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ChapmanCraig

Feb 28 2020
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Impact of Dividends

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The equity components of our client’s portfolios are currently enjoying dividend yields (gross) above 3%.   There are large variations in yield within the portfolios, with some companies paying dividends that yield over 6% and some not paying a dividend at all.

Dividends have provided a significant component of total returns over the long-term. Some studies show that over the very long term, dividends have contributed more than half of the total returns for broad equity portfolios.

Given the importance of dividends to the total return of a balanced portfolio, we thought it useful to provide a brief overview of dividends and how dividends can function as an important signaling device.

Explanation

Dividends are payments made by companies to their shareholders from their current or retained earnings and usually on a regular basis. A company’s ability to pay steadily increasing dividends is seen as a sign of financial and operational strength and stability.  Large, mature, profitable companies with solid cash flows typically pay dividends as part of their capital policy.  However, high-growth companies often do not pay dividends because they believe cash generated from their operations is better used to invest in their business, driving continued growth.

Companies capable of generating an attractive return on equity are more likely to generate more value for shareholders over time by investing in organic growth, rather than returning that cash to shareholders who then need to find other attractive investment opportunities.

Most managements are careful to increase dividends only when they are confident those new levels can be maintained. If a company with a history of steady dividend payments suddenly cuts its dividend, even if to pursue growth initiatives, the market will likely interpret this as suggesting the company’s financial health is deteriorating.

There are three metrics which are commonly used to describe, or assess, the sustainability of a company’s dividend policy:

Dividend yield is calculated as the annual dividends paid per share divided by the current share price. It measures the amount of income received in proportion to the share price over a one-year period – either the last twelve months, or the current fiscal year typically.

Dividend coverage ratio is calculated by dividing a relevant earnings metric by the dividends paid to shareholders.  It measures the sufficiency of earnings (or a related measure such as distributable cash from operations) to cover expected dividend payments.  A higher ratio suggests that the Company can maintain dividends even if earnings were to suffer, while if the ratio is under 1x, the dividends are being paid out of earnings earned from prior years (or increased borrowing), and may be not sustainable.  This ratio is more often considered when dealing with structures that are required to or historically pay out most of their earnings in dividends, such as REITs, MLPs or lower-rated companies with modest earnings growth.

Payout Ratio is essentially the reciprocal of the above, and reflects that percentage of earnings that are being paid out to shareholders as dividends.  Mature companies are often paying out more than 50% of their earnings as dividends.

Dividends are a key metric in some valuation methodologies, although that is a bit complicated for this discussion.

Investing in stocks with an attractive dividend yield provides both income and supports the possibility of future capital gains. Dividend-paying stocks often offer more stable returns and demonstrate a lower than average market risk (or lower Beta), in part because large, mature companies with attractive dividends typically have solid balance sheets and steady cash flows.

But there are limits to this. Managements are not likely to deliberately set a dividend that results in a yield higher than 5 – 6%. When you see dividend yields higher than that, it is more likely that the share price has declined since the dividend payments were set and management wants to maintain dividends so as not to signal weakness.  Therefore, very high yields are often seen as flagging deteriorating underlying financial conditions with the likelihood of a dividend cut in the offing.

During the current economic recovery, companies (particularly those in North America) have materially increased the amount of capital returned to shareholders by purchasing their own shares in the market. While capital is actually returned only to those shareholders selling to the company, the total number of shares outstanding are reduced, providing the remaining shareholders with a slightly higher participation in future earnings and cash distributions.

Companies and commentators sometimes combine the amount spent on share buybacks with that paid out as dividends, to describe a total shareholder return yield. While this clearly overstates their equivalence, and we caution clients not to make that comparison, share purchases send many of the same positive signals as do sequentially higher dividend payments and will be discussed in a separate posting.

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Dec 31 2019
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Securities Backed Lending

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We provide clients with access, via their custody bank, to credit facilities that are backed by their securities portfolio (referred to as securities-backed lending or “SBL”).   Amounts drawn down can be used for any purpose, including to purchase additional securities (which increases leverage within the portfolio).

The interest rate is attractive, and there are no set-up, funding or commitment fees, making this an attractive form of short-term liquidity. In our case, the interest income is earned by the custody bank.

Recent media coverage has described concerns raised about SBL programs, as previously flagged by the U.S. FINRA and industry commentators. SBL can be seen as attractive to asset managers because they are an additional source of income, the assets under management become collateral thus seen as stickier, and if SBL is used for portfolio leverage, then AUM (and management fees) increase.

We have found that this accommodation is particularly helpful for clients that have frequent short-term liquidity needs in connection with real estate or other property purchases. Draw-downs under an SBL are less disruptive to the portfolio strategy than are unplanned withdrawals, to be added back to the portfolio sometime later.

The total amounts drawn by our clients under SBL have declined over the past 18 months; we believe consistent with broad industry experience. Currently, they are under 10% of total AUM.  Their use has been, roughly, evenly split between short-term funding for personal expenses and increased investment portfolio leverage.

Most of the portfolios we manage represent retirement funds, as opposed to shorter-term performance-oriented funds. We very much discourage imprudent use of leverage and are able to monitor client leverage.  Given this careful use of SBL by our clients, as well as the flexible and low-cost nature of the facilities, we are confident that SBL is a valuable additional client service.

However, some wealth managers heavily market SBL, with the result that total amounts outstanding have increased relative to AUM in the past five years.

Conduct issues remain a challenge for our industry and its reputation. Accordingly, we believe that given the commercial incentives to some managers and financial advisors to potentially abuse this product, regulatory enquiries as to how they are marketed and whether “mass affluent” and other retail investors appreciate the risks posed by misused SBL, are fully warranted.

 

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Nov 30 2019
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Economic Substance Regime

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If you use a BVI (or comparable) company to hold an investment account then you may have recently received a, possibly confusing, letter from your corporate services provider. The letter likely described a new set of rules that cover a specific set of activities, referred to required levels of employees, premises and activity in the offshore jurisdiction along with a compliance warning and perhaps provided a recommendation.

This new “Economic Substance” regime will create some compliance and tax issues for those with complicated structures, but they need not create as much difficulty as you may initially have feared.

Background

In the late 1990’s, the OECD began initiatives addressing many practices of multi-national companies and wealthy families that were identified as being used to avoid taxes. Many of these practices are legal tax avoidance schemes that take advantage of gaps created because the domestic tax systems of different countries treat certain types of income or transactions inconsistently.

The OECD’s objectives include greater transparency and better alignment of domestic tax regimes, especially with respect to income-producing activity that is geographically mobile (e.g., royalty and licensing payments, inter-affiliate loans, trading units). In 2013, the OECD and G20 countries adopted a 15-point Action Plan.

Action 5, describing the proposed economic substance rules, primarily addresses entities within corporate groups that facilitate the shifting of profits to low-tax jurisdictions, potentially eroding the tax base where the key income generating activities actually occur.

The OECD was not focused on personal holding companies (“PICs”) when devising this new regime.  Most of their initial work for Action 5 was actually focused on intellectual property rights and associated transfer pricing / income shifting.  And while PICs are often associated with tax evasion, the Common Reporting Standard and other AML regulations are seen as adequate to deal with transparency issues for this type of vehicle.

However, your PIC may not look much different, superficially, from the shell companies actually targeted by these rules and as a result may be drawn into these rules.

Application

Broadly, the EU supports the principle that companies pay taxes in the jurisdictions in which their commercial activities generate income; and when taxpayers claim that income is actually generated in low-tax jurisdictions, that they demonstrate that real income generating activities actually occurred to those jurisdictions – thus the “economic substance” moniker.

The EU / OECD has issued guidelines as to the type of activities covered and rules that would be helpful to demonstrate substantial economic activity. At the same time, they threatened to black-list those countries that did not commit to introducing such helpful domestic regulations.

The so-called “offshore jurisdictions” have been surprisingly compliant and all of the well-known places (e.g., BVI, Cayman, the Crown Dependencies) have responded with proposed changes to their domestic rules.

For example, the BVI enacted an economic substance reporting regime effective January 1, 2019, although the draft code was only introduced in April and the final Rules in October, 2019.

Impact on a Typical PIC

There are nine categories of “relevant activities” covered by the rules. If your PIC is caught in these rules, then it would likely be as a holding company – described more specifically as a “pure equity holding entity”.  Assuming your PIC holds equity investments in a passive nature, then there are three general considerations:

First, the new rules might not even apply to your PIC. This relevant activity is defined as holding only equity investments.

Some corporate service providers are suggesting that the least disruptive non-equity asset classes to add to an otherwise all-equity portfolio include bonds or bank accounts. (There is the issue of proportionality – i.e., what size is required to establish a true “investment” in the context of the total portfolio).  The purpose of adding other sources of income is to remove the PIC from the scope of the regime itself.

Second, even if your entity is a pure equity holding entity, then the entity may be tax-resident somewhere else.  This doesn’t remove your PIC from the reporting regime, but you will not be required to demonstrate economic substance.

It would greatly assist if you had actually filed a tax return in that other jurisdiction. If not, your corporate services firm will likely ask you to get a tax certificate. Those might be difficult to obtain without a real economic connection to that jurisdictions.

Finally, your entity, even if caught within the new rules, likely meets a reduced threshold to show the economic substance designed for passive pure equity holding entities.

For example, unlike the other eight categories of relevant activities, there is no requirement that your entity be directed or managed from within the BVI.

Many commentators believe (and the final BVI Rules strongly suggest) that passive PICs that

  1. have a local registered agent with suitable local premises and staffing (and that ensures mandatory filings are completed), and
  2. comply with the general statutory requirements for BVI companies,

should meet that threshold.

The primary practical impact for you may be a modestly higher annual corporate services fee.

If you have a PIC incorporated in any of the jurisdictions imposing economic substance reporting requirements, then you probably need to seek specific professional advice, at least for the first reporting cycle.

This note is not intended to be advice in any form (except that you should seek advice).  There are complicating aspects of the new economic substance rules and the rules and definitions are not uniform from one jurisdiction to another.

Click here to download a PDF version of this article.

 

 

Oct 21 2019
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Vintage Wine Market Update Oct, 2019

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Vintage wine auctions in 2019 so far are turning out well for the major auction houses. The first half saw strong results and it was not rare to see 100 percent of lots sold.

US-based Acker Merrall and Condit reported a superlative first half when top Burgundy producers like DRC and Leroy continued to lead. Interestingly, a lesser known producer, Domaine Comte Liger-Belair, made a strong impact and has been slowly building a leading position among the top 10 sellers in auctions.  Liger-Belair’s wines include world-renown grand cru such as La Romanée, Clos de Vougeot and Echezeaux.

For the first half of the year, Sotheby’s fine wine sales increased 23 percent year- on-year to USD 65 million. It was their highest spring total since they began auctioning wine in 1970.   Notably, the three-day auction held in Hong Kong in March established a new record, selling 2,700 lots for USD 34.5 million against an estimate of USD 20-30 million.

Although Christie’s May auction in Hong Kong saw most wines sold below their high estimates, the exceptions were Domaine Leroy, Roumier and DRC in top vintages and appellations. A two-bottle lot of Domaine Leroy Musigny 2000 sold for HKD 375,000, which was 97 percent above the high estimate.

October marks the beginning of the Fall auction season in the major markets of Hong Kong, London and New York. Despite the unsettling situation here in Hong Kong, both Sotheby’s and Acker reported strong results. Online bidding allowed buyers to purchase their favorite wines and Sotheby’s reported a 44 percent increase in phone bidding for their early October auctions.

It is noteworthy that there appears to be different preferences in different geographies. The US and UK auction markets remain very keen on top Bordeaux, whereas in Hong Kong the focus seems to be more on Burgundy and less on Bordeaux. Nevertheless, not every wine performs well in auction. As mentioned earlier, only a select few among the Burgundy and Bordeaux estates will sell at levels exceeding their high estimates. For Bordeaux, Chateaux Lafite Rothschild and Petrus in the best vintages usually do very well.  For Burgundy, Leroy, Roumier, DRC and Rousseau are the leaders, but not in every appellation.  Roumier’s Bonnes-Mares, Leroy’s Musigny and Rousseau’s Chambertin Clos de Beze are the most desired, whereas Romanée Conti and La Tache are top sellers for DRC.

It is important for potential sellers to understand that the auction market is uneven and a majority will sell below or just within market price. As is often the case, larger formats seem to attract more attention and enjoy a premium.

While sales in the auction market appear to be doing well in these turbulent times, the broader vintage wine market is feeling the effects of global trade tensions, confusion around Brexit and recent social discontent in Hong Kong. The Liv-Ex indices listed below clearly illustrate this slowdown.

Returns of various vintage wine indices for the latest 12 months to the end of September 2019:

Liv-ex 100 1                       -1.55%

Liv-ex 50 2                          -3.01%

Liv-ex Burgundy 150 3    +6.31%

It is increasingly apparent that Bordeaux first growths are no longer the major driving force in the fine wine world that they once were.  Lesser classified Bordeaux, as well as the second wines from the 1st growth are becoming more attractive to wine merchants and ultimately to wine drinkers.

Top Burgundy remains the focus of both wine buyers and collectors, but given the strong upward trend in prices one must wonder if the region has reached its peak and if there is a speculative bubble. However, what makes Burgundy different from other leading wine producing regions is the sheer scarcity of the product.  There are 33 Grands Crus in Burgundy (the equivalent of Bordeaux 1st growths) and they represent only 1.5 percent of total Burgundy production. There are only 5,000 bottles of Romanée Conti produced annually. The coveted Musigny from Domaine Leroy comes from a vineyard of 0.27 hectares and in 2009 only 600 bottles were produced.

How was the 2019 vintage?

We have heard reports of lesser quantities across the board due to the extreme hot weather during June/July across Europe which caused uneven flowering during the beginning of the growing season. Burgundy could see its production down by 30-40 percent. In Bordeaux, 2019 will be a smaller vintage compared to 2018.  So far, Italian producers are expecting a drop of at least 15%.

In terms of quality, 2019 looks like a very good year for most European wine regions with the exception of Spain which saw the potential of a great vintage dashed by the diluvial rains of last month.

 

  1. Industry benchmark comprised of the 100 most sought-after wines from the secondary market
  2. The latest 10 vintages of the 5 Bordeaux First Growths
  3. Latest 10 vintages of 15 Burgundy wines including 6 DRC

 

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May 28 2019
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ESG Factors should be applied to the Emerging Markets

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INTRODUCTION

We recently posted notes reflecting on the tremendous increase in interest in sustainable or responsible investing.

Many clients would like responsible investing to play a fundamental role in the decisions shaping their investment portfolios. The goal is to feel that you are doing good while seeking financial returns, by supporting positive social and environmental changes.

Investment managers increasingly understand the need to accommodate sustainable investing. This is, in part, because surveys suggest that millennials and women are particularly focused on responsible investing, two demographics that will become increasingly active in selecting investment managers.

GENERAL RATIONALE

Applying ESG factors to investment decisions likely leads to a more complete analysis because it involves analysis that might have been overlooked by traditional approaches.

While there are significant definitional and measurement issues to applying or measuring sustainable or ESG investing, investors appreciate that certain key sustainability issues will certainly impact a company’s ability to generate long-term financial returns.   These include a failure to anticipate changes in environmental standards, poor governance and financial transparency and labour practice that impede retention or promotion of qualified employees.

Not all ESG risks are company-specific. Investment surveys have also identified countries with poor ESG performance that contribute to poor financial outcomes for investors and domestic companies.  This could be the result of inequitable regulatory regimes, political interference or corruption, inadequate preparation for extreme weather or poor-quality financial infrastructures.

For these and other reasons, many commentators suggest that emerging economies may be more vulnerable to ESG-related issues than are developed economies. In addition, emerging market companies themselves often rate poorly on ESG measures.  This may be, in part, a measurement issue resulting from managements often failing to appreciate the importance of providing useful information.

As a result, proper implementation of ESG factors into the investing process may well enhance performance or reduce volatility to a greater extent than would be the case with respect to developed markets.  For instance, Blackrock has found that application of ESG factors in EM resulted in a more significant improvement than they found in DM.

And yet, ESG issues appears to be less embraced by Asia-based investors than has been the case in Europe. A UBS survey suggests that the majority of HNW investors in China are concerned that “sustainable investing” will result in lower investment returns.

Letko, Brosseau & Associates, a Montreal-based investment manager that manages our client portfolios, takes the same bottom-up approach to stock selection to its emerging markets strategies. LBA takes a long-term investment approach and believes that integrating ESG considerations into its investment decision-making as part of their mandate to deliver long-term returns. Oversight of ESG integration resides within their management committee.  Its investment committee is responsible for ensuring that all material ESG considerations are incorporated into the analysis and selection of each emerging market investment.

Those fund managers applying ESG factors to EM, including LBA, have identified a number of useful signals:

  • strong (or lack of), independent board oversight,
  • the competence, experience and diversity of senior management,
  • exposure to inappropriate political interference or involvement,
  • transparency in financial reporting and with respect to related party transactions and interests,
  • a commitment to global environmental and labour standards (or at least local standards), and
  • preparedness for environmental disasters, damages to important infrastructure or social unrest.

 

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Mar 13 2019
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Implementation Issues re ESG Factors

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INTRODUCTION

Many families want responsible investing to play an increased role in the design of their investment portfolios. The goal is a greater alignment between their investments and their personal values, promoting outcomes that are financially rewarding while supporting positive social and environmental change.

Investment managers increasingly understand the need to accommodate sustainable investing, once considered a fetish.

However, obstacles to adoption include confusion around terminology, rationale and implementation.

Investors in the U.S. and Asia have been generally slower to embrace ESG factors or other approaches to responsible investing than have Europeans, because they appear less convinced that it will be impactful and would like clearer evidence of a positive impact on financial performance. But evidence suggests that when a client does decide that ESG investing is important, they do not just nibble, they seek significant ESG allocations.

While not all managers expressly state that they apply ESG factors, good investment analysis necessarily identifies sound corporate behavior and objectives that serve to protect the company and its stakeholders. It would seem unwise to ignore key sustainability issues when assessing a company’s ability to generate long-term financial returns.

 Implementing Within the Investment Processes

JPMorgan estimates $23 trillion of assets are now managed applying ESG factors as a part of the investment criteria, with over $100 billion invested in ESG Funds. According to Barrons, US assets managed under ESG mandates grew 23% (CAGR) between 2014 and 2016 (compared to an average of 5% for the industry as a whole). Approximately half of US financial advisors now have portfolios dedicated to ESG investing.

Applying ESG factors to portfolios, funds and sector indices take a range of approaches including: (i) exclusionary approaches, applying broad principles, or screens or sector bans; (ii) “positive” approaches that include companies with certain performance or improvement scores; and (iii) thematic, or impact, investment approaches.

Measurement Issues

However, ESG classifications can be problematic. It is difficult to manage and report on that which is hard to measure.

ESG data are a means to assist an investor to evaluate a company’s strategy, institutional purpose and management execution and understanding how the company is adapting to transformational change (e.g., changing consumer preferences, evolving policies addressing climate change).

Morningstar (via Sustainalytics) and MSCI have created sustainability ratings to assist in evaluating or scoring mutual funds. Moody’s and S&P now incorporate ESG data into their credit ratings.  But some managers, such as GMO warn against a broad application of third-party scoring systems.  It is also important to identify those factors that are truly material for any particular industry and company.

Implementation Issues

 A consensus is lacking as to what ESG or sustainable investing involves, whether the integration of such in the investment decision is based on seeking improved financial performance or reduced risks (or both), or is simply an attempt to align portfolio construction with personal values.

Like any new trend, responsible investing has its critics.  Some question whether it even is appropriate.  However, more often critics point to difficult implementation and measurement issues.

1.  Definitional Issues

Even though integrating ESG factors within investment decisions has clearly accelerated since 2012, definitional issues appear to be holding back adoption.

The UN’s Sustainable Development Goals created a framework in 2015, but the 17 goals are rather general and difficult to translate into portfolio design.

It is hard to monitor compliance with the Principles of Responsible Investing, even ignoring that many signatories have done little to implement the spirit of the goals.

2.   Not effective in changing corporate behavior

Many critics argue that it would be more effective to engage with managements on broad issues such as climate change, diversity or governance, rather than simply divest.

Some have argued that if too many fund managers exclude certain sectors, then the cost of capital will increase for those sectors and while there might be supply constraints later, it could positively impact the sector’s future returns, perversely.

3.  Limiting choice necessarily results in worst outcomes

The argument is, the larger the asset class you want to exclude, the greater potential underperformance (vis-à-vis a benchmark).

There remains debate on whether ESG has demonstrated itself as a useful style factor.

4,   Is a fad – asset managers owe a duty to focus on the traditional, widely-accepted analytical approaches

Some have questioned whether asset managers owe a fiduciary duty to their clients to take ESG issues into account. In the US, there has been arguments that the manager’s fiduciary duty is focused on financial performance, and that applying ESG factors constitutes activism which may not be part of the manager’s mandate.

For example, when aligning “core” values, are those the values of the manager or of the clients or as prescribed by activist or independent groups. Clients necessarily have a broad range of values.  Communities sensitive to “political correctness” may see this as a liberal intrusion into an otherwise allegedly scientific process.

5.  Primarily a marketing ploy, since quality investment manager s already apply these principles

Others argue that applying ESG factors is redundant because the best companies and best asset managers are already incorporating these factors within strategic and investment decisions. The sustainability of their business model has always been relevant. It is suggested that developing these new frameworks and reporting systems is more likely to confuse and increase costs without a commensurate benefit.

In addition, commentators point out that fund managers often trumpet ESG credentials and commitments and yet have changed their investment approach very little. Companies lay claim to integrate ESG factors into their strategic planning, but it is very resource intensive and time consuming to collect, catalogue and present performance or compliance confirmation.

__________________________

We think it unlikely that there will ever be a consensus on specific frameworks for responsible investing, its role in asset manager deliberations and how best to implement, but so long as research continues to support a connection between sustainable business models and financial performance, and certain demographics increasingly champion the goals, asset managers will be offering a range of approaches to integrate ESG factors and responsible investing. Borrowing from Voltaire – waiting for the perfect approach should not prevent asset managers from improving on current approaches.

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Feb 08 2019
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Applying ESG Factors to investment decisions

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INTRODUCTION

Many families want responsible investing to play an increased role in the design of their investment portfolios. The goal is a greater alignment between their investments and their personal values, promoting outcomes that are financially rewarding while supporting positive social and environmental change.

Investment managers increasingly appreciate the need to accommodate sustainable investing.  Trends supporting interest in ESG include increasing awareness amongst asset managers that (i) sustainability issues do impact financial performance, and (ii) millennials and women, two demographics that will be managing an increased share of AUM going forward, have demonstrated an affinity to responsible investing (potentially impacting manager selection).

However, obstacles to adoption include confusion around terminology, rationale and implementation.

For example, are ESG (environmental, social and corporate governance), sustainable, socially responsible and impact investing different names for essentially similar evaluation frameworks, or would they require substantially different implementations in the eyes of the cognoscenti? 

 We believe that at a broad level, each of these concepts encourage the integration of the clients’ personal values or society’s perceived concerns or an entity’s mission into consideration, alongside traditional criteria, when making investment decisions.

 GENERAL RATIONALE

Applying ESG factors to investment decisions likely leads to a more complete analysis of the investment opportunity because it involves analysis that might have been overlooked by traditional approaches.

DWS and the Univ of Hamburg reviewed (in 2015) the conclusions of over 2000 studies and found that the majority of such studies found a positive relationship between ESG factors and corporate financial performance; while relatively few found a negative relationship.

A long-term study by JP Morgan found that stocks with the poorest ESG scores exhibited greater volatility during choppy markets … supporting the view that sustainable investing may help make investment portfolios more durable.  A recent Bank of America study found companies with better ESG performance exhibited lower earnings volatility and higher ROE over the period reviewed.

While not all managers expressly state that they apply ESG factors, good investment analysis necessarily identifies sound corporate behavior and business strategies that serve to protect the company and its stakeholders. It would seem unwise to ignore key sustainability issues when assessing a company’s ability to generate long-term financial returns.

IMPLEMENTATION

Developing a Framework

There are over 2,000 signatories to the U.N.’s responsible investments initiative, established in 2006 and called the Principles of Responsible Investment (PRI).  Signatories commit to six principles designed to embed ESG considerations into investment decision-making processes and to hold the companies in which they invest to account for ESG failures.

In 2015, the U.N. set out 17 Sustainable Development Goals (SDG) relating to societal challenges including poverty, inequality, climate change, the environment and justice.  Its intention was to redirect investments to address specific problems that may not attract capital purely on expected financial performance metrics, with the goal to achieve a cleaner, healthier and more equitable world.

However, given the broad nature of the goals as well as the implementation language having been prepared for governments rather than investors, it has not been easy for investors to translate these goals to specific practices.

Implementing Within the Investment Processes

JPMorgan estimates $23 trillion of assets are now managed with at least an indication that ESG factors play a part as investment criteria, with over $100 billion invested in ESG Funds.

Managers applying ESG factors to portfolios, funds and sector indices apply a range of approaches including: (i) an exclusionary approach using screens or sector bans; (ii) a “positive” bias designed to include companies with certain performance or improvement scores; and (iii) thematic, or impact, investing.

 1.  Exclusions based on broad failure.

As a first step, responsible investing will look to avoid companies that fail to meet the most basic standards on issues such as corruption, environmental degradation and human rights.

2.   Systematic exclusions.

The early and still a predominate ESG approach is to exclude sectors seen as not meeting society’s priorities. Initially, these tended to be the so-called “sin” stocks (gambling, alcohol and tobacco).

An exclusionary approach has to deal with how broadly a net is thrown. Do you exclude companies that sell alcohol or tobacco (food retailers, pharmacy chains) or just manufacturers?  Do you exclude weapons manufacturers or also those providing components or that have much larger businesses in other sectors (e.g., Boeing or Airbus)? Do you exclude all fossil fuel producers, or only the products with the highest carbon intensity?

This exclusionary approach is sometimes criticized as: (i) being too limiting, potentially hurting returns, (ii) not doing enough to encourage behavioural changes, (iii) not having a strong economic rationale, and (iv) presents a risk of capture by social activist movements.

3.  Screening-based inclusions.

Arguably, a more effective ESG approach goes beyond exclusions as managers become more focused on what to include, as much as what to exclude. Under a best-in-class or positive approach, companies are included or emphasized that have the strongest ESG credentials.

This approach is useful for managers that want to label a fund as ESG based on quantifiable measures (although there are questions about the effectiveness of third-party scoring models).

4,   Integrating ESG factors.

The recent trend is a more comprehensive approach whereby ESG factors are integrated with traditional analysis to improve the investment decision-making process and highlights risk.

For example, a manager with whom we work closely, states that:

“… our approach to investing responsibly and integrating ESG considerations is guided by our mandate to deliver returns that will enable our clients to achieve their long-term investment objectives and our core values.   We believe that companies with sound business practices, including strong corporate governance and responsible management of material environmental and social issues, have better success and deliver stronger financial performance over time.  Conversely, companies that have poor environmental, social or corporate governance practices present risks and controversies that may hinder their financial performance.” 

Under this approach, industry analysts investigate ESG risks as part of their in-house research process and may compliment that work with third-party research. Conclusions are integrated into investment decisions.

This approach can also run alongside an exclusionary framework. For example, the manager cited above excludes tobacco, gaming and thermal coal miners from all portfolios, while its ESG Fund adheres to a much more restrictive investment policy which precludes investments in companies for which ESG information is insufficient or which do not pass certain ESG filters.

5.  Thematic Investing.

Thematic or impact investing generally funds strategies addressing specific environmental or social challenges.  This is often done through investment vehicles that are private and project oriented.

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Jan 20 2019
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Emerging Markets Allocations

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The vibrancy and high growth rates of emerging market economies are often alluring for investors looking to add incremental growth and exotica to their portfolios. The high under-lying growth rates, huge population base and a perception that less transparency and analyst attention suggest that these markets are less efficient was the start-point for many fund pitches.

There have been two broad approaches for adding emerging market exposure to segregated portfolios:

  1. indirect exposure, by investing in well-run western companies with significant emerging market businesses; or
  2. direct exposure, through ownership of companies based and operating within one or more emerging economies.

Our portfolios have historically had a mix of the two, with the bias being toward the first approach. Our portfolio manager is dedicated to a detailed, bottom-up analysis of each company that it evaluates.  This approach is often more challenging when it comes to emerging market issuers, in part because of less access to management, frequently the lower quality of financial information, the reticence of EM management teams (that were not used to that sort of due diligence process), and frankly, less confidence in the quality of corporate governance.

However, the balance has been shifting towards direct exposure over the past decade, as these issues are addressed by more and more management teams in the emerging markets. Client portfolios now have direct exposure to emerging markets at, or slightly above, the MSCI ACWI allocation.

However, and as you are no doubt aware, these elevated growth rates enjoyed by emerging economies have not always translated into elevated total returns for minority investors in emerging markets companies. EMs have had periods of exceptional performance and then periods of under-performance, such as we witnessed in 2018.  In addition, volatility has historically been considerably higher than in developed markets, producing unenviable Sharpe ratios (although Bloomberg Markets pointed out last week that short-term volatility in developed markets was currently above that in emerging markets, a very rare event.)

So what changes, other than greater comfort with due diligence processes, give us more comfort with direct EM exposure than was the case historically?

Emerging economies now represent almost two-thirds of total global GDP, while their stock markets represent approximately one-third of global market capitalisation.   Key global indices have an even lower allocation to EM, at around 10%.  As more China-listed companies are included in indices over the next few years, that figure will rise, but it will still remarkably understate the importance of those economies to global growth.

While emerging economies typically exhibited higher growth rates, their economies were not as large and influential to total global growth as were the developed economies. However, whether it’s China, India, southeast Asia or EM as a whole, their absolute scale has become very important, not just their relative growth.

A recent paper from the Brookings Institute estimated that over 90% of the increased spending power of the global middle class will come from China, India and other Asian emerging countries by 2022.  In other words, the impact that these economies have on global growth is now impossible to ignore.

Second, the composition of what drives emerging economies is evolving. In boom periods of the past, growth was led by low-cost, export-driven manufacturing, domestic property development typically fueled by cross-border capital flows and resource extraction industries.  This led to considerable volatility in EM returns during a business cycle.

However, the less volatile and often domestically-oriented sectors such as healthcare, consumer staples and consumer discretionary sectors are becoming more relevant. In most Asian EMs, the technology sector, albeit still export-oriented, is now much more important – although whether the chip makers and components suppliers have managed to reduce cyclicality is currently on trial. The MSCI EM index now comprises over 40% of technology and consumer sectors.

Third, research focused on the increasing integration of ESG issues (environmental, social and corporate governance) into company analysis and investment decisions has highlighted that this approach is particularly helpful in evaluating risks in the emerging markets. Assuming this is true, and we believe that it is, then the detailed, bottom-up style of investment research (as opposed to the use of passive products) should enhance returns over time, relative to the same impact with respect to developed markets.

Finally, from a relative value perspective, EM currently looks very attractive. While the relative value between EM and DM is somewhat cyclical, the end-of-2018 MSCI EM relative to the MSCI World (normalized to early 2008) is extreme, historically.

As 2019 market outlooks were distributed in the first two weeks of January, it is clear that emerging markets are again very much in the conversation. The large sell-side houses seem about equally divided on the attractiveness of the asset class, informed in large part by their outlook for global growth, the likely strength / weakness of the USD and the likelihood of two or more Fed rate increases during the year.

We do not market or promote any fund products, but if you are interested in more information on how our client exposure to emerging markets is expressed within their segregated accounts, please contact us.

 

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Jan 18 2019
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Keelan Chapman spoke to The Globe and Mail

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Since 2016, Keelan Chapman has been actively supporting our clients in his role as Real Estate Consultant at ChapmanCraig Ltd.   Concurrently, Keelan manages the Canadian Real Estate Investment Center (H.K.)  which assists Asia-based investors in making property acquisitions in Canada.  He was recently highlighted in an article penned by Nathan Vanderklippe in the Globe and Mail, one of Canada’s leading business newspaper.  The article, titled “The Re-returnees”, was published on January 13, 2019, and below in italic is an excerpt.

       When Keelan Chapman moved back to Hong Kong three years ago, he didn’t expect to find himself with a front-row seat to a Canadian exodus.

       Mr. Chapman runs the Canadian Real Estate Investment Centre (Hong Kong), a company he created three years ago to help people in Asian buy property in Canada. He figured his clients, who meet him in Hong Kong’s skyscraper forests of buzzy coffee shops and swish boardrooms, would be investors moving cash into Vancouver’s exuberant housing market. 

       What he has found instead is people looking to buy homes for themselves.

      “My main clients in Hong Kong tend to be Canadians looking to return to Canada,” he says.

An active member of the Canadian Chamber of Commerce in Hong Kong, a founding member of the Pearl River Delta Canada Chamber and an engaged member of the Alumni Association of McGill University, Keelan often speaks at conferences on the Canadian Real Estate market, giving specific updates on the Vancouver, Toronto and Montreal real estate markets as well as on recent implementation of various taxes affecting real estate investors.

From his experience, buyers are interested in Canadian properties for three reasons: investment, for a retirement home or for young families returning so their children receive education within the Canadian education system, whether it be secondary, post-secondary or university.

Vancouver and Toronto continue to attract most interest due to strong family ties developed over the years.   However, since the steep price increases and various policies aimed at foreign buyers in these cities,  Keelan has noticed that he is getting more inquires for cities like Montreal (Canada’s second largest city) where prices are affordable, yields are strong and there is a growing dynamic wave coming from high-tech companies that are looking to take advantage of the city’s collection of world class universities.

Keelan is a licensed real estate broker in the province of British Columbia and regularly travels back to Canada to assist his clients in real-estate matters.

 

 

Oct 31 2018
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Developments in the Vintage Wine Market Oct, 2018

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2018 is turning out to be a very positive year for the vintage wine market with the combination of a broad strengthening of prices, a couple of stunning surprises from recent auctions and a good yielding but high quality harvest.

In France, the 2018 vintage will be a great one in many regions, with the exception of areas which were devastated by hail storms in late May.   Some Bordeaux winemakers are already talking about 2018 being the vintage of a lifetime.  Italy, Spain and Portugal overall had mixed results – an excessively wet spring and very high temperatures during the growing season.

There has been much excitement in the auction market and Burgundy wines have been the undisputed stars.  Two headline auctions took place: Henri Jayer’s sale of his personal cellar in Switzerland in June and the Drouhin family cellars of Domaine de la Romanée-Conti (DRC) in October.   The Jayer collection was comprised of 855 bottles and 209 magnums and sold for US$ 35 million, or an average price of US$ 33,000 per bottle.   Not to be outdone, two bottles of 1945 DRC were  sold in NYC last month for a combined amount of more than US$ 1 million.

The star status of Burgundy wines continues to spill into the general vintage wine market.   However, it should be clearly noted that while the broad vintage wine market is enjoying strengthening pricing, Bordeaux looks to be a laggard after having had a preeminence status for many years.

Below are the returns of various vintage wine indices for the 12 months to end of Oct 2018:

  • Liv-ex 1000   (comprised of 1000 wines from around the world)       +10.4%
  • Liv-ex 50    (comprises the latest 10 vintages of the 5 Bordeaux First Growths)       +1.4%
  • Liv-ex Burgundy 150  (comprises the latest 10 vintages of 15 Burgundy wines incl. 6 Domaine de la Romanée Conti)   + 31.5%

Strong interest in Italian Barolo wine and broad based Burgundies has been a strong support for better pricing in the wider vintage market.

Looking ahead, there are reasons to expect continued stronger prices for leading Burgundy producers other than DRC and Jayer.   Scarcity of Burgundy is a simple fact that we will address in further details in our next update.