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Investment House View Discussion: April 2024

Investment House View Discussion: April 2024

In this wide-ranging discussion, three of our top market experts - Wassim Jomaa, CFA, Naji Nehme, CFA, and David Darst, CFA - cover the global economy, investment themes, and portfolio strategy, taking the latest developments into account and making their predictions for the coming months.

Apr 21, 2024رؤى السوق- 3 min
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The macro outlook

This is a year of elections, including those held in Taiwan, Mexico, Indonesia, the EU, and the United States. There is therefore potential uncertainty around policy decisions (defense spending, bank regulation, and antitrust policy, among others etc.) Does this mean trouble for markets?

Not necessarily. Bond spreads have tightened further since last year, implying that a global recession is (still) not in the cards.

In the US, presidential challenger Trump is perceived as business-friendly, and his lead in the polls is having a positive effect on markets. Democrats are unlikely to risk a recession, and so will avoid any drastic regulation for the time being.

The Fed’s own prediction of three rate cuts for this year looks likely to begin in June. Further monetary policy loosening is also going on in the background, with the slowing down of Quantitative Tightening (QT), and reduction of “reverse repos” reintroducing liquidity into the system.

Inflation is proving sticky, however, thanks to wage growth, meaning that an elevated interest rate and inflation scenario will likely persist for the foreseeable future. In other words, we are not set for a return to ultra-low rate environment to which many had become accustomed.

Pockets of growth

The U.S. has delivered significant growth since the pandemic, but this has been driven to a large extent by significant stimulus spending, which by its nature is unsustainable.

Despite China’s current difficulties, Asia offers some promising opportunities, such as Indonesia and Vietnam. Many are now looking to Japan, whose return to growth is being accompanied by an opening up of the economy to outside investors, as large conglomerates divest non-core divisions or negotiate succession transitions.

A weakening of the Japanese Yen, however, could trigger headwinds, particularly if it prompts China to weaken its own currency and/or flood the global markets with deflationary goods (e.g., semiconductors).

In sectoral terms, Wellness and Longevity provide an obvious target as the global ageing (and in many countries, wealthy) population continues to grow. More broadly, a challenged growth environment will mean that investors must look for firms with higher productivity. Or in other words, firms deploying AI and robotics effectively.

Asset classes

Valuations are high in historic terms (the CAPE is at 34.4 versus a historic 17-19 range). This is not necessarily a trigger for a correction in and of itself. However, individual stocks are at risk of sudden falls from grace, as occurred with Tesla and Apple, which recently dropped out of the ‘Magnificent 7’. This means that non-public alternatives (Real Estate, PE, Private Credit) remain key.

Real Estate

‘Real Estate’ is not a single, homogeneous sector, but a collection of sub-sectors which behave very differently, and must be studied separately. Offices, for example, are transitioning from places to work to places to socialize, and sustainable building practices are becoming more widespread. Commercial real estate that fails to adjust to this trend is likely to underperform.

While Industrial real estate (e.g., data centers) is at risk from trends in automation, Residential units - in particular, multi-family homes - are in high demand. Even so, local regulations (e.g., rent controls) can have a meaningful impact on profitability, meaning the sub-sector as a whole should be approached with caution.

Nursing homes have experienced a sharp decline since the pandemic, but retain long-term demographic potential and hence could be attractive at their current valuations.

Private Equity

Lower valuations have caused difficulties for some PE funds looking to exit deals and deliver returns to shareholders. The ‘Secondaries’ market - now 6% of the PE market overall - is growing to help solve this problem.

The PE game as a whole has now changed from a focus on multiple expansion and revenue growth - both challenged in the current environment - to margin expansion through operational improvement. Sponsors are therefore likely to become specialized in optimizing for certain stages of development (such as growth stage and mature stage) or applying specific improvements including digitalization, synergies through roll-ups, or public-to-private.

Approximately $300bn of the $1.2trn ‘dry powder’ that remains must be spent this year, and so we will continue to see activity. Historically, funds that invest at the bottom of the cycle deliver the highest returns, meaning that higher interest rates could represent a positive development for effective sponsors.

Private Credit

As banks have continued to retreat from lending in many areas (e.g., commercial aircraft, shipping) private lenders have entered these spaces to help finance projects and deals. Recently, this also includes real estate developments and corporate M&A.

Private lenders can often enter agreements on favorable investment terms, including higher interest rates, transaction fees, and upside participation. We have found in the case of real estate that it makes more sense to lend than invest directly, as cap rates have declined significantly in the past decade.

While there are some attractive sectors, such as Cybersecurity, as with all private markets, success depends on the specific opportunity - hence the only strategy is to be opportunistic (rather than blindly ‘piling in’).

Implications for Portfolio Strategy

As we outlined in our recent ‘Shifting Balance’ report, the new ‘high interest, high inflation’ regime will mean that asset classes behave differently in comparison with the past two decades. A new toolkit for portfolio construction is required.

Diversification, while still critically important, is not as straightforward as it was previously. The fundamentals still remain the same, but in proportional terms, the role of alternative assets has increased as the negative correlation between equities and bonds (the classical 60:40 strategy) has weakened.

As companies are also staying private for longer, investing in private markets is increasingly important for gaining early exposure to future ‘magnificent’ stocks. As private investments are less volatile and longer-term in nature than public investments, investors are less exposed to the psychological rollercoaster of the markets and more likely to let returns compound.

Conclusion

The coming environment will not bring more challenges - just different ones, with corresponding opportunities for those who know how to find them.

What is coming to an end is the era of the rising tide where ‘everyone’s a winner’. This is because the winning strategies are not easy to execute without the right expertise. Private credit, for example, can be risky if the investor does not have the right covenants in place (e.g., a ‘step in’ provision to take control if a developer fails to meet obligations).

As returns bifurcate, therefore, it is important to align yourself with those on the right side of the divide. Partnering with an advisory firm that has seen multiple market cycles means that you will not be caught off guard. Deep market experience, combined with access to the right sponsors and the right network in the case of PE, represents the new competitive advantage.

Disclaimer

This presentation is provided to you by The Family Office Co. BSC(c) (“The Family Office”) for informational purposes only, and contains proprietary information that may not be reproduced, distributed to, or used by, any third parties without The Family Office’s prior written consent.

All information, figures, calculations, graphs and other numerical representations appearing in this presentation have not been audited and may be subject to change over time.  Furthermore, certain valuations (including valuations of investments) appearing in this presentation are subject to change as they may be based on either estimates or historical figures that do not reflect the latest valuation.  Although all information and opinions expressed in this presentation were obtained from sources believed to be reliable and in good faith, no representation or warranty, express or implied, is made as to their accuracy or completeness.  The information contained herein is not a substitute for a thorough due diligence investigation.  Past performance is not indicative of and does not guarantee future performance.  Exit timelines, prices and related projections are estimates only, and exits could happen sooner or later than expected, or at a higher or lower valuation than expected, and are conditional, among other things, on certain assumptions and future performance relating to the financial and operational health of each business and macroeconomic conditions.

The Family Office makes no representation or warranty, express or implied, with respect to any statistics or historical or current financial data, whether created by The Family Office through its own research or quoted from other sources.  With respect to any such statistics or data delivered or made available by or on behalf of The Family Office, it is acknowledged that (a) the investor takes full responsibility for making its own evaluation of the materiality of the information and the integrity of the quoted source and (b) the investor has no claim against The Family Office.

Amounts in currencies other than the US Dollar are translated using prevailing market rates as calculated by The Family Office or its service providers and may differ from the rates used by banks.  The rates are indicative only and do not reflect the rates at which The Family Office would be prepared to enter into any transactions with other parties.

 Certain information contained in this presentation constitutes “forward-looking statements,” which can be identified by the use of words such as “may,” “will,” “should,” “expect,” “anticipate,” “project,” “plans,” “estimates,” “intend,” “continue,” or “believe” or the negatives thereof or other variations thereon or comparable terminology.  To the extent this presentation contains any forecasts, projections, goals, plans and other forward-looking statements, such forward-looking statements are inherently subject to, known and unknown, significant business, economic, competitive, regulatory and other risks, contingencies and uncertainties, most of which are difficult to predict and many of which are beyond The Family Office’s control and may cause actual performance, financial results and other projections in the future to differ materially from any projections of future performance, results or achievements expressed or implied by such forward-looking statements.   Investors should not place undue reliance on these forward-looking statements.  The Family Office undertakes no obligation to update any forward-looking statements to conform to actual results or changes in The Family Office’s expectations, unless required by applicable law.

 The Family Office makes no representation or warranty, express or implied, with respect to any financial projection or forecast.  With respect to any such projection or forecast delivered or made available by or on behalf of The Family office, it is acknowledged that (a) there are uncertainties inherent in attempting to make such projections and forecasts, (b) the investor is familiar with such uncertainties, (c) the investor takes full responsibility for making its own evaluation of the adequacy and accuracy of all such projections and forecasts so furnished to it and (d) the investor has no claim against The Family Office.

 This presentation represents a summary of certain information, the full terms of which are contained in a Private Placement Memorandum that should be reviewed for a more complete understanding of the investments and their risks.  In addition, this presentation does not constitute an offer to sell, or a solicitation to buy, any instrument or other financial product, nor does it amount to a commitment by The Family Office to make such an offer at present or an indication of The Family Office’s willingness to make such an offer in the future.

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