CFA Society Singapore Quarterly Newsletter 2018-07 (July)

Quarterly Issue 30 | July 2018 | www.cfasingapore.org

Financing Infrastructure in Developing Economies Multi Asset Strategies

Valuing a Distressed Firm

Liquid Alternative Investments

Publisher: CFA Singapore, 10 Anson Road, #25-09, International Plaza, Singapore 079903 Email : info@cfasingapore.org

Tel : +65-6323-6679

Editorial & Production: NextInsight

in this issue...

Larry Cao, CFA Director, Content CFA Institute (Asia Pacific)

Tham Chiew Kit Managing Director Total Portfolio Strategy, Economics & Investment Strategy GIC Pte Ltd

Multi-Asset Strategies

Kasper M. Nielsen, Ph.D. Associate Professor in Finance Academic Director, MS in Global Finance Program Hong Kong University of Science & Technology

Valuing a Distressed Firm

Lee Seng Chee, Partner Capital Projects & Infrastructure, PwC

9

5

Keith Black, Ph.D., CFA, CAIA Managing Director, Curriculum and Exams CAIA

Liquid Alternatives

Naoyuki Yoshino, Ph.D. Dean, Asia Development Bank Institute

Financing Infrastructure Page 2 | July 2018 | Issue 30

13

17

BOARD MESSAGE

Dear Members, I am pleased and honoured to be appointed as President of CFA Singapore and I take this opportunity to express my sincere thanks to all present and past members of the Board, Committee Chairs/Co-chairs and volunteers, staff, and members for their broad support.

In particular, I wish to thank Jan Richards for going the extra mile for the Society during her tenure as the Society’s President from 29 April 2015 to 24 May 2018.

A number of significant initiatives were implemented under her leadership:

• We started the CFA Singapore Career Development

Mentorship Programme which was very wellreceived by mentors and mentees.

• We won the Society Excellence Award that

recognises societies that have made an outstanding global impact in delivering member value and furthering the mission of CFA Institute in their communities.

(CFA Singapore was recognized as the “Build Market Integrity” winner on the merits of our 2016/2017 Save and Invest Portfolio Series program.)

• To grow the members’ surplus, we formed an

Investment Committee headed by our board member Mark Tan, CFA.

• We brought our Secretariat function in-house.

• We made the delivery of our CFA exam prep

courses more professional by partnering Kaplan Learning Institute, a well-established education and training services provider.

On behalf of the Society, I welcome the following members of our leadership who assumed office on 25 May 2018.

Executive Committee

• Deputy President Simon Ng, CFA • Secretary Rasik Ahuja, CFA • Treasurer Alex Ho, CFA Board Members

• • • • • • • •

Arun Kelshiker, CFA Koh Boon Pin, CFA Kanol Pal, CFA Mark Tan, CFA Laurel Teo, CFA Maurice Teo, CFA Joachim Toh, CFA (co-opted on 25 June 2018) Jack Wang, CFA

Our newly constituted board will come together for a half day retreat to review our vision and formulate our strategies for the next 5 years with a view to moving towards CFA Institute’s Society 2.0 initiative. We will update members in due course on how Society 2.0 will be integrated.

Meanwhile, the Society continues to be kept busy operating within its 3 key pillars:-

1. CFA curriculum body of knowledge supported by our Candidate Programme Committee and University Outreach Committee

2. Members activities supported by our Networking

Committee, Professional Development Committee, and Career Development Committee

3. Market integrity initiatives supported by our Advocacy Committee

The CFA Singapore Quarterly | Page 3

BOARD MESSAGE

Ethics Challenge

Public Awareness

A lot more can be done in the area of building market integrity especially in the area of strengthening / building trust in the financial advisory industry.

According to the CFA Institute Trust Survey, only 10% of Singapore retail investors believe that their financial adviser consistently puts their interest first. This is lower than the global average of 35%.

Even before the Save & Invest Portfolio series organized in collaboration with Sunday Times, SGX and MoneySENSE ended its two-year run in February 2018, we started the Mandarin Save & Invest Portfolio series with Lianhe Zaobao in November 2017.

To address this lack of trust, regulators are working hard with industry stakeholders. At CFA Singapore, we recognise that a strong commitment to ethics and transparency is key to earning investors’ trust and confidence. We believe good ethical behaviour begins in school. Hence, the initiative to collaborate with universities to launch Ethics Challenge for its students towards the end of 2018. Participants are given case studies where they are required to apply the CFA Code of Ethics and Standards of Professional Conduct.

Our Mentorship Programme is into its third year running.

We are continuously improving the programme to include more mentees. If you have benefited as a mentee, we encourage you to consider taking on the role of a mentor sometime in the future.

We also embarked on a weekly column named CFA Singapore Insights for Business Times Weekend Edition.

We continue to get our voices heard especially when it involves important but controversial issues such as Dual Class Shares. Our views on Dual Class Shares was published in Business Times on 3 July with the headline, “Disclosure, conversion safeguards for dual class shares fall short: CFA”.

In February 2018, we published on www.arx.cfa a study which established that market manipulation was not significant among SGX listcos. A special thanks to Chan Fook Leong, CFA, who evaluated 6 years of public announcements by listcos for the project. He was assisted by Alan Lok, CFA. Do reach out to us if you have ideas to share on how the Society may better serve members’ needs.

Tan Lay Hoon, CFA President CFA Singapore

www.linkedin.com/company/cfa-society-singapore

Page 4 | July 2018 | Issue 30

www.facebook.com/CFASocietySingapore

www.twitter.com/CFASingapore

Multi-Asset Strategies a qualitative approach Larry Cao: How a MultiAsset Strategy is Better than a Fund-of-Funds Strategy Actively managed equity strategies used to be the bread and butter of portfolio management demand.

Now, that has given way to multi-asset strategies.

To serve investors well, portfolio managers should stay away from short-term investment horizons caused by the industry’s practice of measuring a fund manager’s performance on a quarterly basis.

Fund managers should be allowed to focus on investment outcomes, which are what really matter to investors. We think that multiasset investing is the best tool for optimizing investment outcomes because you want to look at the

overall result of all your investments put together.

The CFA Programme is the only course out there that trains a person in multi-asset investing.

The typical apprentice programme of investment banks on the buyside focuses on specialized skills.

For instance, you either become a chemicals analyst or an industrial analyst. If you are on the sell-side, you learn financial modelling skills.

Apprentice programmes don’t train one to look at all the assets in the finance industry.

What Prevents Fund Managers from Using a Multi-Asset Strategy Most people think Multi-Asset Investing is for quantitative fund managers with a topdown approach. CFA Institute’s publication, Multi-Asset Strategies:

In 2015, State Street asked 300 fund managers around the world what would drive their firm’s business in the coming 3 years. Two-thirds of them said it was going to be multiasset strategies (versus single-asset traditional actively managed equity or fixed income, passive equity or fixed income, or alternative mutual funds).

Most books on multi-asset strategies use mathematical formulae extensively. To make multi-asset strategies more accessible to those of us who are less quantitatively inclined, CFA Institute recently published Multi-Asset Strategies: The Future of Investment Management.

Its editor, Larry Cao, CFA (Director of Content at CFA Institute (Asia Pacific)), and one of the book contributors, Tham Chiew Kit (Managing Director, Total Portfolio Strategy, Economics & Investment Strategy, GIC), spoke to CFA charterholders in Singapore. The presentation was organized by AsiaPacific Research Exchange and took place on 3 May 2018 at Capital Tower.

The CFA Singapore Quarterly | Page 5

The Future of Investment Management, illustrates that people who only understand fundamental investing principles can also use multi-asset strategies.

Some fund managers think: Why do I need to know the whole thing when I only manage a slice of the portfolio? I haven’t seen a fund manager who says: This is not the best time to invest in my asset class. Instead, fund managers say things like: It’s always a good time to invest in emerging markets. But you need to justify to yourself how your product fits into the overall pie. There are times in the market cycle when it is better for a fund manager to stay away from the market.

Larry Cao, CFA Director, Content CFA Institute (Asia Pacific)

In his capacity as director of content for Asia Pacific at CFA Institute, Larry Cao conducts original research and develops educational products with a focus on the investment industry.

Larry has 20 years of experience in the investment industry. Prior to joining CFA Institute, Larry worked at HSBC as senior manager for the Asia Pacific region.

He started his career at the People’s Bank of China as a USD fixed-income portfolio manager.

He also worked for US asset manager, Munder Capital Management, managing US and international equity portfolios, and Morningstar, managing multi-asset investment programs for a global financial institution clientele.

Larry has been interviewed by a wide range of business media, such as Bloomberg, CNN, the Financial Times, and the Wall Street Journal. He is also a frequent speaker at conferences, and his work has been published in academic and industry publications on the subjects of asset allocation, equities, exchange-traded funds, financial planning, fixed income, and retirement and saving behavior.

Larry graduated from the University of Notre Dame with a master’s of business administration degree. He was also a visiting scholar at the MIT Sloan School of Management.

Page 6 | July 2018 | Issue 30

Unless one is managing a purely foreign fund such as foreign reserves, most asset owners started out by investing domestically, and went beyond that into international developed markets, into less developed markets, and eventually into emerging markets. Increasingly, asset owners are investing in alternatives. Those who do not are constrained by requirements such as daily price updates. At the other end of the spectrum are endowment funds that may invest a significant portion of their portfolio in less liquid products such as infrastructure or timber.

What’s Wrong with a Fund of Funds Strategy A fund of funds (FoF) strategy follows the old asset allocation framework. As asset classes grow, FoF simply increases the number of asset classes. If you have 50 to 60 asset classes in your portfolio, you will be completely confused as to what really drives the return and risk of your portfolio.

Secondly, these asset classes are meant to be independent of each other. When you have that many asset classes, the correlation between asset classes increases.

Sometimes, asset classes are added to a FoF portfolio for marketing reasons. If its competitor invests in 15 asset classes, the fund manager would invest in at least 16 just so as to achieve investment product differentiation.

Factors Show What Drives Portfolio Returns A multi-asset strategy is different from a FoF strategy that puts funds under different asset classes together. In multiasset strategy, the portfolio manager understands what drives the returns of the investment products.

Typically, fund managers need to be able to do asset allocation. Once you have done that, you can do security

selection yourself, or you can farm it out. You need to be able to either pick securities or pick funds. If you can’t pick securities or funds, you need to be entirely passive; you need

to be able to pick passive assets such as ETFs. Grantham, Mayo, Van Otterloo & Co. chose to invest in forestry assets instead of gold for long-term capital gains because there is no scarcity of gold that leads to long term price appreciation. Owning timberland made sense because returns have historically come from the biological growth of trees.

The label Factor Investing simply implied that if you invest in a particular factor, you get extra returns from it. The days of Factor Investing are behind us. Recent studies in the US market show that premium from factors is no longer obvious. Risk premium is more obvious in Europe and even more so in Asia.

But generally, this premium is being arbitraged away.

We often talk about “unintended” bets. From a risk management standpoint, factors are a way of looking at whether portfolio risk is according to your investment thesis.

During the oil price run-up to 2007, there were fund managers who invested a significant amount of their portfolio in oil majors, oil equipment companies, agriculture companies, and fertilizer companies. In the US, where ethanol is mixed with gasoline for automotive vehicle fuel, a significant portion of US corn production is used for ethanol.

The fortunes of these companies were dependent on oil prices. During the global financial crisis in 2008, portfolios with a high correlation to oil were hit. With multi-asset strategies, factors give a good picture of what drives the return and risk, which may not be so obvious in the traditional asset allocation model.

Tham Chiew Kit Managing Director Total Portfolio Strategy, Economics & Investment Strategy GIC Pte Ltd

Tham Chiew Kit is head of total portfolio strategy (TPS) in the Economics & Investment Strategy (EIS) department at GIC Singapore. He leads TPS in providing recommendations to GIC management, the board, and the client regarding the construction and management of the GIC portfolio and its active strategies.

In particular, TPS provides market assessment and portfolio analysis to support GIC management and the GIC board in the investment decisions. Mr Tham joined GIC in 1993 as a senior economist in the Economics department. In 1994, he was transferred to the Foreign Exchange department, where he spent 6 years, with his last held position there as a senior invstment manager. In 2001, after a stint at Morgan Stanley, Mr Tham returned to GIC’s Foreign Exchange department and was subsequently deployed to the Investment Policy & Strategy (IPS) department in 2004. In 2011, Mr Tham was appointed head of strategic asset allocation in the newly formed EIS department, following the merger of the IPS and Economics & Strategy departments.

Mr Tham earned an B.A. in economics (2nd upperclass honors) in 1985 and an M.A. in economics in 1989 from Cambridge University. The Singapore Public Service Commission awarded him a President’s Scholarship in 1982.

The CFA Singapore Quarterly | Page 7

Multi-Asset Strategies

GIC’s Investment Framework (2013 annual report)

Tham Chiew Kit: GIC’s Multi- longer-term investment thesis and gestation period. We can have an Asset Philosophy GIC is a fund manager whose clients are the Ministry of Finance and the Monetary Authority of Singapore. We do not manage third party monies.

As a long-term investor, GIC has the leeway to ride through adverse market developments in the short and medium term in order to achieve better long-term outcomes. This is an option rather than an obligation.

If markets have moved to where we think they should be, we take profit or cut losses. We are not obligated to sit on any investment position.

As a long-term investor, we also try to capitalize on our strengths by investing in asset classes like real estate and infrastructure with a

investment horizon that is as long as 20 years.

The most important criteria for judging our performance is a 20-year rolling annualized number net of inflation. During the 1990s and early 2000s, it used to be easier to make money from market returns as well as active alpha activities. Nowadays, we have to be a lot more nimble, innovative and broad-minded when we build a robust, diversified multiasset portfolio.

There are two kinds of risk that GIC pays special attention to: •

Losing a lot of money over a short period of time -- Risk related to big market drawdowns.

•

Deviation from the benchmarks given to us by our clients.

Most of the time, we try to hold an investment portfolio with a strategic asset allocation that will generate the maximum amount of return over the long term, subject to the risk constraints. That has to do with the beta risk that we take.

To generate additional return, we exercise a fair amount of discretion in deviating from our strategic asset class weights. In some of our active strategies, we invest in assets that may not even be in the benchmark.

Our stock-picking activities and deals in the private markets have added considerable alpha.

The need to have clear and strong governance is very important to us.

Hence, there is great emphasis to separating accountability over beta decisions and bottom-up alpha decisions.

E

Page 8 | July 2018 | Issue 30

PVT =

FCFT+1 r-g

PVT = Terminal value in discounted cashflow valuation FCF = Free cash flow T

= Terminal point in time

r

= Discount rate

g

= Long term growth

It is critical to have a high-quality estimate of terminal value, which accounts for most of the total value.

Valuing a Distressed Firm in a disrupted industry Case Study Warren Buffett’s Investment in a Distressed Newspaper Business Financial markets were greatly surprised when BH Media Group, a subsidiary of Berkshire Hathaway, announced on 12 May 2012 an offer to buy Media General’s newspaper divisions for US$142 million. The newspaper industry was once the dominant source of news and information. However, circulation and advertisement revenue declined sharply in the 2000s when news and information became increasingly available on the Internet and social media.

Meanwhile, U.S. newsprint and pulp prices moved in an upward trajectory (except during the global financial crisis of 2008).

At that time, Media General operated 18 TV stations and published 64 newspapers. It accumulated losses of US$765 million from 2008 to 2011. Between 2007 and 2011, it shed almost 40% of its workforce.

Over the same period, it cut capital expenditures form US$74 million to US$19 million. It stopped paying dividends in 2009. The stock fell from a high of almost US$78 in 2004 to $1.20 in October 2011.

In December 2011, Media General had a total debt of US$658 million, of which US$363 million was in the form of a variable-date syndicated bank loan that was due in March 2013. Another US$295 million was in the form of senior secured notes issued in 2010, rated CCC+ and paid quarterly interest at the rate of 11.75% (with face value of US$300 million due in 2017). In addition to its financial leverage, it had pension and post-retirement benefit obligations

Hong Kong University of Science & Technology professor Kasper Meisner Nielsen used a Harvard Business School case Buffett’s Bid for Media General’s Newspapers to discuss with CFA members:​

• Basic valuation tools and techniques

• Practical application of • • •

valuation to business cases Warren Buffett’s decision to invest in the newspaper industry in 2014 Valuation of apps and social network companies What you can (and ca​​nnot learn about business cases from valuation technique

The presentation was organized by the Society’s Professional Development Committee and held at International Plaza on Wednesday evening, 23 May 2018.

www.cfasingapore.org | Page 9

totalling US$455 million, of which US$132 million was underfunded.

In February 2012, Media General announced that it had entered into a refinancing agreement that extended the maturity of the bank loan by 2 years to March 2015. The key condition was the need to raise US$225 million prior to 25 May 2012, to prepay a portion of the outstanding bank loan, and to establish certain liquidity reserves.

Berkshire offered to buy 63 daily and weekly newspapers and their real estate holdings for US$142 million in cash.

The deal excluded all pension and other benefit obligations. In a separate agreement, Berkshire provided Media General with the following loan + warrants deal: • • • • • •

US$400 million term loan and a US$45 million revolving facility.

Term loan interest rate at 10.5% paid quarterly, equal to the company’s existing secured notes (rated CCC+ as at May 2012).

Haircut of 11.5% discount to face value, providing US$354 million of cash to Media General to be fully used for repaying the outstanding bank loan.

Maturity term was 8 years.

Berkshire receives “penny warrants” exercisable within 8 years at 1c per share for 4.65 million Class A common shares (19.9% of Media General’s common shares outstanding).

Berkshire has the option to nominate a director to Media General’s board.

Professor Nielsen’s Analysis Investment Thesis Technological developments changed the speed at which news was produced and delivered. Some newspapers tried to switch a physical hardcopy format to an online subscription model, while others offered content for free. It was hard to be optimistic about the industry, where the growth rate was at best zero.

Warren Buffett saw value in community newspapers that carried local news (as opposed to commoditized international news). Community news included obituaries, weddings, and events of local sports clubs.

He excluded Media General’s Tampa Tribune from the deal because being a metropolitan newspaper in Florida, it did not fit into his investment thesis. The cashflow projections of the company’s newspaper division were positive

Page 10 | July 2018 | Issue 30

but declining. He was not taking over a business waiting to generate cashflows in the future but a business with positive cashflow from day one.

Buffett’s approach was to buy assets based on the pricing of the overall industry outlook. He could create value if the community newspapers were not as adversely affected as the rest of the industry.

He was convinced that there was a community demand that would protect demand for such newspapers.

Risks The service of offering news that interests people is now offered by Facebook, which knows more than newspapers about what its users are doing. The fundamental problem with network economics is that it is the biggest player that has the most value to add, and therefore that

will tend to be most competitive.

Politicians are clamping down on Facebook because it knows so much that it has the position of a monopoly on individuals’ personal information.

The Math 1. The deal was priced at 4 times EBITDA, a deep discount because the industry outlook is very discouraging. The value will increase if actual circulation and cashflows are higher than the average newspaper.

2. Assuming the loan deal was priced correctly with the yield equal to the coupon rate of 10.5%, the market value of the loan was equal to the face value of the loan. The value of the loan deal was the difference between the amount he was lending (US$354 million) and the face value (US$400 million)

Valuing a Distressed Firm

that he would receive: US$46 million.

3. Additionally, the penny warrants were worth 4.65 million shares X (Media General stock price - 1c), or about US$19.4 million.

4. The loan + warrants added US$65.4 million to the deal value in exchange for helping the asset seller to solve its liquidity needs. Effectively, Buffett was paying only US$142 million - US$65.4 million = US$76.6 million for the community newspaper businesses.

5. Rather than ask what is the value of the investment, an alternative perspective was to ask at what growth rate would Warren Buffett break even by paying US$142 million for the deal. Without the loan and warrant deal, at a discount rate of 11%, a discounted cashflow analysis shows that the breakeven long-term growth rate was -1%. With the loan and warrant deal, breakeven longterm growth rate was -21%.

General Advice About Valuation Narratives from Industry Macro to Firm Before we open up the spreadsheet to calculate the valuation model, we should always think about the

value creation process behind the firm that we are valuing. We need to understand the company’s history and background, where the firm is coming from, what its main idea is, what products it has, what its competitive edge is, and how capable the management team is.

narrative and the numbers.

We also need to understand the industry: the market outlook and competitive strengths. If the company introduces a new product, how are its competitors going to respond.

3. What is the revenue model?

Finally, we need to understand how that outlook is affected by the macroeconomic environment.

What changes are there in the political landscape? Is there going to be a trade war between the U.S. and the rest of the world? How is all that affecting the value of the firm?

The narrative should always be about the firm’s forward-looking profitability because that captures its future cashflow which will be used in the valuation exercise.

Feedback Loop between Narrative and Numbers A narrative can be a base case. It can go up to an option value scenario.

By conducting sensitivity analysis in our valuation exercise, we get to understand how sensitive is the value of the firm to the underlying economic factors.

Once we understand how sensitive the value of the firm is to the economic factors, we understand the narrative better. There is a feedback loop between the

Connecting the Narrative to the Drivers of Value 1. Understand the size of the market.

2. What is the market share the firm may get?

4. What is the profit margin?

5. How does the product allow the firm to earn economic rent?

6. What future investment needs are there in order for the firm to stay competitive?

7. Is this an industry with a free cashflow identity where once I’ve sunk in my investment, I get to enjoy free cashflow in the future?

All of that will be expressed as free cashflows in the spreadsheet. You have to keep in mind that different narratives will give different numbers.

Each of us will have a different narrative. We can put more or less weight on the base case, as opposed to the high growth or option case.

Valuation is never an exact science.

At best, we end up with a range of possible valuations of a firm. Yet, valuation is a worthwhile process because it enables us to learn something about the drivers of value.

Value Drivers vs Uncertain Factors Consider a PRC energy company intending to buy a coal mine in Australia in order to ship coal back

www.cfasingapore.org | Page 11

to China for electricity generation. When we look at the PRC firm’s investment thesis, we know there are at least 25 economic factors that impact our investment decision. We know that coal price is going to be important. We know that exchange rates are going to be important because coal is priced in USD and its labour in Australia is going to be paid in Australian dollars. There is going to be political risk -- maybe the new government in Australia is going to increase royalties on mines.

The valuation exercise enables us to understand how sensitive the firm’s value is to changes in each of these factors. Instead of having a list of 25 unknown factors, we can use sensitivity analysis to rank the importance of the factors. If we can boil the 25 factors down to 3 that drive valuation, we are in a better position to make an investment decision.

It is almost impossible for us to know the future price of coal. We are not able to precisely guess the exchange rate risk. But being able to narrow down the factors that are driving valuation helps us to understand when we are making a good investment.

Kasper M. Nielsen, Ph.D. Associate Professor in Finance Academic Director, MS in Global Finance Program Hong Kong University of Science and Technology

Kasper Meisner Nielsen is Associate Professor of Finance at Hong Kong University of Science and Technology. Professor Nielsen previously taught at Chinese University of Hong Kong and Copenhagen Business School, and was a Research Fellow at Centre for Economic and Business Research in Copenhagen.

He received a BS, a Master and a Ph.D. in economics from the University of Copenhagen. His research interest is applied microeconometrics in the areas of corporate and household finance.

He has studied the consequence of family succession on firm performance, the value of independent directors, and why individuals shy away from stocks. His work has been published in academic journals including The Quarterly Journal of Economics, Journal of Financial Economics, Review of Financial Studies, Management Science, Review of Finance, Journal of Corporate Finance and Journal of Banking and Finance. His research has been awarded with external financing from competitive research grants on several occasions.

Long-Term Outlook is Key We are going to project cashflows into the future, maybe 5 to 10 years down the road. Beyond this, we are not comfortable with coming up with annual projections of cashflow. So, we need simplifying assumptions that help us to capture the terminal value beyond that terminal point of visibility. Beyond that point, we assume that cashflows grow at a fixed rate.

In the long term, most firms grow at the speed of the economy.

If the company is in an emerging industry, the terminal growth rate may be greater than economic growth. If it is in a disrupted industry, the terminal growth rate may be lower than economic growth.

When we value a PRC company, we are not going to use China’s current economic growth as its long-term growth rate. China’s economic growth rate will eventually slow down. So, we are looking at a long-term growth rate of a developed economy of typically 2% to 3%. That’s the anchor point for which we can allow differences only if it is supported by the narrative.

E

Page 12 | July 2018 | Issue 30

Liquid Alternatives The four broadest and largest categories of alternative investments are: hedge funds, private equity, real assets, and structured products.

Many private placement investment funds are referred to as hedge funds, a term associated with incentive fee structures that can attract top investment talent.

Unlike traditional mutual funds that are highly regulated and available to the retail public, hedge funds can use leverage and sell short.

They are typically available only to qualified institutional and wealthy individual investors with minimum investments often starting at $500,000 or more. The essential characteristic of a hedge fund is the use of skill-based trading strategies that generate returns with substantially different risk

and return exposures compared to traditional mutual funds.

In most jurisdictions in the world, hedge funds are not freely available to individual investors. Hedge fund managers are usually given the largest investment flexibility because their management fees are the highest. An institution that engages a hedge fund manager is able to have a highly customized portfolio. For example, the institution can say, “Don’t include oil stocks” in my portfolio.

Hedge Fund Incentive Structure May Encourage Manager Risk-taking The flip side is: Hedge funds don’t have transparency. They may not necessarily disclose their investment positions. If a hedge fund manager gets 2% in management fees plus 20% of investments gains but need not be accountable for losses, he may take unnecessary risk.

Keith Black, Ph.D., CFA, CAIA, Managing Director of Curriculum and Exams for the CAIA Association, addressed CFA charterholders in Singapore on 17 May 2018 about the growing number of investment managers that have made products available in a “liquid alternatives” format. These products comply with UCITS or the Investment Company Act of 1940 regulations, are subject to significant regulatory differences from private placement products, and are widely available to retail investors.

The event was organized by the Professional Development Committee.

Attendees at the seminar were given a complimentary copy of the book “Alternative Investments: A Primer for Investment Professionals.” A free download of this book can be found at the website of the CFA Institute Research Foundation at https:// www.cfainstitute.org/en/research/ foundation/2018/alternativeinvestments-a-primer-for-investmentprofessionals.

www.cfasingapore.org | Page 13

One way to fix that was to require the fund manager to have a certain amount of his personal funds invested in the portfolio alongside the investor.

Hedge Funds Lock-up Period Historically, most alternative investments were offered in limited partnership structures. These private placement structures are exempt from securities regulations as they are available to only a limited number of high net worth investors. So, transparency is not mandated and there is maximum investment flexibility.

There may be a minimum time (such as one to 3 years) that the investment monies will stay locked up. Some hedge fund managers need a 3-year lock-up period because they are investing in distressed debt, aircraft leases, or unlisted stock.

These illiquid or complex assets may earn higher long-term returns.

Keith Black, Ph.D., CFA, CAIA Managing Director Curriculum and Exams CAIA Association

Keith Black has over 25 years of financial market experience, serving approximately half of that time as an academic and half as a trader and consultant to institutional investors.

During his most recent role at Ennis Knupp + Associates, he advised foundations, endowments and pension funds on their asset allocation and manager selection strategies in hedge funds, commodities, and managed futures. Prior experience includes commodities derivatives trading, stock options research and CBOE floor trading, and building quantitative stock selection models for mutual funds and hedge funds.

Dr. Black previously served as an assistant professor and senior lecturer at the Illinois Institute of Technology. He contributes regularly to The CFA Digest, and has published in The Journal of Wealth Management, The Journal of Trading, The Journal of Investing, and The Journal of Alternative Investments, among others. He is the author of the book “Managing a Hedge Fund,” as well as the coauthor of the 2012 and 2015/2016 second and third editions of the CAIA Level I and Level II textbooks.

Dr. Black was named to the Institutional Investor magazine’s list of “Rising Stars of Hedge Funds” in 2010. Dr. Black earned a BA from Whittier College, an MBA for Carnegie Mellon University, and a Ph.D. from the Illinois Institute of Technology. He was a member of the inaugural class of the Chartered Alternative Investment Analyst (CAIA) candidates.

Page 14 | July 2018 | Issue 30

However, this lock-up period is not necessary for hedge funds trading long-short equity, or if all of their underlying portfolio assets are in the futures markets.

Democratization of the Hedge Fund Business We are seeing an increasing availability of hedge fund-like strategies in liquid markets. Some of these products are known as liquid alternatives, hedged mutual funds, or public alternatives. We are seeing a tremendous growth in the U.S. of 40 Act vehicles that can invest in hedge fund structures.

Hedge fund industry assets reached US$3.215 trillion as at 31 March 2018, according to Hedge Fund Research. There is over US$400 billion invested in liquid alternatives in the U.S. alone and an additional €450 billion in the UCITS market, up from less than a quarter of that 10 years ago. Liquid alternatives are now one-quarter of the global hedge fund business.

With liquid alternatives, the retail investor can invest in longshort equity, market neutral equity, long-short credit, nontraditional bond funds, currencies, commodities, volatility, and multi-manager products. All these are available in a daily liquid format. There is retail investor demand for hedge fund strategies as they offer diversification from a stock and bond portfolio.

Not all alternative investments can be found in liquid format.

For example, private equity or distressed debt are not common objectives for liquid funds.

Returns: Liquid Alternatives vs Hedge Funds

Regulation of Investment Funds

A 2013 study by Cliffwater showed that the performance of liquid alternatives managers is highly correlated with that of hedge fund managers. The study found that the returns generated by liquid alternatives managers were 42bps to 94bps lower a year compared to hedge funds. That may be due to the rules the liquid alternative managers are constrained by. Even though liquid alternative managers had lower fees, they also had lower returns than hedge fund vehicles.

•

Investment funds generally referred to as mutual funds are registered with regulators and can be offered to all investors

•

In the US, mutual funds are regulated by the Investment Company Act of 1940

•

In Europe, UCITS (Undertakings for Collective Investment in Transferable Securities) regulations govern the mutual fund community

Liquid alternatives are largely for individual investors. If you have been an institutional investor that has used a private hedge fund business for some time, you are going to continue to allocate to that private hedge fund business and pay fees of 2% + 20% rather than move into the liquid alternative space.

•

In Canada, National Instrument regulates investment funds

•

Over 90% of UCITS and 40 Act funds follow traditional investment strategies, such as longonly stock and bond mutual funds and ETFs

•

A growing portion of UCITS and 40 Act funds are being managed as “liquid alternatives,” which are registered funds managed using alternative investment vehicles or strategies.

How to Invest in Liquid Alternatives

81-102

If we are going to build a portfolio with liquid alternatives, we start by diversifying the traditional portfolio of stocks and bonds. We can start by building a portfolio that is 60% invested in global equities and 40% in global fixed income.

Such a portfolio has had a return of 5% since 2008 and a risk of 10% (33% drawdown in 2008).

The liquid alternatives products that diversify the portfolio are: Managed futures in the UCITS (0.1 correlation to equities and 0.4 correlation to bonds); Currency manager (0.01 correlation to stocks and 0.06 correlation to bonds); Volatility funds (-0.4 correlation to stocks and zero correlation to bonds).

Correlation of Liquid Alternatives to Stocks and Bonds.

Source: CAIA, Morningstar, Bloomberg. US Stocks are represented by the S&P500 TR; US Bonds are represented by the Barclays US Agg; Global Stocks are represented by the MSCI World Free NETR USD and Global bonds are represented by the Barclays Global Agg Index Hedged

www.cfasingapore.org | Page 15

Liquid Alternatives Products with a high correlation (such as long-short equity with a 0.83 correlation) to the stocks that are already in our portfolio do not diversify our equity risk.

If we invest 10% in long-short equity, 10% in managed futures, or 10% in volatility, our return would still be 4.7% for all these strategies but our risk has come down from 10% to 8%.

Our drawdown improves to as little as 27% instead of 33% in the stock and bond portfolio.

Even though we moved only 10% of our portfolio to liquid alternatives, we would have been able to cut our drawdown by up to 600bps during the global financial crisis. If we had added 20% to 30% of liquid alternatives into our portfolio, we could reduce that drawdown to as little as 20%.

Adding liquid alternatives to a stock and bond portfolio reduces risk faster than it reduces return. In an example of a 60:40 stock and bond portfolio, we moved 10% of each asset class to managed futures and equity long-short. Since 2008, there has been a very small difference in terminal welfare. However, it would have made a huge difference in drawdown during a financial crisis.

Due Diligence: Hedge Funds vs Liquid Alternatives Due diligence on private hedge fund managers is difficult because they may not necessarily be in databases. Firstly, you need access to the manager. Then you need to have their track record, visit them and ask them questions. Some of them will tell you they have really good returns but won’t tell you where the returns come from.

Performing due diligence on liquid alternatives managers is more feasible because all of them have publicly disclosed data. They are in databases such as Morningstar and UCITS Alternatives. These databases list the underlying managers for liquid alternatives products. These underlying managers are listed because they file prospectuses, report a daily NAV, and have regular reports on their portfolio holdings.

Most managers of liquid alternatives have less than a 5-year track record.

As these managers started after 2008, there is no record of how they performed during the global financial crisis.

A Barclays study has found that fund managers who move into liquid alternatives tend to outperform if they had a long-short track record compared to managers with a long-only track record. The shorting experience is different from the long-only experience.

E

Page 16 | July 2018 | Issue 30

Financing Infrastructure in Developing Economies Naoyuki Yoshino, Ph.D. Asia Development Bank has estimated Asia needs annual infrastructure investment of US$1.7 trillion (5.9% of GDP) from 2016 until 2030 to maintain its growth momentum, tackle poverty, and respond to climate change.

Asia can be divided into the following regions: Central Asia, East Asia, South Asia, Southeast Asia, and the Pacific. The needs are the greatest in South Asia and the Pacific, where infrastructure investment needs have been estimated to be as high as 8.8% to 9.1% of GDP. As public sector funding has fallen short of such huge investment needs, governments have found it necessary to seek private sector participation for infrastructure projects. Needs are greatest in

the power sector, accounting for 51.8% of the investment estimates (the others being transport, telecommunications, water & sanitation). The second greatest need is in transport, accounting for 34.6%.

High Risk of Infrastructure Investments Private sector players face the risk of infrastructure ventures being halted when governments are changed, especially in developing regions. Over time, costs may exceed what was budgeted as a project may take as long as 5 to 6 years to construct. Upon completion, the project needs to be operated profitably and maintained at an acceptable service quality standard. Foreigners who invest in infrastructure projects also face exchange rate risk.

In the past, most of the return to private sector investors came from user charges. However,

The governments of developing economies recognize the catalyzing role of infrastructure investment for sustainable growth.

At part 2 of a seminar on financing infrastructure, the following distinguished guest speakers shared their views on how commercial companies can participate in such projects: • Professor Naoyuki Yoshino, Ph.D. (Dean and CEO of Asia Development Bank Institute and Professor Emeritus at Keio University) •

Lee Seng Chee (PwC Singapore Partner overseeing its Capital Projects and Infrastructure division)

The event was jointly organized by CFA Singapore’s Advocacy Committee and the Asia-Pacific Research Exchange. It took place on 11 April 2018 at Capital Tower. CFA Singapore Board Member Kanol Pal, CFA was the event facilitator.

Part 1 was published in the January 2018 issue of the CFA Singapore Quarterly.

The CFA Singapore Quarterly | Page 17

user charges are often regulated by the government as electric power and water supply are necessary utilities for people. As user charges cannot be set too high, fees collected from users usually cannot cover the total costs of construction and operation. Because of this, it has been traditionally difficult for private sector investors to participate in infrastructure projects even though PrivatePublic Partnership has been often advocated.

If spillover tax revenues created by the infrastructure project can be returned to the investors, the rate of return on infrastructure investments will increase. That way, long-term funds such as pension funds can invest in infrastructure.

Naoyuki Yoshino, Ph.D. Dean and CEO Asian Development Bank Institute

Naoyuki Yoshino is Dean and CEO of the Asian Development Bank Institute and Professor Emeritus at Keio University, Tokyo, Japan. He obtained his Ph.D. from Johns Hopkins University (United States) in 1979 where his thesis supervisor was Sir Alan Walters, economic adviser to former British Prime Minister Margaret Thatcher.

He was named Director of the Japan Financial Services Agency’s (FSA) Financial Research Center (FSA Institute) in 2004 and is now Chief Advisor. He was appointed as Chair of the Financial Planning Standards Board in 2007. He has served as Chairperson of the Japanese Ministry of Finance’s Council on Foreign Exchange as well as its Fiscal System Council (Fiscal Investment and Loan Program Section). Additionally, he has been a Board Member of the Deposit Insurance Corporation of Japan and President of the Financial System Council of the Government of Japan.

He was nominated for inclusion in Who’s Who in the World for 2009 and 2013, and was named one of the Top 100 Educators in 2009. He obtained honorary doctorates from the University of Gothenburg (Sweden) in 2004 and Martin Luther University of Halle-Wittenberg (Germany) in 2013. He also received the Fukuzawa Award in 2013 for his contribution to research on economic policy.

Page 18 | July 2018 | Issue 30

I propose disbursing an incremental tax revenue stream to the infrastructure investors that is large enough to mitigate these risks. For example, the construction of a highway creates many new industries within the vicinity of the railway stations. New commercial and residential buildings will be constructed. Property tax, income tax, corporate tax, and sales revenues from the vicinity will increase.

In the past, all these tax revenues went to either the central or local government. Infrastructure investors never received any monies out of these tax revenues. When investors are compensated only from user charges, the rate of investment return on infrastructure projects is very low.

Good infrastructure can create a large amount of spillover tax revenue in the region. One example is the Southern Tagalog Arterial Road (STAR) in the Philippines that was built to improve road linkage between Metro Manila and Batangas International Port. During each of the 2 years of construction, tax revenue to Batangas City increased by over 25% annually. When the highway was completed, tax revenue decreased slightly compared to during the construction period. By the 4th year after the highway was completed, tax revenue had almost doubled compared to during the construction period. Tax revenue to Batangas City continues to grow every year.

Lee Seng Chee The Belt and Road (B&R) initiative is an endeavor of unprecedented scale, impacting a third of the global economy with a reach of 65 countries on 6 economic corridors as follows: •

China - Central Asia - West Asia

Financing infrastructure in developing economies

PwC chart: China Perspectives - Different Positioning of Key PRC cities

•

Bangladesh - China - India Myanmar

•

China - Mongolia - Russia

•

China - Pakistan

•

China - Indochina Peninsula

Asian Infrastructure Investment Bank (AIIB) was set up to support multilateral organizations such as the World Bank and Asia Development Bank that have been doing much work to accelerate infrastructure development in emerging markets. AIIB is not just a China play. There is a lot of participation from other countries.

China is looking to use B&R to showcase its growing technical excellence and demonstrate its compliance with globally recognized standards for technology, safety, and sustainability.

The initiative addresses China’s industrial overcapacity, allows it to internationalize its currency, and gain global recognition. It also

increases exports and facilitates trade.

Many countries with emerging economies predominantly rely on external technical and financial assistance for infrastructure development. They rely on financing provided by multilateral banks on a bilateral basis in order to fund the development of infrastructure assets. Developing an infrastructure asset can be very complex for an emerging market.

Most of the time, the problems we find in these projects are related to a lack of capacity and competencies.

The agencies responsible may not have the resources to develop a mega project. Without external support for these agencies, a number of these projects will probably not materialize.

Infrastructure investment plays a very important role in developing an economy. The multiplier effect

extends beyond the value of the investment in each of these projects. Every time you build a toll road, a public hospital, or a public school using frameworks that attract private sector money, you are looking at widening and deepening the socio-economic impact in these countries.

Over time, without developing infrastructure, economic development will stall. That can potentially become a very big problem that brings instability to the region. Asia is home to a large population with household GDP way below US$10,000 per annum in many countries. B&R is not the only infrastructure program around the region, but it can potentially play a big role because of the amount of support from a large number of participating countries, especially from China. China and major economies like Japan are expected to play big roles.

The CFA Singapore Quarterly | Page 19

Over the last 10 years, China has realized that economic growth generated from the traditional coastal region and in the south has increased the cost base. Some traditional industries that have fared very well in those parts of China are now too expensive. Over the last 10 years, China started the “Go West” strategy.

It is developing in central parts of China such as Chengdu and Chongqing. Besides supporting the local industries and local markets within China, one huge potential of provinces like Yunnan or Sichuan is really to connect to other Asian countries at the border of China. The challenge of exporting goods and services through that channel is the general lack of infrastructure in those areas.

Lee Seng Chee Partner, Capital Projects & Infrastructure PricewaterhouseCoopers Singapore

Lee Seng Chee is a Partner with PricewaterhouseCoopers Singapore and he provides financial advisory services in the Capital & Infrastructure projects. He has extensive experience (>17 years) in financial analysis, structuring, finance raising and M&A activities in both buy and sell side, government and private sector advisory roles, including expertise in Public Private Partnerships, Private Finance Initiatives frameworks.

He has advised in the development of a number of milestone infrastructure projects and transactions in Asia and Europe covering sectors including power, water/waste water treatment, transport infrastructure (toll roads, bridges, ports, mass rapid transport, airport etc). Mr Lee has worked with many government agencies, major projects finance institutions, infrastructure funds, strategic investors (eg developers) and multilateral/bilaterals donor agencies on infrastructure development, investments and divestments.

In addition to lead financial advisory roles, he also provides valuation advice and financial modelling to assist clients to assess business decisions. Prior to joining PwC in Singapore, he worked on project finance transactions across Europe whilst with PwC London for more than 7 years. Seng Chee graduated from the London School of Economics (UK) and is a Fellow of the Institute of Chartered Accountants in England and Wales.

Page 20 | July 2018 | Issue 30

Discussion on making projects bankable

Some of the projects that we are now very active in include the toll road projects that help to promote the cross-border trade. There are many such projects, especially along the Mekong river region going through Laos that will better connect China with places such as Thailand, Vietnam, and Myanmar.

The connectivity is not only via roads but also via shipping lanes where we are seeing a flurry of M&A activities.

There are new port developments and acquisitions of existing ports for expansion. That will also facilitate more trade within the region. Besides plans for Chongqing and Kunming, there are also specific plans for various cities to support the wider area of the B&R initiative. (Refer to map: China Perspectives - Different Positioning of Key PRC cities) Current Funding of B&R Programme The total financing of major B&R infrastructure projects amounted to an estimated US$186 billion of investments as at the end of 2016, including: •

Silk Road fund - US$6 billion

•

Policy banks - US$110 billion

•

Commercial banks - US$67 billion

•

Multilateral banks - US$3 billion

We think this pie will continue to grow and the proportion of contribution from the various sources will continue to change. One challenge about infrastructure projects is the development of a very sound financial and economic case.

The opportunity exists for sponsors who are willing to take a long-term view on these investments. All private sector investments will need some kind of return. Most of these concessions are between 25 to 30 years. Some concessions even extend beyond the 30 years. These concessions give

s

private sector companies the right to operate the business and to collect the relevant revenues.

Financing infrastructure in developing economies

If the economic case for these infrastructure projects can be strong, we can expect more participation by private sector companies and commercial banks.

The Basis for Joint Ventures There is a clear role in the following areas that commercial companies can participate in: •

Banks to provide project financing for these projects

•

Insurance companies

•

Asset managers looking to deploy funds for returns with stable longterm cash flows

•

Strategic investors who are developers of the infrastructure or suppliers of materials.

In my experience, there are situations where PRC SOEs welcome foreign partners. Some of these projects are relatively new territories for them.

Over time, many of such PRC companies gained greater appreciation and awareness of the different standards and environment as they venture out of China. Some of the earlier forays that PRC companies ventured into (such as the African continent back in the 1990s and certain forays into Southeast Asia) have not always been smooth sailing. Sometimes, they may feel the need for a joint venture partner to help them navigate around the hurdles.

By and large, PRC SOEs have an advantage in construction work because of organizational scale. They are able to deploy a large number of personnel required to undertake projects. In this respect, the opportunities for partnership in construction may be limited.

Construction projects can be classified into offshore and onshore. Some of the civil engineering work can be undertaken by local services providers. We see a lot of sub-contracting in that regard. The teams that undertake such projects are made up of professionals and experts from various disciplines.

Professionals that wish to play a role in the infrastructure sector may wish to align their skillsets to the delivery of these projects.

E

The CFA Singapore Quarterly | Page 21

Networking

Andy Lopata shares on how to network with confidence (8 May, The Exchange @ Asia Tower)

JP Morgan Run on 26 April

CFA Singapore CrossFit 2 (3 April, The Lawn @ Marina Bay)

Page 22 | July 2018 | Issue 30

Professional Development

Mido Shammaa, CFA, FRM, discussed Stock Selection through a Mult-Factor Model based on a Weight-of-theEvidence Approach (9 May, SMU).

HKUST Associate Professor and Academic Director, MS in Global Finance Program, Kasper Nielsen, (right) discussed valuation of distressed firms (23 May, CharterNexus).

Managing Director, Total Portfolio Strategy, Economics & Investment Strategy, GIC, Tham Chiew Kit, discussed how GIC adopted multi-asset strategies (3 May, Capital Tower).

PwC Singapore Partner, Lee Seng Chee, (right) discussed Opportunities for Financing Infrastructure on the Belt & Road Regions (11 April , Capital Tower).

Barbara Stewart, CFA discussed Smart Women and Risk-taking (10 April, Capital Tower)

The CFA Singapore Quarterly | Page 23

Career Development

q Wong Yuhan (left) trained mentors and mentees on tactful communications at the Mentorship Program Launch on 2 April.

The CFA Singapore Quarterly features the latest in thought leadership, best practices, and investor education activities of investment professionals in Singapore. Written by a financial journalist for veterans as well as those aspiring to greater heights as an investment professional, this quarterly newsletter commissioned by CFA Singapore is produced by NextInsight (www.nextinsight.net) and circulated to about 10,000 CFA charterholders and program candidates. Email or call Sim Kih ( simkih@nextinsight.net ) at 6438-2990 for feedback and inquiries.