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Private equity funds offer retail investors a route into the private markets boom

While the value of global stock markets has trended up for decades with remarkable…
The post Private equity funds offer retail investors a route into the private markets boom first appeared on Trading and Investment News.

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While the value of global stock markets has trended up for decades with remarkable consistency, the number of public companies has fallen significantly since peaking in the late Nineties.

Between the years 2000 and 2020, the number of companies listed on U.S. stock exchanges fell from 7000 to a little over 4000. That’s a decline of around 40% in 18 years. A recent report by the consultancy Finbold says a total of 179 companies were delisted from U.S. stock exchanges between 2020 and 2021.

usa listed companies

Source: theglobaleconomy.com

Here in the UK, the London Stock Exchange’s main market combined with AIM reached its peak in 2007, after a wave of listings through the early years of the century. The total number of public companies in the UK reached more than 3,000 in August 2007. As of October 2021, 2oo1 companies were listed on the London Stock Exchange. That’s a fall of a third in 15 years.

Number of companies trading monthly on the London Stock Exchange from January 2015 to October 2021

chart

Source: Statista.com

In August 2000, the total market capitalisation of the LSE’s main market was £5.3 trillion. Today, a little over 21 years later, it has dropped to around £2.4 trillion – a decrease of over 50%. This, it’s worth stressing, is in nominal terms; the decline in real terms, after adjusting for inflation and the fall in the comparative value of the pound, is even more precipitous.

Despite a strong 2021 for IPOs, the number of companies listing in the UK is also continuing to fall when looked at as a long term trajectory. That means the trend towards a smaller London Stock Exchange doesn’t look like it will turn any time soon.

World Bank data shows the global trend is following the same pattern, though the reverse only started around 2010.

chart 2

Public stock markets will, of course, continue to be a pillar of capital markets and investment portfolios. But it is also a fact that more companies are shunning the pressure of delivering quarterly growth stock markets demand for longer by remaining private until a later growth stage. Or retiring from public markets to return to private ownership.

Private equity typically works in two ways. Either it invests in young, growing companies and, if all goes to plan, realises profits when they eventually go public or are bought up by a larger company a few years down the line. Or it acquires already established companies seen as failing to realise their full value potential. These can be companies that are currently privately owned.

Over the past few years, private equity firms have also been increasingly targeting public companies they believe could perform better with the luxury of a period of restructuring without the need to meet investor demands for constant growth. Since the start of the pandemic, we’ve seen private equity groups snap up major London-listed companies such as the supermarket chain Morrisons outsourcer G4S, infrastructure builder John Laing and defence companies Meggitt and Ultra Electronics.

Private equity has seen an opportunity in the cool attitude to London-listed stocks from stock market investors over the past several years. A mix of Brexit and Covid saw valuations trail comparable companies listed on Wall Street and other developed markets. Private equity has spotted a bargain.

Private equity’s advantage over public markets is time. Private ownership can allow a company to make short to mid-term growth sacrifices in favour of a long term strategy. That also means private equity investments should be made with a longer-term horizon. Private equity investments are typically more volatile than stock market investments. They are also riskier. But over the long term also generally deliver better average returns than public markets.

According to a report by J.P. Morgan Asset Management, since 2009 private equity funds have delivered between 1% and 5% in excess annualised returns (net of all fees) over the S&P 500 index, the benchmark the firm used for public markets. And the S&P 500 has performed considerably better than London’s FTSE 100 over that period.

Some market analysts believe it will become harder for private equity funds to deliver similar outsized returns in future, with margins shrinking. However, there is still a strong argument private markets both offer good diversification from public markets and could well continue to outperform them over coming years.

Private equity funds

Private equity is often seen as an option that is restricted to institutional investors or the wealthy. But there are also opportunities for retail investors to gain exposure to private markets via funds and listed trusts. And they’ve done very well over the past ten years.

The HarbourVest Global Private Equity trust whose holdings range from the online clothing retailer Shein to the cryptocurrency exchange Coinbase has gained almost 600% over that period.

hvpe

By comparison, the Fundsmith Equity fund that invests in publicly listed companies internationally, and is considered to have performed well, is up by 467% over the past decade. And despite its strong share price returns, HarbourVest still trades at a discount of around 16% to its net asset value (NAV).

Other private equity trusts available to UK-based retail investors have also generally performed well over the same period. And also still trade at a discount to NAV. Pantheon International trades at an approximately 18.5% discount to its NAV, ICG Enterprise at a 17.5% discount, NB Private Equity over 20% and Standard Life Private Equity at around 15.5% below NAV.

Investors have noticed and the investment platform Interactive Investor says HarbourVest was its fourth most bought trust in October and November. At the start of October, its discount to NAV was almost 29% and it still looks cheap despite a 15% share price gain since.

Why are private equity trusts trading at a discount to NAV?

One of the main reasons private equity trusts have traded for so long at steep discounts is thought to be investors being put off by relatively expensive fees and complex structures. The Association of Investment Companies says HarbourVest’s ongoing charges and performance fee added up to 2.5% last year.

The trust’s performance has justified the fees but they could prove a burden in leaner years. There are, however, cheaper options. Scottish Mortgage, for example, which invests in both public and private markets, charges just 0.34% a year.

Who should consider private equity exposure and how much?

Financial advisers typically recommend retail investors only invest in private equity with a time horizon of at least 15 years due to the asset class’s greater volatility than public markets. For example, shares in private equity trusts dropped by up to 50% from February to March 2020 when the Covid-19 pandemic first struck and markets briefly panicked. The S&P 500 lost around 21% over the same period.

Investors should leave plenty of time for private equity holdings to bounce back from such shocks. It’s also usually recommended that retail investors don’t allocate more than around 10% of their portfolio to higher risk, higher reward private equity bets.

But for those with an already well-diversified portfolio, private equity could be an interesting option in the pursuit of long term returns.

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Economics

The retailers that should weather the coming economic storm

Conditions are about to get tougher for retailers as they face a perfect storm of falling incomes, galloping inflation, and rising interest rates.  These…

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Conditions are about to get tougher for retailers as they face a perfect storm of falling incomes, galloping inflation, and rising interest rates.  These impacts will crimp the discretionary spending power of many people. The one exception could be the under 25-year-old Gen Z demographic, who have fewer non-discretionary costs than other age groups. The retailers who sell to them could fare better than most.

Over the last six months, discretionary retail stocks have been among the worst performers on the ASX, with the S&P/ASX 300 Retailers Accumulation Index underperforming the broader market index by 13 per cent over that period. Admittedly, this recent under performance merely unwinds the 20 per cent out performance of this index in the preceding 18 month period which coincided with the recovery in the market from the pandemic lows.

Over the last six months, only 1 of the 17 stocks in this index has managed to perform better than the broader market, JB HiFi, while four generated losses of over 50 per cent. Notably these stocks, Red Bubble, Kogan, City Chic and Temple & Webster, are all online retailers, and performed very strongly over the first year of the pandemic as they were perceived to be COVID winners.

Figure 1: Total return of retailing stocks between 16 Nov 2021 and 16 May 2022

Source: Bloomberg

The market is concerned that the combination of falling incomes – as households face rising inflation on a broad basis eating into real spending power, and rising interest rates – will reduce discretionary spending power. However, it is not as simple as this. 

While these factors are likely to lead to pressure on overall discretionary consumption, these factors do not affect all segments of the economy equally.

CBA’s economic team has released data for household income and spending growth for the March quarter of 2022. This data is broken down by age demographic.

In looking at the potential impact of spending from cycling the impact of large stimulus payments that were received by households in the prior year, CBA’s data suggests that the percentage of Millennials receiving some sort of government payment has fallen the most relative to the December quarter of 2021 followed by Generation X. Gen Z and Baby Boomers have experienced less of a reduction.

Offsetting the reduction in government benefits is an increase in the percentage of people receiving a salary. This is likely as a result of people returning to work post the pandemic and the current strong labour market.

Figure 2: Share of households receiving government benefits or salaries
(change between 4Q21 and 1Q22)
Source: CBA

This then feeds into the impact on each demographic’s growth in overall income over the last 12 months. This shows that Gen Z has benefited the most from the current strong employment market with increased employment and strong wage growth while the percentage receiving government benefits remains higher than other demographics and above pre-pandemic levels. 

Figure 3: Household income and spending – annual average % change in 1Q22
Source: CBA


Not surprisingly, it is also Gen Z that has shown the strongest spending growth in the March quarter. For the other generations, spending growth has exceeded income growth, implying that their savings rates have declined to fund that growth in spending.

But savings are still well above 2019 levels for all generations and still rising. This will provide a buffer against cost increases and slowing growth in the medium term as inflation and higher interest rates bite. Gen Z has the biggest savings buffer.

Figure 4: Household savings – average deposit and offset balancesSource: CBA

Not surprisingly, overall household wealth is considerably higher than at the end of 2019, primarily as a result of rocketing residential property prices on the back of emergency monetary policy settings. The wealth effect of housing prices is an important driver of discretionary spending in Australia and has benefited retailers over the last two years.

Figure 5: Household wealth – average per household

Source: CBA

Of course, what interest rates can give, they can also take away. With variable mortgage rates likely to increase 1-2 percentage points over the next year, residential property prices are expected to fall, reversing some of this wealth effect.

There is no doubt that conditions are set to tighten for retailers over the coming year. However, reversing wealth effects from falling property prices and falling discretionary income levels will primarily impact those generations that own most of the housing stock, namely the Baby Boomers, Gen X and to a lesser extent the Millennials. Baby Boomers are more likely to be impacted by falls in house prices while Millennials will be more impacted by the need to allocate more of their income toward mortgage repayments.

For those that rent rather than own their home, rents are also likely to rise, as property owners try to pass on rising mortgage, utility and maintenance costs to tenants.

Those with families will be more impacted by rising prices of non-discretionary goods and services like food and utilities. This impact will be concentrated on Millennials and Gen X.

While not immune, the younger Gen Z demographic is likely to fare better than other generations given it faces fewer non-discretionary costs, and is not as exposed to property and wealth effects. At the same time, it is experiencing the strongest income growth and has had the most significant increase in its savings over the last two years.

Hence, we prefer retailers that cater to this younger demographic in the discretionary segment such and Universal Store and Accent Group.

The Montgomery Funds owns shares in City Chic, Universal Store and Accent Group. This article was prepared 18 May 2022 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade Goodman Group you should seek financial advice.

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Economics

What Is the VIX Volatility Index? Why Is It Important?

What Is the VIX and How Does It Measure Volatility?In finance, the term VIX is short for the Chicago Board of Exchange’s Volatility Index. This index…

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The VIX strives to predict market volatility through the lens of options trades.

Wavebreakmedia from Getty Images; Canva

What Is the VIX and How Does It Measure Volatility?

In finance, the term VIX is short for the Chicago Board of Exchange’s Volatility Index. This index measures S&P 500 index options and is used as an overall benchmark for volatility in the stock market. The higher the index level, the choppier the trading environment, which makes its other nickname pretty apt: the fear index.

It’s important to point out that the VIX measures implied, or theoretical, volatility. It measures the expectation of future volatility based on a snapshot of the previous 30 days’ worth of trading activity.

What Do the VIX Numbers Mean?

  • A VIX level above 20 is typically considered “high.”
  • A VIX below 12 is typically considered “low.”
  • Anything in between 12 and 20 is considered “normal.”

When there is increased activity on put options, which means that investors are selling more puts, the VIX registers a high number. Investing in a put option is like betting that the price of a stock will go down before the put contract expires because puts give investors the right to sell shares of a stock on a specific date at a specific price.

These are bearish investments, ones that can take advantage of emotions like fear. There is a saying on Wall Street that does “When the VIX is high, it’s time to buy” because the general belief is that volatility may have reached a peak, or a turning point.

When the VIX falls, that means that investors are buying more call options. Investing in a call is like betting that the price of a stock will go up before the call contract expires. In other words, a falling reading on the VIX indicates that the overall sentiment in the stock market is more optimistic, or bullish.Although the VIX isn't expressed as a percentage, it should be understood as one. A VIX of 22 translates to implied volatility of 22% on the SPX. This means that the index has a 66.7% probability (that being one standard deviation, statistically speaking) of trading within a range 22% higher than—or lower than—its current level within the next 12 months.

How Is the VIX Calculated? What Is the VIX Formula?

In a nutshell, the VIX is calculated by the Chicago Board of Options Exchange using market prices of S&P 500 put and call options with an average expiration of 30 days. It uses standard weekly SPX options and those with Friday expirations, but unlike the S&P 500 index, which contains specific stocks, the VIX is made up of a constantly changing portfolio of SPX options. The Chicago Board of Options website goes into more detail about its methodology and selection criteria.

How Do I Interpret the VIX?

There are many ways to interpret the VIX, but it’s important to note that it’s a theoretical measure and not a crystal ball. Even the sentiment it tracks, fear, is not itself measured by hard data, such as the latest Consumer Price Index. Rather, the VIX uses options prices to estimate how the market will act over a future timeframe.

It's also important to understand how much emotion can drive the stock market. For example, during earnings season, a company’s stock may report solid growth yet see shares plummet, because the company did not meet analyst expectations. So much of what goes on in the market can be summed up by feelings, like greed, as investors spot appreciation potential and place buy orders, which drive prices higher overall. Fear is evidenced when investors try to protect their investments by selling their shares, driving prices lower.

At its worst, fear-driven selling can send the market into a tailspin and lead to emotions like panic, which can result in capitulation.

But the VIX is not designed to cause panic. It is simply a gauge of volatility. In fact, some investors, especially traders, view the increased turbulence as a signal to buy, so that they make a profit either through speculation or hedging and thus capitalize on the situation.

Can the VIX Go Above 100?

Theoretically speaking, the VIX can top 100, although it has never reached that point since data collection began in 1990.

The two highest points the VIX has ever reached were the following:

  1. On October 24, 2008, at the height of the Financial Crisis, which stemmed from the global implosion of mortgage-backed securities, the VIX reached 89.53.
  2. On March 16, 2020, during the beginning of the COVID-19 pandemic, the VIX recorded a high of 82.69.

Analysts also believe that had data collection begun in the 1980s, the VIX would have topped 100 during the Black Stock Market Crash, on Monday, October 19, 1987.

This chart from FRED, the Federal Reserve’s data center, details the VIX from 1990 to 2022. Shaded areas illustrate periods of recession:

Chicago Board Options Exchange, CBOE Volatility Index: VIX [VIXCLS]

FRED

How Do I Trade the VIX? Can You Buy Options on the VIX?

Investors can’t invest directly in the VIX, but they can invest in derivatives that track the VIX, such as VIX-based exchange-traded funds (ETFs), such as ProShares VIX Mid-Term Futures ETF (VIXM), and exchange-traded notes, like the iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX) and the iPath Series B S&P 500 VIX Mid-Term Futures ETN (VXZ).

What Is the VIX at Today?

To view the VIX’s current reading, visit the webpage maintained by the Chicago Board of Options Exchange; it is updated daily.

What Are the VIX’s Current Volatility Predictions?

The stock market has been in choppy waters for most of 2022. Tech stocks, the Nasdaq, and stocks with high P/E ratios have taken a beating as investors worry about continued inflation, the Russia/Ukraine war’s effect on energy prices, the aggressive pace of interest rate hikes from the Federal Reserve, and China’s extreme “zero-COVID” policies. All of these things are causing the storm clouds to gather around the possibility of recession.

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Economics

Over-Aggressive Fed Faces “Financial Accident” – Guggenheim Warns Recession Risk Rising

Over-Aggressive Fed Faces "Financial Accident" – Guggenheim Warns Recession Risk Rising

Via Guggenheim Partners,

Fed Aggressiveness Following…

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Over-Aggressive Fed Faces "Financial Accident" - Guggenheim Warns Recession Risk Rising

Via Guggenheim Partners,

Fed Aggressiveness Following Delayed Liftoff Sets Up 2023 Collision

The risks of tightening into a downturn.

If two trains are heading towards each other at different speeds, when will they collide?

This grade school arithmetic problem is playing out in the Federal Reserve’s (Fed) execution of monetary policy. In this case, one train is the aggressive tightening plan as telegraphed by the Fed and the other is the U.S. economy which, while still strong, is showing a few signs of cooling. Investors want to know when the collision—a recession—will occur.

The Fed’s dual mandate calls for full employment and price stability. Historically, the Fed would change the fed funds rate in response to changes in the unemployment rate and changes in inflation (i.e., the second derivative of the price level). Simply adding up these changes (flipping the sign for unemployment) has tracked well with changes in Fed policy. This relationship has held over several decades and through both tightening and loosening of monetary policy.

However, over the past year there has been a notable divergence in this relationship. The steep drop in unemployment and sharp acceleration in inflation was met by an unresponsive Fed. This breakdown in the typical reaction of the Fed can be attributed to the unique nature of the pandemic shock, the Fed’s updated policy strategy, and a misreading of the inflation surge as transitory. The result is that the Fed, as it now acknowledges, is badly behind the curve and “expeditiously” moving ahead with 50 basis point hikes to both keep inflation expectations in check and protect its reputation.

At the same time, however, inflation is now decelerating and the pace of decline in the unemployment rate is slowing. Had the Fed followed the historical pattern in the chart above, the fed funds rate would be around 2.5 percent now and the Fed would be able to start pulling back on rate hikes as the economy cooled. Instead, the Fed looks poised to hike to around 3.5 percent into next year, when inflation will have slowed further and the unemployment rate will have largely leveled off. With the passage of time as the Fed continues to hike, we will likely find ourselves experiencing the effects of increasingly restrictive monetary policy.

Well before it reaches this terminal rate the Fed will increase the risk of overshooting, causing a financial accident, and starting a recession. Such an asynchronously tight monetary stance should exacerbate the cyclical slowing of the economy and cause a recession as early as the second half of next year. Given this collision course between the Fed and the cooling economy, long term interest rates are likely near a peak.

As Scrooge asked in Charles Dickens’ A Christmas Carol, “Are these the shadows of the things that Will be, or are they shadows of the things that May be only?” Only time will tell.

And as Guggenheim's CIO, Scott Minerd, noted on CNBC earlier, don't expect The Fed to protect your downside in the market either... "we are going to be meaningfully lower in stocks by the end of the year because The Fed has made it clear that they do not have a put on the stock market."

Guggenheim's fears correspond with SocGen's previous warning that this cycle puts the peak of the Fed Funds at just below 1.0%, or less than 3 more rate hikes before the Fed is forced to reverse!

Tyler Durden Wed, 05/18/2022 - 17:00

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