February 2017 AlphaFOR INSTITUTIONAL INVESTORS & ASSETQ MANAGERS BLOOMBERG FOR FLYING HIGH PRIVATE EQUITY Eagle Alpha’s New product from CEPRES alternative data

LONESOME STOCKS SUSTAINABLE Randeep Grewal REAL ESTATE investigates Five areas of focus

JAGUAR POUNCES TRENDING IN LatAm real LENDING estate opps Lending trends to watch

Eastspring – the hidden giant Interview with Guy Strapp

www.AlphaQ.world EDITORIAL

elcome to the first issue of AlphaQ for 2017 and what a start to the year we have seen, with macro events Wdominating and the markets apparently lapping it up. We bring you a profile of Eastspring, one of the largest asset management firms in the world, with USD140 billion under management, that is not so well known outside its native Asia Pacific but whose roots lie in the much-loved Prudential. Our man from the Pru is Guy Strapp, interviewed here. If you want to get ahead in these challenging times, how about you sort your Woozle from your Eagle Alpha – we profile two firms

ELEANOR ROSTRON offering a different approach to data gathering for investment managers. We also have a ‘Bloomberg’ for private equity offering from CEPRES – a FinTech company that has developed a private credit analysis tool called PE.Analyzer.

Managing Editor You may not have heard about 871(m) yet but the 30 per cent Beverly Chandler Email: [email protected] withholding tax on dividend-equivalent payments for non-US Contributing Editor James Williams Email: [email protected] investors will have an impact. Your guide to this issue comes from Online News Editor Mark Kitchen Jon Brose and Craig Hickernell and Brett R Cotler of Seward & Email: [email protected] Deputy Online News Editor Kisssel LLP. Emily Perryman Email: [email protected] Finally, this month sees Randeep Grewal, our regular columnist, Graphic Design Siobhan Brownlow Email: [email protected] quote Elvis and deep dive into lonesome stocks. Sales Managers Simon Broch Enjoy the read, Email: [email protected] Malcolm Dunn Beverly Chandler Email: [email protected] Christine Gill Managing editor, AlphaQ Email: [email protected] Marketing Administrator Email: [email protected] Marion Fullerton Email: [email protected] Head of Events Katie Gopal Email: [email protected] Head of Awards Research Mary Gopalan Email: [email protected] Chief Operating Officer Oliver Bradley Email: [email protected] Chairman & Publisher Sunil Gopalan Email: [email protected] Published by GFM Ltd, Floor One, Liberation Station, St Helier, Jersey JE2 3AS, Channel Islands Tel: +44 (0)1534 719780 Website: www.globalfundmedia.com ©Copyright 2017 GFM Ltd. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the publisher. Investment Warning The information provided in this publication should not form the sole basis of any investment decision. No investment decision should be made in relation to any of the information provided other than on the advice of a professional financial advisor. Past performance is no guarantee of future results. The value and income derived from investments can go down as well as up.

AlphaQ February 2017 www.AlphaQ.world | 2 CONTENTS

February 2017 AlphaFOR INSTITUTIONAL INVESTORS & ASSETQ MANAGERS BLOOMBERG FOR FLYING HIGH PRIVATE EQUITY Eagle Alpha’s New product from CEPRES alternative data

LONESOME STOCKS SUSTAINABLE Randeep Grewal REAL ESTATE investigates Five areas of focus

JAGUAR POUNCES TRENDING IN LatAm real LENDING estate opps Lending trends to watch

15 20 25

Eastspring – the hidden giant Interview with Guy Strapp NEWS FEATURES 18 Flying high James Williams profiles Eagle Alpha’s www.AlphaQ.world 04 Investigating the Woozle effect alternative data offering based on thought Woozle or evidence by citation is the leadership; data insight; analytical tools; name of a new firm offering ongoing Companies featured in raw data, and bespoke projects channel checks on global consumer this issue: companies 20 Sticking to the middle ground • BB Biotech James Williams find that, although • Bedford Row Capital 05 Beating the banks off the beaten path cautious overall in its outlook for global Advisers Interview with Alastair Evans of Bedford real estate in 2017, Hamilton Lane, an • CEPRES Row Capital Advisers alternative fund manager with USD40 • Eagle Alpha billion in discretionary AUM, does see 06 Whither biotech in 2017? some strong fundamentals throughout a • Eastspring Dr Daniel Koller, lead manager of BB good portion of the market • Hamilton Lane Biotech, writes that Biotech was one of • Jaguar Growth Partners the most widely reported sectors in 2016 22 Asia credit – a separate allocation • NN Investment Partners Yu-Ming Wang and Bertram Sarmago 07 Managing the main event of Nikko Asset Management believe • Nikko Asset Interview with Omni Event’s John Melsom that Asia credit should be treated as a Management on his approach to managing his big separate allocation, rather than part of • Omni Partners picture event fund EMs • S&P Global Ratings FEATURES • Seward & Kissel LLP 25 Jaguar pounces on LatAm real estate Latin American real estate offers an • TH Real Estate 09 Cover story: Eastspring – The hidden abundance of attractive entry points • Woozle Research giant Interview with Guy Strapp, CEO, and long-term growth opportunities, Eastspring Investments, the USD140 particularly in markets such as Brazil and billion Asian investment management Mexico arm of Prudential and the region’s largest 28 Rating US hydropower risk retail manager Michael Ferguson, director, US Energy Infrastructure, S&P Global Ratings writes 11 The 871(m) rule January 1, 2017 saw the US Internal that, despite Trump, the US is enjoying a Revenue Service implement rule 871(m). financing renaissance in hydropower Jon Brose, Craig Hickernell and Brett R 30 PE.Analyzer: the Bloomberg for PE Cotler of Seward & Kissel LLP explain James Williams writes that CEPRES how this will affect the sector has rolled out a new platform to give institutional investors a way to effectively 13 Real estate sustainability trends benchmark private capital market in 2017 James Williams writes that a new report investments published by TH Real Estate highlights 32 “Are you lonesome tonight?” five areas of focus for future real estate Columnist Randeep Grewal calls on Elvis investment including big picture trends to examine so-called lonesome stocks and industries 15 Trending in lending in 2017 Gabriella Kindert, Head of Alternative Credit at NN IP writes on trends to watch in alternative lending during 2017 saying banks will shrink their lending

AlphaQ February 2017 www.AlphaQ.world | 3 ALPHAQ NEWS FEATURE

Investigating the Woozle effect

oozle may not be an academic term with “What is interesting to me, Wwhich you are familiar, but watch this space, literally. Nearly a year ago, Mark Pacitti, is that primary human and Charlie Ellis founded Woozle Research, a intelligence gathering actually solution to the Woozle effect theory of evidence yields interesting results, new by citation, whereby a finding gets repeatedly quoted until taken as the truth. fundamentals that people Disambiguation is another term for the aren’t talking about.” phenomenon, but doesn’t trip as easily off Mark Pacitti, Woozle Research the tongue. Pacitti was at multi-strategy firm Citadel for three years working in state of the art developments for global quantitative strategies, looking at alternative data sets such cross between equity research, but not from a as till receipts and satellite imagery. press or management statement, but going to He left to set up Woozle Research, a firm the source on the ground, sleuthing to get the dedicated to providing institutional investors information.” with primary research and equity intelligence The firm declares who they are when using human sources or what Pacitti likes to conducting research and doesn’t break NDAs, call ‘systematic scuttlebut’. but relies on a mosaic of non-material, public “What I find is that a lot of the industry uses information that in aggregate provides their buzz words like big data and machine learning,” clients with an informational edge. Pacitti says. “A lot of it is noise, so what is “It’s a mosaic of public information that may interesting to me, is that primary human be material once it has been collected as a huge intelligence gathering actually yields interesting amount,” Pacitti says. results, new fundamentals that people aren’t Their system lends itself most to consumer talking about.” firms, but the deep research team can take This mosaic of human intelligence spreads on custom projects. “We can do healthcare, across the 70 and growing consumer companies what drugs professionals are prescribing, globally that the firm covers. “It goes against or automakers, talking to dealerships and the random data collection and finding the examining the supply chain. The way we look hidden signal,” Pacitti says. “What we do is less at it is focusing on the key stakeholders in any prone to paradigm shift as we gather human country and intelligence gathering techniques intelligence sourced directly from companies and use those two mechanisms to develop under coverage.” the products.” Examples of how they work include The service is subscription led, allowing interviewing a mosaic of company stakeholders people to pick the companies in which they to capture leading and exclusive insights into are interested or do a customised search the direction, magnitude and reason behind across a sector, such as supermarkets, where in-store sales and profitability. sometimes they track all seven of the UK Sainsbury’s better than expected sales figures supermarket chains. over Christmas were also correctly called by Pacitti has written a paper on MiFID II – Woozle, based on their primary research (such headed with Einstein’s quote: ‘If we knew what as observation, surveys, polls) to target key we were doing, it wouldn’t be called research’ stakeholders (such as employees, customers, – and believes that while, in the short term, delivery sites) to predict company earnings. the restrictions on third party research will be “In six months or so, we have managed detrimental for everyone involved, in the long to partner with several multi-billion dollar term, funds that use Woozle are happy to pay assets under management hedge fund clients,” out of their own pockets, so it will probably not Pacitti says. “They like the fact that it is a affect them. n

AlphaQ February 2017 www.AlphaQ.world | 4 ALPHAQ NEWS FEATURE

Beating the banks off the beaten path

ormed in February 2016, Bedford Row For investors who are suffering from what FCapital Advisers, one of the leading non- Evans calls the ‘return-free risk’ of investing in bank arrangers of listed debt securities, started Treasuries, the resulting high yield asset backed out with modest aims of achieving two or three and transferable securities they produce offer a listings in its first year, but ended up doing 11 good alternative portfolio solution. and issuing GBP440 million in senior secured, “Our niche is that we see investment banks asset backed bonds with yields of between 5 are mainly just involved in the larger deals of and 8.5 per cent. around USD300-500 million, as they have many Alistair Evans, director, says: “Our raison mouths to feed and predominantly deal with d’etre is to fill the gaps that the banks used to other large institutions, whereas as a boutique, occupy,” citing both a requirement for debt we believe that a lot of the best yields and funding and an unwillingness to lend in the Alistair Evans, director, assets are available between GBP20 million and Bedford Row Capital aftermath of the global financial crisis due to Advisers GBP150 million,” Evans says. bank de-leveraging and increased regulatory Bedford Row Capital Advisers sees a wide pressures. spread of deals with two to five potential new “Given that nearly USD14 trillion in deals coming to them every week, which they negative-yielding debt is currently in circulation then assess to determine the most interesting in and there are many under-funded pensions out terms of yield and investor security. there, we also believe investors are desperately “Real estate is probably the most logical searching for yield. and well suited asset class for this type of “Banks aren’t lending and yet there are lots structure,” Evans says. However, they have a of good businesses with good assets and strong diversified book. The firm did two renewable cash flow who can’t get access to debt funding,” energy listings in the biomass sector last year Evans says. and is soon to be listing a mining deal as well While the usual route to creating a bond as considering two deals in the aviation and the might involve a trip to the lawyers, Bedford Row shipping sectors. Capital Advisers takes on the whole process, “Banks aren’t interested in anything slightly listing bonds on HMRC recognised exchanges off the beaten path at the moment and investors such as Dublin, Channel Islands or Frankfurt, are increasingly hungry for yield therefore and then supporting them by running the it made perfect sense for us to fill this gap,” listed structure. Evans says. n

AlphaQ February 2017 www.AlphaQ.world | 5 ALPHAQ NEWS FEATURE

21st Century Cures Act passed by Congress in Whither biotech in 2017? December is a big step in the right direction. Drug payers have been putting more pressure Dr Daniel Koller, lead manager of BB Biotech, on the prices of newly approved drugs, writes that Biotech was one of the most widely especially those targeting diseases where reported sectors in 2016. Not only did the US the market is big and several products are election bring turbulence to biotech stocks but already available (for example diabetes). That 2016 also reminded us of the importance and contrasts with the situation in oncology, where impact of social media, he says. drug manufacturers hold the best cards when negotiating prices due to the high level of hen Hilary Clinton tweeted on drug unmet medical need. Wprices being a pillar of her election 2017 will bring an acceleration of important campaign, big pharma and biotech stocks took product approvals and milestone announcements a mighty hit, concerned that she would change for the industry. At this year’s JP Morgan the way the US prices drugs. Gyrations before Healthcare conference, which is always a tone and immediately after the US presidential setter for the year ahead, most of the biotech election meant the year closed with large cap firms were in good spirits. There were positive biotechnology companies trading near their all- signals regarding the fundraising climate as well time lows for price/earnings multiples low. Mid- as the sector’s innovative strength. caps and small caps suffered even more. While Reporting season for the past year is many broad stockmarket indices extended now getting under way and most companies their 2016 gains in the fourth quarter, the should meet expectations. Takeover activity Nasdaq Biotech Index (NBI) lost ground in the is also expected to see a boost in 2017. With same period. biotechnology valuations at attractive levels, When Donald Trump was revealed as the more acquisitions by large players, including 45th President of the United States, the sector pharmaceutical firms, are likely. Actions of the rallied on relief that drug pricing wasn’t a incoming presidential administration in the primary concern of his. But the gains were US may accelerate this trend and we expect short lived as Trump went back on his word investors to follow suit. Repeal and rework of in an interview with Time magazine where he the Affordable Care Act (ACA) will be front and pledged to cut the cost of prescription drugs. centre throughout the year, and there may be At his first news conference as president-elect choppy reactions to possible drug price controls Donald Trump accused the pharmaceutical or moderation in the US. industry of “getting away with murder.” Despite these transitional events which The news caused the iShares NASDAQ will be attentively scrutinised as always, BB Biotechnology Index to close 3 per cent down Biotech remains convinced that the future on the day. Questions regarding the future of the biotechnology industry is bright. The direction of healthcare policy under the Trump sector will further demonstrate its strength as administration are likely to be the greatest a source of innovation – and notwithstanding factors overhanging the sector. short-term uncertainties from political changes What is certain is that the healthcare reform – we believe these sources will be converted introduced by Trump’s predecessor Obama will into value for patients, care providers, the cease to exist in its current form. Tom Price, healthcare system at large and, of course, the new Health Secretary and an outspoken investors. BB Biotech looks forward to an opponent of Obamacare, will be setting the exciting 2017 and remains dedicated to new agenda for US healthcare policy. Debate is finding, analysing and investing in leading-edge likely to centre on how spending on healthcare biotechnology firms with exciting news flow and is financed in the future. Here it appears that robust growth prospects. n the role of the government will become much smaller, regardless of the shape or form it takes, “Not only did the US election bring turbulence but policy specifics are still scarce, particularly to biotech stocks but 2016 also reminded us with regards to drug pricing. Yet the biotech sector stands to profit from of the importance and impact of social media.” positive signals on the regulatory front. The Dr Daniel Koller, BB Biotech

AlphaQ February 2017 www.AlphaQ.world | 6 ALPHAQ NEWS FEATURE

Managing the main event

ohn Melsom is CIO of the Omni Event Fund, “We focus on hard catalyst events,” Melsom Jan actively managed global event-driven says. “A lot of what we do is around M&A strategy with a focus on equity and equity- transactions, but we do not have a traditional related securities of companies undergoing broad-based risk arbitrage approach. We trade significant corporate actions and other hard situations internationally in real-time, and catalyst events. within our key regions of North America, Melsom explains that he has been with Omni Western Europe and the Asia-Pacific” Partners since its formation back in 2004, The portfolio is built on a best ideas basis so working with its founder Steve Clark since 2001 there is no top down approach to geographical and co-managed the prior flagship event-driven capital allocation. “We focus on big, liquid fund which never had a down year. situations mainly in large and mid-cap listed Omni Event was launched in September equities. Liquidity is something that is quite 2013 and is managed by Melsom from his base important to us,” he says. “We try to find in Irvine California. As of the end of January multiple ways to add alpha throughout the deal, the strategy has over USD430 million under through the structuring of trades and entry management drawn from what Jim Konte, Head points, or adjustments in positioning around of US Investor Relations, describes as: “A good specific events in the course of a transaction.” mix of large family offices in the UK and US, The fund aims to be a true absolute return and institutional investors mainly from the US.” fund so the strategy’s correlation to US equities The last four months of 2013 saw Omni for example is below 0.2 and output beta is Event make 6.3 per cent, 2014 saw Melsom’s basically zero. “If the market is up 30 per cent first experience of a down year with a loss of there is a chance we won’t be, but we will 3.5 per cent, 2015 saw a gain of 16.6 per cent, be having a pretty good year,” Melsom says. last year up 11 per cent and so far the fund is “Likewise if the market is down 30 per cent we up around 3.5 per cent this year. should still make decent returns.”

AlphaQ February 2017 www.AlphaQ.world | 7 ALPHAQ NEWS FEATURE

He comments that now is a different environment from when he managed his prior fund. “The lower interest rate environment makes it harder than in 2007 and, given the volatility, we are pleased with the returns we are making now.” 2016’s macro surprises, such as Brexit and the Trump victory, are something Melsom is aware of, but actively managed risk successfully around the events. “Because of the way we build the portfolio a lot of the risks are idiosyncratic to a particular deal. We are however very careful to manage any common risks within the portfolio. For example if there is an aggressive macro sell off in oil you have to be careful the portfolio isn’t carrying too much exposure to oil companies,” he says. He tries to run a concentrated portfolio throughout the year with maybe 20 on the book at one time, but the top 10 will probably make up 80 per cent of the portfolio. “We look for the best opportunities and dedicate our resources there,” he says. Sectors that feature in his portfolio at the moment are M&A in pharma and biotech, which John Melsom, CIO of security and cloud based security and more is he says is beginning to heat up again despite the the Omni Event Fund coming through in oil and gas. mixed messages coming from President Trump. “There is activity across the board,” Melsom “Activity continues both ways, with says. “The semiconductor industry constantly Japan’s Takeda buying into the American goes through consolidation. At the moment, the pharmaceuticals sector through Ariad, and only thing worth noting there is that Chinese Johnson & Johnson bidding for Actelion in inbound interest will be tougher going forward, Switzerland. There are plenty of cross-border with Trump potentially being more protectionist situations going on. given it is a sensitive sector.” “Pfizer has recently said it is not necessarily For Melsom, it is hard to say what he waiting for tax clarity before engaging in new typically likes to look for as the situations tend deals, so there is potential for more to happen to be so different from another and assessed in the space. There is also a strong possibility on a case-by-case basis. Having said that, they of change in the tax landscape of corporate like to see deals with good strategic rationales, America which could increase the number of and if there is some fear in the market over bolt-on acquisitions for pharma companies, a specific issue that they feel they can get a particularly if there is an amnesty for bringing better handle on, they will use that to get in at overseas money back to the US. attractive levels. “For a long time before Trump came into “Over the life of a situation, we are good the picture, Republicans were in constant at picking points when you have the best argument over how to keep US companies in risk reward,” he says. “On the other side, the US, as many were trying to invert into we are good at cutting risk. Every position is other tax jurisdictions. With the Republicans assessed on what we are willing to lose if we controlling both houses of Congress, and are completely wrong so the focus is very much Trump in the White House, there is a high on the downside and we adjust that every likelihood of an overhaul of the tax code and a day. Our biggest risk is an idiosyncratic deal repatriation amnesty.” break, which can happen, but we try to avoid Melsom also sees smaller deals in the them and manage that risk very quickly if the technology sector, particularly around internet situation changes at all.” n

AlphaQ February 2017 www.AlphaQ.world | 8 INTERVIEW Eastspring – the hidden giant Beverly Chandler interviews Guy Strapp, CEO of Eastspring Investments, the USD140 billion (as at 30 June 2016) Asian investment management arm of Prudential plc

perating since 1994, Eastspring is has been the growing importance of China and one of the largest asset managers in India. Those markets don’t hit the criteria in OAsia. Guy Strapp has been working at terms of a high level of GDP per capita, but the Eastspring for 10 years, almost to the day, and ‘capita’ takes over with their large populations. was appointed CEO in 2013. Accessing those markets has become Five years ago, the firm undertook a increasingly important.” rebranding process which unified a diverse Eastspring has a joint venture in India with list of other names and brands and gave them ICICI PRU – the largest and most successful what Strapp calls ‘the right separation’ from asset manager in that region, and a joint Prudential plc – a powerful insurance brand in venture in mainland China with CITIC Pru, Asia and Europe. which currently ranks in the 30s in terms of “In Asia, the Eastspring brand is well assets under management, but is a business that recognised in the segments where we want it to ‘is turning in a favourable way’ Strapp says. be,” Strapp says. Within Hong Kong, the firm has a joint The company has an on-the-ground presence venture with Bank of China International, in 10 different Asian markets, (China, South managing money for the Mandatory Provident Korea, Singapore, Taiwan, Malaysia, Hong Kong, Fund, (the MPF) the compulsory retirement Indonesia, India, Japan and Vietnam), has fund for employers. distribution offices in the US and Europe, and is All the other jurisdictions in which the largest retail asset manager in the region. Eastspring operates are wholly owned Assets are invested across a range of asset subsidiaries of the ultimate parent company, classes including equities, fixed income, multi- Prudential plc. asset, infrastructure and alternatives on behalf Geographically across the world, there of both retail and institutional clients. The is no overlap between Prudential’s various Luxembourg SICAV platform is largely used investment arms – whether with M&G in the by European and Asian institutional clients – UK, specialising in Global, UK and European and has assets from a wide variety of regions, solutions, or PPMA in North America. In terms including Chile. of Asian investment, Eastspring has a strong Reflecting on his 10 years with the firm, list of institutional clients from the Nordics, Strapp says: “The Asian markets’ underlying the Gulf countries and Asia, where they themes are still very similar to what they manage money for central banks and sovereign were 10 years ago. The large mutual fund institutions. opportunities rest in north Asia, where there The world’s largest pension fund, Japan’s is a higher GDP per capita – in places such as GPIF, has money with Eastspring and the firm’s Japan, Taiwan and Korea, where sophisticated Japanese Equity strategies’ rank in the top decile. investors seek both onshore and offshore “Our Asian equity capability is second to opportunities. Hong Kong and Singapore fit none,” Strapp says. “What hasn’t changed in these criteria to an extent, but have relatively 10 years is that Asia is the home of emerging small populations. markets in terms of equities. With China “What has changed over the last 10 years opening up and by the time the China A shares

AlphaQ February 2017 www.AlphaQ.world | 9 INTERVIEW

growth isn’t going to be as bad as everyone is saying, so people are moving out of bond substitutes and into cyclical stocks. And Asian equities are cheap, with growing economies. There is an incredible opportunity for retail and institutional investors to be investing in global emerging market equity.” Eastspring has also innovated by establishing a multi-asset team, which is relatively new for Asia. There is also a key focus on private equity and infrastructure projects. “There are a lot of interesting things in the infrastructure space,” Strapp says, referring to a large infrastructure transaction they are working on with the World Bank’s International Finance Corporation. “There is the whole China new Silk Road approach with a lot of discussion about the infrastructure investment’s shortfall globally, but particularly in Asia, and we will be devoting a lot of time and resources into real assets over the next five to 10 years,” Strapp says. Other innovations include a quant team of seven individuals who are devising investment solutions for institutional and retail clients. Specifically, a factor oriented strategy with a low volatility product in Asia and in the global space, which now has a three-year track “What hasn’t changed in 10 years is that record, and numbers that Strapp describes as Asia is the home of emerging markets in ‘encouraging’. “We are limited only by one’s imagination terms of equities.” in terms of the solutions we can bring to bear,” he says. Guy Strapp, Eastspring Investments What really pleases him, as he takes a moment for reflection at his 10-year are included in the MSCI Asia Index, Asia will anniversary with the firm, is the outstanding become 80 per cent of the global emerging growth at Eastspring. “We have maintained market equity index. That gives us an edge, and accelerated that growth over the last because we have locally based teams running three to four years in what have been difficult global emerging market equity capabilities, markets; and we continue to build on that, which is rare in the industry. We see GEM which is pleasing.” Eastspring’s AUM has indeed as a key growth area, as well as a significant experienced a growth of almost 100 per cent opportunity for investors.” in the past three years, with 2014 and 2015 Strapp is excited by the opportunities registering record third party net inflows of presented by the last few years of GBP5.4 and GBP6 billion respectively. underperformance in emerging markets, which He likes the complexity of the company and have created a valuation gap between emerging the high quality and diversity of people across and developed markets. the firm. “The S&P and the Dow are at near all-time “10 years ago, if you had asked me ‘where highs as uncertain investors have gone into will you be in 2016?’, I don’t think I would have stock markets based on concerns about bonds expected Eastspring to make the sort of profit and interest rates – emerging markets in Asia we did in 2015 – and generate the growth in have been a victim of that. However, there is assets while strengthening our investment led now a rotation in psychology to say that global culture,” Strapp says. n

AlphaQ February 2017 www.AlphaQ.world | 10 U.S. REGULATION

The 871(m) rule Jonathan P Brose, Brett R Cotler, and Craig T Hickernell of Seward & Kissel LLP write on the US’s Section 871(m) rules which are being phased in at the moment and the likely impact for non-US investors

ection 871(m) of the Internal Revenue and ELIs that sufficiently correlate with or Code subjects non-US investors to a 30 that are substantially equivalent to US equity Sper cent withholding tax on dividend- securities, depending on if the transaction is equivalent payments on notional principal classified as a simple or complex contract. contracts (NPCs) (ie, swaps) and equity-linked A broker or dealer determines whether a instruments (ELIs) (eg, forwards, futures, transaction is simple or complex, but if neither options) that reference US equities. party to the transaction is a broker or dealer, Section 871(m) has been gradually phased-in this obligation falls on the short party. Simple and is expected to come into full effect in 2018. contracts reference a single, fixed number of This article provides an overview of determining shares with a set or determinable maturity date. how to classify transactions for 871(m) Complex contracts are any contracts that are purposes, whether a transaction is required to not simple contracts. be withheld upon, and how a non-US investor Further, the 871(m) rules instruct short satisfies its obligations under Section 871(m). parties to combine multiple transactions, Generally, the 871(m) rules apply to NPCs treating them as a single transaction. A short

AlphaQ February 2017 www.AlphaQ.world | 11 U.S. REGULATION

Jonathan Brose Craig Hickernell Brett Cotler party should treat two or more “Section 871(m) withholding tax applies to dividend- transactions as a single transaction when the long party enters into equivalents paid on simple contracts that have a multiple transactions referencing the delta of at least 0.8 and on complex contracts that same asset, the combined transactions meet the substantial equivalence test.” replicate the economics of an 871(m) transaction, and the transactions were entered into in connection with substantially equivalent to owning the payment, when final settlement is each other. underlying asset. made, or when the long party exits the The short party may presume that Section 871(m) includes several transaction. Thus, when a long party transactions are not entered into in exceptions, including one for dividend- pays the depreciation on a security net connection with another transaction if equivalents paid on contracts of a dividend-equivalent amount, the the long party holds the transactions referencing qualified indices. Qualified short party must remit to the IRS the in separate accounts or enters into the indices are non-US indices and indices amount it would have withheld had it transactions more than two business that reference only long positions of been paying the dividend-equivalent to days apart, unless the short party has at least 25 securities and meet certain the long party. actual knowledge that the transactions weighting and other requirements. The current 871(m) rules do not should be treated as a single, combined A safe harbour exists for an index in provide relief for this so-called ‘cashless transaction. Without guidance on how which US securities comprise less than withholding’, but adherence to the to combine transactions, taxpayers 10 per cent of the index’s weighting. ISDA 2015 Section 871(m) Protocol may combine transactions using any Indices relying on the safe harbour by swap counterparties, effectively reasonable method. must be widely traded and not formed amending the documentation between Once categorised as simple or for tax avoidance purposes. If an them, ensures that the long party complex, the short party or broker exception does not apply to a contract will bear any liability for 871(m) determines whether to withhold and that satisfies the delta or substantial withholding. The 2015 Protocol whether an exception from withholding equivalence tests, the short party replaces any ISDA 2010 HIRE Act may apply. Section 871(m) withholding or broker should withhold on the Protocol previously in place for swap tax applies to dividend-equivalents paid dividend-equivalent amount. transactions entered into on or after on simple contracts that have a delta of The dividend-equivalent amount January 1, 2017. Swap counterparties at least 0.8 and on complex contracts is the product of the delta times the may receive requests from dealers that meet the substantial equivalence number of reference shares times the to adhere to the 2015 Protocol as test. These tests are measured at the dividend-per-share amount when a a condition to entering into swap earlier of the instrument’s pricing or payment is made or when a dividend- transactions that are subject to the issuance, unless the contract is issued equivalent is determined. Unless 871(m) rules. more than 14 days after pricing, in reduced by an income tax treaty, The 871(m) rules are complex, which case delta is determined at the short party should withhold 30 containing various rules and issuance. In other words, Section per cent of the dividend-equivalent exceptions. You should consult 871(m) subjects to withholding simple and remit such amount to the IRS. your tax advisors to determine your contracts that are highly correlative Withholding should occur when withholding and reporting obligations to and complex contracts that are the long party makes or receives a in a potential 871(m) transaction. n

AlphaQ February 2017 www.AlphaQ.world | 12 REAL ESTATE Real estate sustainability trends in 2017 James Williams writes that a new report published by TH Real Estate entitled THINK 2017: Five things you should know, highlights five areas of focus for future real estate investment: big picture trends, cities to watch, leading sub-sectors, technology trends and sustainability.

ooking at the bigger picture, 2017 and asset managers towards setting is likely to be another year of their own reduction targets and Lgeopolitical upheaval with trade, “implementing a long-term focus on migration and globalisation “all centre sustainability”. stage”, says the report. This year will To that end, TH Real Estate has set see the start of divergent monetary its own long-term targets, which are set policy, with the US Federal Reserve to be announced to the marketplace in likely to further tighten monetary the coming weeks. policy whilst the “Japanification” The firm already reports to its of Europe looks justified. “2017 will investors on a quarterly basis on the signal the start of divergent global carbon efficiency of the funds that

Central Bank policy, with pronounced Abigail Dean they are invested in and also produces implications for equity, bond and real an annual carbon efficiency report for estate markets,” comments Michael the majority of its funds. “We have 10 Keogh, Associate Director of Research Long-term science-based carbon funds across Europe that respond to & Strategy and TH Real Estate. reduction targets The Global Real Estate Sustainability The five cities to watch in 2017 will “This is something that has really come Benchmark (GRESB). This offers a be Hong Kong, Washington DC, San to the fore since the Paris Climate lot of transparency to our investors Francisco, London and Berlin. The Accord was ratified last year. There and the wider public in terms of the report states that in San Francisco, for is a global agreement to limit global energy efficiency of our buildings,” example, apartment vacancies will tick warming to no more than two degrees. confirms Dean. higher “as 2017 deliveries face weaker Businesses are increasingly looking at Technology is undoubtedly playing a demand”. With the city having some of what they can do in order to fulfil their important role in this, with companies the highest office and apartment rents obligations to this, in the anticipation like Siemens providing cutting edge in the US, tenant interest and activity that there will be increased legislation, solutions to real estate investment in more affordable areas of the Oakland globally, which will inevitably push managers to help them monitor, in metro area have increased “and could them along that path,” says Dean. close to real time, the performance provide an effective arbitrage play”, the Dean notes that TH Real Estate is of buildings in their portfolios. TH report notes. seeing some of its investors beginning Real Estate uses several technologies Of particular interest to many to set their own targets; particularly to monitor its buildings when doing investors today is the issue of sustainable Dutch and Nordic investors, some of refurbishments and upgrades and in investing. This is being applied to their whom have set quite aggressive carbon day to day operations. entire portfolios, including real estate. reduction targets per unit of money “Having that real time data allows A focus on sustainable factors can they invest. us to optimise our buildings and make distinguish growth opportunities, while “We want to ensure that we remain them as energy efficient as possible. minimising the risk of obsolescence attractive to those investors and to It’s something we are starting to do within a portfolio. tenants as well, as some of the large more of in premium Grade A office Abigail Dean, TH Real Estate’s banks and retail brands are also setting buildings. That is the mechanism Global Head of Sustainability, their own reduction targets,” says through which we will be meeting our highlights five specific trends that Dean, adding that there is a multitude sustainability targets going forward,” could emerge in 2017. of factors that are pushing landlords confirms Dean.

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Sustainable real estate investment products Products with an explicit sustainability strategy are set to become more widespread in response to investor demand. At TH Real Estate, the approach taken is to integrate a sustainability programme into the DNA of its core products, as opposed to launching explicit sustainable real estate strategies. A good example of this is its European Cities Fund, which has a distinct sustainability strategy. “That fund will only invest in certain cities based on whether we think they will deliver a return in the future for our investors. There are many factors that went into the process of selecting those cities, and sustainability was one of them. missing at the moment is a clear way of “We apply a climate change filter to all of our benchmarking how a property performs investments where we look at what will be the against those factors. For new builds there is potential impacts of climate change on buildings something called the Well Standard, which has in the future. That is a core part of how we select just started to emerge, and I’m sure there will investments in the first place. We also have be competitive certifications around health and strategies that we apply in the European Cities well-being but there isn’t anything that you Fund whereby, whenever we acquire a building, can apply to existing building stock. There are we immediately do an audit and come up with certain things we can do, such as improving air an action plan to improve the efficiency of that quality, etc, but I’m sure there will soon emerge building to save energy throughout the lifetime of a benchmark that will allow asset owners to owning that property,” explains Dean. benchmark existing buildings.” Dean thinks this will be useful for tenants Health, well-being and productivity when selecting the best workspaces for their The ability for tenants to benchmark and staff; particularly for corporate headquarters. improve health and well-being factors in She confirms that TH Real Estate is already the workplace, to determine the impact on conducting a few pilot projects in this area. The productivity, is set to become a growing trend technology for benchmarking is still emerging, for new building stock. “but it is something we are actively looking into For the average corporate tenant, 1 per cent and excited about,” says Dean. of their costs go on energy, 9 per cent goes on The two other trends that Dean points out rent and the remaining 90 per cent goes on staff. in the report are uncertainty about the impact From a landlord’s perspective, TH Real Estate is of global political changes in environmental happy to save its tenants energy to reduce their legislation, and growing global unrest with the costs but that is only addressing 1 per cent of status quo. their cost base. “If we can make improvements “We need to think about what the impact to office space to make staff more productive, of these different sustainability trends will be, and reduce absenteeism and staff turnover, not just today, but in 10 or 15 years’ time,” that is going to be a lot more meaningful to the urges Dean. “That is the way investors are now corporate tenant,” comments Dean. thinking. Whereas 10 years ago they wanted She notes that the debate around the health us to tick a box to say we had a sustainability and well-being of staff and how it is linked to strategy, now they are asking more articulate their office surroundings is starting to become questions. They are going into a lot more more popular. Things like natural light, air detail, asking for examples of how we are quality, thermal comfort, accessible staircases, implementing a sustainability strategy and what cycling storage facilities: these things are our long-term targets are. important to tenants. “The market pressure in that area has “As we mention in the report, what is definitely become a lot more sophisticated.” n

AlphaQ February 2017 www.AlphaQ.world | 14 ALTERNATIVE LENDING Trending in lending in 2017 Gabriella Kindert, Head of Alternative Credit at NN Investment Partners writes on key trends to watch in alternative lending during 2017.

onnectivity and interdependence have The first six months of financials in 2016 increased in most industries, including indicate declining trends in many aspects, Cfinancial services in the last decade. In including revenue and deposits. The net interest the wave of digital transformation, new business margin of the Top 10 listed banks in the sector models are born. further reduced to below 1.5 per cent, which From the crisis of 2008 to date, EUR19 is structurally lower than in the US. Return on billion has been invested in FinTech companies equity was 5.8 per cent, which remains below (CB Insight, 2016) with hundreds of them the cost of capital, estimated to be around 9 newly founded. Though this number may not per cent. The prolonged low profitability is seem very high in the context of the balance very challenging, especially as it coincided sheets of the entire financial sector (EUR28 with a low equity base and increasing capital trillion) or the recent fines some banks needed requirements. to pay, there are many aspects that are clearly Regarding outlook, the quantitative easing changing in the landscape of financial services. programme is being extended so any interest Customer expectations drive changes in rate hike is pushed well into the future. This business models. New partnerships as well as environment forces banks to be more efficient methods of connecting borrowers and lenders with all of their key resources: people, branch are born. network, system and their balance sheet. In Herein I provide my reflection on recent practice, this implies closing down branch trends and highlight some key predictions for offices, reduction of headcount, further 2017 in the Alternative Lending landscape in consolidation and tighter balance sheet Europe. management. Since the peak of 2008 until 2016, more than 350,000 jobs disappeared. This Banks will continue to shrink their seems high, but between 2000 and 2008, almost balance sheets and will invest in new one million jobs had been added to the sector. business models and partnerships In this context, there might be still potential for Europe relies heavily on banks. Therefore, in job cuts. (The figures are based on listed banks order to assess the lending ecosystem, I always representing approximately 80 per cent of the start with what is going on with the banks. total assets of the European sector.) Banks have been shrinking their balance sheets Banks will further explore alternative lending since the crisis. In 2008, the total assets of avenues and strengthen cooperation with banks in the Euro region stood at EUR33 trillion institutional investors and FinTech companies. and declined to EUR28 trillion by 2015 (ECB, This creates new attractive opportunities for 2016). Just to put this number into context, the investors or potential partners that may have decline is higher than the combined balanced limited business origination or risk management sheet of five major banks (Rabobank, ING, ABN capabilities but offer balance sheet capacity or AMRO, Deutsche Bank and Unicredit) as of more efficient business execution. June 30, 2016. In terms of profitability, it did not really Political support to alternative lending will improve this year. Interest rates continued to strengthen be low, capital requirements became harder, The funding needs of the European economy compliance rules and penalties remain harsh. remain larger than ever. The sentiment that

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This vulnerability of Europe is clearly illustrated by the Basel IV debate in recent months. The proposed legislations, which had been discussed in Santiago some weeks ago, favour a regime shift towards a less risk-based approach for credit risk. These would need to be aligned and inserted in capital requirements of European banks (Capital Directive) with very significant potential impact on the economy, including mortgage lending. Proposals to increase capital requirements for lower risk- weight portfolios, such as mortgage loans are disproportionately hitting European banks (Fitch, 2016). As the European banking system finances about 75 per cent of the economy, the potential adverse impacts are a lot higher. In contrast, only 25 per cent of the US economy is financed by banks. It is largely capital market-based and long-term residential property risks are covered by government agencies (Fannie Mae and Freddie Mac). This diversification enables the US banks to operate with lighter balance sheets and any new legislation has less impact. European banks are more sensitive to any regime shift and could be forced to decrease their direct lending to corporations and households. More importantly, any of these adverse changes in lending capacity has a direct impact on the economy. They understandably issued a strong pushback on the proposal. This illustrates profound vulnerability. As Olivier Guersent, DG for Financial Stability, Financial Services and Capital Market Union at EU pointed out this month, “We have to set “European banks are more sensitive to the rate of retention in securitisation market to any regime shift and could be forced to make sure that there is a market. Legislations are no use if there is no market anymore.” decrease their direct lending to corporations This implies a stronger push for support and households.” for developing alternative lending channels, securitisation market and capital market Gabriella Kindert union initiatives. There is also likely to be Europe in terms of economic growth is lagging more scrutiny and consequently, regulation to behind the US seems more widespread than ensure consistency and a more level playing ever. The need for a more diversified funding field between risks of banks and non-banks and source in Europe is more urgent than ever. transparency to investors about risks they are I see strong evidence that the conviction taking. among key decision and policy makers in Europe is leaning towards increased lending Institutional investors will show increasing via alternative sources. Over-reliance on banks acceptance to alternative fixed income made us too vulnerable and constrained our products (eg. private debt) economic development and we need to increase The search for yield remains a key theme in a resilience via diversifying funding sources low-return, volatile environment. Those who towards the European economy. can deal with and accept the illiquid nature of

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the asset class will find a safe haven in private debt. These assets have limited liquidity and mark-to-market pricing; consequently, they ‘look and feel’ stable. Institutional investors (insurance companies, pension funds, etc) are inherently more suited to participate in funding the economy because they capture a large percentage of long-term savings. However, the infrastructure to facilitate this remains mostly at the banks and the investments need to be channelled via capital markets and partnerships. The growth of partnerships has been painstakingly slow. There needs to be significant education and convincing done also at supervisory board level at these institutions. Last but not least, investors seem to have high return expectations from private debt instruments that need to be managed. At the moment, a high percentage of investments are going to the highest risk basket in private debt (eg, direct lending with return exceptions of 6-10 per cent). The potential private debt will have negative impact on others in the universe is a lot larger than lending at 6-10 sector. FinTech companies will further recognise per cent to sub-investment-grade companies. the importance of operating in a regulated European banks have about 1.5 per cent net environment in order to build trust and scale interest margin and lend at an average interest their business model. Regulation above a rate of 2.5 per cent. The bulk of the traditional certain size is inevitable and unfortunately, banking products are safer assets and can be an extremely costly (systems, KYC, compliance excellent alternative to traditional fixed income and risk management costs). In contrasts, products. Some of these new assets classes (like risk management and compliance are core Dutch mortgages) has been favoured by many competencies of banks and the associated costs institutional investors recently and a lot of are already inherent. similar product initiatives are likely to come. Rather than perceiving FinTech companies as competitors, financial services companies will FinTech: Getting more mature, more be reviewing avenues to develop collaboration regulated with new collaborations models for mutual benefit and assess to what Many companies were formed with a mission extent they can incorporate innovative business to implement a new business model in the ideas in their incumbent setup. Many financial financial services industry. 2017 is likely to be services companies (eg, BBVA, Santander, an important year for FinTech when many of Goldman Sachs, JP Morgan) have established these business models will be tested on their incubation centres, dedicated VC activities ability to scale and operate under increasing and M&A departments to capture on the most regulatory scrutiny. The market will understand interesting opportunities. the significant differences between certain sub- A recent survey conducted by Roland Berger segments of FinTech companies. Payments and confirms that over 85 per cent of FinTech blockchain services are likely to cause the most companies anticipate stronger cooperation disruption and we will see further diversification with incumbents. The most important reason of deposits payments from retail clients. mentioned was the access to a stronger Some new companies will simply run out customer base. The power of this approach is to of money to support their business model. ensure that business or product innovation can The market is likely to test the real value be scaled up in a regulated environment, create contribution of ‘smart algorithms’. With a mode of comfort and eventually generate a increased interdependence, potential defaults critical mass. n

AlphaQ February 2017 www.AlphaQ.world | 17 BIG DATA Flying high As alternative and traditional fund managers look to enhance their trading strategies and move away from crowded trades, James Williams discovers that Eagle Alpha is leveraging the explosion in ‘big data’ to offer buy-side firms alternative data sets to harness alpha.

ne of the biggest challenges yet integrated alternative data into for any hedge fund manager their environment. There is a large Ois finding novel data sets focus educating investment managers that they can utilise to develop new on the best processes to use to leverage investment ideas for the portfolio and alternative data and to develop ongoing steal an edge on the competition. The best practices, says Kilduff. As for the problem is that traditional data sets are raw data component, this is offered by used by all and sundry, and while some way of a data directory that keep track brokerages excel at producing niche of the best emerging alternative data sector reports in small cap equities, the sets worldwide. majority uses the same data. “Our data procurement specialists In that regard, it is a problem for the are constantly sourcing interesting new big mutual fund houses as well. Eagle Emmett Kilduff data sets; to date, we have handpicked Alpha is a pioneer in the alternative 490 data sets and we can help clients data sector and is working to meet to navigate the best data sets for this challenge head-on. In brief, the At the other end of the spectrum one them to try. With regards to bespoke objective at Eagle Alpha is to provide might have consumer transaction data, projects, we just launched this in investment managers with an array of which doesn’t have a long history, isn’t January 2017. Some firms don’t have ‘alternative data’ tools that have the available on well-known platforms and is the capacity to crunch through lots of potential to generate new insights, and, therefore non-traditional. Social media data and can now use us to do bespoke by default, market alpha. is still a relatively new concept. All the work for them,” confirms Kilduff. “I left Morgan Stanley in 2012 to set data generated by Facebook, Twitter, Ronan Crosson is Director of Data up Eagle Alpha on the basic premise LinkedIn is non-traditional data. Insights at Eagle Alpha. He explains that the amount of ‘alternative’ data is “However, in five years’ time it will that the firm’s in-house team of data growing exponentially today but a lot of all just be data, regardless of whether scientists and engineers are constantly buy-side firms aren’t taking advantage it’s traditional or non-traditional,” finding interesting data sets, which of it,” explains Emmett Kilduff, CEO says Kilduff. then get cleaned and structured. and Founder of Eagle Alpha. “At a “This is the next major change in “Then, the step we are most heavily high level, we define alternative data the investment process; it’s something involved in is alpha extraction by as ‘non-traditional data’ that can be that hasn’t happened since 1998 with way of data insights. The reports that incorporated into the investment the introduction of expert networks. we produce look and feel similar to process. More specifically, we define it We see a lot of fundamental asset traditional investment banking reports, across 20 different categories such as management firms moving to adopt but the data underlying them is very online search data, trade data, satellite quantitative strategies. One of the ways different, as are the techniques that and weather data.” to achieve this is by implementing we employ. The three most common categories alternative data into their investment “We have skill sets within the team used by the buy-side, says Kilduff, are process to gain better insights.” that are not available to traditional consumer transaction data, application There are five parts to Eagle Alpha’s analysts,” explains Crosson. usage and web traffic data, and thirdly offering: thought leadership; data The reports focus largely on geo-location data. insight; analytical tools; raw data, and macro developments in the markets Traditional data sets are available to bespoke projects. and equities; specifically US and UK the market from the usual sources. It is Thought leadership is offered consumer discretionary and technology data that is easy to source. because most buy-side firms haven’t stocks.

AlphaQ February 2017 www.AlphaQ.world | 18 BIG DATA

To illustrate the efficacy of these data fastest growing. A lot of Western brands insights reports, in a report on 15 December have dependence on China and it’s therefore 2016 Eagle Alpha (using Google Trends data) important for them to have access to this data.” wrote that its Search Signals index on Finish The auto sector is also an important Line pointed towards a weakness in the economic indicator of consumer health, company’s same store sales. consumer spending, which can be useful “The sharp downtrend observed in the index to macro investors who are looking to get in recent months indicates that expectations early signs and leads on China’s wider for SSS growth at FINL are at risk, or that economy. Crosson says that there are four management outlook for the February quarter main components to the data set: volume may disappoint”, said the report. The Search sales, transaction price, rebate (insights into Signals indicator was prescient in providing manufacturers’ promotional activity), and directionality on this key company metric. showroom indicators (real inventory, real data The company’s stock reacted to the on enquiries). change in fundamental outlook and is “The CAI data set will provide investment down significantly since the day of the managers actionable insights on the Chinese announcement; currently -24.7 per cent since auto industry, well in advance of industry they reported in December. participants reporting their results. This “We do a lot of work to back test data sets to supports Eagle Alpha’s objective which is to test correlations, to build models and perform enable asset managers to obtain alpha from out-of-sample testing; testing the predictive alternative data,” adds Kilduff. power of the data sets. That gives clients “It is critical nowadays to analyse the confidence that the data and the insights we are performance of dealers at the local level. The extracting are valuable,” says Crosson. data allows investment managers to assess One significant development in recent weeks opportunities in a competitive market with is the announcement by Eagle Alpha that it has many participants,” opines Crosson. “The added a China Auto Insight alternative data set findings will better inform numerous strategies to its stable of partner data sets, which buy-side including equity long only and long/short, credit clients can choose to access; other examples and macro.” are UK housing data, US job postings data and In Kilduff’s view, data beats opinion. Global EPOS data that provides insights into Investment managers are always looking for consumer trends. a new edge. “Corporates want to know what This is the first time such granular data has consumers think when the latest iPhone is been collected on China’s automotive industry, released, for example. They are analysing cleaned and made available to the finance consumer behaviour data so the buy-side really industry. ought to be too. “Our partner in China is the leader in Most of the hedge funds we speak to want providing data on China’s auto industry. They to think about next quarter’s earnings for are covering 80 per cent of the market in terms consumer stocks and a lot of our quant fund of the manufacturers they work with. And these clients want to make sure they are not missing manufacturers are their own clients so that out on the next best alternative data sets.” gives you a sense of how valuable their data is,” The amount of data being created is growing says Kilduff, adding that the data is also unique exponentially. In a few years’ time, says Kilduff, in terms of how it is collected. there are going to be thousands of alternative “It is collected using a panel of over 1,300 data sets that will create opportunities for Chinese dealerships, combining other data investment strategies to generate alpha. sources such as web data and more traditional “In the last two quarters of 2016 we saw a data sets to create a large and well-structured significant uptick in interest in alternative data database. sets among traditional mutual funds as well as This data will be useful for those looking hedge funds. It’s not just the most innovative to invest in China’s auto industry as well active managers using these data sets; the level as global car manufacturers that have large of adoption across the asset management as exposure to China. China is now the number a whole will, I believe, continue to spread in one car market globally and also one of the 2017,” concludes Kilduff. n

AlphaQ February 2017 www.AlphaQ.world | 19 ALTERNATIVE FUNDS Sticking to the middle ground James Williams finds that, although cautious overall in its outlook for global real estate in 2017, Hamilton Lane, an alternative fund manager with USD40 billion in discretionary AUM, does see some strong fundamentals throughout a good portion of the market.

nd while other real estate investors might be looking at the extreme Aedges of the asset class to uncover opportunities in core assets on the one hand, and ‘pure development’ opportunities on the other, Hamilton Lane is focusing its attention on the middle ground. “We certainly do see some good opportunities, but we are approaching the market with a degree of caution at the moment. We continue to follow demographics to help identify investment opportunities – we think that will be a key factor to investors’ success over the long term,” outlines Robert Flanigan, Vice President Real Estate at Hamilton Lane. Flanigan explains that some concern with core assets is that pricing has increased meaningfully on a global level, and more specifically in the US and the UK. A lot of that Robert Flanigan, Vice He says that where real estate investment increase, he says, has been driven as much by President Real Estate managers have to become very discerning is in at Hamilton Lane capital demand fundamental growth. identifying exactly what risks are being taken. “At the opportunistic end of the spectrum, If someone is simply buying an asset that has which often times means pure development been priced inappropriately and the return we are cautious about putting a lot of new expectations look a lot like core-plus, that vacancy into the marketplace at this point in doesn’t necessarily mean that the risk profile the cycle. Instead, one could buy some vacancy will also be the same. Conversely, one might buy with a value-add component, make some something that is a true core, stable asset, which, improvements and then enter into a lease-up by applying a little more leverage in the portfolio, strategy that has a short, intermediate term can help to achieve core-plus like returns. risk profile to it, albeit at a lower overall return. “These are two very different scenarios That, to us, seems a more interesting strategy and investors have to be comfortable finding than pure development play, where you are the right balance (from a risk management taking on entire projects with lease-up and perspective). It’s something that we would look vacancy risks,” says Flanigan. at closely and it’s important to be aware of In his view, such an approach is a potential the nuances that exist that could lead to very recipe for getting caught in a downturn. different outcomes,” states Flanigan. “Broadly speaking, we think the core-plus One of the main challenges facing all real and value-add markets look attractive,” adds estate investment groups is putting dry powder Flanigan. to work. Raising institutional assets is not a

AlphaQ February 2017 www.AlphaQ.world | 20 ALTERNATIVE FUNDS

problem; the demand is there. But, from a the landscape for the retailer and how is that supply perspective, there is a growing number of affecting consumer patterns? With those investment managers chasing the same assets, types of structural changes taking place, we which in turn is driving up the price of assets expect opportunities to present themselves. and causing concerns over pure core real estate. With ecommerce comes an increased need To highlight this, the latest Preqin Real Estate for distribution solutions and those need Spotlight report for February 2017 shows that to continue to get closer to the end user, to in 2016, a total of USD108 billion of aggregate compress the supply chain,” explains Flanigan. capital was raised by 225 private real estate Finding well-located industrial assets is, funds. In January, there were already 525 private however, very difficult. Historically, these real estate funds targeting USD177 billion; a were properties that developers looked at and record high. However, the aggregate value of considered a higher and better use for the PERE deals in 2016 was USD202 billion in 2016, land on which they stood; for example, an a 16 per cent decrease on the USD241 billion of aluminium warehouse sitting in an area where deal capital in 2015, underscoring a slower deal people wanted to live. That’s now changing, flow because of increased competition. according to Flanigan. “You have to look for very specific scenarios; “We think there will continue to be tailwinds it becomes a ‘roll up your sleeves, asset by around these industrial assets and it is being asset, market by market, corner by corner’ driven by the increased usage of technology exercise. That will be a key differentiator going for consumer purchasing. It is driving up forward: those who put the time and effort in demand for warehouse storage and, in many to properly operate real estate. There’s a lot of ways, technology is changing the way that money looking for deals and as global capital space is being used. We look at how this will continues to compete in this space, it will create tailwinds and where those demand be increasingly important to really know the drivers might push things forward in a positive operational element,” says Flanigan. direction, even if there are difficult macro He agrees that there is quite a bit of headwinds to contend with.” competition from the large institutions and In the UK, there are similar demographic sovereign wealth funds who have the time and trends at play, but a big difference is that resources to learn about real estate markets. there are clear structural changes with respect However, a lot of the activity he sees is focused to the way people are living. In London, for on a handful of gateway cities across the globe. example, there is simply not enough supply to “We’ve seen a lot of money being pushed into meet demand. a few places and that has created some of the “In London, what we would think of as disparity between gateway markets and secondary ‘student housing’ doesn’t exist. Within the locations. The large institutional pension plans rental market, that creates both risks and and SWFs have some very sophisticated and opportunities – for those who know where to smart people they are employing and partnering find them. Moreover, we believe that the UK with to execute on these strategies.” will resolve its Brexit concerns and whatever Demographic patterns play a key role in how happens, the UK will continue to be a global Hamilton Lane seeks out potential real estate economic hub,” says Flanigan. opportunities. What kind of demographic plays “Going forward, it’s likely that the European are going to continue to create tailwinds in the market may shift back toward those with the market? In the US, the two main cohorts are most operational expertise. It’s not that there the baby boomers and the millennials. won’t still be distressed opportunities, but more “Baby boomers are one area of focus, so that the current environment is better for because people at that stage in life are a bit those who are strong operators of real estate. more predictable in how they act versus a Those who can extract value through real young person who may be more mobile and estate operations are the ones that will end up unsettled. In terms of demographic strategies, benefiting at this point in the cycle. Being able one of them is healthcare related: whether to operate assets at a fundamental level and that’s senior housing, medical offices, etc. being prudent on the amount of vacancy and “Another important one is technology. Take types of risks are some of the most important ecommerce, for example. How is that changing considerations today,” he concludes. n

AlphaQ February 2017 www.AlphaQ.world | 21 ASIA

Asia credit – a separate allocation Yu-Ming Wang, Global Head of Investment and Chief Investment Officer, International, and Bertram Sarmago, Investment Director, Asian Fixed Income, at Nikko Asset Management have written a paper expounding their theory that Asia credit should stand alone from global emerging market (EM) debt.

he authors believe that Asia credit should also by the strengthening of local financial be treated as a separate allocation, institutions and regulations, which have Trather than part of an Emerging Market added stability and transparency. allocation, for the following reasons: The authors list five reasons for a separate • As regional markets evolve, the distinction allocation: between Developed and Emerging Markets is losing its meaning – and allocating to Asia 1. Diversification credit as part of EM makes less sense. One of the benefits of treating Asia credit • Particularly in Asia, where the emergence as a separate allocation is that it can more of China, the growth of integrated supply fully capture the diversification benefits of chains and the rise of intra-regional markets, incorporating it into a broader portfolio. Indeed, the line between developed and emerging is diversification is the only “free lunch” available blurring. to investors and should be utilised to its • The growth of the Asia credit market reflects maximum potential, in our view. this change. From a small and illiquid market The growth of the Asia credit market has dominated by sovereign issuers at the start been remarkable, reflecting both the funding of the century, Asia credit has emerged as a needs of regional growth (which accounts for deep, diverse, USD700 billion asset class in almost 80 per cent of global GDP growth) and its own right. the demand by local institutions for local debt • This asset class is supported by strong instruments. Just as remarkable has been the fundamental economic growth in Asia, and risk adjusted returns: from Jan 2009 to Sep

AlphaQ February 2017 www.AlphaQ.world | 22 ASIA

2016, the annual volatility for hard-currency “In Asia the line between Asian Investment Grade (IG) credits has been approximately 4 per cent, while returns have developed and emerging is been almost double that – yielding a Sharpe blurring.” ratio of nearly 1.9x. This is far lower volatility than comparable Emerging Market debt, and even US IG debt. Key contributors to this fact global trade and financial flows. We see this have been the sustained fundamental growth evolution towards a more multi-polar world and substantially lower debt servicing ratios for as part of the integration of new growth many Asian corporate issuers, coupled with the centres into global institutions. diversification of income streams. Strong buying This evolution is reflected in the RMB being Yu-Ming Wang, Global support from long-term Asian investors has also accepted as a reserve currency by the IMF, and Head of Investment supported the lower volatility figure. and Chief Investment growth in regional initiatives, such as the One- The Sharpe ratio for Asia IG hard currency Officer, International, Belt-One-Road programme. Even if broader credit has outperformed similar credits in other at Nikko Asset free trade agreements, such as Trans Pacific Management regions on risk/return basis from Jan 2009 to Partnership, are derailed by political opposition, Sep 2016. intra-regional agreements will continue to Yet for many institutional investors in develop in support of greater cross-border flows. developed markets, Asia credit remains an Asia credit offshore market development exotic asset class, on a par with Emerging also reflects this intra-regional growth. As can Market debt. The image many have about Asia be seen since 2009, the share of flows into credit goes back to the Asian Financial Crisis the market coming from Asia has grown from of shallow markets with low liquidity, high 49 per cent to 71 per cent. This is due to the volatility and domination by foreign flows. creation of wealth in Asia and the development The quarterly returns for the JACI Asia of more robust pension, insurance and banking Credit Index vs Barclays Aggregate is highly systems that are driving the “local bid” demand dispersed. The average correlation over the past for Asia fixed income assets. 10 years (January 2006 – December 2016) is At the same time, new issuance has also only around 51 per cent. become more diverse as it has grown. China has Hence, for a US or European investor seeking replaced Korea as the largest country-market higher risk-adjusted fixed income yields, it segment, but India and Indonesian issuances may make more sense to add Asia credit to a are also increasing in order to meet their domestic portfolio than 1) low yielding, highly funding needs. As Asian corporations become correlated local credit or 2) less correlated, but more sophisticated and able to access direct highly volatile EM credit. funding through offshore markets, we expect this growth to be self-reinforcing. 2. Asian economic growth and the evolution to multi-polar world 3. A benchmarked strategy under-weights While there have been major political surprises growth this year, including Brexit and Trump’s victory, A traditional CAPM approach uses benchmark we do not see the opposition to “globalism” indices as the proxy for listed securities. reversing the fundamental trends that are However, in markets such as Asia, where growth driving Asia’s economic growth and influence across the region is uneven and at very different in global politics. Rather, these political stages, an over-reliance on benchmarks can give events reflect a reaction to these and other a skewed view of opportunities. Even on market internal trends: cap weighted equity benchmark, tracking the • Internal pressure: the poor distributional index tends to reinforce a size bias to investing. efficiency of capitalism has resulted in Furthermore, liquidity limits, capital flow rules greater social inequality, thus causing and other constraints mean that benchmarks discontent that may lead to dire outcomes if can skew an investment approach away from left unresolved. fundamental growth and toward primarily the • External pressure: the global economy is largest established firms. In the case of fixed changing and Asian countries, particular income, the impact of benchmark biases is even China, are taking a more prominent role in more significant. By matching a benchmark in

AlphaQ February 2017 www.AlphaQ.world | 23 ASIA

which the largest debt issuers are allocated the lower than EM debt markets. Furthermore, the largest investment, the index essentially favours strong fundamental growth in the region has indebtedness over other factors, such as growth. meant that default rates have been lower (and From a contribution to global GDP growth recovery rates have been far higher) for Asia perspective, Asia ex Japan clearly dominates. than EM. Indeed, according to JP Morgan, for However, by investing in Global Aggregate 2016 YTD on High Yield markets, Asia default or Global Credit strategies, global investors rates are 0.9 per cent, compared to 3.5 per cent allocate less than 5 per cent to the region, a for the EM average, and 2.4 per cent for the US, large underweight compared to the region’s which is consistent with historic trends. growth contribution. Thus, a separate allocation In sum, we believe that treating all EM debt to Asia credit is required for investors to better as a homogenous asset ignores significant Bertram Sarmago, reflect the real economic significance of the differences (and therefore alpha opportunities) Investment Director, region. In regards to investment in Asia credit, Asian Fixed Income, and that a more nuanced approach can capture Nikko AM also advocates an active approach, at Nikko Asset these returns with lower risks. rather than following regional fixed income Management benchmarks. This allows investors to limit 5. Including an Asian asset class is exposure to issuers, such as China property accretive to a Global/EM portfolio firms, which may be large, but around which we By taking a more focused approach to Asia have quality concerns. through a stand-alone allocation, investors can leverage specialised expertise in an asset class 4. What is an emerging market? Does it that can enhance the overall risk/return profile apply to Asia credit? of a Global or EM portfolio. A blended portfolio If you compare the risk and return profile of with a 20 per cent JP Morgan Asia Credit Index Asian credit to that of Latin America or other separate allocation and an 80 per cent Barclays regions, there is very low correlation. Also, Global Aggregate Index allocation would have within Asia, there are very clear differences consistently outperformed a 100 per cent in the stages of development between markets allocation to the latter over the past five years such as Vietnam and Korea. Investors need by approximately 2.4 per cent in USD terms. to decide how granular they wish to be in At the same time, because Asian credit is assessing market differences; however, investing a relatively small component of the Barclays in Asia as part of an Emerging Market allocation Global Aggregate Index, with only around a 50 ignores the significant differences between key per cent correlation, apart from yield pick-up markets there and in other regions. by overweighting to Asia credit, there are also For example, with dollar strength expected significant risk diversification benefits from to continue, any country running a positive a separate allocation to the asset class. This current account is a safer place to invest. is particularly true of Asia Credit Investment Almost all of the Asian countries have positive Grade with its high Sharpe ratio. current account balances, providing capital to the rest of the world – whereas many other Conclusions EM countries are net capital importers. Since • Aggregating Asia credit as part of a the 2013 taper tantrum, India and Indonesia Global or EM portfolio, ignores the return have implemented structural reforms and enhancement, risk diversification benefits we are seeing improvements in their current that can be captured through a stand-alone accounts. In addition, as a result of running allocation. strong current account balances, countries like • Asia Credit IG hard currency has one of the India and Indonesia also have built up large highest returns per unit of volatility of any foreign currency reserves, which also add to segment of the global credit markets. Thus, their stability. we believe that overweighting this asset class As noted earlier, increasing wealth through a stand-alone allocation can improve accumulation in Asia, and the growing portfolio performance. sophistication of local financial institutions • This performance is supported by in channelling that wealth, have been key fundamental growth trends in Asia, which drivers of liquidity in Asia credit markets and are not reflected in a global index-hugging part of the reason that volatility has been approach to allocation. n

AlphaQ February 2017 www.AlphaQ.world | 24 LATIN AMERICA Jaguar pounces on LatAm real estate Latin American real estate offers an abundance of attractive entry points and long-term growth opportunities, particularly in markets such as Brazil and Mexico, as their middle class demographics continue to rise, writes James Williams.

ver the last 10 years Brazil’s middle to the previous five or six years. There’s been class has grown by 40 million and a move away from the political left towards Othose people are now buying goods and the centre ground in places like Argentina services which were previously unavailable to with former President Cristina Fernandez de them. Kirchner indicted and Pedro Pablo Kuczynski That is showing up in the rising numbers being elected in Peru. There are still outliers of shopping malls, improved healthcare as like Venezuela that remain an issue, but there these people move up the pyramid (private is relative political stability, generally speaking,” healthcare), the demand for bigger houses and comments McDonald. luxury apartments and so on. He says that 20 years ago, real estate “The growth of the middle class and investing in Latin America was largely focused subsequent consumer demand are drivers, on capital intensive private growth businesses. either directly or indirectly, in the businesses There were no relevant public real estate that we participate in; whether it be logistics, companies, as such. Fast forward to today, and hospitality, shopping malls: our investment the public markets in countries like Mexico strategy is focused on businesses that have huge and Brazil are deep and vibrant ‘although I untapped demand,” explains Thomas McDonald, would say they are still in their first phase of Managing Partner, Jaguar Growth Partners, a evolution; some companies probably shouldn’t New York-based investment firm focused on real be public. estate private equity with an office in Sao Paulo. “This represents deep value opportunities: With more than 100 years’ experience within either right-sizing public companies, taking the team, Jaguar is an active partner with subsidiaries out of public companies, merging the real estate-related operating companies it public companies and taking them private. invests in throughout Latin America, the aim Those kinds of opportunities have widened being to build scalable, institutional-quality our universe substantially compared to 20 businesses. years ago. We have a combination of deep- The firm has just announced the final value investments and more traditional growth close of its first fund, Jaguar Real Estate investments in the JREP portfolio,” explains Partners I LP (JREP), having raised USD350 McDonald. million in discretionary and non-discretionary Over the past year Jaguar has committed in capital. JREP focuses on the most compelling excess of USD200 million of capital in several markets in Latin America including Brazil, portfolio companies including LatAm Logistic Mexico, Argentina, and the Andes region. Properties (LLP), Brazilian retail property Retail, residential (single family and multi company Aliansce, and, most recently, Brazilian family), speciality finance, logistics warehouse AEL home builder, Tenda. distribution, hospitality are just some of the Emerging markets generally require a great investment opportunities the team looks for. deal of experience and patience. There is often “Politically, we’ve seen a positive trend over volatility and sometimes it can be significant. the past 12 months in Latin America compared Where Jaguar brings value to its LPs is from

AlphaQ February 2017 www.AlphaQ.world | 25 LATIN AMERICA

Jaguar might, to some, be regarded as contrarian investors. At a time when private equity groups are looking at core markets in more developed markets, Jaguar is exploiting the chance to invest in under-valued real estate companies where there is less competition to put capital to work. Asked where this level of conviction comes from, McDonald responds: “We’ve seen cycles over the past 20 years and frankly much prefer to be looking at investments when the airplanes aren’t full of people travelling from New York down to Brazil or Argentina. That’s when you find better opportunities and more attractive entry prices. If one considers the Aliansce deal – if you look at historic valuations, they were well below where traditional shopping centre operators had traded, mainly because of short-term concerns over Brazil – we had been looking at that deal for 18 months before actually pulling the trigger.” Being patient, but also having the conviction and the ability to make an investment decision when the time is right, is key to investing having invested in Latin America for more than Thomas McDonald, in Emerging Markets, he says. “Our LPs are 20 years through different economic cycles. Managing Partner, providing us with that responsibility and Jaguar Growth Partners “We are very familiar with companies like support in making those judgment calls. These Tenda. These are companies we’ve either are private equity investments not trades. been directly involved with previously, or We benefit from years of having studied have worked with their management teams these companies and become familiar with previously. The same applies to Aliansce, management. In every case, we’ve had year Brazil’s third or fourth largest commercial retail long conversations with management and gone operator in Brazil. We believe there is still through various iterations before arriving at the room for Brazil’s shopping mall sector to grow final deal.” organically and also through consolidation,” There are a couple of criteria that are opines McDonald, confirming that in the past, consistent in all of the investments that Jaguar’s partners have also worked with BR Jaguar makes. Malls, Brazil’s largest shopping mall operator. One is assessing the ability for the target “We participated on the investment company to build a scalable platform. The committee and have acted as catalysts for the second is management. What is the quality of consolidation of the shopping mall industry management, the alignment of management in Brazil for the past 10 years. Investing in with shareholders in the target company? Aliansce therefore represented an opportunity In most instances, management teams need for us to participate in what we see as the to be improved, says McDonald. Having next stage of consolidation in Brazil’s shopping an understanding and agreement with the centre sector. It’s a company we know well, company’s founders and key shareholders on we know the board members so it was familiar what needs to be done “is part of what goes into territory for us. That’s not to suggest the the work we do”. investment process is easy. Choosing the Right now, he says that Jaguar particularly right partners is the most difficult part of the likes the logistics sector. equation. “It’s a sector we’ve invested in previously “We draw on all of our experience when in Brazil, Mexico and China. In our first fund entering into any new investment opportunity,” we have a logistics platform focusing on the explains McDonald. Andean region called LatAm Logistics Property,

AlphaQ February 2017 www.AlphaQ.world | 26 LATIN AMERICA

which operates in Peru, Colombia, Costa Rica and Panama. We see opportunities beyond that in Argentina and Brazil that in some cases are more developed than the Andean region and yet are still under-penetrated versus more developed markets. We like the logistics space across LatAm as a whole. “The majority of the fund is invested. We are working currently on our final investment for the fund, which will represent the conclusion of JREP’s investment activity,” confirms McDonald. One of the key skills for any investment manager, is right sizing the deal. How does a manager know what the appropriate capital commitment should be for a specific investment opportunity, ensuring the optimum risk/return outcome? McDonald says that, ultimately, it comes down to portfolio diversification. “We think about that in four ways for the fund. One is geographic; the JREP I fund has two investments in Brazil, one in the Andean region and one in Mexico. The second is sector diversification; we have Aliansce on the retail side, Tenda on the homebuilding side, LLP on the logistics side, etc. The third component is the fact that we cover the spectrum from early-stage businesses to well-established public companies. “The fourth and final component is, what does the business need for the next round of capital in the private space? And with respect to the public space, what size of participation in “Jaguar is exploiting the chance to invest in a business will allow us to have portfolio impact under-valued real estate companies where but also have a voice in the company by sitting on the board? there is less competition to put capital “We take each investment on a case-by-case to work.” basis but we will typically look at them through those four lenses.” trusted partner to provide them with access Building experience in Latin America, and to emerging markets generally, as well as real other emerging markets, takes many years and estate and private equity specifically. requires boots on the ground to not only source “We therefore ticked all three boxes. Another deals but work with local partners to navigate investor in the fund was looking for a regional the sociopolitical risks. As Jaguar has been approach as opposed to trying to pick the right active in Latin America for decades, McDonald country and the right manager and our model says that the boards of target companies was very attractive for them; we ticked the “understand our roles and desires and embrace emerging market, real estate and regional boxes us as catalysts for change. We will not invest in for them,” adds McDonald. a company without the support of management Jaguar is currently in the process of and the board.” completing the final deal in JREP I. “We Current investors in JREP I include participate in sectors that we think will be prominent institutions such as New York attractive to further investment and liquidity,” Life. They were, says McDonald, looking for a concludes McDonald. n

AlphaQ February 2017 www.AlphaQ.world | 27 CLEAN ENERGY Rating US hydropower risk Michael Ferguson, director, US Energy Infrastructure, S&P Global Ratings, writes that despite fears that Donald Trump’s ascent to The White House could be a major blow to renewable energy, the US is currently experiencing a financing renaissance in one particular source: hydropower.

he recent election of US president in the US due to siting and planning concerns Donald Trump has cast doubt over the and, not least, the large capital costs during Tcountry’s priorities for power generation construction. and, not least, the future of the Obama That said, any suggestion that political administration’s Clean Power Plan. In particular, shifts could alter hydropower’s significance the appointment of climate change sceptics to is somewhat overstated given most of the key positions in Trump’s administration denotes US Northwest is dependent on hydropower, a deviation from his predecessor’s commitment especially with large coal retirements already to reducing carbon emissions through a large planned in Oregon, Washington and Idaho. scale shift towards renewable sources. Indeed, any of the aforementioned risks to Although hydropower’s future role in the hydropower have not prevented a flurry of US’s energy strategy is unclear, instead of a Michael Ferguson, capital injection to improve and rejuvenate director, US Energy diminishing role, we expect the US’s 2,200 Infrastructure, S&P the country’s existing portfolio. For instance, hydro facilities to remain resilient. Indeed, we Global Ratings between 2005 and 2013, more than USD6 are experiencing something of a renaissance for billion of capital spending contributed to hydro asset financing – not least because recent upgrading the US’s hydro fleet’s capacity by transactions in the space have commanded nearly one and a half gigawatts (GW), and we substantial prices. anticipate seeing similar spending during the Such high multiples, we believe, stem from next decade. hydropower’s numerous advantages with regard So, why has this hydropower resurgence to asset longevity, its low variable cost structure occurred? The key advantages are the and, importantly, flexible generation capabilities resource’s very long asset life and its that can meet changes in demand patterns. comparatively low variable operating cost, as Donald Trump’s ascent to the Oval Office well as its ability to capitalise on pricing peaks. does not represent the beginning of the end From the 6.8 GW Grand Coulee Dam on for hydro assets – instead, we believe the downwards in size, the majority of North renaissance will likely continue. With this in American assets have either eclipsed or are mind, we aim to address questions around approaching our presumed asset lifespan of 50 how we assign ratings to this asset type. As years. Such project longevity provides one crucial such, we place significant focus on the asset advantage to energy ratepayers: insulation against age resource risk and whether the plant a volatile commodity price – both in terms of enjoys sufficient liquidity features, such as power pricing and capacity costs. access to revolving credit facilities, in order In this respect, we expect hydro to determine the accurate level of risk for financing to remain robust in the face of any infrastructure investors. exogenous political or market forces. The While mass hydro plant closures in the more pressing question, however, is how to foreseeable future remain unlikely, the accurately ascertain the credit risk of US construction of new hydro assets is impractical hydropower assets.

AlphaQ February 2017 www.AlphaQ.world | 28 CLEAN ENERGY

DAVID G RIGG

Of course, with hydropower facilities’ “We expect hydro financing to remain robust unique characteristics in mind – notably, their advancing age and potentially substantial in the face of any exogenous political or capital expenditures – achieving an investment market forces.” grade rating criteria can be challenging without appropriate risk mitigants. utilise longer debt service reserves of around a To assess these risks, we do not forecast how year – while six months for investment grade long a plant might operate in a vacuum – but project finance is a market standard. What’s how its cost-effectiveness and performance more, in order to protect against unexpected could change in the long-term and how likely – and often substantial – maintenance costs it will remain financially economical in the that accompany ageing infrastructure, an idle wider marketplace; this is a key component of revolving credit facility is available that, if assessing refinancing risk. necessary, that could cover the plant’s operating Thankfully, with few newly-constructed costs for one year. hydro assets in North America to consider, Of course, while unfavourable market many plants have a comprehensive and lengthy conditions, such as the current lower gas and track record – some of which have decades power price environment, have dampened of hydrological data available to determine hydro’s relative profitability and cash flow, what constitutes either a high or poor hydro facilities are able to survive slump performance year. periods in the commodity cycle and retain Complicating this, however, is that certain profitability in the long-term. And as we move regions of North America – particularly on into a period during which demand patterns the West Coast – are experiencing meaningful could become less predictable, hydropower’s year-to-year variations in water levels on a operational flexibility will be crucial to magnitude that can affect the asset’s debt meeting unexpected spike or troughs in future service coverage ratio (DSCR). In order to energy demand. mitigate this challenge, S&P Global Ratings will With this in mind, although the election of assess the degree to which a hydro generator Donald Trump may change the Clean Power will reserve part of its capacity in order to gird Plan’s course, the favourable economics of against underperformance during periods of hydro generation coupled with the market’s peak usage. willingness to support upgrades are continuing For hydro assets, which are typically unhindered. In terms of hydro assets’ future, we burdened by seasonal water levels, fluctuating believe that the ongoing financing renaissance cash flows are a concern. Often, hydro assets is a promising signal. n

AlphaQ February 2017 www.AlphaQ.world | 29 PRIVATE EQUITY PE.Analyzer: the Bloomberg for PE James Williams writes that CEPRES has rolled out a new platform to give institutional investors a way to effectively benchmark private capital market investments.

he PE.Analyser uses technical need for advisors serving LPs to have and fundamental analysis to more sophisticated tools to serve their Tachieve a three dimensional clients,” says Schmidt. view into their investments. It is Secondly, PE.Analyzer operates the first benchmarking platform of such that the LP gets market statistics its kind and by design, it will allow and allows them to analyse a range of investors and fund managers to managers, based on a tacit agreement exchange investment data in a secure between both parties; the GP will only environment. allow the right category of investor “The private market industry to review their performance and (PE, RE, infrastructure, private track record. debt) is getting very large, but the “PE.Analyzer acts as an automised way it is treated, from a quantitative broker where fund managers allow LPs perspective, is still far behind to look at their track records, see what compared to the sophistication with they have delivered to investors in the which stocks and bonds are analysed. past, and make them better understand We think PE.Analyzer will be the next how and where they invest. logical step in the development of the “By giving them more structured private capital markets,” says Daniel “The manager can self- transparency, it makes it easier for Schmidt, CEO of CEPRES. LPs to invest because they understand He hopes that the platform will analyse in advance the manager and gain confidence. One achieve two goals: to make the to determine whether side can better analyse and understand process of investing in private capital LPs will view them the investment proposition (the funds more efficient, and to bring a LP), the other side can create faster higher level of understanding to the favourably.” confidence (the GP) and both sides get to benefit from a closer, more efficient asset class. Daniel Schmidt, CEPRES These two points are essential to alignment,” explains Schmidt. enhancing the investment process, One might think that PE managers both for LPs and GPs. “The platform the quantitative background of returns, would naturally guard against opening will help GPs to better understand of risks, of cash flows and so on. By up their doors to LP review but the their investors, craft the right message, analogy, it will work similarly to a opposite seems to be true. So far, and find the right investors in the Bloomberg terminal in terms of the CEPRES has approximately 2,700 fundraising process. This should information the end user gets on stocks funds on the platform, 36,500 deals make the investment process and the and bonds. and covers USD4.2 trillion worth of fundraising process more efficient and “In the private markets, PE.Analyzer PE-backed companies. It is averaging sophisticated,” says Schmidt. is beneficial for both LPs either 50 new registered users per month. There are two parts to the platform. with their own internal investment “Are fund managers happy disclosing Firstly, the analytical part where processes and to verify external advice. information to potential investors? Yes, PE.Analyzer helps LPs to understand There is also a strong and growing they are, because they recognise it is

AlphaQ February 2017 www.AlphaQ.world | 30 PRIVATE EQUITY

treated confidentially and helps them The solution was to become part of about volatility and downward pressure improve their fundraising process,” a large LP with a large balance sheet to on public markets, PE.Analyzer shows suggests Schmidt. invest in PE. CEPRES was, at the time, that private infrastructure can help “They obviously won’t disclose part of an investment management hedge risk and enhance a balanced this information to everybody, only to business and executed due diligence portfolio,” says Schmidt. potential LPs who they think could be and portfolio structuring processes. This ability to benchmark GPs deals valid investors. They would ordinarily With this LP backing CEPRES could be an important enhancement share such information via email and could convince GPs to be part of the and whilst Schmidt doesn’t think it send different versions to different CEPRES network. “We convinced will change the way that people think LPs – a huge workload; now they can many GPs but nevertheless it took about why they should invest, it should do it in a more secure, structured way. 10 years to develop the database. give them greater efficiency. They will Moreover, the manager can self-analyse Then, in December 2010, we decided be able to perform analysis on a much in advance to determine whether LPs it was time for CEPRES to become wider range of GPs in a much shorter will view them favourably. If they an independent entity in order to be timeframe. identify potential weaknesses, they completely objective and not have “One insurance company told us have the chance to address them. biased interests. that on average the time it took to This gives GPs the chance to view “Today, we work with LPs around perform fundamental analysis on a themselves through the eyes of an LP.” the world including North American, manager, gathering the data, crunching So far, institutional investors using European, and Asian pensions, it, etc, was three weeks. When they the CEPRES platform have conducted insurers, family offices, advisors, etc do it today on PE.Analyzer, it takes due diligence on USD1.9 trillion of to help them better understand the them 20 minutes and they can now Buyout, Growth, Venture, Private Debt, benefits of investing in private equity, concentrate their valuable time on the Infrastructure and Real Estate funds. how they can improve their investment relevant qualitative due diligence,” Based on those 36,500 deals, LPs decisions, and how to evaluate confirms Schmidt. can analyse monthly cash flows, track investment outcomes. All this is then Schmidt confirms that in the next revenue developments, calculate implemented as data and analytics into few months, CEPRES is planning to correlations of revenues to returns; the platform,” adds Schmidt. roll out a several groundbreaking all granular data points that provide a Considering that PE.Analyzer applications for the platform. greater level of sophisticated analysis processes hundreds of thousands LPs can analyse their portfolios, that an investor otherwise wouldn’t have. of transactions and trillions of strategically & tactically decide where “We actually started CEPRES back dollars of investments in a matter of to invest, get connected to range of in 2000 where we emerged out of seconds, Schmidt says: “What our fitting GPs and get regular new and a scientific research project,” says developers and quants have achieved is groundbreaking services to enhance Schmidt, discussing the origins of the astonishing.” their investment process. firm. “As more European institutions, Recently, using PE.Analyzer to “Our goal is to offer a complete such as insurance companies and analyse thousands of privately held investment platform by connecting pension plans, invest in private Infrastructure assets, CEPRES found LPs, GPs and advisors and support markets, the risk is that they make that since 2002 there was a beta them to be more professional and inadvertent mistakes because of a (correlation) to the US corporate bond efficient in the private markets,” lack of data and investment analytics, market of -0.9 and an alpha of 19.5 explains Schmidt. which was evidenced by the crash of per cent. He views PE.Analyzer as important the venture capital bubble. Out of this The results were derived from as Bloomberg terminals being crash, the European Commission said the new PE.Analyzer Alpha Beta introduced to the stock market to more than 10 universities, ‘Please Framework that uses regression industry that today are also used by all come together and work out a way to analysis to calculate the risk market participants. better analyse private equity from a adjusted return (alpha), together “It’s an asset class that is getting risk perspective’. with the correlation (beta) to an bigger and it’s only possible to invest “I was part of this group. We started underlying market – in this case US into that asset class if certain standards reaching out to GPs to ask whether corporate bonds. are met. Our platform is just a logical they would like to share their data. “Infrastructure, as a yielding asset, development of the industry. We won’t As you can imagine, initially all of can be a useful alternative for liability- be the only one, but we do have a first them said ‘No’. There was nothing in driven fixed income investors, like mover advantage. Systems like this will it for them so we had to find another pensions and insurers seeking higher become the accepted standard in a few solution.” returns. For those especially worried years,” concludes Schmidt. n

AlphaQ February 2017 www.AlphaQ.world | 31 COMMENT

“Are you lonesome tonight?” Our regular contributor, Randeep Grewal, calls on Elvis to examine so-called lonesome stocks and industries.

Are you lonesome tonight, However much investment banks and Do you miss me tonight? brokerages claim to operate on a global basis, Are you sorry we drifted apart? it is rare that analysts covering a sector really Does your memory stray to a brighter sunny coordinate at an in-depth level across regions. day? As a result of limited, or indeed no comparable, Elvis Presley, 1 Nov 1960 local players these ‘lonesome’ stocks tend to be under-covered. (It is much more profitable lvis Presley recorded ‘Are you lonesome for an analyst to cover an industry with dozens tonight’ at the suggestion of his manager of players in his region as knowledge can be EColonel Tom Parker. The original song amortised over much more trading volume). was written by Roy Turk and Lou Handman I thought I would illustrate, with an industry in 1926 and was a favourite of Marie Mott, the that is generally loathed, how digging deep can Colonel’s wife. find some interesting attributes for investors in Recently I have been looking at ‘lonesome’ a lonesome industry. stocks and industries… The memory industry is an example of a There are a number of industries which lonesome industry: this comprises two main operate on a global basis but whose competitors subsectors – DRAM which is used within in any one geographical market are limited. computers for storing code and data for

AlphaQ February 2017 www.AlphaQ.world | 32 COMMENT

immediate execution; and flash memory which of the local businessmen who had invested used is used for longer term storage. Though the a witching stick to find a gusher. That first fab two types of memory are different, there is the was built for USD7 million; and one of their ability for the large manufacturers to switch major investors was a potato farmer. production lines, albeit with some considerable It is unlikely that in the current day a new effort, between the two; thus investors need to startup in memory would be competitive or consider both subsectors together. obtain the necessary scale without spending In DRAM there are three players (Samsung, over USD10 billion and there would still be the SK Hynix and Micron) who, between them, issue of obtaining the intellectual property and control over 90 per cent of the market. In the knowhow to build competitive chips. The contrast the flash memory market has six (Flash Ventures) Yokkaichi fab alone produces players (Samsung, Toshiba, Sandisk (part of 50 variants of flash and uses 20,000 different Western Digital), Micron, SK Hynix and Intel) processes in its manufacturing. who control over 90 per cent of the market. It Another example of investor ‘impressions’ is might appear that a US analyst would have a that historically the memory market was highly chance of understanding the flash industry, but dependent on PC sales; and the purchasing for both US players (Western Digital and Intel) power of a limited number of PC manufacturers flash memory is only part of a much bigger versus numerous memory suppliers ensured business. The list of flash makers significantly that the suppliers always had a weak hand. understates the market consolidation as Sandisk Nowadays, however, the limited number of and Toshiba manufacture via a series of joint suppliers, and the diverse areas of demand for ventures (known as ‘Flash Ventures’); similarly memory – including mobile handsets, smart Micron and Intel have a joint venture (IMFT). televisions, cloud infrastructure providers Thus a diligent memory analyst in Korea, and automotive manufacturers – suggest that Japan or the USA in a regionally organised bargaining power has shifted to the suppliers. brokerage is likely to cover only part of the The massive consolidation in the industry memory industry. means that there is now a single site The memory industry is the archetypal (Yokkaichi) which produces one third of the highly cyclical commodity producer – at least in entire global flash supply. In such a situation, the minds of many investors; with low barriers where three to five companies are dominant to entry, intense competition and massive in the whole industry, one might wonder if capital investment. The history of the industry, cyclicality is going to be reduced going forward. with multiple bankruptcies or closures, and Investors will delight in discussing the latest poor capital returns also scars many investors variant of the iPhone. However they are often and again contributes to its ‘lonesome’ status. less interested in the various product lines in One of the reasons I look for ‘lonesome’ a ‘lonesome’ industry. Over time, DRAM has industries and companies is that there is a become specialised for specific applications, or greater opportunity for a variant perception designed for certain customers’ requirements if the market view is based on impressions (eg for specific mobile phone manufacturers); rather than analysis. For instance, industries also, certain customers have very exacting tend to be cyclical if there are numerous standards (eg automakers require suppliers players and the principal requirement to enter to be qualified). Thus, according to some the industry is capital. As shown above, the estimates, only 25 per cent of DRAM is pure memory industry is significantly consolidated; ‘commodity’ chips which are headed for the additionally patents and know-how required to desktop PC market. The increased cost of manufacture memory are a considerable barrier switching helps reduce the commodity nature to entry. of the industry. I like finding industries whose Micron was started by three design engineers products, over time, become more specialised in the basement of a dental practice; to keep and differentiated. costs down their first fab was based on the Generally, silicon chips benefit from scaling plans of a supermarket (the meat locker on the from Moore’s law – and this means that flash plan was enlarged and made into a clean room). memory, in the form of Solid State Drives The first fab was built on a ranch to reduce the (SSDs), is penetrating the laptop PC market. land costs. As the site was short of water, one Indeed, by the end of 2017 or early 2018 it

AlphaQ February 2017 www.AlphaQ.world | 33 COMMENT

is likely that over half of new laptops shipped will have SSDs rather than hard disk drives. Similarly, there are some server or cloud based applications where it is already more economic on a total cost of ownership basis to swap out hard disk drives for SSDs. As prices fall the addressable market increases rapidly. For instance if price was not an issue, who would not want a 2 TB SSD in a laptop; and 1TB of storage in a mobile phone? It is interesting that though mobile phone companies (especially Apple) are covered by enthusiastic analysts, the PC industry is another ‘lonesome’ industry (partially because there is only one major US listed PC manufacturer – HP Inc.) Often when the ‘customers’ of a lonesome industry are themselves poorly covered, investors miss significant trends such as the scale of replacement of hard disk drives by SSDs Randeep Grewal is Thirdly Intel and Micron have been working in laptops. a portfolio manager on a new memory technology known as 3D for the Trium Multi- I have attended analyst meetings where Strategy Fund. This X-Point, which apparently has hybrid features there has been discussion about the most article is written in a of both DRAM and NAND; however, it is not obscure items to do with eg Apple. However I personal capacity; the entirely clear when it will be widely available views and opinions are have not met an analyst who will discuss with or how it will fit into memory architectures. those of the author me if the new Intel mobile processors in the and do not necessarily Fourthly Chinese state-owned Tsinghua Kabylake (and subsequently in the Cannonlake) reflect those of Trium. Unigroup is planning on spending up to USD70 processor families will lead to adoption of billion to enter the memory market. Their first LPDDR4 and hence allow laptops with more significant production is expected in 2018 but it than 8-16GB of DRAM which would attract will take several years to ramp up; and it is not power users. Though it may be an obscure entirely clear whether they have the knowhow issue, the point is that potential future drivers or access to the intellectual property portfolio are often neglected as far as lonesome stocks to give them freedom to operate. are concerned. Interestingly RCA and the Colonel were Historically memory was manufactured in unsure what to make of Elvis’ rendition of ‘Are 2D; currently the industry is undergoing a You Lonesome Tonight’ and held off releasing transition to 3D – with the leading edge chips it for several months. Yet when it was released comprising 64 layers (SK Hynix is working on 1 Nov 1960 there were 900,000 orders in on a 72 layer process). In the short term this the first week alone. Nowadays it is considered transition has also tightened supply until the one of his greatest works after his return from process is perfected. Such transitions for a the army. lonesome stock can be very profound – as it Of course, music (together with photos and potentially changes the profitability for the video) is one of the big drivers of increasing whole industry but is poorly covered. demand for memory. All the above suggests a ‘brighter sunny day’ Similarly, despite the above listed concerns for memory; however it would be remiss of me, it is likely that 2017 will be considered a or any analyst, not to also identify that there vintage year in the memory industry with are a few potential clouds on the horizon. supply tightness and growing demand leading to Firstly, will the transition to 64 layer 3D supra-normal profits. Hopefully, it will also be chips lead to oversupply? Secondly, there are a profitable year for investments in lonesome significant questions over Toshiba as a result industries. n of its nuclear division; but for investors in The Trium Multi-Strategy Fund had the memory industry, this raises the issue as positions in some of the stocks mentioned to whether the ‘New Fab 2’ will be on time at the time of writing. These positions may or delayed and the impact on other players. change without further notice.

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