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Alternative Investments Part 1– September 2022

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Alternative Investments Part 1– September 2022

Over the past 10 years, one of the most significant developments in terms of investment allocations amongst the very wealthy has been the huge growth in their allocation away from traditional products into alternative assets and strategies.  However, due to practical and regulatory issues, retail investors are unlikely to be involved in investment products or strategies beyond the traditional.  This is first of two posts which attempts to introduce the “Alternatives” space; but we are not recommending any particular investment approach with respect to Alternatives, nor exploring issues such as historical returns and appropriateness.

“Traditional assets” refer to publicly traded equities, bonds and cash, both in segregated form or bundled into funds that trade or offer regular (usually daily) redemption opportunities.

Alternatives” can be divided into two broad categories.  First are private assets – generally any investable asset that is not a traditional asset.  This includes private equity, private credit, infrastructure assets and real estate.  [Private meaning issued by companies that are not publicly traded and have therefore generally not made public detailed operating and financial information.]

Second, are strategies or funds that use short selling or leverage and other strategies not normally seen in traditional funds.  The entities managing these strategies are often referred to as “hedge funds”.

Investment vehicles offering Alternatives tend to have the following attributes:

  • are less liquid, less regulated and require a larger minimum commitment that is usually the case with traditional investments;
  • the underlying assets have a return profile that is not highly-correlated with traditional assets, or
  • the underlying assets are traditional assets, but the strategy generates return or risk characteristics that are different from those of traditional assets, perhaps through leverage or complex trading strategies, or
  • The returns from the underlying assets are structured to provide different risk return profiles to different investor groups.

We see more non-traditional assets and strategies becoming available to retail investors, perhaps because:

  1. the proportion of Alternative assets within institutional client portfolios has exploded, raising their profile and public awareness, encouraging asset managers to replicate strategies or access to asset classes for a broader pool of investors;
  2. many retail investors are wealthy, and non-traditional assets could likely serve a useful purpose in their total portfolio; and
  3. the increased use of computing power has reduced the scale required to profitably manage certain strategies.

Alternatives are often considered exotic, high-risk strategies reserved for the very wealthy, who can afford to suffer significant losses.  However, many Alternatives are designed to reduce risk and could be appropriate in many portfolios.

For example, many family offices are more concerned with preserving capital and earning a reasonable return, than with maximizing returns on that capital.  They are prepared to give up some of the potential upside to generate steadier returns over time.

Private Equity

Private equity (or “PE”) funds originated as funds that purchased shares of public companies for the purpose of taking the company private.  This was achieved sometimes via a hostile take-over or working with existing management (often referred to as a Leveraged Buy-Out, or LBO).

PE funds tend to use significantly more debt than is typical for a public company and bring more intensive or aggressive management to the business, with the intention to increase its profitability, extract capital and one day sell (to a strategic buyer, other PE firm, or take public in an IPO).

Over time, due to perceived superior returns, PE firms have built enormous capital pools and have expanded their range of investment strategies.  They have funded platform-based industry roll-ups, activist approaches, minority positions in growth companies and managing the premium pools of acquired insurance companies.

The term private equity could also refer to Venture Capital and Growth Capital, because these investments are made prior to a company going public.  Growth Capital, is invested at later stage than is VC; typically once a start-up has established its business model and is growing revenue but wishes to remain private for longer.  More than 50% of the funds deployed by PE firms in 2021 could be described as Growth Capital.

PE firms are estimated to have $3.4 trillion of committed but unallocated capital, with approximately a third of that in buy-out funds.   Despite much slower capital markets year-to-date 2022, the PE firms are reportedly still raising record levels of funds, with financial advisors estimating that the ultra-wealthy Family Offices continuing to increase their over-all asset allocations to PE.

Private Credit

Historically, large companies could borrow by selling bonds to institutional investors or borrowing from banks.  Over time, adjacent lending markets have developed to exploit opportunities around these two main pillars.

After the 2008 financial crisis, Regulators raised the cost of risk taken on by banks through higher regulatory capital and buffers and new reporting standards.  This caused banks to pull back from some credit markets tending to push costs higher in those markets.

The higher returns on offer drove capital into the private credit space.  Credit funds, some sponsored by existing PE firms, raised billions to make available to companies that could not easily access the senior lending bank market or public bond markets – due primarily to size but perhaps a combination of size and credit quality.

The rationale for this enlarged private credit market is that:

  1. Diversifying a total portfolio, especially those heavy to equities and investment grade debt;
  2. With bank lending cut back, there were more opportunities to lend to borrowers with adequate credit quality than was previously the case;
  3. Central bank liquidity expansion had materially reduced yields on conventional investment grade bonds to the level that return expectations at many institutions could not be achieved, whereas the private credit market offered returns above 6% without unreasonable risk;
  4. Leveraged lending (like all bank lending) is typically floating rate, which appeals to many investors; and
  5. As a market perceived as local, illiquid and perhaps inefficient (e.g., lack of credit ratings and publicly-available financial information), the narrative developed that returns relative to risk taken could be attractive across the business cycle.

 

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Vintage Wine Market Update – July, 2022

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Vintage Wine Market Update – 2022 July

As discussed in our update last November, 2021 was undeniably a challenging vintage.  It has become known as the miracle vintage as the savoir-faire of winemakers made all the difference.   If one knows where to look, there will definitely be some very tasty bottles to buy.  This vintage is often described as aromatic, fresh, low in alcohol and well balanced.  White wines are showing very well across all appellations.

2021 is also a vintage where properties with financial resources played a decisive role.  Chateaux had to invest both money and labour into a vintage that in the end produced very low yield.

With the en-primeur campaign now drawing to a close, it is fair to say that, in general, the 2021 vintage for Bordeaux does not offer value for money and did not attract excited buyers.   Save for a few of the best wines such as Carmes Haut-Brion, Cheval Blanc, L’Evangile, Figeac, which might offer potential increase in value, the rest offers little financial interest at this stage.

 

Fine Wine Prices Continue to Increase

Prices continue to increase, despite an initial sudden drop at the beginning of the COVID pandemic Liv-ex indices have maintained their steady climb.   In 2021, the Liv-ex 100 (100 of the most sought-after wines on the secondary market) rose by 22%.  Since our last report, Liv-ex Champagne 50 and Burgundy 150 prices have risen an additional 9% and 14%, respectively. Italy and California wine prices also continued their steady climb.

Increased global wealth, coupled with wine-drinking being perceived as one of the few authorized pleasures during prolonged COVID-related social restrictions and lockdowns, led to a surge of interest in fine wine.

A new and increasingly important factor pushing up prices is the effect of climate change on wine production.   Burgundy, for example, already known for its smaller crops, has been heavily impacted by a combination of hotter, dryer growing seasons and extreme climatic incidents such as destructive hail or late frost.

 

Auction Market

Despite the pervasive social restrictions due to the COVID pandemic, global auction revenues increased more than 50% from 2020.   2021 was, by far, the best year in terms of sales for auction houses, big and small, with revenues from live and online wine auctions reaching USD 582 million.  2022 looks to be another promising year, with the major auction houses such as Acker, Sotheby’s, Christie’s and Zachys already recording increased sales in Q1.  Acker, the largest in terms of revenue over the past two years, forecasts a further increase of 8-10% this year.

 

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Currency Fluctuations

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Click here for the introduction to our “Investing in the Post-Covid Era” series of materials.

Currency fluctuation is an ever-present factor that investors should take into account.

We have come a long way since pre-Bretton Woods, but there remain serious challenges for investors and portfolio managers in dealing with currency fluctuations.

Currency exchange rates fluctuate constantly, impacted by many economic and sentiment factors. These can be exacerbated by a country’s poor economic policies, its exposure to increasing commodity prices and reversing capital flows from foreign investors.

Nearly all Central Banks have been or are about to start raising interest rates significantly, with the view to moderating inflation by tightening financial conditions.  Historically, tightening financial conditions has impacted some economies, particularly emerging economies, more than others, including by triggering significant foreign exchange rate volatility.

Our comments will focus on the role currency selection and the associated risks may play in your own personal investment decisions.

Economics

There are many economic factors that lead to the strength or weakness of one currency versus another. A nation’s trade, current and capital accounts, and its government’s fiscal and monetary policies, including the local-currency yield curve, are important factors.

For example, a country experiencing a decline in its currency may see increased exports of locally produced goods or services. A country can support its currency by raising local interest rates.

During periods of calm, investors often move funds from low interest rate countries to higher interest rate countries.  However, during periods of heightened uncertainty, investors unwind carry-trades or seek safety in securities in currencies perceived as safe, such as US dollars, Swiss Francs or the Japanese Yen.

Of course, economic analysis is unfortunately never that simple — multiple factors, both internal and external, simultaneously impact a country’s currency movements, with some tending to have short-term impacts and some are felt longer term.

Minimize Currency Effects

While foreign exchange risks are only some of the many risks to which your investment portfolio is exposed, there are ways that professional managers mitigate or avoid these risks.  They may manage foreign exchange exposure to match clients’ liabilities, or they may hedge certain exposures, or they may diversify appropriately.

Professional advisors and economists also use various models or theories to help forecast currency movements, e.g., the purchasing-power parity theory. These models incorporate many factors mentioned above and include interest rate differentials, relative economic strength and inflation expectations.

Your Investment Objectives

If you need regular income from your investment accounts, then the currency mix chosen for your investments should match up well with the currency or currencies in which your expenses are based.  For example, if you are retired in the United States, then you would be more comfortable with a significant portion of your portfolio producing a USD income.

However, your specific objectives might be best met by a good, internationally-oriented, discretionary investment manager. Your currencies exposure would be directly related to your specific asset allocation.

A good portfolio manager will include currency-related risks when assessing investment opportunities.  For example, currencies are a relevant factor in determining a company’s cost structure and competitive position.

Currency implications are unlikely to drive investment decisions or portfolio construction, but we suggest that these issues be included in discussions with your financial advisor when evaluating returns or matching your portfolio parts with your long-term financial objectives.

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Selecting Undervalued Stocks

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Financial analysis is a key to out-performing in investment management.  We explain the best ways for individual investors to do investment research.

The ultimate goal of investors should be twofold: to acquire undervalued assets and to dispose of those assets as soon as they become overvalued. A key benefit of purchasing undervalued assets is that there are two different groups that can influence the trading price of your assets.

The first group comprises industry players that wish to grow through acquisition. This is especially so in situations where markets are not performing well.  In such circumstances, companies often buy other companies if they are undervalued.  That is, if the cost of purchasing the target company is cheaper than building up the parent company in order to expand its operations or enter a new industry, a company will purchase another.  A premium is generally paid for the target company, resulting in an increase in its share price.

The second group that can influence the price of assets is the market itself, which includes investment funds, pension funds, other portfolio managers, as well as individual investors.  These entities buy and sell stocks based on a number of criteria unrelated to those of the industry players.

As such, an investor can look to two avenues for his or her assets to increase in value, rather than relying solely on the market.

The purchasing of undervalued assets requires one to look at stocks not simply as tradable commodities, but as the foundations on which companies are built. Whether you buy 1,000 shares or one million shares you are buying part of a company. This is an important concept.

The most efficient way for individual investors to know when to sell and when to buy is through thorough financial analysis.

This type of analysis is not the same as technical analysis, which studies the demand and supply of securities and commodities based on trading volumes and price studies. Technical analysts use charts or computer programs to identify and project price trends in the market. It has never been clear, however, whether this type of analysis is useful for investors. It may be of use to traders, but not to investors.

It is important for individual investors to know how to go about conducting their own financial research if they so desire, as well as how professional analysis is carried out and why it is important.

Is financial analysis simply a matter of looking at a company’s financial statements? Certainly not. Financial analysis provides information about a company’s past and present performance. It also quantifies future expectations.  Financial analysis is sub-divided into the following three groups

  • Economic analysis is the basis used to determine capital market and industry performance estimates. Furthermore, it provides projections for the total economy in terms of GDP, inflation, profit, monetary and fiscal policy and productivity.
  • Capital market analysis provides value and return estimates for the securities markets.
  • Security analysis studies industries and the securities of individual companies to develop value and return expectations for those individual securities

The information required for your analysis is available if you know where to look for it. The first place to start is at the original source, such as information prepared and sent by the company itself to its shareholders and to the financial press.

You can simply write to the companies to request quarterly and annual reports. Many companies have web sites that allow you to e-mail your requests.  In fact, it is much easier and cheaper to source as much information as you can from the Internet.

Another important original source of information is that which is filed by the company with a regulatory body.  For companies that trade in the US, quarterly reports and annual reports comprising complete audited balance sheets, cash flows and income statements can be obtained from the Securities and Exchange Commission web site.  For local Hong Kong companies, an investor can request the latest annual report directly from the company.

Subscription services such as Moody’s and Standard & Poor’s are also available which summarize almost all original company information such as balance sheets, cash flows and income statements. These services provide much more than just sovereign ratings and corporate debt ratings.

Finally, there are many online data providers. Useful features include a comparison of a company’s valuation ratios, dividends, historic growth rates, financial strength ratios, profitability ratios, and management effectiveness ratios with the industry ratios and the S&P 500.

Furthermore, companies often provide information to industry and trade organisations, and to supplier and customer groups. This information is then circulated amongst their respective members.

Brokerage reports can also be useful for industry overview and the financial models they often contain.

Given the losses seen in equity markets in the past months, investors may be skeptical of the value of sell-side financial analysis.  Sentiments swing to undue market pessimism in periods of crisis and recession, and back to undue market optimism during periods of prolonged prosperity.

However, purchasing undervalued assets will always provide superior investment returns. The most foolish decisions are most often made in purchasing assets rather than in selling them.  As such, taking the time to determine which stocks are undervalued will probably make the decision to sell, when the time comes, much easier and more comfortable.

 

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Vintage Wine Market Update – November, 2021

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The Liv-ex 100 index, which is the leading benchmark for the vintage wine market, rose by 2.2% in October and 19% to the end of October. It is now back to its pre-2011 level. Overall every wine region is showing solid price increases with Burgundy, Champagne, Italy and Rhône performing the best.
Burgundy continues its steady ascent towards new highs as recent low yielding vintages coupled with continuous high demand continue to push prices higher.

The top white Burgundy wines are stepping into the limelight. According to Liv-ex, the amount of white Burgundies traded has increased by more than a 1,000% over the past ten years. Domaine Leflaive, Coche Dury, D’Auvenay are just a few names which make Chardonnay lovers dream. Traditionally, the UK and US markets have driven demand but the Asian market, particularly Hong Kong, is showing some interest in this golden libation.

Among Bordeaux first growths, Chateau Lafite Rothschild is again very popular, commanding seven of the top ten searches on Liv-ex so far this year, as well as being the most expensive.  Paradoxically, when it comes to highest average scores, Chateau Haut Brion takes top rank . Again according to Liv-ex, the average price for a case of Lafite is £7,000 compared to £5,000 for the other four estates. The Lafite brand is appealing to many more consumers than ever.

Growing diversity best describes the fine wine market in 2021. More wines from a larger pool of regions are trading than ever before, giving investors and wine lovers even more opportunities and choices.

Auction World

Following in the footsteps of a world record breaking September auction in Hong Kong, Burgundy wines were the stars of Acker’s latest auction on November 8th. Domaine de la Romanee Conti (DRC) wines led the pack, with one lot of 3 bottles of Romanee Conti 1999 selling for US$ 96,387, followed closely by wines from Domaine Leroy and by the great master of white Burgundy, Domaine Leflaive.  According to John Kapon, Chairman of Acker Wines, the appetite for outstanding wines continue to grow not only for Burgundy wines but for a large range of collectible bottles.

The November auction in Hong Kong realised sales of US$5.8 million.

Sotheby’s two day sale in Hong Kong last month saw 100% of the lots sold for a total amount of US$ 12.6 million. An average of 75% of the wines were sold above their high estimates as 2021 is set to be a record breaking year for Sotheby’s in Asia. Christie’s will hold its annual Fall auction in Hong Kong starting on November 25th with an impressive selection of great vintages from Domaine Leroy and Armand Rousseau, Chateau Petrus and Romanee Conti.

France harvest 2021: A Winegrower Vintage

2021 will be remembered not only as one of the smallest crops since 1977 but also as an extremely complicated vintage to produce. Every wine region in France was affected. A combination of spring frost, mildew, constant rain in June and a cool month of July led to low yields. The growing season was unusually time consuming as wine growers had to keep going back to the vineyard to check and treat the vines. This year will probably also be remembered as a costly vintage to produce due to the amount of treatments necessary to keep a very small crop healthy.

2021 is a technical vintage which will require lots of finesse to attain high quality. The saving grace of the vintage was the late summer ripening (mostly September) which allowed the more fortunate estates to produce good to excellent quality wines. In Bordeaux, producers are praising the vintage as offering great balance between acidity and alcohol, with excellent merlot grapes and well-ripened cabernet.  It is certain that 2021 will produce less alcoholic wines in contrast to the past three years and many wine professionals are looking forward to tasting these more classic Burgundies and Bordeaux.

Focus on Spain. The renaissance of a great wine-growing country

For many, Spanish wines are synonymous with affordable, mass produced Rioja reds.  Although, this might still be the case, the wine scene has changed dramatically over the past two decades. Quality driven winemakers in Rioja and in Ribera del Duero, such as Peter Sisseck, Carlos Lopez de Lacalle, Benjamin Romeo and Telmo Rodrigues, have created new wines going back to more terroir-focused production making better use of local, indigenous grapes. This renaissance of the traditional Rioja and Ribera del Duero is paving  the way for other wine regions to emerge.  Priorat, Toro and Bierzo are now producing much sought after wines of very high quality.   Clos Erasmus, Clos Mogador,  Descendientes and Bodegas Numanthia (LVMH group) are just a few of the top producer names in these newly discovered regions.  Many of Spain’s new wines are made in small quantities, fetching high prices and are slowly becoming investment grade.   More than ever, Spain offers great quality wines at affordable prices.

 

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The Family Office Comes to Asia

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Click here for the introduction to our “Investing in the Post-Covid Era” series of materials.

 

The American system of family offices has begun to take off in Asia.

The early 1900s saw the likes of John D Rockefeller and Henry Phipps Jr. make fortunes and try to preserve those fortunes by setting up investment trusts for their children. These fortunes, and many others, were managed by what has become today a growth industry in the US – the family office.

What was once done exclusively for one family was soon offered to other wealthy families. We can see examples of this in the development of the Bessemer Trust that originally managed the investments of the Phipps family and the Starwood group that looks after the Sears Roebuck fortune. Both now serve as family offices for many families.

The development of the Asian family office is in its early stages and has important implications for lawyers and accountants in Hong Kong and elsewhere in the region.

What is a Family Office?

The family office generally groups lawyers, accountants and investment professionals in one office that works for the multi-generation family. Besides undertaking tax preparation and planning, estate and trust administration and overall investment management (which includes traditional investment portfolios, private equity and real estate), family offices sometimes pay the bills, make travel arrangements, stock up the wine cellar and arrange for school admissions.

Increasingly, young Asians are being educated and are working and living outside the Asian region. Fewer of them decide to join the family businesses started by their fathers and grandfathers. As such, the issues of succession and estate planning are beginning to become concerns for wealthy families.

Likewise, there is greater need to manage the large pools of capital raised from selling businesses and real estate. Professionals, who are able, experienced and exclusively focused on the task, can best undertake the job of managing these capital pools.

The American family office industry is quite mature. There are now groups that advise families on establishing a family office, selecting a family office and executive search services that find professionals to work in family offices.

Why Use a Family Office?

Wealthy Asian families have increasing contacts beyond their national borders which means there are a greater number of matters that potentially affect multi-generation family wealth management.

For example, let’s look at the simple case of a family member moving to North America. First, when succession takes place from one generation to another, the residence of the beneficiary can result in large estate duties on the family fortune. Second, the tax paid on investment income, a domain best left to tax experts, becomes a pressing issue. Third, the assets, sometimes heavily concentrated in one industry and geographic area, should be diversified to meet the demands of family members with residences abroad and / or family members living abroad.

Beyond this, families often make direct investments in foreign countries in real estate or operating businesses without properly monitoring the investments. To properly address any of the above is a full-time job for someone, even when using outside professionals such as lawyers and accountants.

Sometimes a family member from the second or third generation is willing to take on the tasks. Even they, however, are likely to require administrative assistance.

The Asian Family Office

We believe that the development of Asian family offices will continue to see steady growth over the next 10 years and will develop its own characteristics. Some families will embark on setting up their own. Others will use the services of open family offices to limit costs and test the waters, and getting the services they need, before deciding whether to go on and establish their own.

Accounting, legal and investment advisory firms often have special relationships with their clients and sometimes provide advice on matters related to family wealth management.

The co-operation between these firms and other specialized professionals is in the best interest of the client and the professional firms themselves. The Asian family office will likely start as a central office which will co-ordinate the work among accountants, lawyers, investment advisors and other professionals.

 

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Who is Minding the Store?

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Understanding how your investments are managed is the safest measure against financial loss. During every investment cycle, frauds and failures are discovered at investment managers and broker / dealers.

In view of this, the best policy for preventing investment loss, either through fraud or financial collapse, is understanding how your investment accounts operate. Investors should be as concerned about asset custody as about investment performance.

Who Actually Holds Your Assets? If you don’t know, you should! Your financial adviser should explain in detail how your assets are safeguarded. As a rough guide, there are three distinct functions in investment process: investment management, brokerage and custodial services.

Understanding these functions, which are all independent from each other, is useful in assessing their importance to the overall investment performance and to the security of investment assets.

It’s really quite simple. A fund manager carries out your investment requirements by making decision to acquire and sell securities. The buy and sell transactions are executed by a registered dealer or broker. The broker / dealer then settles the transaction with the custodian – a bank or financial institution that keeps custody of securities (stocks, bonds, treasury bills, funds, cash, etc) – where you, the investor, have a custodian account.

Brokerage houses and brokers / dealers enjoy broader recognition among individual investors than do custodians. However, the extent to which investors understand this highly specialized business is unclear. Financial strength is the most vital factor to consider when selecting a custodian or brokerage house, as some are well-managed and financially strong, while other are less so.

How Does the Transaction Process Work?

There are many different types of financial adviser, each determining the number of parties that will be involved in a client’s investment process.

  1. The fund manager manages your monies according to your investment objectives; then sets up an account at a custodian bank and transfers funds to the custodian account.
  2. The fund manager purchases shares of XYZ Corp for your account by giving an order to a broker or dealer to buy shares of XYZ. The manager instructs the broker or dealer to deliver the shares against payment to the custodian account and at the same time, instructs the custodian to pay against receipt of the XYZ Corp shares.  With selling transactions, the reverse applies: dividend and interest payments are deposited in the custodian account.
  3. You wish to withdraw money from the investment portfolio and inform the fund manager, who then has to ensure that there is enough cash in the custodian account.  As the sole authority over the custodian account, you inform the custodian bank as to where you wish to have the funds sent.

Choosing Your Service Provider

How does the transaction process apply to investment accounts at banks, brokerage houses or in mutual funds?

A bank usually provides both investment management and custodial services. If the bank operates a brokerage firm, it is likely that transactions are posted through that firm. When a brokerage firm is retained as an investment adviser, the firm normally provides custodian services and executes most of the transactions, provided that the firm is a member of the stock exchange where the transactions are made. If the bank uses outside service providers, such as a mutual fund or hedger fund, additional institutions will act as custodians and advisers. The structure of a mutual fund incorporates both an investment manager and a custodian.

Clear, legible and comprehensive account statements, which vary depending on the adviser, are also an important means to effectively monitor your investments. You should make sure that these statements are audited by a reputable third party, and it is advisable to see a sample statement when carrying out due diligence on potential investment advisers.

By understanding the three parts of the investment process, the role each service provider plays in safeguarding your investments will become much clearer. Ensure that you are getting the best protection at each stage of the investment process – every service provider should be examined individually, as well as all together as a team.

The investment business, as with all businesses, offers few free lunches. Fees and other expenses will affect the returns earned by the investment portfolio. It is just as important to understand the functional role, as well as their related charges, in the investment process, in order to determine whether good value is delivered.

The current economic situation may be a difficult period for many investors given the market volatility, so don’t make things worse by leaving yourself open to loss of money through fraud or service provider financial weakness.

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Protecting Your Investments

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There is much you can do to minimize your investment risk and maximise your returns.

Leading international financial institutions offer conflicting opinions on the direction of the world’s major economies and interest rates.  How can you better protect your own investments?  How can you best position yourself in the current capital markets?

Remember that a large investment manager does not guarantee good investment performance.  It is a good idea to do some of your own homework and monitor your investment performance.

If during regular meetings with your investment adviser you feel that your investment objectives are no longer being met and no attempt has been made to re-align your investments with your objectives, you should seek another adviser.

If you believe that either negligence or fraud has occurred, you should go to the Securities and Futures Commission immediately.

Statements

Clear, legible and comprehensive statements are an important means to effectively monitor your investments.   You should keep a good record of your statements.   With the aid of clear statements, you will be in a better position to follow your adviser’s explanations as to how your portfolio is reacting to prevailing market conditions and how your investments are expected to perform in the coming 12 to 18 months.

Statements of investment accounts will vary from one type of adviser to another.  Mutual fund statements will include all the assets of the fund.  While your investment adviser should be able to answer any questions you may have about the performance of the fund, it is unlikely that he or she will be in frequent contact with the manager of the fund.

Mutual fund statements will be different from those of a bank, a brokerage house, or a discretionary manager.  It is also likely that statements from advisers within the same category will vary.  For example, some international stock brokers and private banks may have accounts for holdings in different foreign currencies, whereas others may just convert everything back to one base currency. Furthermore, market prices of some of the securities may be approximate or not current.

You should ask to see a sample statement when you are doing your initial due diligence.  This should include a portfolio statement as well as a transactions statement.  You should check to see whether these statements are audited by a reputable third party.

Good Positioning

International financial markets are constantly changing.  Many investors try to time the markets in order to optimize gains.   It is highly unlikely that anyone can successfully time the market over an extended period.  How does one position an investment portfolio to get the best returns according to one’s investment objectives?

If you were a collector of French wines, you would stock your cellar with wines from Bordeaux, Burgundy and perhaps the Rhone Valley.   You would allocate a certain percentage of cases to each region, much like asset classes.   You would have a diversified collection, with a number of different chateaux and vintages from each region.

The major investment asset classes are cash, bonds (fixed-income) and equities. Real estate, another important asset class, will be addressed in a separate article. After you have determined your asset allocation, you should then choose any  number of different securities in each asset class.  Each asset class has different risk and reward characteristics.  Individual securities should be selected according to individual investment acumen and method.

Asset Allocation

Often market increases occur over a very brief period, sometimes a matter of weeks.  If you wait until the market has made a large advance and then make investments, you run the risk of having missed out on most of the returns.

How do you determine what is the best asset allocation to achieve your investment objectives?

Different financial advisers have different approaches.  Your local stock broker cannot advise you on asset allocation because he or she works in one asset class – equity – and in only one market, the Hong Kong Stock Exchange.

Asset allocation advice is generally included in the services provided by discretionary investment managers and private bankers.

In addition, there are advisers who will only provide asset allocation advice, leaving you to find the appropriate manager.

What is Diversification?

Diversification is often explained using the adage “don’t put all your eggs in one basket”.  Diversification helps decrease one’s market risk.  There are many methods of diversification.  You can diversify between asset classes and within asset classes.

However, you must choose the method which best suits your objectives.  For example, if you already have numerous assets such as business, real estate and regional stocks, in Hong Kong and elsewhere in Asia, you may wish to diversify into other international markets.

In diversifying among different security positions, you should try to find a balance which offers the best protection while achieving the best return.  This is a matter of style and method.

For any equity portfolio, there should be no fewer than 30 positions in order to benefit from diversification and if the portfolio is smaller than $1,000,000 then probably no more than 40 to 50 positions.  For a larger portfolio, for example US$10 million, then the number of positions could increase to even above 60.

Note that the number of positions does not increase in proportion to the total dollar value.

Managing as many as 60 positions becomes a job for a professional.  If you wish to manage a portfolio of between US$300,000 and US$1 million without the help of a professional adviser, you will need to possess the professional skills necessary to undertake such a task.

Once you have determined your asset allocation you can also choose to use either discretionary portfolio managers or mutual funds.  Both will provide you with the necessary level of diversification.

However, you should be careful not to over-diversify both because you will find that it will take a great deal of time to monitor your portfolio properly and over-diversification can actually lead to poor investment returns.

As an investor, protecting yourself against loss should always be a primary consideration.  A clear investment account statement is fundamental to protecting your investments and is a tool of empowerment, facilitating your ability to monitor your investments and your investment manager’s performance.

Asset allocation and portfolio diversification provide protection against rapidly changing market conditions by spreading your risk and allowing you to benefit from different market cycles.

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Investing Without Borders

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Click here for the introduction to our “Investing in the Post-Covid Era” series of materials.

With the recent turmoil in global equity market, we look at the essential skill for achieving strong investment returns.

The dramatic fluctuation in global equity markets of the past 18 months have caused many people to reconsider their investment strategies. We hope that one of the outcomes will be that investors will be less complacent.

To be a good international investment manager one should be a generalist, not a specialist.  Contrary to what investment professionals may say, we believe that strong investment returns are founded on a few simple concepts.  In the mid-1990’s, Daniel Brosseau, a co-founder of Letko, Brosseau and Associates, outlined these concepts to industry peers in a presentation title. “Investing Without Borders’. The analogy is simple and clear and as relevant today as it was a decades or so ago.  Of course some of the company names will seem outdated but the concept remains as robust as ever and of course the global economy is more intricate and intertwined as ever.

Imagine a dinner menu with a fixed menu and an à la carte menu (see Table 1 below). As an investor, you can choose the fixed menu of country allocations, such as the US, Europe, Japan or Asia. We prefer the à la carte menu by which we look at the world from an industry perspective and select a favourite dish in each country.

Imagine another list (see Table 2) which portfolio managers might choose from, from the Dow Jones index and a list of auto producers.

The greater your knowledge, the higher the probability of success

Everything we have learnt from a business and economic point of view tells us it is much easier to deal with and analyze Manager B’s list because it is comprised of companies in the same industry. One can examine competitive position, cost structures, profit margins, capacity growth, etc. Even international questions such as the impact of currency swings, interest rates and duties can be analyzed more easily from the industrial perspective using Manager B’s list.

Analyzing Manager A’s list is more difficult. Comparing IBM or McDonalds to Nike is not easy. What you can say or conclude is limited. However, if you compare GM to Honda or BMW, things become clearer. It is more natural to compare GM to Toyota than to Walt Disney.

In order to shop in a very large store with excellent products, prices and variety, it follows that one has to go to the global store but how does one increase the probability of achieving superior investment results in a world without borders?

Getting it Right

The greater your knowledge, the higher the probability of success.  But a little knowledge may be damaging and too much knowledge can hurt as you may end up focusing on the details to the detriment of the larger picture.

The Valuation Model

The valuation model and the quality of the analysis and judgment are very important in order to be able to properly interpret the facts. The better and more rigorous the analysis, the higher the probability of being right.  This is usually improved by looking at a variety of situations.

Amplitude of Valuation Distortions

The greater the valuation distortions are, the greater the odds of being right.   A corollary of this is that the wider the population of investment candidates to choose from, the greater the probability of finding undervalued securities.

When you widen your analysis, you increase the investment candidates and the environment in which they operate.  As knowledge increases, the quality of analysis should also improve. As you increase your population of companies, the chance of finding cheap stocks increases.  Thus, the probability of making right decisions increases.  Superior investment returns are attained by the consistency of making the right investment decisions.

People often say that to invest in Europe, one needs a European manager.   It should be noted that to do quality analysis and observe valuation distortions, the manager’s location is unimportant.

You may retort that some people have better sources of facts.  Clearly, the investor or portfolio manager who plays golf with a senior executive of General Motors may have an edge over the one who does not.  However, in today’s world, we believe that those benefits are eroding, due to the quantity and speed with which information is now made available

The question we hope to raise through this article is whether the allocation decision is best made with a top-down approach, that is to say, an approach which distributes funds between world markets periodically, or, by an ongoing analysis of industries and companies which compares valuations and opportunities on a global basis.

Table 1:

Fixed Menu A la Carte
US S&P 500 Chemicals Semi-conductors Forest Products
Japan Nikkei 225 Metals Airlines Auto
U.K. FTSE 100 Media Retail Oil & Gas
Germany Dax Telcom Mining Food Processing
France CAC 40 Healthcare Pipelines Software

Table 2:

Manager A Manager B
Dow Jones Companies 10 International Auto Companies
Microsoft McDonalds Corp Toyota Motor Renault SA
Boeing Co Nike Ford Motor General Motors
Pfizer General Motors Fiat Chrysler Volvo AG
Coco-Cola Co Walt Disney Honda Motors Scania
Cisco Systems Procter & Gamble BMW Hyundai

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Vintage Wine Market Update – June, 2021

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The international wine market is  quite different from how it looked 10 years ago.  While Bordeaux used to be the dominant growing region, its trade share by value is now just  slightly more than 35%, according to Liv-ex.   That the market continues to broaden is a positive thing for wine lovers across the world, offering them a chance to discover great bottles to enjoy.

Furthermore, a broader wine market is also an important factor to take into consideration when building a wine investment portfolio.   A well diverse collection of wines is a key to wealth preservation.

Liv-ex reports that the Fine Wine index 100 is now close to the highs reached in June 2011.  The index 100 is the industry benchmark, including the price movement of the 100 most sought-after fine wines in the secondary market.   Over the past 12 months, the Index 100 has steadily climbed despite many hurdles along the way, such as Brexit, COVID-19, US tariffs and stock market fluctuations.

As of the first week of June, Liv-ex index Champagne 50 is showing the best performance with a year-over-year gain of 13.2%, followed closely by the Burgundy 150 index’s 9.9% increase.

Bordeaux 2020 and the En primeur campaign

The verdict is out:  the 2020 vintage is definitively part of a trilogy of excellent vintages along with 2019 and 2018.    Wine critics also agree that it is an irregular vintage.  The well-established rivalry between left bank and right bank, Merlot versus Cabernet Sauvignon seems to be going full swing right now, with some wine professionals stating that the Merlot grape is showing better than the Cabernet.

However, the more reserved wine critics seem to think that it is not so clear-cut and that both left and right banks have produced outstanding wines.    The key factor is the soil composition and the well-known concept of “terroir”.   In other words, the capacity that some estates have to cope with difficult climatic growing seasons due to the quality of their land and having the financial resources available to do what is necessary in the vineyard.

In comparison with the 2019 vintage, there has been a slight increase In prices, of between 5 to 10%,

The world of auctions

As Christie’s summarizes it: “Asian buyers continue to drive global demand”.   With a sell-through rate of 88% and half of the lots selling above their high estimates, the May week-long series of auctions in Hong Kong was certainly considered a success.   On May 20th, 98% of the wines offered were sold for a total of US$5.9 million.   Three magnums of DRC Romanée Conti 2004 were sold for US$129,359.

Still in Hong Kong in May, Sotheby’s sold 99% of its lots for a total of close to US$16.5 million. The star of the show was a unique lot of 6 bottles of Vosne Romanée Cros Parantoux 1989 from the famous Henri Jayer, which sold for over US$386,000.

The possibility of following the auction and bidding online has been greatly beneficial to the auction houses.   It opened the door to a much younger crowd of buyers around the world and Asia in particular.

Bordeaux is back

The wine-making style for the 2020 vintage is more in line with classical Bordeaux – producing wines that are less extracted, with lower levels of alcohol and softer maceration.  Freshness is a recurring adjective in tasting notes.  According to many wine critics, the 2020 vintage is a continuity of what has been happening for the past few years.

In terms of trade, Bordeaux wines are back in demand.  The suspension of US tariffs, a succession of excellent vintages with a superb but relatively under-priced 2019 vintage are contributing to a renewal of interest.   Famous brands such as Lafite Rothschild are currently very popular on the secondary market.

Burgundy 2019:  an overview

Is the 2019 vintage in Burgundy an extraordinary one?   It would seem to be the case according to merchants and wine critics who agree that quality is present across the board from regional and village appellations to the most sought-after Grand Cru wines.  Balanced wines are present for both reds and whites, with great aromatic expression and fine but powerful tannins.

For most wine professionals, this is a unique vintage of superb quality with great aging potential.   The down side of this vintage is the quantity. Frost in springtime and a long dry summer contributed to a rather smallish production.

In conclusion, the general quality of the vintage 2019 offers the opportunity to buy wonderful white and red wines from less well-known and less expensive appellations.   A chance for everyone to taste the magic of great Burgundy.

 

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