Welcome to our first newsletter:
The Four Pillars of Virtue
In this Summer newsletter, we share our perspectives on topics within the four pillars that make up Virtue Capital. These are areas we are present in and see significant client demand - Structured Solutions via Virtue Capital Solutions (VCS), which has been set up in association with Societe Generale, and Alternative and Direct Investment Opportunities (Real Estate, Hedge Funds and Private Equity) via Virtue Capital Partners (VCP). The combined entities of VCS and VCP make up the Virtue Capital brand which is able to service institutional clients for a number of their financial and investment needs.
In the latest phase of our corporate development we are pleased to announce the appointment of two non-executive directors namely Bob Tyley and Dr Robert Crenian.
The appointments will strengthen our corporate governance through their ability to provide constructive and objective insight to the team. In addition, they bring a wealth of experience and advisory capability to our two core areas of business namely, multi-asset structured solutions and direct and alternative investment opportunities.
Bob Tyley: 30 plus years of financial service experience. Previously, Bob was a Senior Advisor for Morgan Stanley's Insurance Solutions Group and has been an Investment & Risk Specialist heading up Asset Liability Management, (ALM), and Strategic Solution Groups at a number of Tier 1 Investment Banks including Goldman Sachs and Merrill Lynch.
Bob is a Chartered Fellow of the Chartered Institute for Securities and Investment, (CISI) and Specialist Member of the Institute of Risk Management. Bob has a Masters in Mathematics from Oxford University.
Dr Robert Crenian: 18 plus years of experience in the financial services sector primarily focused within the hedge fund industry. Previously, Robert was Managing Director of Renaissance Technologies LLC for Europe and the Middle East. Prior to that he ran the Product Management Group at Aspect Capital. Robert was also a senior Quantitative Strategist and Risk Manager at Citigroup Smith Barney and Dresdner Bank.
Robert has a PhD in Econometrics from University College London and also attended Cambridge and Bristol universities.
For anyone who has awkwardly been asked to make a loan to a family member or a friend, peer to peer lending offers a welcome ‘get out of jail’ card, provided they pass the credit scoring filters! Should they fail the credit score then Flendr (www.flendr.com) promises to “help friends stay friends”!
The question in the early 2000s as to what P2P means would have been answered by an explanation involving computer network nodes or you would have been directed to Napster, an early (deemed illegal) music and file sharing website. Ask the question now and one is told about alternative financing sources for borrowing or referenced to the new sharing economy where everything from dog owners renting out their pooches (yes it does exist! - www.borrowmydoggy.com) to new start-ups like www.rentecarlo.com which allows you to turn your unused family car into a self-financing yielding asset machine. With apologies to dog owners or petrol yield heads, we will focus on the more prosaic world of peer to peer in alternative financing.
Peer to peer financing has excitingly stepped out from the murky world of shadow financing to become a credible alternative asset class in its own right, so much so that even the Government have noticed it – Financial Secretary to the Treasury David Gauke said in October 2014 ”P2P lending is an exciting, innovative new sector and it’s right that investors who want to lend money via P2P platforms should be able to hold these loans in their ISA alongside more traditional investments.” The FCA in April 2014 began to formally regulate this market albeit with the risk warning that it is still outside the scope of the Financial Services Compensation Scheme.
The Brits as ever take a leaf out of Jonathan Ive’s Apple playbook and take innovation design credit for the first launch of an online P2P platform with Zopa (www.zopa.com). Launched in 2005 it has so far leant out £887 million with total cumulative UK lending across the main platforms of more than £3.7bln, (source Liberum). The US takes credit for the sheer size and exponential growth of its P2P loan volume.. Lending Club (www.lendingclub.com) has advanced over $9bln in loans alone and raised an eye watering $8.9bln in the IPO space. Its current market cap is $6.3bln. Prosper (www.prosper.com) has advanced $3bln and has innovatively securitised $330mln of debt via BlackRock. The UK beats the US on P2P loans on a per capita basis which many attribute to the positive regulatory framework in the P2P sector.
In the current environment of dismal yield, this asset class offers lenders a mouth-watering attractive yield proposition coupled with the future inherent tax benefits of investing via an ISA in the UK. Liberum AltFi Returns index for the UK shows a current yearly absolute return from investing into the 3 largest UK platforms (Zopa, Funding Circle and RateSetter) as 5.19%. Contrast this with the highest 1 year fixed deposit account in the UK being, surprisingly, The Punjab National Bank at 2%! Through active credit scoring techniques, actual defaults in 2014 in P2P loans amounted to just 0.52% (peer2peer Finance Association).
Individual investors can spend a considerable amount of time accessing the various platforms and dealing with the complexities of setting up and managing big data number crunching processes - such as making loan selection decisions. Alternatively, one could simply invest in a fund of fund type structure where one outsources the skill and judgment of loan selection to an external manager. An example of a listed closed end vehicle is P2P Global Investments PLC, the first UK listed company dedicated to investing in Credit Assets originated via online lending platforms globally. The company trades as a closed end fund with two share classes and a combined market cap of about £480mln representing a 7.5% premium to Net Asset Value (NAV). We are also in contact with other private vehicles that will assist in investing into this dynamic asset class without the premium to NAV.
The number of investment choices continues to rapidly expand in this high octane growth asset class, coupled with an increase in investment from yield starved institutional investors such as, hedge funds, PE and VC firms and even banks. Morgan Stanley has estimated that global marketplace P2P lending can reach a base case of $290bln by 2020 with an expected 51% CAGR. Within the P2P sector, loans verses commercial real estate lending are significantly starting to expand with new operators beginning to open up as lending criteria becomes tighter for mainstream lenders.
The regulatory and economic environment has made the use of structured credit a key component for Insurance companies within portfolios backing their annuity business.
In February the PRA released a letter updating its latest thinking on the use of equity release mortgages (“ERMs”) as assets within Insurance company portfolios. In particular they were focussed on their use as assets acceptable for the use of the matching adjustment. This update critically changed the PRAs viewpoint from “unlikely to qualify” to “likely to be acceptable” once they have been restructured, as long as the structuring proposals comply with the relevant legal and regulatory requirements. In that letter a number of challenges were put forward for Insurers to consider when restructuring their credit assets:
- that the structuring is appropriately recognised within the group’s risk management framework
- the appropriateness of any internal rating model used
- the requirements of the PRA are met with regards to the valuation of the structured assets
- that any partial internal model needed for evaluating the risk exposures should satisfy the relevant requirements for model use
- that the underlying assets be considered suitable given the nature of the liabilities being matched
The last point confirms that, although this advice was written with respect to ERMs, the use of structuring techniques is fully valid for all appropriate assets as long as their detailed requirements are met. This is fortunate; many of the “alternative” credit investments now being considered by insurers, such as infrastructure and mid-market lending, contain features that would otherwise undermine their use within matching adjustment portfolios.
Having determined that the assets are appropriate and that the structures can be valued acceptably, a lot of the remaining challenge then falls on the ability to develop appropriate models as needed. The complexity required will depend on the nature of the structuring, and may well have to provide internal ratings and risk exposures. These models will need to be acceptable to the PRA.
Model approval is another area where the PRAs requirements are challenging. Fortunately a lot of work is being done by the industry on the topic of model validation. The Internal Model Industry Forum, set up by the Institute of Risk Management, has just released their first document “The validation cycle: developing sustainable confidence and value”. This provides a summary of their guidance about the internal model validation cycle. It is good to see these issues being addressed in an industry wide context, in conjunction with the PRA, to provide confidence that firms will have the ability to set up and use internal models as key components of their asset portfolio implementations.
If credit assets are not structured to enable them to be included in matching adjustment portfolios they still may have a role as assets for insurance companies. However the matching adjustment is important to enable insurers to offset some of the credit spread volatility that they are otherwise exposed to. And as Jayan Dhru, global head of corporate ratings at S&P has just commented: “What happens in the US leveraged finance market over the coming months could well be a foretaste of what is to come on the other side of the Atlantic.” Time and effort spent structuring may be time well spent.
The UK Real Estate Market Breathes a Conservative Sigh of Relief
The year started with a hangover of deals that missed year end 2014 coming through the market as interest rates for development and mezzanine finance continued their downward spiral. New entrants to the market (46 new lenders in 2014 according to Savills) have forced existing specialist lenders to sharpen their pencils, driving headline rates lower as leverage ratios have crept higher. Whilst we have seen several mezzanine lenders consider the move into the equity slice of the capital stack in order to maintain rates of return, delivery from senior lenders has been mixed, especially on the more challenging projects.
The UK election gave some investors an excuse to pause for breath but the clear election result was a relief to the market overall. An obvious caveat however, is the potential for a fresh Scottish referendum given the weight of support for the SNP. Whilst we remain sanguine about the chances of a Brexit, the constitutional implications of a ‘stay-in’ vote backed by a Scottish electorate who may subsequently leave the Union would be interesting.
Development finance for hospitality assets has picked up as trading improves to the point where new construction makes sense. Established hotels are finally trading above replacement value, particularly in UK gateway cities where a good mix of business and leisure use can be attracted to support occupancy throughout the week. The JLL hospitality team predict global hotel transaction volumes of between $65bln to $68bln in 2015, (a 15% increase over 2014).
Construction costs remain a concern across all asset classes as witnessed by the 2014 pre-tax losses at McAlpine and Balfour Beatty and the recent bankruptcy of GB Group (refer ONS chart below for construction output prices).
Our acquisition and disposal mandates have remained consistent with demand for ‘value added’ commercial opportunities in the UK, both inside and outside of Central London. We are seeing demand for hotels with 100 plus keys in the main European gateway cities and we retain a mandate to seek buyers on a small selection of continental European hospitality assets.
"The top 25 hedge fund managers (are) making more than all of America's kindergarten teachers combined." — Hillary Clinton on Saturday, June 13th, 2015 in a campaign rally speech.
Much to the chagrin of Hillary Clinton and judging by the flow of fresh capital (+$23.7bln added in May according to eVestment with the majority of new capital allocated to equity hedge and event driven strategies) hedge funds are here to stay.
Prequin, a source of data and intelligence for the alternative assets industry, has found over 227 institutional investors with at least $1bln invested in hedge funds. 25% of that investment comes from Public Pension Funds followed by 16% from Sovereign Wealth Funds (see the chart below for largest global HF investors). Alarmingly for anyone who worries about concentration risk akin to too many obese people in a small lift, the 10 largest funds account for 83% of gross notional exposure. Given leveraged notional sizes involved the FCA also recently issued a hedge fund survey (June 2015) in which they caution on concentration risk and state – “Hedge funds fail or close down on a regular basis without causing a significant impact on the financial system, but very large hedge funds potentially pose a risk.” Like all investments, diversification and correlation need to be examined ahead of dipping ones toe's!
Picking the most consistent performers amongst the herd is an art in itself but can be very rewarding. George Soros’ Quantum Fund has, for example, made net gains since 1973 inception of $41.9bln, Ray Dalio’s Bridgewater $41.7bln and John Paulson’s Paulson & Co $23.5bln since inception. Fund of funds can take the selection burden out of one's hands and supposedly provide access to otherwise closed funds.
Blackstone, the largest global alternatives asset manager “preserves and protects $310bln in assets”. According to Bloomberg the behemoth has expanded assets annually by 18% for the last three years, attracting AUM from sovereign wealth funds, wealthy investors and family offices.
The bright minds at PwC predict that by 2020, going at the current breakneck Tour de France speed, assets into hedge funds will increase to approximately $5 trillion - a mere $2 trillion behind their expectation for the more illiquid $7 trillion in private equity investments.
Did we mention, that for anyone looking to setup or invest in hedge fund strategies we are more than happy to provide assistance?