Illiquid assets
Roger Ibbotson Are investors rewarded or penalized for holding illiquid stocks?
Sven-Christian Kindt Exploring the upside of new illiquid alternatives.
Alexander Ineichen Hedge funds overcome recent challenges.
Carol Franklin Trees represent a growth opportunity for the patient investor.
03
Standard financial theory tells investors to carefully assess the tradeoff between return and risk. Liquidity is a third key consideration. This
Global Investor (GI) is about the liquidity and illiquidity of individual
assets and overall financial markets. Just as risk and return are uncertain before the fact, so is liquidity. Some assets may appear highly liquid, only for their liquidity to suddenly vanish. Moreover, changes
in liquidity often correlate with shifts in risk. As our article on fixed
income (page 62) points out, some more exotic bonds become very
hard to sell just as their perceived risk increases, and when less liquid
assets are pooled in typical (open-end) funds, such difficulties can
be amplified (see page 24).
This does not imply at all that we would advise against investing
in illiquid assets. In fact, assets that eventually generate high returns
are very often highly illiquid. Those who invested in Apple, Google
or Microsoft when they were small (unlisted!) ventures run out of
garages garnered huge returns. Apart from private equity, this GI
covers a broad range of other more or less illiquid assets ranging
from forests to farmland to infrastructure, and from real estate, the
most common of illiquid assets, to the most exotic passion investments. We also look at the pros and cons of investing in hedge funds,
which are not necessarily particularly illiquid, but where the sources
of return are often harder to identify than those of other more visible
illiquid assets.
Adrian Orr, CEO of the New Zealand Superannuation Fund, known
for its innovative investment philosophy, points out (page 26) that
even investors with long horizons should gauge the liquidity of their
overall portfolio carefully: investments in illiquid assets should be
balanced by some that can be easily sold. This rule is of even greater importance for private investors whose investment horizon is
typically shorter and where the potential for a drastic change in
p ersonal circumstance (and thus need for liquidity) is that much more
pronounced. The temptation of abandoning such caution seems particularly high at a time when both nominal and real expected returns
on the most liquid of assets are so meager. Conversely, investors
should avoid overpaying for liquidity: Professor Ibbotson (page 10)
argues that investors tend to overrate (and thus overpay for) the
b enefits of owning large cap stocks. The fact that these assets can
be traded in almost any circumstance may not only render them
more expensive but also prone to excessive price gyrations. In sum:
make sure that the analysis of risk and return is complemented with
a careful review and stress test of the liquidity of assets and
investment vehicles.
Giles Keating, Head of Research and Deputy Global CIO
04
THE ALLURE OF
LIQUIDITY
CURSE OR BLESSING?
TEXT MARKUS STIERLI Head of Fundamental Micro Themes Research
ILLUSTRATION FRIDA BNZLI
What do we know
about liquidity?
A particular focus of this Global
Investor is on market liquidity.
By this we mean the presence
or absence of the ability to
sell (liquidate) an asset quickly,
without impacting the market
price significantly, and without
institutional constraints.
Measuring market
liquidity
For many asset classes, bid-ask spreads are
a convenient and straightforward way to measure market liquidity, with declining (tightening) spreads indicating greater liquidity, and
vice versa. The spread is simply the cost that
you would incur if you were to sell an asset
on the market and immediately purchase it
back. But, as we will discuss throughout this
Global Investor, the concept of market liquidity is more complex than that. To start with,
the bid-ask spread is not easy to measure for
many assets, such as real estate. Moreover,
market liquidity typically varies dramatically
Liquidity
has many
meanings
In the wake of the financial
crisis, the liquidity of the
f inancial system became
05
06
07
08
09
Contents
Global Investor 1.15
10
42
16
44
Amid rising interest in less liquid alternatives, Sven-Christian Kindt points out the
reward for sacrificing unneeded liquidity.
18
21
24
26
Attractively consistent
At the helm of the New Zealand Superannuation Fund, Adrian Orr talks about
patience, opportunity and very long horizons.
30
Talking teak
She has branched out. Carol Franklin has
a diverse background including language,
insurance and plantation ownership.
39
Institutional investment
in t imberland
48
52
56
In passion we trust
58
62
No exit?
10
11
Liquidity premium
Psychology
and (il)liquidity
Maintaining a certain amount of liquidity in a portfolio is fully justified, but investors tend
to pay up too much for it while underestimating the extra returns from holding illiquid assets.
The o verpricing of liquidity seems to be greater in equities than in bonds, in part because
in equities the price is strongly influenced by stories, whereas in bonds it is dry mathematics.
INTERVIEW BY OLIVER ADLER Head of Economic Research, JOS ANTONIO BLANCO Head Global MACS,
SID BROWNE CIO and Head of Research Liquid Alternatives
12
Whats
especially
interesting in
liquid markets
is that giving
up a little
bit of liquidity
actually
can have a
surprisingly
big impact.
Roger Ibbotson
How Moodys
measures
liquidity stress
n periods of market stress, investor scrutiny often moves onto lower-rated financial instruments that have been issued
with a premium yield level attached.
C oncerns about the ability of issuers to meet
ongoing cash obligations for coupon payments
can lead to investor flight from speculative
bonds, just at the moment when those issuers
most need to shore up their finances to remain
in business. Classic examples might be riskier
consumer finance companies, smaller oil and
gas firms, and heavily leveraged property
d evelopers. If the stress period persists, such
issuers are often unable to raise suffic ient
short-term debt to maintain their trading
a ctivities and, if undercapitalized, they may
even fail.
Defaults in this riskier zone can prove contagious, both because of the effect on other
parties exposed to a given sector or deal, and
due to the psychological effect on the gener
al investing public. A vicious illiquidity circle
can develop, as occurred in real estate loans
in 20082009, and may require government
intervention and ultimately debt write-downs.
Liquidity, a key element of credit analysis
13
Article by
John Puchalla, Senior Vice President,
Corporate Finance Group at Moodys
Co-Author
Gregory Fleming
Senior Analyst
+ 41 44 334 78 93
gregory.fleming@credit-suisse.com
14
Roger Ibbotson
Private equity
in emerging
markets
15
1
The untapped potential
of emerging markets
Emerging markets make up:
39%
of global output
18%
14%
Markus Stierli
Fundamental Micro Themes Research
+41 44 334 88 57
markus.stierli@credit-suisse.com
11%
Nikhil Gupta
Fundamental Micro Themes Research
+91 22 6607 3707
nikhil.gupta.4@credit-suisse.com
Global opportunity
High expectations
USD 29 bn
+97%*
USD 4 bn
+327%*
30
20.8
20
10
0
2009
*2014 vs 2009
5
Data sources used for the article: Datastream, Emerging Market Private Equity Association, Preqin
2014
In search of exit
15.7
8%
5%
2.7
6.9
China
5.5
4
India
0.6
1.5
Brazil
0.1
Nigeria
1.5
0.1
Russia
2009 2014
0.3
South Africa
7%
22% 3%
2007
454
Financials
253
415
Telecoms
126
242
Consumer
goods
63
119
Oilandgas
539
42
Basic
materials
458
40%
145 exits
50%
USD 9bn
PE investments in 2009 ,
USD mn
2014
83 exits
65%
PE investments in 2014 ,
USD mn
USD 38bn
16
Investors are increasingly showing appetite to commit to less-liquid alternatives. This includes
investment opportunities in areas such as private equity, private debt and real assets. According
to a recent study, shifting from liquid assets in which the primary investment return results
from the markets (or benchmarks) movements to less liquid investments in which the primary
source of the return is due to a fund managers skill at navigating an investment to a successful
outcome typically results in a median return premium of 20%27% over a funds life, and
more than 3% per year. This illiquidity premium can be further enhanced by investing with the
best-performing managers. These managers typically generate top-quartile investment returns
and outperform the median performance benchmark by as much as 20 percentage points.
Despite the opportunity to enhance overall portfolio returns (while reducing exposure to daily
market volatility), individual investors tend to be under-allocated to illiquid alternatives relative to
institutional investors. One oft-cited reason is the restriction on withdrawals of ten years or
longer before fully returning capital and profits to investors. However, the recent growth of shorter
duration and yield-producing investment strategies, such as direct lending to small and mediumsized enterprises, coupled with the emergence of a secondary market for early liquidity,
may result in greater comfort with and more appropriate allocations to illiquid alternatives.
AUTHOR SVEN-CHRISTIAN KINDT
Liquidity
trends
in illiquid
alternatives
17
Relative to individuals, many institutional investors with long investment horizons, such as
pension plans (with their liabilities for retirees)
and endowments (with their ongoing operating
budgets), have built up significant allocations
to illiquid alternatives, as shown over the last
two decades. In 2013, the average US endowment
held a portfolio weight of 28% in alternative
assets, versus roughly 5% in the early 1990 s.
A similar trend is evident among pension plans.
In the early 1990 s, pension plans held less
than 5% of their portfolios in less liquid alter
natives; today the figure is close to 20%.
Having a long-term investment horizon may give
more patient investors an edge in harvesting
the illiquidity premium. They can be rewarded for
sacrificing liquidity that they do not need.
Venture capital
14
Manager dispersion
increases as illiquidity grows
12
16
Private equity
8
6
4
2
Real estate
Small equity
10
Global
government
bonds
40
Hedge funds
20
High yield
10
Median
10
Illiquidity estimates
28%
19.4%
30
US fixed
income
Deposits
Allocation to alternatives
% of investment portfolio
Top decile
2nd quartile
3rd quartile
bottom decile
2%
20
Long-only Long-only Hedge
fixed income equity
funds
Private
equity
Pension
Endowments
Individual
investor
Liquidity options
Historically, illiquid investment propositions such as venture capital and private equity funds required ten years or longer before fully returning capital
and profits to investors. However, the growth of shorter-duration and yield-producing investment strategies and a secondary market for early liquidity may
result in greater comfort with allocations to illiquid alternatives. The strategies outlined below are only a small subset of more liquid options available to
the investment community. These, and others, should make it easier for individual investors to sacrifice liquidity that they do not need in order to capture
(some of) the illiquidity premium.
Secondary strategies
The private debt market has seen strong growth since 2008, primarily
driven by direct lending funds. According to alternatives data provider Preqin,
over 200 private debt funds have raised in excess of USD 100 billion of
new capital commitments in 20132014. Private debt is characterized by
shorter investment duration relative to venture capital and private equity
funds, and in the case of direct lending, funds can be combined with regular
yield payouts to investors. The outlook for investing in the direct lending
space remains positive due to persistent structural factors preventing middle
market companies from accessing the broader traditional credit markets.
While credit supply remains tight, demand for middle-market credit remains
strong due to the expected deployment of committed, uninvested capital
(also referred to as dry powder) and the refinancing overhang of middlemarket companies.
The secondary market in illiquid alternatives has been fueled in the recent
past by new regulations (e.g. the Volcker Rule), by record amounts of
dry powder and by improving economic conditions. A record USD 42 billion
of assets have traded on the secondary market in 2014, up from USD 9billion
in 2009. Investors increasingly see secondaries as a viable channel to
generate liquidity before fund lockups expire. They are using the secondary
market to rebalance their illiquid portfolios, exit poorly performing investments, reduce capital costs or comply with new regulations. In order to
increase liquidity for investors, some managers are now proactively offering
the possibility of exiting their funds early. For example, in its latest flagship
fund, a US buyout manager committed to selling fund stakes twice a
year to a preselected group of preferred buyers. Other managers have
started to provide interested sellers with a list of potential buyers.
18
Hedge funds
On doing your
homework
TEXT BY ALEXANDER INEICHEN
19
any seasoned investment professionals argue that liquidity is an illusion. It is something you think you have, and
can measure in good times, but it vanishes immediately
during a perfect storm. It is a bit like your path toward
the emergency exit in a concert hall: under normal circumstances you
can run toward the exit within seconds; when fire breaks out, you
cannot. Liquidity is something everyone seems to require at the same
time. The financial crisis of 2008 is a good example. Markets literally
disappeared for a while. So-called market makers would delete their
prices on their screens and not pick up the phone, even in markets
that were considered liquid prior to the market disturbance. Another
example is the more recent decision by the Swiss National Bank to
drop its quasi-peg to the euro in January 2015. For a short time, the
foreign exchange market considered as the most liquid market in
the world stopped functioning properly.
Hedge funds a quasi-liquid, superior return profile
Alexander Ineichen
In his 2000 book Pioneering Portfolio Management, David Swenson, the CIO of Yale Universitys endowment fund, distinguishes between liquid and illiquid. But, for hedge funds, he creates something
in between that he calls quasi-liquid. This is a very elegant turn of
phrase. Hedge funds are indeed not as liquid as US large-cap stocks,
but are also not as illiquid as, say, private equity or real estate.
In the last couple of years the gloss has come off hedge funds.
Earlier, the high returns had turned a niche product into a flourishing
industry. For example, an investment of USD 100 in the S&P 500
I ndex at the beginning of 2000 was at USD 89 (11%) five years later,
including full reinvestment of the dividends. The same investment of
USD 100 in an average hedge fund portfolio, after all the fees everyone complains about, stood at USD 141 (+ 41%) five years later. This
is a big difference.
Hedge funds did well in the second part of the last decade too. In
the five years to December 2009, a long-only investment in the S&P
500 went from USD 100 to USD 102 (+2%), whereas an investment >
20
of USD 100 in the average hedge fund portfolio went to USD 132
(+ 32%). This is still a big difference, but it had gotten smaller. In the
five years to December 2014, a USD 100 investment in US equities
more than doubled to USD 205 (+105%). However, USD 100 in the
average hedge funds portfolio only rose to USD 125 (+25%). As an
investor, which sequence do you prefer: 11%/+2%/+105% or
+ 41%/+ 32%/+25%? The second sequence is superior in two ways:
higher-end return with less volatility. I like to think of the first sequence of returns as nature. That is what you get if you do not apply risk management: moderate overall return with high volatility.
Hedge funds can improve this sequence with active risk management.
The second sequence does not appear in nature, it is man-made.
Hence the fees.
Challenges big and small
The biggest challenges hedge funds face today are linked to the
smaller managers. First, they find it very difficult to raise capital
b ecause the financial crisis and the Madoff incident caused private
investors to more or less disappear. They are coming back only very
slowly. This means the main source of capital comes from institutional
investors who have a more sophisticated decision-making process.
They expect a hedge fund to have at least USD 100150 million under management and three years of proven real returns. Furthermore,
institutional investors conduct due diligence with their managers, because a lack of it was one of the sources of disappointment in 2008 .
Institutional investors also expect various layers of operational excellence, adding to the cost base of hedge fund operators. This means
that the barriers for smaller, less-established managers have risen.
Finally, regulation has intensified. Large hedge funds can deal with
the added bureaucracy more efficiently than smaller managers.
But large hedge funds also face challenges, and one of them is
related to regulation. The financial crisis, and the regulation wrath
that it triggered, resulted in investment banks downsizing their trading operations. Liquidity in many markets went down. Because of the
winner-takes-all effect that resulted in large hedge funds getting
larger and larger, these growing hedge funds see dwindling liquidity
as a challenge. A less liquid market means diminished opportunity
and is more prone to gap risk.
Are hedge funds a good/bad investment?
quires less research than an investment in US equities. An investment in US equities requires less research than an investment in
hedge funds and so forth. In sum, hedge funds are not for the lazy.
Why I want hedge funds in my portfolio
Hedge funds originally marketed themselves as absolute return products that deliver positive performance in any market environment.
Now, in the wake of the financial crisis, hedge funds focus on their
diversification benefits and risk-adjusted performance. A portfolio of
hedge funds does not obviate any alternative or classical way of
portfolio construction. However, hedge funds have properties that
you do not find in other areas of finance. For example, trend-following managers have had a positive return in 17 out of 19 major corrections in the equity market since 1980. This is unique. There is nothing else in finance that has such favorable correlation characteristics.
Among other asset classes, measured low correlation more often than
not turns into an illusion when it is most needed, somewhat akin to
perceived liquidity.
Over the last decade or so, the conceptual arguments for investing in hedge funds have not changed much. However, the market
place has changed. For example: hedge funds as a group are larger;
the largest funds are larger; some trades are more crowded; liquidity
in some market areas is lower due to Dodd-Frank; yields are lower
and IT is more important. But again, conceptually, an intelligently
structured portfolio comprising independent returns and cash flows
is as worth considering by every thoughtful and diligent investor as it
was in 1949, when the first hedge fund was launched. If you know
the future, invest in what goes up the most. If you do not, construct
a portfolio where the source of returns and cash flows are well balanced and the risk is actively managed, while not forgetting that perceived liquidity can turn into an illusion.
21
Hedge Funds
Liquidity
a key to
hedge fund
performance
Annualized returns
Low liquidity
Low liquidity
decreasing
increasing
High liquidity
High liquidity
decreasing
increasing
22
Liquidity tight
0.80
0.70
0.60
0.50
0.40
0.30
0.20
0.10
Liquidity plentiful
0
Jan. 92
Jan. 96
Jan. 00
Jan. 04
Jan. 08
Jan. 12
Marina Stoop
Cross Asset and Alternative Investments Strategist
+41 44 334 60 47
marina.stoop@credit-suisse.com
23
1800
1600
24
Open-end versus
closed-end funds
Making what turns out to be the right investment
decision can hinge upon the underlying asset
type, and understanding the fundamental
differences between open-end and
closed-end funds.
In good times
1400
10
1200
In times of crisis
11%
1000
12
14
16
800
18
20
600
01.05
07.05
01.06
07.06
01.07
07.07
01.08
07.08
01.09
07.09
Discount to NAV in %
Index points
7%
nvestors have many choices when selecting a pooled investment fund: regional
versus global, active versus passive, bonds
versus equities, famous manager versus
start-up, and so on. But one choice can be
overlooked: open-end versus closed-end
funds. On occasion, this may be the most
important issue.
As we will show, the practical difference
for investment returns may not be great under
normal market conditions, but can become
significant at times of market stress, especially for funds investing in illiquid assets such
as real estate, small caps, or specialized credits. In such cases, a closed-end fund may be
the better structure.
Key differences
When markets become stressed, such as during the financial crisis, some assets may become illiquid, while others remain easy to sell.
When this happens with an open-end fund,
the first investors to exit will tend to receive
cash obtained by the manager from sales of
the more liquid assets. While this is good for
these faster-moving investors, slower-moving
investors are left with units in an imbalanced
fund that holds mainly illiquid assets that cannot be readily sold and for which the theoretical valuation may fall further than the more
balanced portfolio existing before the stress
began. Well-known examples in recent years
include some frontier-market, real estate and
credit funds. Fund managers may have some
ability to restrict (gate) withdrawals. If this
is done early in the stress situation, it in effect
temporarily makes the fund closed, protecting
remaining investors. But in a worst-case scenario, this closure happens after the faster
investors have left, which leaves remaining
investors trapped with a pool of illiquid underlying assets that may then eventually be sold
as soon as some limited liquidity reappears,
which unfortunately is likely to be near the
bottom of the market.
Clearly, this process simply cannot happen
in a closed-end fund. Faster investors who
try to exit will likely find few buyers, forcing
25
Giles Keating
Head of Research and
Deputy Global Chief Investment Officer
+41 44 332 22 33
giles.keating@credit-suisse.com
Lars Kalbreier
Head of Mutual Funds&ETFs
+41 44 333 23 94
lars.kalbreier@credit-suisse.com
26
Attractively
consistent
Patient, yet opportunistic. Those are two key characteristics
of the New Zealand Superannuation Fund, whose very long-term
investment horizon allows it to pursue contrarian and illiquid
strategies if the price is right, all while managing liquidity at the
whole-fund level.
INTERVIEW BY OLIVER ADLER Head of Economic Research
JOS ANTONIO BLANCO Head Global MACS
27
Adrian Orr is CEO of the New Zealand Superannuation Fund, which has posted annualized returns between 17% and 25% over the last five years.
28
Managing portfolios
a quest for value
Credit Suisse Private Banking follows a structured investment approach,
which starts by defining a suitable strategic asset allocation (SAA) for its
clients and then actively managing the mandate portfolio in a disciplined
way around this SAA . However, the SAA is periodically checked and
a djusted (see interview). Although financial markets in some broad sense
tend to be efficient, there are costs to finding relevant information quickly
and acting on it appropriately; so price movements in response to events
are sometimes neither instantaneous nor always correct. This opens
opportunities to improve the return and risk characteristics of portfolios
over time by deviating from the strategic allocation in various ways.
We therefore manage portfolios actively, generally in all dimensions
across asset classes, markets, currencies and individual securities.
In our quest to add value, we combine in-house insights with added
value provided by other parties as long as their investment style fits
with the logic and structure of the mandate portfolios and the requirements
of the client. Unless specifically instructed to do otherwise, discretionary
portfolios for private clients are predominantly invested in fairly liquid
assets, in the sense that we focus on assets that are easy to trade and
monitor, although we will take some limited liquidity risk by investing some
of the portfolios in asset categories (like high-yield bonds) and strategies
(hedge funds, for example) that are less readily tradable and should
therefore generate a liquidity premium on top of their other characteristics.
Our prudence with regard to illiquid assets is the result of regulatory
considerations (some asset categories cannot be offered to private
investors because they require very specialized know-how and may entail
high and unusual risks) and the fact that investments in illiquid assets
limit our ability to adapt the portfolios to the changing environment and
client needs. These types of assets are therefore best managed separately
from the liquid part of the portfolio.
29
Adrian Orr
30
Talking
teak
31
32
Carol Franklin
There are a
lot of beautiful
and interesting
trees, but they
have no inter
national market,
whereas there
is a functioning
international
teak market.
Carol Franklin
33
34
Tree Partner
Province Darin
Shareholders investment 2014: CHF 4,207,407
1 The Tree Partner Company comprises two teak plantations totaling 170 hectares, located within three hours driving distance of Panama City.
2, 3 Engineers periodically gather statistics on how well the trees are growing. The first commercial thinning occurs at about eight to ten years, when the tree
trunks measure 40 centimeters circumference minimum.
35
36
4 Trees cut from the first thinning will be made, for example, into door frames. 5 Panamas proximity to ports is a huge advantage in terms of cost. 6 Harvest takes place
around 20 years after the planting, when the entire plantation is felled, or clear-cut. 7 The plantations provide jobs and learning opportunities to the local communities.
8 The fruit of 10 years labor: the wood from thinnings is collected at the entrance to the plantation, then loaded into 12-meter containers and shipped, primarily to India.
37
38
Institutional
investment
in timberland
In the first two decades of investment by institutions outside the wood-products industry,
activity was confined to large university endowment funds. US timber companies using
GAAP accounting had to pay tax on forest
owned even when it was not being logged,
thus incentivizing them to sell such plantations
to US tax-free pension funds. Preferential tax
treatments for real estate investment trusts
( REITs) also encouraged corporate divestment. During a period of strong equity market
returns and declining inflation, the motivation
for institutional investment was limited to
those with a long time horizon for returns and
an unusually broad mandate on alternative
investments, enabling direct holdings of unlisted assets. This led the same institutions
interested in pioneering private equity to explore the scope for investing in timberland, as
a component of natural resource portfolios.
Front-runners were the endowment managers
for Yale and Harvard Universities. Yale alone
holds three million acres of forests.
Harvards Head of Alternative Assets,
Andy Wiltshire, worked in the New Zealand
forests sector early in his career, and drove
the 2004 purchase of a 408,000 -acre New
Zealand timber estate by the Harvard Management Company. Kaingaroa Forest was the
largest commercial forest property on the
countrys North Island. A 30% share of this
huge forestry block was divested two years
ago to the Canadian Public Sector Pension
Investment Board with an additional stake
taken up by the New Zealand Superannuation
Fund. Broadening of interest from private institutional to public institutional investment is
thus well underway.
Timber has appealed to observers noting
long-run real annual returns of 10%15% on
intensively managed, short-rotation plantations. Seeing the very positive returns from
timber and its low volatility, sovereign wealth
funds and large public pension funds have
been acquiring exposure to commercial forest
assets. Corporate pension plans now own
around 10% of the asset class.
Based on measured returns on investment, timber is not positively correlated with
other assets. But, because the timber price
is responsive to house-building cycles, the
run-up to the credit crisis in 2008 saw timberland prices climb and then drop sharply.
The sluggish recovery in US housing led to
a multiyear opportunity for pension funds
to acquire timberland assets at reasonable
valuations, and most have entered the market
39
40
Farming and
forestry investment
Timberland is the investment term for
China
d pulp to
harvestable forests, as is farmland for agriculture
n d wo o
ber a
m
u
l
th of
investment. Both types of investments act
wo r
4b n
D
as portfolio diversifiers, satisfy investors
S
sU
or t
xp
desire for real assets and have
e
da
na
emotional and social resonance.
Ca
por t s U S D 2 .6
But they do require patience.
E U28 ex
b n w
Ch
imp
ina
or t
SD
sU
USA
to
Ex
5%
th
or
w
po
rts
BRAZIL
95%
ARGENTINA
NE
ZE
AL
AN
7%
3%
50%
50%
15%
80%
50%
E x p o r t 5 0%
35%
Hardwood domestic
Softwood export
Hardwood export
Rubber export
ST
RAL
IA E xpo
rt
65
b
9
m
8i
Softwood domestic
SD
2.
il
mB
ea
yb
so
of
US
s
rt
po
im
ina
Ch
ns
azi
fro
ea
Br
ns
th
yb
or
o
fs
m
fro
raz
r th
wo
n
7b
bn
1
9.
H AME
R
tin
3.
D
US
0%
t 10
ICA
A SIA
100%
SOUT
en
00
rt
g
Ar
t1
po
fro
rts
ina
90%
or
C A N A DA
Ex
po
im
E x p o r t 10 %
SA
10%
AU
ar
of
oy
n
ea
EU
10%
bo
e USA
n from th
f c ot to
or th o
Ch
Source: FAOSTAT,
Statistics Canada, Rubber Manufacturers
A ssociation, New Forests Asset Management
%
87
er
15 . 8 b n
USD
r t s to the U SA
po ber
x
e m
a f lu
o
C
a
wo n a d
r th
or
ap
EU28
p
Ex
dp
hi
13
an
SA
po
nw
2 . 6b
er
na
im
ts
US
b
.3
of p
ap
SA
he
CANADA
nw
th
or
s
of
b
oy
an
ro
sf
U
the
or th
NZ timber destinations
Logs constitute New Zealands third-largest export industry. New Zealand is also now the worlds
leading log exporter (as of 2012) and the biggest
supplier of softwood logs to China (as of 2013).
JAS: Standard units. Source: UN Comtrade, New Zealand MPI
Index
16
3000
14
The U
SA im
por t
41
2500
12
s US
D2
. 9b
2000
10
nw
or t
ho
fp
ap
er
1500
an
dp
1000
ap
er
bo
500
2
ar
fro
0
m
D 2 . 6b n
r t s US d paper
xpo
board t
an
o Ru
8 e of paper
2
ssia
E Uor th
w
Ch
in
0
03
04
05
06
07
08
09
10
11
12
13
03.87
03.95
03.03
03.11
RUSSIA
Th
SA
ex
po
rts
3.3
D
US
b n
ea
of m
r th
wo
JAPAN
US
3.
3b
ir y
pro
du
cts
from
lia
Soybeans
Dairy products
Meat
Paper and paperboard
Cotton
Lumber
Wood pulp
Mature, intermediate
and emerging timberland
investment regions
Agricultural productivity is
greatest in the worlds temperate zones. Nonetheless, other
regions, such as South America
and Africa, where water is still
plentiful, are drawing investor
interest.
Mature
Intermediate
Emerging
Selected international
agri-trade flows in USD
tra
Au
s
Farmland
ex
po
Zealan
Aus t
N ew
rts
rts
da
b n
po
of
1. 7
im
th
D
US
ina
or
th
wo r
Ch
p o r t s U S D 1. 6b
ralia ex
n wo
r th
hina
t ton to C
of co
of m
eat
to
Ja
pa
CHINA
AUSTRALIA
Find more
information in
the articles
on pages
39 and 42
NEW
ZEALAND
Japa
t to
42
Farmland
a fertile
investment
2014
2055
2014
2055
Food demand
is set to grow
by over 60%
as the world
becomes
wealthier
Find additional
details on
our map on
page 40
Global
population is
expected
to increase by
some 50%
43
Maximizing sustainable
yield and minimizing
environmental risks means
that it is critical to
partner with real farm
operators.
Griff Williams
Griff Williams
44
As an illiquid asset, real estate takes time to sell and the length of the selling period can
vary heavily. For indirect investments in particular, there may be regulatory frameworks and
the possibility of pooling properties that moderate the negative effects, but there will
still be a certain risk of illiquidity due to the inherent heterogeneous characteristic of real
estate. However, investors with a sufficiently long time horizon can cope with these
risks and are compensated by a potentially higher return compared to more liquid assets.
01_Allocation to property in
UHNWI investment portfolios
02_Asset allocation of
Swiss p
ension funds as
of September 2014
7.0%
in percent
35
19.7%
30
25
33.7%
4.9%
20
15
10
5
31.3%
s
Au
tra
las
ia
a
e
ia
al
st rica rica
IS
A s i a /C A f r i c G l o b u r o p e E a
e
e
E
dl h A m n A m
ss
d
u
i
R
ti
rt
M
a
o
L
N
1.2%
2.1%
45
46
Research
Search costs
24 weeks
Preliminary checkand
non-binding offer
Agency costs
12 weeks
Due diligence
Market, legal, tax, technical
and environmental due diligence
1 3 months
Closing
Additional costs
(transfer taxes)
12 weeks
Weeks
0
10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29
Even if liquidity is enhanced by pooling properties, there is still no guarantee that this
will work all the time. Sometimes pooling
properties only results in pseudoliquidity,
which works when markets are rising (see
also Open-end versus closed-end funds,
page 24). In contrast, in times of falling markets, the number of potential sellers surpasses the number of potential buyers. This can
also happen for complex real estate-related
financial instruments such as residential and
commercial mortgage-backed securities
( RMBS /CMBS) as investors learned in the
aftermath of the financial crisis. Confidence
could not be restored on short notice. The
risk of moving from a liquid to an illiquid market environment depends on the legal framework, as seen in the case of German openend real estate funds. The announcement of
possible regulatory changes to the corresponding legal framework triggered massive
redemptions by investors who wanted to retrieve their capital before the new regulation
was introduced. In contrast, listed fund structures with a fixed capital base such as in
Switzerland are less exposed to such risks.
Selling real estate may become easier
As long as properties are tied to specific locations, real estate will face liquidity issues. But
we believe that real estate properties will become a priority for investors in the coming
decades. First, real estate still does not have
the appropriate or optimal weight in many asset allocations. Second, interest rates may
stay at low levels for an extended period of
time, which makes real estate returns attractive and should help to improve liquidity from
the sellers perspective.
Philippe Kaufmann
Head of Global Real Estate Research
+41 44 334 32 89
philippe.kaufmann.2@credit-suisse.com
47
Beat Schwab
Head Real Estate Investment Management Switzerland
+ 41 44 333 92 42
beat.schwab@credit-suisse.com
48
Infrastructure
on the rise
Source: Preqin
Transport sectors
Telecommunications
and technology
Energy
Social infrastructure
Resources
and waste
2014
282bn of
USD
infrastructure assets
90%
of surveyed investors plan
25%
of surveyed investors plan
2007
94bn of
USD
infrastructure assets
49
50
Financing
Infrastructure bonds
ture management companies such as train operators, pipeline managers, etc., while they will also purchase bonds where there are credit
guarantees either by government, supranational institutions or banks.
Risks
51
encourage market sources of finance, including transparent securitization, particularly for small and medium enterprises and we endorse
the multiyear program to lift quality public and private infrastructure
investment. It is obvious that at the level of individual governments
and also the IMF, OECD and EU, accelerating infrastructure projects
is a clear macropolicy objective. S&P has estimated that infras tructure
financing needs worldwide could total USD 3.4 trillion annually until
2030. For governments, infrastructure investment is clearly attractive
given the initial positive impact on employment and the longer-term
multiplier effect on the economy.
Trends
Robert Parker
Senior Advisor
+44 20 7883 9864
robert.parker@credit-suisse.com
52
Looking
beyond
liquidity
Global Investor asked two Credit Suisse wealth managers
to describe the illiquid asset landscape from the point of
view of investors. Do clients feel it is worth trading liquidity
for a dditional returns? How much of their portfolios do clients
allocate to illiquid assets? Are some assets more popular
than others? And how does culture affect asset choices?
INTERVIEW BY MANUEL MOSER Senior Financial Editor, Credit Suisse
53
Patrick Schwyzer (left) and Felix Baumgartner from Private Banking&Wealth Management, Credit Suisse, take a moment to exchange viewpoints.
54
PatrickSchwyzer
Felix Baumgartner
55
56
Market overview
Indexes compare each sectors
growth over a ten-year period,
using the central 80% of
data and a 14 -month moving
average (14MMA ).
12,000
10,000
8,000
6,000
4,000
2,000
06
07
08
09
10
11
12
13
14
In passion
we trust
The idea of objects of desire as investments of passion took off in the UK in the late 1970s
with the publication of Alternative Investment. As an investment analyst in the City of London,
the late Robin Duthy noticed that, while conventional investments were intensely studied for
past performance and future potential, no systematic analysis of the markets for art, antiques
and collectibles had been undertaken. Working with the late Sir Roy Allen at the London School
of Economics, he devised a sophisticated methodology of trimming and smoothing mechanisms,
which eliminated seasonal and other distortions. It is important to remember that when the
media reports eye-catching prices for collectibles sold at auction, the prices paid by the buyer
will be substantially higher than the cash received by the seller; transaction costs in these
markets (e.g. auctioneers or agents commissions) can be sobering, reflecting the price paid
to overcome the illiquidity inherent in trading high-value idiosyncratic items.
Photo: malerapaso/ G etty Images Sources: Art Market Research & Development (AMRD)
05
All successful
buying must
be based on confidence, whether
in a dealer or
in oneself, and
the only basis
for confidence
in oneself
is knowledge.
Robin Duthy Alternative Investment
Founder of Art Market Research
Watches
Growth by brand from January 2004 to December
2014 using the central 80% of data from the
AMRD Watch Index, calculated on a 14MMA basis.
The index was rebalanced to 1000 in 2003 .
2,000
1,800
1,600
1,400
1,200
1,000
800
01.04
01.06
01.08
01.10
01.12
01.14
01.06
01.08
01.10
01.12
01.14
01.05
01.08
01.11
01.14
Investment vehicles:
Italian classics in pole position
Most of us past a certain age are likely to have
owned and subsequently lost a prized possession
that has gone on to become a valued collectible.
It seems that a combination of rekindling ones
youth and the empty nesters disposable income
enables enthusiasts to purchase rare items,
and this is nowhere more obvious than in the
c lassic car market. Prices for some classic cars
are going through the roof, and it is the Italians
that continue to lead the market. Ferraris
1959 1982 models have seen a 1,350% increase
in the last ten years. Maseratis produced between
1958 and 1982 have also seen some a ction in
the last six months, having increased in value by
over 23%. The 1946 1977 era B ritish Triumphs
have almost flatlined in comparison, but have
c ontinued to rise slowly, with a compound growth
rate of 3.9% over the last ten years.
57
Jewelry
AMRD Pearl Jewelry Index vs AMRD General
J ewelry Index on a 14MMA basis over ten years.
The index was rebalanced to 1000 in 2003 .
5,000
4,000
3,000
2,000
1,000
01.04
01.06
01.08
01.10
01.12
01.14
58
European securitization
To foster economic growth, the European Central Bank needs to revive the securitization market.
This market is currently down to 25% of precrisis volumes or only 14% of US issuance in 2013.
Improved transparency, the clearing of bank balance sheets and improved regulatory rules are expected
to provide a catalyst for the securitization market going into the second half of 2015, offering
attractive yield opportunities for investors.
59
100%
2,000
80%
1,500
60%
1,000
40%
500
20%
0%
2006
2007
2008
2009
2010
2011
2012
2013
2014
60
We believe that the data published by the EBA and ECB on banks
risk exposures and risk-weighted assets should allow the market to
better understand and quantify the eligible securities. From an issuers
point of view, we conclude that there are currently situations where
an unsecuritized portfolio may require less capital than a securitized
portfolio (see adjacent box). As a result, the loan portfolio to be
securitized might contain a higher proportion of assets with a higher
risk weight attached to it. Thus, we believe that securitization may
take place in regard to high-quality small and medium enterprise (SME)
loans due to the higher risk weights applied. This is precisely the
area where the ECB is trying to unlock the funding gridlock.
With securitization accounting far from clear under International
Financial Reporting Standards ( IFRS) and a likely piecemeal
approach to capital relief, we have tried to estimate the potential
size of qualifying securitization assets for Europe. Depending on the
range of assets taken into account, we have adjusted the data for
asset encumbrance and estimate that the market could range from
a minimum of EUR 1 trillion (including mainly SME loans) to EUR 2.4
trillion (including lower risk-weighted asset categories such as securitized or collateralized lending). From the asset breakdown, we
predict that securitization is more likely to reopen bank funding channels for SME s and corporate lending as we would expect the capital
relief to transmit into lower sustainable funding costs in these sectors. We therefore believe that securitization can play a key role in
serving the macroeconomic policy objectives of the ECB to foster
economic growth.
Given the completion of the AQR and the launch of the ABS
purchase program, we believe that these are supportive steps toward
a fully fledged securitization market throughout 2015. In turn, we
continue to believe this will provide a positive backdrop for the
Eurozone by releasing capital pressure from banks balance sheets,
reducing the cost of borrowing for SME clients and providing lending
to the economy. In an environment of very low yields, investors
(including the ECB) will gain access to higher-yielding assets, which
we expect to be attractively priced at the beginning to reopen the
securitization market.
Christine Schmid
Head of Global Equity&Credit Research
+ 41 44 334 56 43
christine.schmid@credit-suisse.com
61
A
Capital requirements for typical loan portfolios
We take three types of loan portfolios and apply the
risk weights under the standardized approach. We
take a secured residential mortgage, a commercial
mortgage and an unsecured corporate loan,
and present our capital charge analysis below:
1 RESIDENTIAL MORTGAGE RISK WEIGHT = 35%
B
Capital requirement for a typical securitization
For a bank that keeps 5% of the portfolio on its
books, the maximum capital charge would be
as follows:
1 RISK WEIGHT = 5 12.5 = 62.5
2 CAPITAL REQUIREMENT = 0.08 62.5 = 5%
We can see that a bank does not always gain capital
relief from securitization. For residential mortgages,
for example, the capital requirement is greater for
the securitized asset than for the underlying loan
portfolio. This difference in capital treatment might
encourage securitization of high risk assets, i.e.
on a risk-based measure, a higher risk-weighted
SME asset would generate more capital relief for a
bank than a lower risk-weighted residential mortgage.
Regulators thus have to address the risk weight
a pplied to securitization of assets more closely
c ompared to the underlying risk of the assets.
62
No exit?
The efforts of regulators to strengthen the financial system
have led to both lower and more volatile liquidity in the corporate
bond markets. As a result, investors could potentially find
themselves in a situation where no one will buy. To properly
manage expectations, and to be able to plan ahead, investors
need to understand this new landscape and what it means.
volatile markets. As a result, banks and dealers have reduced their fixed income trading
activities since 2008 as well as their ability to
warehouse risk and facilitate capital market
activities.
Conditions affecting structural changes
The structural change stemming from financial regulation comes at a time of historically
low interest rates fueled by quantitative easing programs adopted by central banks around
the globe. On the one hand, we believe that
this accommodative stance has reduced market uncertainty and thus eased investors
concerns about liquidity. On the other hand,
low interest rates have increased the corporate debt markets as companies take advantage of the lower funding costs. In Figure1, we
show the increasing gap between primary
dealers inventory and the size of the US corporate debt market. Moreover, investors moti
vation to drop low-yielding government debt
and pile into higher risk and most often less
liquid securities has also risen due to monetary
policy, in our view. This in turn adds to liquidity concerns again (see Figures 2 and 3).
Liquidity most relevant in times of stress
63
SIFMA data
8,000
250
7,000
200
6,000
5,000
150
4,000
100
3,000
2,000
50
1,000
0
0
2001
2004
2007
2010
2013
2009
2011
2013
03_Outstanding US bond
market debt
US debt markets have increased 14-fold from
1980 to 2013. Source: Credit Suisse, SIFMA
USD bn
40,000
35,000
30,000
25,000
20,000
15,000
10,000
5,000
0
Jan Hannappel
Equity and Credit Research Analyst
European and US Banks
+41 44 334 29 59
jan.hannappel@credit-suisse.com
1980
1990
2000
2013
64
Authors
Nikhil Gupta
Robert Parker
Jan Hannappel
Equity and Credit Research Analyst European
and US banks..............................................................
jan.hannappel@credit-suisse.com.................................
+41 44 334 29 59.......................................................
Jan Hannappel is a Research Analyst in Global Equity and
Credit Research at Credit Suisse, focusing on European
and US banks. Before joining Credit Suisse in 2014,
he was a corporate finance analyst. Jan Hannappel holds
an MA in Accounting and Finance from the University of
St.Gallen. > Pages 6263
Oliver Adler
Lars Kalbreier
Gregory Fleming
Senior Analyst.............................................................
gregory.fleming@credit-suisse.com...............................
+41 44 334 78 93.......................................................
Gregory Fleming joined Credit Suisse in 2006 as a senior
analyst for the Investment Decision Cockpit and Investment
Committee. Previously, he worked in portfolio strategy
for Westpac and Grosvenor Financial Services Group,
and for the International T
extile M anufacturers Federation
as a global economist. He holds an MA with Distinction
in Economic History from the University of Canterbury,
New Zealand. > Pages 13, 3839, 4243
Philippe Kaufmann
Head of Global Real Estate Research............................
philippe.kaufmann.2@credit-suisse.com........................
+41 44 334 32 89.......................................................
Philippe Kaufmann is Head of Global Real Estate R
esearch
at Credit Suisse Private Banking and Wealth Management, where he also worked for Swiss Real Estate Research
for six years. Before joining Credit Suisse in 2007,
he worked for a policy consulting firm and an economic
research company. He holds an MA in Economics from
the University of Fribourg, Switzerland. > Pages 4447
Christine Schmid
Head of Global Equity&Credit Research........................
christine.schmid@credit-suisse.com..............................
+41 44 334 56 43.......................................................
Christine Schmid is Head of Global Equity&Credit
Research at Credit Suisse Private Banking and Wealth
Management. She has covered financials for 15 years
and coordinates the global financial view. She holds an
MA in Economics from the University of Zurich, and is
a CFA charterholder. > Pages 5861
Beat Schwab
Head of Real Estate Investment Management Switzerland
beat.schwab@credit-suisse.com...................................
+41 44 333 92 42.......................................................
Beat Schwab has been Head of Real Estate Investment
Management Switzerland since November 2012. From
2006 to 2012 he was CEO of the real estate services
group Wincasa AG . During his career he held various position in the construction industry and real estate markets.
Mr.Schwab holds a PhD in Economics from the University
of Bern and an MBA from Columbia University. > Page 47
Markus Stierli
Head of Fundamental Micro Themes Research............
markus.stierli@credit-suisse.com...............................
+41 44 334 88 57.......................................................
Markus Stierli is Head of Fundamental Micro Themes
Research at Credit Suisse Private Banking and Wealth
Management, based in Zurich. He holds a PhD in
International Relations from the University of Zurich
and is a Chartered Alternative Investment Analyst.
> Pages 0408, 15
Giles Keating
Marina Stoop
Sven-Christian Kindt
Head of Private Equity Origination&Due Diligence.........
sven-christian.kindt@credit-suisse.com.........................
+41 44 334 53 88.......................................................
Sven-Christian Kindt is Head of Private Equity Origination&Due Diligence at Credit Suisse Private Banking
and Wealth Management. Before joining Credit Suisse in
2008 , he worked for Bain&Company and A.T.Kearney
in London. He holds degrees from ESCP Europe and the
University of Michigans Ross School of Business.
> Pages 1617
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Credit Suisse AG , Investment Strategy&Research,
P.O. Box 300, CH-8070 Zurich
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