2010 Annual Partner Conference Highlights
May 11, 2010
We thank the over 200 investors, advisors, managers and friends who joined us for Alternative Investment Group’s Annual Partner Conference, held on April 20th at the Mandarin Oriental Hotel in New York and April 28th at the Ritz-Carlton Hotel in San Francisco.
We provide a brief summary of the conference below. For those unable to join us this year, we look forward to seeing you in 2011.
Keynote Speaker
Dr. R. Glenn Hubbard was our conference keynote speaker in New York and San Francisco. Dr. Hubbard is Dean of the Columbia Business School and has been a member of the Columbia University faculty since 1988. He was Chairman of the White House Council of Economic Advisors (CEA) from 2001 to 2003, during which his responsibilities included advising the President on economic policy, tax and budget policy, emerging market financial issues, international finance, health care and environmental policy. While serving as Chairman of the CEA, he also chaired the Economic Policy Committee of the OECD. In addition to writing more than 100 scholarly articles in economics and finance, Dr. Hubbard is the author of two leading textbooks on money and financial markets as well as co-author of Healthy, Wealthy, & Wise: Five Steps to a Better Health Care System.
Dr. Hubbard started his talk by sharing his views on the current U.S. economic recovery. He referred to Milton Friedman, who described business cycles as analogous to plucking a string – the harder you pluck, the harder the opposing response; the deeper the recession, the stronger the ensuing recovery. In a typical recession, if more than 2.5% of output is lost, one would expect real GDP to rebound around 6% in the first year. However, Dr. Hubbard does not expect the current recovery to follow a typical path since the recession was caused by massive leverage that resulted in serious disrepair of the financial system. He sees GDP growth at 3.5% in 2010 and slowing down in 2011. He does not see the labor market bouncing back as vigorously as it would in a typical recovery.
He further explained that the financial crisis could be attributed to several factors. First, changes in global capital flows - savings accumulating in countries like China and Emerging Asia where domestic intermediation does not work well. The resulting excess liquidity causes global interest rates to fall and when this happens, it is not a surprise that prices of assets with longer lives, such as houses, go up. Also, while the housing boom was global, it was accentuated in the U.S. by financial innovation. Second, U.S. monetary policy - following the recession in early 2000, monetary policy was extremely accommodative despite the enormous tax cuts and strong economic growth from 2003 to 2005. This loose monetary policy put wind into the sails of the incipient bubble. Third, failure of regulation - we had a structure that made it easy to arbitrage regulatory differences. Hubbard compared these factors to three slow moving train wrecks which evolved into the financial crisis.
Dr. Hubbard then recounted the weekly luncheons he had with Federal Reserve Chairman Alan Greenspan during the time Dr. Hubbard was Chair of the White House Council of Economic Advisors. At one of these luncheons, Dr. Hubbard and Alan Greenspan had a discussion about whether monetary policy was too easy. Chairman Greenspan responded that “this time is different because of resilience”. Dr. Hubbard believes Chairman Greenspan was both wrong and right on this comment. He was wrong about the financial system having such resilience that it would weather any crisis, but he was right about the resilience of the U.S. economy. To date, the U.S. has lost the smallest amount of potential output of any of the OECD countries due to its high productivity growth and flexible labor market practices that allow businesses to be as nimble as possible, even given high shocks to the system. Dr. Hubbard then went back in history and recounted the debate Nixon and Khrushchev had about which country’s economy was best. Khrushchev argued that what made the Soviet economy superior to the U.S. and others was their expertise in “rocket thrust”. Nixon responded that the greatest innovation of the U.S. at the time was “color TV”, which was considered the leading consumer product innovation at the time. Dr. Hubbard pointed out that Khrushchev’s bragging about an economy focused on rocket thrust meant it was not focused on innovation, education and other productivity aspects of the economy. The Soviet Union’s lack of focus on these critical areas led to its economic decline. Dr. Hubbard believes we have the same type of problem facing the U.S. today. We face a growing budget deficit and an enormous overconcentration of our public spending on entitlement programs. We will also be spending 10% more on social security, Medicare and Medicaid, and every tax in the U.S. would need to go up significantly (about 60%) to accommodate this increase in spending. We compensate this increase by not having money to spend on defending the country, educating children and supporting basic research. The better way to approach this issue is to focus on productivity growth and fiscal stability which would require us to spend more time on innovation and research, and figuring out a way to reform our tax system (instead of just raising taxes). We should care about innovation since personal satisfaction and optimism have been proven to be incredibly correlated to how dynamic an economy is in terms of entrepreneurship and investment in research and development. Dr. Hubbard believes we should also be focusing on institutions that are too big to fail. If something is too big to fail, then it must also be too complicated to succeed. Dr. Hubbard believes it is important to let people choose the size of their institution, but they should not expect taxpayers to bail them out. The government must set up regulatory reform that would allow it to confront very large/complicated institutions and let them fail necessary. To reform capital markets, Dr. Hubbard advocates a system that looks more like a progressive tax. The larger the risk-weighted balance sheet of an institution, the larger the proportionate amount of capital they need to hold. This allows banks to hold proportionately more capital, but rids us of the problem of too big to fail, since the institutions are held accountable for their risk taking. Instead of Washington focusing on these big issues surrounding productivity, they are focusing on important, but not as significant issues, such as executive compensation and the Volcker rule. Dr. Hubbard believes if the Volcker rule had been enacted three years ago, it would not have made any difference in averting the financial crisis.
Manager Panels – New York
Will Muggia, President of Westfield Capital and portfolio manager of Westfield Life Sciences, a long/short healthcare fund, shared his views on the healthcare sector, including the implications of recently passed healthcare reform legislation for one of the largest sectors of the U.S. economy. Will sees the healthcare reform bill as solving the objective of expanding coverage, but does not think it comes close to addressing the issue of lowering healthcare costs. He is currently long on opportunities he believes will benefit from the healthcare reform bill, including hospitals, which are the initial beneficiaries of reform, and pharmaceutical distributors, which are driven by the wave toward generics. On the short side, Will has taken advantage of medical device companies, which are subject to enormous excise taxes and are vulnerable to being squeezed by hospital pressures. However, he finds shorting to be very challenging in the current market since healthcare is a defensive sector going through a strong cyclical growth period. Corporations are also holding historically high levels of cash, so one needs to be cognizant of shorts that may be acquisition targets. Will maintains his long-term fundamental view on both his longs and shorts and considers the current environment to be fertile ground for good opportunities.
Dan Loeb, founder and portfolio manager of Third Point Capital, shared his views on event-driven investing. Dan is selectively taking advantage of distressed opportunities but sees fewer anticipated restructurings than he originally thought would arise in this post-recession economy. The three areas that Dan remains focused on are performing corporate bonds, mortgage securities yielding mid to high teens, and distressed situations from last year that are cheap relative to their peers. Dan has stayed away from mistakes others are commonly making, such as leveraging up bonds with low yields and illiquid securities. Although Dan remains focused on fundamental investing, he realizes in today’s world he must also understand what is going on in the regulatory environment, since almost every important market movement comes out of legislation. In the last two years, Third Point has worked with various consultants to gain a better understanding of what is going on in Washington. On the short side, Dan believes it is important to understand a company on a relative basis and the underpinnings of its industry. From a sector perspective, Dan is currently bullish on financials due to strong consumer banking, improving credit quality and very strong trading profits.
Simon Peters, lead portfolio manager of Gartmore’s AlphaGen Rhocas fund, and John Gordon, portfolio manager, and Greg Lesko, managing director, of Deltec Asset Management shared their views on opportunities in developed and emerging markets.
Simon sees the enormous dislocation in the financial system as generating huge long and short opportunities. The fund’s net exposure is kept fairly low (10%) due to headline risks, including sovereign risk, regulatory risk and business model risk. On the long side, he sees the strong names getting stronger, as banks take advantage of the crisis by recapitalizing parts of the banking system and restructuring their business models. On the short side, his positions include banks that entered the crisis with large balance sheets that also contain commercial real estate. These banks are finding it difficult to reevaluate their business and are often overvalued.
John and Greg are focused in emerging markets but also invest in developed markets, including the U.S. Prior to 2009, they saw emerging markets as a sector that investors utilized to supplement their performance, but would invest for the long-term in developed markets. They now see this trend reversing. There is a demographic population shift in many of the emerging countries where economic activity is increasing at an accelerating rate. John and Greg see Brazil, Indonesia, China and India as countries with large populations and a growing middle class that drive domestic demand. Brazil, for example, improved their economy by enacting a disinflationary and economic policy that was eventually able to provide an improved standard of living to low and middle class populations while reducing real interest rates. On the subject of an overheating Chinese economy, John and Greg point out that the Chinese government is successfully implementing controls to curtail the housing bubble.
Manager Panels – San Francisco
Art Spinner, founder and portfolio manager of Spinner Asset Management, and Will Piersol, managing director of Clairvoyance Capital, gave an overview of opportunities they are currently seeing in the technology sector. Art opened the panel by explaining the super cycle of technology. Enterprise hardware spending shrunk 2.6% per year for the last ten years following the tech bubble, then fell an additional 21% following the latest recession. He sees us not only having reversion to the mean, but just one new technological innovation could spur a ten-year cycle. We currently have many more innovations that could propel it even further. Art sees tech spending fitting into three buckets – replacement (led by the move to clean energy), enterprise (led by business cycle) and consumer (led by increasing penetration of handheld devices) - each of these having its own separate growth path. Art explained that with Moore’s law, computer power doubles every two years and will actually begin to accelerate as massively increasing volumes drive down costs and spur increased innovation. On the long side, he mentioned that big-name companies like Apple, Intel and Cisco get all of the media attention, but it is the small-cap media supply chain companies that make the pieces that go into technology hardware where the real value is found. On the short side, Art is finding opportunities in large, platform companies that have lost their advantage both technically and managerially.
Will explained that Clairvoyance is focused on the entire tech supply chain, with 15 analysts covering each layer of the global supply chain. They use a top-down approach to find the best place to be in the supply chain and then use bottoms-up analysis to identify stocks that are the most attractive. In response to a question about the riskiness of investing in China-domiciled companies, Will noted that many of the big players are listed in the U.S. and therefore follow U.S. laws and accounting standards. As for their investments domiciled in emerging markets, they will not make an investment in a firm where they have not met the management and they will judge for themselves the character of the company. Will also explained that if you were to invest only in the U.S., you are limited to leading hardware names, such as Cree in LED lighting and large solar companies. On the flip side, within the vast Asian markets, they are able to buy stocks across the entire supply chain for companies that make the parts that go into end products, such as LED light bulbs and solar panels, illustrating the power of investing internationally versus focusing exclusively in the U.S. Will also mentioned that while Asian companies can be managed more efficiently than U.S. companies because of their labor advantage, technological innovations continue to come mainly from the U.S.
In response to a question about how to invest in such a nascent recovery as we are having in the U.S., both Art and Will made the point that the U.S. is no longer the driver of global growth. For example, they explained that factory workers in emerging countries such as China and India are quickly growing personal incomes to the point that technological affordability is no longer an obstacle. Once we hit this inflection point, growth will be exponential.
John Osterweis of Osterweis Capital Management discussed how the 2009 stock rally heavily favored low quality companies, making it a challenging time for fundamental long/short managers. From an historical perspective, housing has always driven the economy out of recession, but it clearly will not play that role today. Unemployment is also coming down at a much slower rate than a typical recession, mostly due to companies being maniacal about cutting costs and banks constricting capital flow by keeping credit tight. The consumer is constrained due to higher unemployment, lack of credit, impaired balance sheets and overleveraged housing. John does not see inflation as an imminent problem, given the slow recovery in the labor markets. However, if the velocity of money picks up as a result of continued government stimulus and banks start to pump money back into the system, this could have an impact on inflation. John has structured the portfolio to look like a classic inflation hedge in preparation for this. In the current market, he is seeking quality stocks on the long side that will go up more than the market. The short side remains more challenging as low quality names are skyrocketing in the market rally. In the healthcare space, John is finding opportunities that have arisen from healthcare reform, including big pharma. Although his portfolio is focused in the U.S., he does tap into emerging market opportunities through large, multinational companies such as Nestle, Diageo, and Unilever which have direct investments in emerging markets.
Alternative Investment Group Partners’ Forum
Stewart Greenfield opened up the Partner Panel by reviewing the long-term results of the Alternative Investment Group funds, which have outperformed broad equity benchmarks at a much lower level of volatility since inception, along with giving an update on how our funds performed for the first quarter 2010.
David Storrs gave an overview of additions to the Alternative Investment Group team and firm AUMs.
Marita Wein focused on the regulatory changes that are evolving in the aftermath of the country’s worst economic crisis since the Great Depression. Marita described how the crisis has provided the necessary momentum for rigorous regulation and oversight, including a revamping of the SEC’s division of enforcement that would target asset management, a modified version of the uptick rule, increased hedge fund transparency and an overhaul of the U.S. financial regulation. Marita expressed how Alternative Investment Group understands that superior risk management is critical to our success and although we welcome regulation and oversight, we realize it will never be a substitute for our rigorous due diligence and monitoring. Alternative Investment Group endeavors to remain at the forefront of hedge fund industry best practices.
Maria Tapia and Rich Cheung covered the type of opportunities we are seeing in the event-driven space, which comprises a healthy allocation to our funds. The opportunities our managers are seeing include event-driven activity triggered by major corporate actions such as a merger, acquisition or divestiture, distressed investing and post-reorganization investing. The event-driven opportunities are coming from an environment of robust M&A activity aided by massive inflows into fixed income, record high corporate cash levels and low growth companies that seek revenue growth through acquisitions. The post reorganization opportunities have emerged from companies coming out of bankruptcy with a restructured capital structure.
Maria Tapia and Chris Ayton gave an overview of emerging market managers and the types of opportunities our managers are seeing in Asia. While we observe that growth in the U.S., Europe and Japan remains subdued, Asian growth remains very strong compared to Western counterparts. Alternative Investment Group’s manager selection strategy in Asia is to invest with managers who focus on company fundamentals in the wider context of the overall market, avoid managers who make heavy bets either by being very net long or very net short, and seek managers with strong experience and deep understanding of local cultures.
David Storrs wrapped up the panel by explaining how Alternative Investment Group is taking advantage of the above mentioned investment opportunities. For example, we replaced approximately 25% of the managers in Alternative Investments, L.P. last year, a higher than average turnover, due to people or strategy changes, and we increased the non-U.S. and event-driven allocations. In the International fund, David talked about the significant amount of work we conducted in the past year, including replacing over half the managers to position the fund better in the current environment. Specifically, we reallocated assets to take advantage of opportunities in Greater China, Korea and Japan, and we added pan-European managers and a manager that invests globally in energy and transportation. David also explained that Alternative Investments, L.P. and Alternative Investments International, L.P. had very favorable tax efficiency for the past year and stressed how important this is for investors in taxable funds.
In both New York and San Francisco, many of the participants stayed for lunch and joined their colleagues, managers and Alternative Investment Group partners and staff.