venues or CSDs, the concept of equivalence plays little if no role when it comes to the management and marketing of EU and non-EU funds. Indeed, the UCITS directive and the AIFMD already offered pre-Brexit a relatively clear framework.
The impact on UK and Luxembourg
What does this mean in practice for UK funds? Any fund that is not a UCITS is by definition and from a European perspective an AIF. Those UK-domiciled UCITS will lose their UCITS label. They will qualify as non-EU AIFs as from 1 January 2021. They may still be marketed to European investors subject to the conditions set out in the AIFMD, which are obviously more restrictive. Non-EU AIFs can indeed only be placed subject to the terms of the National Private Placement Regimes, if any, of each individual EU Member State. They will no longer benefit from a marketing passport as the AIFMD 3rd country passport has not been activated.
And for Luxembourg? Any Luxembourg UCITS that is today marketed in the UK will similarly no longer be viewed by the UK as a UCITS from 2021 onwards. That said, there is wide consensus among policymakers and asset managers that it is key, from an investor choice’s perspective, to keep the UK market open to overseas funds, especially when considering that UCITS are retail products with a high degree of investor protection. Today, most money market funds and ETFs marketed in the UK are overseas funds, almost invariably domiciled in Luxembourg or Dublin.
To avoid any disruption, the UK government and the FCA implemented a Temporary Permissions Regime (TPR) which enables relevant firms and funds which passport into the UK, to continue operating in the UK when the passporting regime ceases to exist on 31 December 2020. All Luxembourg investment funds registered for distribution have made use of the TPR mechanism.
The TPR is obviously a short-term facility to bridge the gap until new legislation is passed and effectively implemented in the UK. It is expected that this will take two or three more years from now.
2021 and beyond
From January 2021 onwards, the UK will become a 3rd country. The legislator may impose additional requirements on overseas funds like this is currently the case with EU funds distributed in other 3rd countries such as Switzerland, Hong Kong etc.
The UK Government (HM Treasury) launched a Public Consultation on the Overseas Funds Regime (OFR) post Brexit, to which ALFI responded in early May. ALFI generally agrees on the approach taken, in particular the concepts of outcomes-based equivalence set out in this Consultation. The main challenge for overseas funds will obviously lie in the additional requirements (such as the requirement to comply with FCA PS18/8 on the Assessment of Value) that the UK legislator, being no longer bound by EU legislation, may impose on overseas funds. It may trigger additional costs hence each overseas fund will need to weigh the costs and benefit of continuing marketing in the UK.
Delegating management
A major point of attention in the relationship between the UK and the EU post Brexit is the delegation of portfolio management. Delegation is explicitly permitted in the UCITS Directive and AIFMD. Cooperation agreements between EU Member States and third countries must be in place in case of delegation, which will be the case.
The designation of delegates in and outside the EU is subject to strict requirements of initial and ongoing due diligence, and oversight of delegates. A framework with the required protections and safeguards is already in place. As a result, there is a wide consensus in the industry that they are no reasonable grounds to revisit the delegation framework in the context of the reviews of the AIFMD and UCITS Directive.
Supriya Menon, Senior Multi-Asset Strategist at Pictet Asset Management.. Supriya Menon, Senior Multi-Asset Strategist at Pictet Asset Management.
Two powerful forces have shaped the global equity landscape in recent years – passive investing and private equity (PE). A broad range of investors have turned to index-tracking funds for low-cost exposure to the broader market. Meanwhile, a somewhat smaller but growing group have gravitated towards PE, attracted to its potentially higher returns and diversification benefits.
The growth of passive and private investment has been such that, together, the assets under management of the ‘two Ps’ have quadrupled over the past decade to some USD 12 trillion, overtaking the traditional active equity market (at USD 11 trillion).
In our view, passive and private investing might take different paths over the next five years.
When it comes to passive funds, their best days may now be behind them. Investors and regulators are becoming increasingly aware of – and concerned by – the risks that come with the expansion of index trackers. Research shows passive investing poses threats to market stability and sustainable investing.
The prospects for PE look brighter, though whether it can continue to grow its share of the pie is contingent on it becoming more widely accessible and less opaque.
Investors have gravitated towards PE, attracted to its potentially higher returns and diversification benefits
Historically, PE has been considered too much of a risk for all but the most experienced, professional investors. But that is no longer the case. One reason is the sheer size of the market. Because private equity-owned companies are proliferating while the number of listed firms is falling, the arguments for opening up PE to individual investors have become too loud to ignore. This speaks to the democratisation of finance.
That is not to say passive investment will go into reverse, just that the pace of expansion may slow as investors and regulators discover that passive strategies, while cheap and easy to access, are far from risk free.
Re-pricing risks and benefits
While passive’s low fees might look attractive in an era of post-pandemic belt tightening, that comes at a price: index trackers follow the entire market, rather than picking the best bits at any one time. That is a problem because the mispricing that has occurred during recent bouts of volatility has created fertile ground for stock pickers. The gap between winning and losing stocks will only widen as companies that embrace innovation and technology thrive and the strength of balance sheets becomes ever more important.
More generally, the rise of passive investing threatens efficient market pricing. The stock market relies on active investors to determine an equilibrium value. Yet under index-tracking, the shares of companies with large weightings attract more capital irrespective of their financial performance. So, if the system is dominated by passive investing, the price of a security ceases to function as a gauge of a firm’s underlying prospects, leading to capital misallocation. Potentially making matters worse is the concentration of the passive market. There are growing concerns that as index-tracker funds continue to accumulate assets, the lion’s share of that money will flow to the three large asset managers that control the passive industry. Already, the big three passive fund houses collectively own more than 20 per cent of US large-cap stocks; they also hold 80 per cent of all indexed money. Should those proportions continue to rise, the resulting concentration of shareholdings – known as common ownership – could reduce competition and threaten the efficient functioning of markets. There is a growing body of research attesting to these negative effects. A 2018 study (1), for instance, found that when big institutional investors were large shareholders in firms producing both brand-name and generic drugs, the generic manufacturers were less likely to produce non-branded versions. This increased prices for consumers. Similar trends have been documented in other industries where common ownership is high, such as airlines and the banking sector. This is causing alarm among regulators in Europe and the US – the Federal Trade Commission and the US Securities and Exchange Commission have both said they are monitoring developments closely.
Passive investing does not necessarily aid the development of responsible capitalism, either. Passive funds, by their nature, do not choose the companies they invest in. That reduces the potential for investors to engage with the companies and to encourage them to embrace responsible and sustainable business models aligned to environmental, social and governance (ESG) principles. Passive portfolios tend to invest in so many companies as to make direct engagement with them impractical, and the small share of each holding within the portfolio reduces the incentive on an individual company basis.
Private equity, of course, is also far from risk free, but we would argue that many of its issues may be better understood and reflected in pricing.
First, there is the problem of transparency. PE has a patchy track record on ESG, for instance, and the requirements for transparency and disclosure for privately held firms are far less stringent even if a few are now trying to change that.
Then, there is debt. PE also has high leverage (just under 80 per cent of buyout deals in 2019 were carried out at over six times EBITDA relative to roughly 60 per cent at the prior peak by this measure in 2007) (2). PE investments are also primarily in small and mid-sized firms, whose business models are less well established. These factors could weigh on PE returns in a period of pandemic-induced economic weakness. Furthermore, PE-owned businesses are excluded from some government bailout schemes, while those that are available tend to come with complex conditions that may relegate them to a last resort.
In the longer term, though, the PE sector can help to finance businesses in a period when public markets may be less open. We may see more public companies taken private, as well as PE funds gaining minority stakes in listed companies, with an eye to increasing these later.
Dry powder
Crucially, PE has plenty of dry powder, some USD1.46 trillion according to latest available data (3). That can be used to shore up balance sheets and, later, to make new investments, supplemented by additional money that major investors have signalled they would like to allocate to PE. (The reported gap between actual and intentioned allocations stands at over 2 per cent of private sector pension funds’ total assets) (4).
A potential game changer will be the drive to democratise finance. Historically, PE has been the preserve of institutions and the ultra-wealthy – a disparity that regulators are now looking to fix by opening up the market to individual investors. The US has led the way, laying the foundations for ordinary savers to invest in PE funds through employer-sponsored 401(k) retirement accounts, which analysts forecast could bring in USD400 billion of fresh cash (5). The US Labor Department, meanwhile, sanctions the use of PE in professionally managed multi-asset-class investment vehicles, such as target-date, target-risk, or balanced funds. Other countries, including the UK, are considering similar moves.
Potential attractions for current and future PE investors include diversification benefits and a broader opportunity set – not because PE companies are somehow inherently better, but because they tend to have different characteristics to listed equities.
For a start, they are younger. The median age of a company going public in the US has risen from an average of seven years in the 1980s to 11 years between 2010 and 2018. The private market also includes a large number of small but rapidly growing companies with significant intangible assets. Typically such firms do not want to disclose their early stage research publicly and therefore favour a closed group of shareholders. What is more, in the US at least, the pool of private investments is deepening. Private companies are proliferating while listed ones are in decline. Since 2000, the number of listed companies has fallen to 4,000 from 7,000.
PE also offers the possibility of benefiting from operational improvements in the way businesses are run. When executed well, this can lead to impressive returns.
However, choosing the right PE investments is far from straightforward. The fees are relatively high and investment structures are complex. Moreover the sector lacks transparency, so opening it up to less experienced individual investors (such as 401(K) holders) presents challenges for regulators. Indeed, the US Security and Exchange Commission has recently rebuked PE and hedge fund managers for charging excessive fees and appearing to favour some clients over others (6). There are calls for reform of the fee structure to make the industry more sustainable, and a few firms have already started to move in that direction (7).
Due diligence is much more important in PE than in public markets
Due diligence is much more important in PE than in public markets. According to our research, in 2018 the difference in performance between the 5th and 95th best-performing funds was 60 per cent in the US PE universe, versus just 8.5 per cent for US small/mid-cap equity funds. Studies also suggest the high persistence of manager returns, which was a feature of private equity – has declined, meaning yesterday’s winners are now less likely to top the tables tomorrow.
Due diligence is paramount: there are some signs in the US that, in aggregate, the returns gap between listed and private equity is starting to narrow. Indeed, over the next five years, we forecast global private equity returns of 10.3 per cent per annum in dollar terms, which represents a premium of just 2.8 percentage points over public equities, almost half its long-term historical average. That’s partly because of the sheer weight of capital chasing potential opportunities. Of course, the high dispersion means that some will do much better while others fare much worse. And, at a time when bond yields are very low, even a lower-than-average excess return may be attractive to many.
PE has the potential to continue to capture an ever-growing share of the equity market – as long as it succeeds in opening up to a wider range of investors and proves its potential to add value. Passive equity has already shown what can be achieved with a democratic approach and will continue to do well, but, having grown faster and for longer and attracting greater scrutiny from regulators, it may now be nearer its natural plateau as a proportion of equity AUM.
Column written by Supriya Menon, Senior Multi-Asset Strategist at Pictet Asset Management.
For more information on Pictet AM’s Secular Outlook report, detailing key market trends and investment insights for the next five years, please download here
Notes:
[1] ‘Common Ownership and Market Entry: Evidence from the pharmaceutical industry, Newham, M., Seldeslachts, J.,Banal Estanol, A., 2018 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3194394
[2] Bain Private Equity Report 2020
[3] Preqin, as of June 2019
[4] McKinsey Global Institute, “A new decade for private markets”
[5] Evercore
[6] SEC, June 2020
[7] “An inconvenient fact: private equity returns & the billionaire factory”, L. Phalippou, 2020
Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to risks and uncertainties that could cause actual results to differ materially from those presented herein.
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US equities were lower during the month of September, ending a streak of five consecutive months of gains. Investors sold shares as a reaction to the news of a resurgence of coronavirus cases in Europe. The “Big 5” tech companies as well as other growth/momentum stocks contributed to the weakness for US equities over concerns of crowded positioning and stretched valuations.
Fears are intensifying over a resurgence of COVID-19 from students going back to school, colder weather and the start of influenza season. However, increased optimism about the progress of a vaccine and treatment trials have investors hopeful that the economy will not endure another global shutdown.
While dialogue has remained open for a bipartisan deal for additional coronavirus stimulus, political tensions have made negotiations difficult and unclear. The upcoming presidential election has added more volatility to the markets as well as the political uncertainty associated with a potential delay of declaring a winner due to mail-in ballots and likely litigation.
While technology stocks have been the primary beneficiaries during COVID-19, other areas of the economy (including housing, retail consumer spending, business capital expenditures, and government-backed infrastructure related spending) will likely lead in a recovery. As stock pickers, we can use the current volatility as an opportunity to buy attractive companies, which have positive free cash flows, healthy balance sheets and are trading at discounted prices.
Merger activity in the third quarter topped $1 trillion, an increase of 94% compared to the second quarter and the strongest quarter for dealmaking since the second quarter of 2018. Worldwide M&A now totals $2.3 trillion year-to-date, a decrease of 18% from 2019 levels. Technology, Financials and Energy & Power were the most active sectors accounting for 43% of all dealmaking. Europe and Asia Pacific have remained bright spots for M&A, increasing 15% and 19% respectively, while dealmaking in the U.S. has declined in 2020 by 42% to $815 billion. Global deals valued between $5 and $10 billion have increased 23% over 2019, while mega deals (deals valued over $10 billion) have declined 33%.
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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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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Pixabay CC0 Public DomainJana Vukomanovic. Jana Vukomanovic
As global markets attempt to recover their poise in the relentless shadow of COVID-19, one hot topic has perhaps challenged economists more than any other: What will be the pandemic’s effect on inflation? We believe the inflation rate will be between zero and 1%, and this is already priced in the market. But the picture for 2021 is only now starting to clear, presenting a new landscape of opportunities for investors in the inflation-linked bond market.
Many experts predicted the global coronavirus lockdown would be disinflationary – and they were right. The fall in activity did have a clear effect on prices for a variety of reasons. At AXA IM, we now forecast 2020 inflation to average 0.4% in the Eurozone, 1.0% in the US and 0.7% (1) in the UK – rising to 0.7%, 1.4% and 1.5% respectively for 2021. The impact, however, has not been a one-way street – we are already starting to see signs of higher pricing in some sectors which could suggest market expectations are too low.
One factor that has served to depress core inflation has been the inclusion of more online pricing into the data, an understandable measure given the impact of the lockdown on consumer behavior. However, we believe several other factors are having the opposite effect. Food prices, for example, have tended to climb during this period, as have telecoms prices after a long period of decline.
Hidden effects
In some areas we are still assessing the longer-term trend, although there does appear to be some evidence that education and health prices could continue to rise, alongside some localized trends in leisure and tourism services where consumers are no longer travelling to cheaper destinations. Inflation surveys could have a difficult job adapting to new realities in consumption patterns.
More fundamentally, there is evidence that the post-lockdown response from consumers has pushed some economies towards a more aggressive rebound than had been feared, accompanied by a parallel rise in prices. Figure 1 below shows that recent inflation numbers in the US have been the most solid seen in years, and that the rebound has been broad-based. In addition, as we move into 2021, inflation numbers worldwide will reflect a negative base effect from oil prices, which slumped as the pandemic spread.
From a more macro perspective, we see a medium-term risk that the COVID-19 outbreak could exacerbate tensions in the current model of globalization. Pre-pandemic – alongside US President Donald Trump’s ‘America First’ approach to trade – there had already been a shift towards a more protectionist tone in global markets. Now the virus has forced countries and businesses to re-assess the flow of goods, services and people across borders.
Hedging into view
These observations mean we believe there is a general risk to the upside for inflation as we move into 2021. And it is a risk that we believe has not been adequately reflected in market expectations.
One way to gauge how markets expect inflation trends to evolve is to look at inflation swaps. The chart below (Figure 2) shows that realized inflation since June is consistent with the top-end outlooks for inflation. The inflation swap market, however, is still pricing in the lower end, particularly in Europe but also to some extent in the US. Our expectation is for a potential aggressive rebound of inflation at the beginning of 2021, and we believe investors should consider preparing for that eventuality.
Naturally, these factors to the upside are encouraging more investors to explore ways they can hedge inflation risk and is having a tangible impact on the inflation bonds market, already underpinned by active monetary policy and supportive fiscal policy. Consumer behavior, the rise of protectionism and the possibility of regulatory price effects (for example through green policies) will be central to the potential uptick in prices – but central banks will also do what they can to push inflation higher from this point.
Column written by Jonathan Baltora, Head of Sovereign, Inflation and FX – Core at AXA IM.
To learn more about this topic, please contact Rafael Tovar, Director of Wholesale/US Offshore Distribution, AXA IM atRafael.Tovar@axa-im.com.
Notes:
[1] AXA IM estimates as of September 2020
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