Major Financial Centers Widely Differ in Breadth of Activity

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The coronacrisis may well be a  watershed moment – both business mix and key players are likely to change. Development strategies will involve regional and global positioning for flow and advisory business; developing new products and market capabilities as well as going offshore. Meanwhile exchanges further consolidate faster than ever before as the world gets even more networked.

Hong Kong – Critical Success Factors for Major Financial Centers

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Will latest U.S. moves to punish China over disputes on trade, IP, coronavirus origins and recent imposition of national security laws on Hong Kong affect its status as a major regional financial center? Eliminating policy exemptions and treating Hong Kong as part of China is bound to affect existing rules on travel, extradition treaties, investment and export controls as well as trade and financial market regulation.

We studied major financial centers around the world and uncovered some generic critical success factors. People – the availability of good personnel and the flexibility of labor markets:  Business Environment – regulation, tax rates, levels of corruption and ease of doing business; Market Access – levels of trading, as well as clustering effects from having many financial services firms together in one center; Infrastructure – the cost and availability of property and transport links; General Competitiveness – to be good at most things.

It is against such and other criteria that Hong Kong’s future competitiveness may be examined.

 

 

Offshore Financial Centers & Tax Havens Impacted in Coronacrisis BailOut

The offshore world is physically dwarfed and legally separated, but institutionally connected and closely linked.  For many smaller economies, this is sometimes seen – incorrectly – as an “easy way” to break into the financial industry. Now, many countries are refusing to let companies registered in offshore tax havens access financial aid from coronavirus bailout packages – Gibraltar, Bahamas, Andorra, Bermuda, British Virgin Islands, Cayman Islands, Panama  are increasingly scrutinized. France, Poland, Belgium and Denmark exclude companies from taxpayer-funded relief programs. But Ireland, the UK, Luxembourg and the Netherlands as well as U.S.  companies that engaged in corporate inversion transactions are eligible.

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Coroncrisis Is Healthcare Real Estate Crisis Too

Congress allocates $175 billion in relief aid to hospitals and other healthcare providers to cover expenses or lost revenues tied to the COVID-19 pandemic. At least 10 health systems have received $200 million or more in federal COVID-19 relief in the form of reimbursements for providing COVID-19-related care, e.g., building temporary structures, leasing properties, buying supplies, hiring and training additional workers and increasing surge capacity. This has important implications for the health care real estate sector – much of which is owned by REITs.

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Will Major Financial Centers Change After Coronacrisis?

Despite the coronacrisis and Brexit, New York and London to continue to dominate. Other important regional and specialist centers are increasingly vying. Frankfurt, Singapore and Tokyo will continue to assert role as hubs, with the status of Hong Kong now somewhat challenged. Financial centers have critical mass, transparent, liquid and broad markets alongside the talent required to execute business – these skills and structures can be adapted for new markets.

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Will Hong Kong Remain a Major Region Financial Center?

China to strip Hong Kong of legal autonomy. U.S. to decline certification of autonomy from China which may trigger financial sanctions under Magnitsky Act and other  provisions under Hong Kong Human Rights and Democracy Act. This will affect trades, visas, customs, banking and law enforcement and regulation cooperation. Financial centers are always reflections of a wider context, from current market issues, to local financial players, to international investor flows, to the culture and history of the country in which they operate.

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European Union 2020 Coronacrisis Stimulus Twice that Provided in 2008. Equals Entire Global Stimulus During 2008 Global Financial Crisis.

After today’s NextGenerationEU announcement I did a back of envelop calculation to contrast the already announced, and proposed stimulus, with the European outlay during 2008. The data shows that European Union 2020 coronacrisis stimulus is twice that it provided in 2008. Infact, it equals the entire global stimulus during 2008 Global Financial Crisis. Still too early to arrive at implications of this huge outlay.

Pandemic Emergency Purchase Program has envelope of €750 billion to buy government and corporate bonds. Complements big bank stimulus package. Eases collateral standards and removes self imposed restrictions on purchases. Next Generation EU of €750 billion as well as targeted reinforcements to the long-term EU budget for 2021-2027 will bring the total financial firepower of the EU budget to €1.85 trillion.This is near equal to the $2,000 billion stimulus provided across the world during the 2008 global financial crisis.

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EU Unveils New Recovery Instrument Next Generation EU

#ActiveAllocator Research- ‘Today, the European Commission has put forward its proposal for a major recovery plan. To ensure the recovery is sustainable, even, inclusive and fair for all Member States, the European Commission is proposing to create a new recovery instrument, Next Generation EU, embedded within a powerful, modern and revamped long-term EU budget. The Commission has also unveiled its adjusted Work Program for 2020, which will prioritize the actions needed to propel Europe’s recovery and resilience.’

We welcome this initiative and await details.

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Spin-off and Carve-out IPO / Spin Overview

As the coronacrisis progresses, we expect companies to separate portions of business. Such actions will be driven by strategic decisions to divest businesses and/or valuation creation opportunities. These may take form of spin-offs, carve-outs or sales. Primary reasons for spin-off include (i) Value creation – both for parent company and new separate public company; (ii) Certainty of execution; (iii) Tax free to parent and its shareholders; (iv) Can be run parallel with other divestiture alternative. These are typically a 6-12-month process that involves carving out a business from the parent (e.g. financials, management). It involves various documentation and filing requirements (e.g. SEC filings, IRS private letter ruling) and may or may not be preceded by an IPO. We provide an overview here.

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Foreign M&A Deals: Bloomberg May 23 article “China’s $941 Billion Sovereign Fund Seeks More Resilient Assets”

Bloomberg May 23 article “China’s $941 Billion Sovereign Fund Seeks More Resilient Assets”

We expect much greater scrutiny for foreign M&A deals as well as delays especially for direct investments made by Sovereign Wealth Funds, particularly China Investment Corp. We describe the ‘typical’ approval process timeline and outline key considerations in the highly opaque and secretive CFIUS review process.

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Acquirer Considerations:

What is the host country for investor?

  • UK, Europe, Canada, Japan, Korea, raise few security or political issues
  • 7 countries investing the most in the United States, all of which are United States allies (the United Kingdom, Japan, Germany, France, Canada, Switzerland, and the Netherlands) accounted for 72.1 percent of the value added by foreign-owned affiliates in the United States and more than 80 percent of research and development expenditures by such entities
  • China raises unique issues

Does the acquirer have a good record of compliance?

  • Focus on US, foreign laws and previous CFIUS commitments
  • Focus also on acquirer’s record with respect to its own products or services or competition practices

Does the acquirer have state ownership?

  • Have the acquirer’s leaders been implicated in any law enforcement or regulatory actions?
  • Has the acquirer effectively complied with previous CFIUS commitments?
  • Will investment raise political issues in Congress?

 

Target Considerations:

  • How important are target’s assets to national security of the United States?
  • Are there government contracts?  With which agencies? Classified?
  • Is target a direct supplier to U.S. government or subcontractor?
  • Does the target have export-controlled technologies?
  • Are the target’s assets considered “critical infrastructure”?
  • Does target have outstanding litigation or competitive issues that could lead competitor to politicize CFIUS process?
  • Who are the target’s non-government customers?
  • Has the target effectively complied with previous CFIUS commitments?
  • Does target have dominant position in market for key technologies or services?

Economy: Oil Market May 22, 2020

Oil prices rise to $33. Storage crisis easing. Supply curtails to 11.5 million b/d. Fuel demand increases and stockpiles reduce 5 million barrels. States ease lock-down and travel rises.  Demand uptick matched with OPEC supply cuts, and U.S. wells shutdown. But gasoline demand is still soft, and outlook is still fragile with low prices discouraging production.

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The Capital Allocator’s Perspective – Framework for Operational & Investment Due Diligence

The record of Operational & Investment Due Diligence within private equity, real estate, hedge funds and traditional investing has been dismal through the ages. An after the fact event, it is usually about shutting the barn after the horse has bolted. The function has done very little to insulate investor portfolios from losses. The activity has devolved to fiduciary CYA, designed to protect the wealth management firm, pension or sovereign fund, consultant or product purveyor from liability. In going through a roster of standardized questions, to which are offered standardized answers, it is about dotting the ‘i’ and crossing the ‘t’.  One now sees new digital platforms that collate, collect, structure, and offer fund manager data for easy access to prospective investors.

The Capital Allocator is in the business of entering into partnerships with fund sponsors to potentially generate significant returns, mainly through long-term capital appreciation, by making, holding and disposing of privately negotiated equity and related investments.

Such investments are usually made as a passive investor in vehicles directed by a third party fund sponsor; as a result, the investor has only indirect influence over-achieving ultimate investment objectives. We believe that a methodical approach to selecting sponsors—which combines scientific rigor with seasoned subjective judgment— may contribute to creating strong results in a variety of economic environments. We present here a ‘best practices’ framework for selecting financial sponsors. We draw attention to important issues, metrics and considerations deemed worthy of exploration.

What follows does not represent an exhaustive list, of course. Each investment and operational diligence mission inevitably take one down paths that are not common to other missions. One must be prepared for this—and even seek it and relish it. For, it is forays beyond the common and readily available, that enable real insight into the people with whom one entrusts with one’s capital.

What is missing is the capital allocator’s nuanced perspective. We suggest one here.

Download PDF here:

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Do Illiquidity Provisions Boost Hedge Fund Performance?

Retail investors who are ineligible to invest in quality hedge funds, in hard to access investment vehicles, either because they do not meet minimum levels of wealth or income standard, or the high subscription amounts often needed to participate in such funds gravitate to liquid alternative investments. The rise of liquid alternative investment funds, packaged in mutual fund formats over the past years, as the fastest growing category of “alternative investments” is now well documented. McKinsey & Company suggest “retail alternatives will be one of the most significant drivers of U.S. retail asset management growth over the next five years, accounting for up to 50 percent of net new retail revenues”.

With liquid alternatives beginning to find increasing traction in institutional portfolios too, the question is – are they an effective substitute for hedge funds and other illiquid structures? Little empirical fact based exists and opinions abound.

Our research at ActiveAllocator.com attempts to answer this question and concludes that they are not.

Retail investors in considering hedge funds immediately encounter a wide variety of strategies, organizations and structures. Indeed, hedge funds, rather than being an asset class, are broadly a collection of governance structures and investing techniques with many common structural features. Unfortunately, from an investor’s perspective, it is often difficult to decipher which structural features are useful, which imply tradeoffs and which are simply undesirable. The dearth of empirical research leaves investors to make intuitive judgments about what features they should favor.

We re-examined a sub-set of provisions governing fund investing- liquidity terms. In contrast to alternative mutual funds, which allow investors to redeem their holdings on a daily basis with little or no advance notice, hedge fund investors are subject to a variety of terms that may restrict their ability to access their capital. All things equal, investors prefer more liquid investments to less liquid investments. Liquidity provides investors with a valuable option – specifically the opportunity to trade in and out of investments in order to rebalance a portfolio, respond to unforeseen cash flow requirements or redeploy capital towards other opportunities.

While the benefits that liquidity offers to investors are clear, the costs associated with greater liquidity are less apparent. We explored two related questions:

•Do investors pay a price – in terms of lower investment returns – for better liquidity? In other words, do funds with more favorable liquidity terms underperform less liquid funds?

•If the answer to the question is yes, then what drives this cost? In other words how can one explain the under-performance of more “liquid” funds?

Our research finds that there has been a substantial performance cost from offering increased liquidity. The under-performance cannot be attributed to fee levels or the strategy pursued by a particular fund. We are unable to attribute the liquidity cost to differences in skill across managers; we do not find strong evidence that less skillful managers (whose performance is weaker) offer more attractive liquidity terms.

Instead, our results indicate that managers who offer more restrictive liquidity terms are able to outperform more liquid managers because they are able to pursue a broader range of attractive trading opportunities.

Download PDF:

Do Illiquidity Provisions Boost Performance

Model Portfolios. One Size Fits All. Bad Bad Idea During Coronacrisis.

The notion of putting retail investors in cookie-cutter mass-produced standardized buckets of allocations, referred to as model portfolios, is remnant of antiquated ‘90s thinking. In 2020, during the coronacrisis it is akin to paying a doctor expensive (very typically over 1% of assets) fees for an over-the-counter pain medicine prescription.

Bespoke allocation goes far beyond conventional passive risk and return trade-off found in model portfolios. It personalizes for unique investor preferences including accommodating a desire or aversion to alternative investments, expressing preferences for desired levels of illiquidity, considering different investing horizons, incorporating time varying risk preferences as well imposing constraints on specific asset classes to reflect unique investor circumstances.

Departing from model portfolios has potential to foster greater transparency. Moreover, it raises the quality of discourse an advisor has with her client. It encourages a conversation not on historical, but around forward looking risk- return expectations. It also brings nuance in investment decision making, conspicuous by absence in model portfolios.

Rather than persist with the historical notion of putting clients in coarse model portfolios, a far better approach is to begin by analyzing the forward-looking statistical properties and expected behavior of a client’s existing portfolio. This helps to arrive at the best combination of asset sub-types that improve existing allocations on a variety of chosen metrics.

ActiveAllocator.com lets you create bespoke portfolios in 10 clicks, in 10 minutes and at 1/10th cost.

ActiveAllocator is a digital asset allocation platform with technology-enabled customized advice capabilities. It is the world’s first portal that seamlessly integrates traditional, illiquid and alternative investments within portfolios. It helps investors analyze existing allocations, discover inefficiencies and create bespoke portfolios in minutes.

 

Transcend Cookie Cutter ‘Model Portfolios’ in 10 clicks, 10 minutes, 1/10th Cost

ActiveAllocator helps you go beyond traditional model portfolios by utilizing disruptive technology driven personalization. Create directional, semi-directional and non-directional market exposures in minutes.

  • Aggregate your holdings in seconds across your banks, financial advisors and custodians. Arrive at your true economic exposure. Go beyond financial products, and funds and securities you own. Understand why you may be sub optimally allocated.

 

  • Then, in seconds, optimize your portfolio on by linking your brokerage accounts and send order messages to your broker directly from ActiveAllocator’s platform. Once done, import real-time portfolio data from your brokerage firm, and see the most current picture of your portfolio’s – not historical but rather,  forward facing characteristics.

 

  • Compare your portfolio with others’. Including those, supposedly bespoke, being created by private banks and wire-houses at huge fees with attendant product driven conflicts of interest.

 

  • Increase your asset class universe to over 50 sub asset-classes including alternative investments, automate implementation, trading and periodic re-balancing.

 

  • Express your own investment views while making strategic allocation decisions.

 

Investing in Distressed Debt

Download white paper authored by Sameer Jain to explain the characteristics of distressed debt.

investing in distressed debt

#ActiveAllocator Research – Distressed Debt. WSJ today, May 19 page B2, reports that 59 distressed debt funds are in the process of raising $67 billion. I have long advocated that opportunistic and distressed debt may have a useful role in investor portfolios. I had authored one of the early white papers explaining the characteristics of distressed debt which whilst dated in the data is still very useful.

Watch video: The updated 2020 opportunity

 

Commenting on WSJ Article May 18 2020, “Saudi Fund Snaps Up Some U.S. Stock Bargains”

WSJ article May 18, “Saudi Fund Snaps Up Some U.S. Stock Bargains”.  Saudi Arabia’s $300 billion SWF, The Public Investment Fund,  in Q1 2020 bought around $500mm equity each in Facebook, Walt Disney, Marriott, Cisco, Citigroup, Bank of America, Boeing, Carnival, Live Nation Entertainment inter-alia.

The U.S. has long been very open to receiving foreign capital in U.S. firms. Now we see a rise in protectionism,  trade barriers and inward-looking sentiment seeping into policy and regulation. The number of transactions reviewed by the Committee on Foreign Investment in the United States (CFIUS) has been growing and the fear of foreign state governments buying distressed assets increases. Opposition is no longer just vocal; a lot of activity is taking place behind the scenes in Washington. Constituency interests, too are crowding out traditional policy interests. Any involvement, other than through voting of shares, in substantive decision making of key U.S. companies is likely to be scrutinized. For mergers and acquisitions post CFIUS review, the standard process could now be longer than the typical 45-60 days if the transaction is believed to be a “threat to impair” national security.

This will be especially true for direct investments, more than for portfolio investments. How different SWFs are treated depends in large measure on how transparent they are, national security concerns as well as reciprocity.

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Technology Driven Personalization in Financial Advice

ActiveAllocator’s core growth strategy capitalizes on several long-term industry trends that continue to be valid and even stronger in 2020. One being mass-customization. Technology driven mass customization is affecting many customer oriented industries, driving clients to expect highly personalized services uniquely tailored to their specifications. ActiveAllocator allows the “traditional” advisor to provide a modern digital advice experience. Recognizing that the “market of one” is the new norm, we go far beyond broad meaningless categories such as the wide spectrum of “very conservative” to “very aggressive” investors. Rather, our system is designed to drive the individualization of every aspect of asset allocation, down to the level of a single client.

Customers demand personalization without realizing they are demanding it, as they grow accustomed to companies anticipating their needs and offering what they’re looking for – sometimes before they even know what that is. Retailers and travel companies are using predictive tools and algorithms to exceed expectations, yet digital teams at financial firms have been slow to re-engineer websites and apps to enable highly personalized digital experiences. As consumers become more accustomed to personalized services – from online music selection, to customized exercise plans, to personal shopping, to travel – expectations will further rise. Within the financial advice sector, our approach rapidly exposes the fallacy of the “one size fits all” solution approach – such as those embodied in model portfolios and managed accounts.

Personalized service is going to be a key weapon in advisors’ battle, against competition from and disintermediation by, digital advice platforms. Once investors realize that the same managed accounts offered by advisors can be manufactured in minutes by robo-advisors at a fraction of fees, advisor fee compression is but inevitable. In an era when money can be managed effectively, efficiently and cheaply, ActiveAllocator helps advisors move up the value curve. Marrying our cutting edge fact-based, algorithm-driven predictive analytics with the advisor’s special understanding of the client’s unique circumstances drives superior outcomes. We believe that this powerful combination goes far beyond anything offered by emerging digital financial advice platforms, robo advice and digital investment managers.

 

 

Central Bank Reserve Management: How Much is Too Much?

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#ActiveAllocator Research: Ideas about the right level of international reserves have changed with the evolution of markets and crises. Paul Krugman in a recent interview suggested that the attitude at the moment should be “don’t worry about government deficits so much and start spending”. The U.S. Federal Reserve and other counterparts have moved aggressively with sweeping emergency rate cuts, and offers of cheap dollars, to help combat the coronavirus pandemic. Emergency policy easing by central banks in UK, Europe, Japan provide stabilization. But can countries pump indefinite  liquidity into markets to support monetary and fiscal stimulus? The coronavirus pandemic will test how much debt countries can bear.

 

For much of the post-war period, the rule of thumb was that international reserves should cover three-to-four months of imports. The Guidotti rule that reserves should exceed short term debt is now generally accepted as benchmark for assessing the adequacy of reserves – governments should be able to stay out of market for new financing for up to a year if needed. With the growth of capital markets, views of reserve adequacy have changed. Countries are now expected to have more reserves to protect against potentially large and disruptive capital flows, even if the exchange rate regime is floating

Factors include the exchange rate regime, the size and currency composition of the debt, trade flows, monetary aggregates and an assessment of risks and structural aspects of the market. Taking all these into account often raises the estimate of required reserves

 

Which Asset Class is Now Attractive For You? Which is Not?

The world has changed in 2020 and so should your investment portfolio. But has it?

Given what you/ your client already owns within a portfolio, should  one own more of a particular asset class? Or less? What is attractive and what is not?The most consequential, and often best decisions, are those that are made at the margin. However marginal decomposition, on a forward- not backward -looking basis within portfolios is easier said than done. While there is much written in the academic literature, one is often hard pressed to arrive at fact based decisions at the moment of making investing calls.

In the past such was often relegated to opinion, conjecture and gut feel. Not anymore. ActiveAllocator calculates it for you in 15-20 seconds.

New USPS Postmaster General Louis DeJoy Should Divest Real Estate Portfolio

The changing dynamics and competitive pressures of  the postal industry should catalyze introspection to monetize its real estate portfolio. USPS core business is not be a real estate owner. Portfolio analysis and segmentation ensures that maximum value is extracted real estate owned. We urge new Postmaster General Louis DeJoy to segment and monetize  its considerable real estate assets.

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