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Is Listed Infrastructure The Most Attractive Investment Avenue Now?

Summary In the current global scenario where traditional asset classes no longer assure stable returns, listed infrastructure is attracting investors in a big way. In 2015, investors have largely been cautious about the equity markets due to expectations of stable growth in the US and the likely interest rate hike by the Fed. However, inconsistent economic indicators, the Greek crisis, and a slowdown in China impacted returns. Even amid concerns about the global economy, bond yields were at their lowest in most developed economies, making fixed income investments unattractive. Global fund managers consider real estate an alternative investment avenue for stable returns on their investments, as real estate assets are likely to witness substantial price appreciation. By Ati Ranjan and Subarna Poddar Global fund managers consider real estate an alternative investment avenue for stable returns on their investments, as real estate assets are likely to witness substantial price appreciation. Listed infrastructure, an up-and-coming segment of the real estate sector, is gradually gaining traction among fund managers due to its monopolistic nature, price inelasticity, stable predicted cash flows, and inflation hedging characteristic. Although these assets are also traded in the form of equities, the underlying asset is immune to default risks due to strong government backing. Furthermore, these equities act as defensive plays during the downturn. Listed infrastructure assets are largely government or quasi-government owned. The sovereign backing makes ongoing infrastructure projects less likely to default compared with other privately held real estate asset classes. These assets work in a cost plus model; hence, profitability is already hedged. Also, listed infrastructure assets typically enjoy monopoly due to entry barriers set by the local governments, thus maintaining stable cash flows. Demand for these assets is often inelastic to price changes, such as electricity, water, toll, as people continue using these utilities despite tariff changes. Thus, this asset class provides stable returns even during an economic downturn. Although investment in infrastructure is capital intensive, the equity route makes it cheaper, investor friendly and keeps transactions transparent. High-return, moderate-risk asset class What is listed infrastructure? Listed infrastructure is a comprehensive and diversified asset class of largely state-owned or public-private partnership (NYSE: PPP ) companies that develop, manage, and own assets related to energy, communications, water, transportation, and other systems essential for an economy. This asset class is segmented into small units and listed as equities on stock exchanges. Hence, the quantum of investment is lower than that of a direct investment in real estate. Furthermore, these equities act as defensive plays and protect investors during market corrections as they carry low default risk and are backed by sovereigns. The asset class outperformed during pre and post crisis period If we compare the performance of the S&P Global Infrastructure Index with its peers over the pre and post economic crisis period, we can see that infrastructure clearly outperformed during the pre-crisis (2006-07) and post recovery period, i.e., 2012 onward. During the recovery period (2010-2011), the asset class clearly outperformed equities (S&P 500 Index). The chart below shows that the asset class has remained superior to equity investments over 12 years and, hence, we can conclude that it offers better returns irrespective of the economic conditions. Performances of various asset classes over last 12 years: Source: Bloomberg Most attractive features of listed infrastructure Financial and operational performance · Access: Direct exposure to global basic infrastructure facilities that are monopolistic · Liquidity: Liquid exposure to infrastructure investments, and no issue with deal flows and fixed investment horizon · Transparency: Access to existing and established infrastructure facilities, and no issue with blind pool investing · Low impact of regulatory changes: Regulatory changes are managed by governments; as these assets are primarily government or PPP projects, the regulatory changes are likely to have low impact on them · Diversification: Allows global investors to easily diversify their portfolio holdings as per the specific risk profile (e.g., geographic allocation, currency, level of gearing, and regulatory and political risks) · Cost: Cost is lower than unlisted infrastructure investments or direct buying/selling of properties · Level of gearing: Lower level of gearing than unlisted infrastructure and real estate firms, and primarily backed by government funding Classification of listed infrastructure Source: Aranca Research Cash generation and return · Higher dividend: Dividend accounted for over 33% of the overall returns of the S&P Global Infrastructure Index in the last 10 years; average dividend growth outpaced average inflation. · Predictable cash flow: The assets work in a cost plus model; therefore, future profitability is secured. · Inflation protection: Revenues of listed infrastructure companies are linked to inflation, thereby providing protection against it. (i.e. concessions permitting rent escalations linked to inflation, regulated price mechanisms that consider rate of inflation) Growth in dividend per share of listed infrastructure companies vs. CPI (click to enlarge) Source: Bureau of Labor Statistics, IMF, Bloomberg, Aranca Research Operational risks Delays: Since these kinds of projects are majorly government owned, there are possibilities of delays in project execution; this could interrupt income generation from the project. Financing: As many emerging market economies are facing funding shortage, there is possibility of slower disbursement of resources as well, as big funding organizations may not sanction adequate grants. Recovery of other alternative asset classes: Other asset classes could recover at a faster pace and make investment in listed infrastructure assets less attractive. Why listed infrastructure? Since the beginning of 2015, global equity markets have witnessed significant volatility due to a series of global events. Slowdown in China’s economy, declining GDP of Japan and the Greek debt crisis dampened investor sentiment. The Eurozone still has a long road ahead in terms of complete recovery. Amid a strengthening dollar, emerging economies such as China and India are not offering encouraging signs to equity investors. The US is the only market that has performed fairly well in 2015 compared with other geographies, supported by a bullish dollar and an expected rate hike by the US Federal Reserve later this year. The ongoing volatility in oil prices have kept investors directionless. Oil prices witnessed a steep fall until mid-2015, primarily due to strong non-OPEC oil production forecast. The OPEC’s refusal to reduce oil output worsened the situation. Furthermore, the withdrawal of sanctions on Iran after the nuclear deal exerted pressure on oil prices. The weak outlook for oil prices impacted the earnings of companies in the energy sector across the world, which consequently reflected in their stock prices. In addition, the ongoing drop in commodity prices affected investor sentiment across global markets. Separately, possibility of new drug pricing rules triggered negativity about biotech stocks, which was once considered the most defensive sector. Performance of major global equity indices (2015 YTD) Source: Bloomberg Among the investment options available, portfolio managers prefer fixed income or bonds, real estate investment trusts (REITs), bullion, and listed infrastructure to create a balanced portfolio. Bond yields globally are already under pressure and reached their all-time lows in January 2015 (US 30-year Treasury yield at +1.7%, UK 10-year gilt yield +1.4%). Moreover, any increase in the rates, especially a rate hike by the US Fed, would make them an unattractive investment option. With regards to gold, a sharp drop in its prices has severely impacted its safe-haven status. With continued decline in commodity and gold prices, the bullion price is expected to remain under pressure in the near term. Real estate is another alternative that provides higher capital gains; however, it is capital intensive and, hence, represents higher risk. In such a scenario, where most of the sectors are underperforming, a defensive play with stable returns and moderate risks is likely to gain attention of the global fund managers. Listed infrastructure is an asset class with all the above mentioned qualities. It offers high returns as well as steady income and assured capital benefits. The equity route makes it less capital intensive and provides benefits of the bull-run during positive economic scenario. Furthermore, this asset class is inflation protected. The inflation-linked nature of revenue from infrastructure businesses enables an automatic hedging against any rise in interest rates, thereby providing listed infrastructure an edge over other investment options. Market size of listed infrastructure assets to rapidly increase According to McKinsey Global Institute, infrastructure investment of around USD57 trillion would be required to achieve the projected global GDP by 2030, accounting for 3.5% of the expected global GDP in 2030. Furthermore, the Organization for Economic Co-operation and Development estimates a required global investment of USD40 trillion in new and existing infrastructure projects by 2030. With such large infrastructure spending, opportunities in listed infrastructure are expected to substantially increase. Market capitalization of listed infrastructure assets has increased to USD3.3 trillion in 2015 YTD as compared to USD861 billion in 15 years ago. Market capitalization of global listed infrastructure Source: Aranca Research The advancements in the global listed infrastructure market have enabled easier access to an asset class that has been traditionally illiquid. Historically, the global listed infrastructure market has performed robustly irrespective of the market scenario. This asset class offers higher returns at moderate risk. Currently, in addition to several smaller-sized funds, six major global funds are operating in this segment, with a combined asset size of USD4 billion. Some major players in the listed infrastructure segment that hold investments from top global fund managers are: Source: Fund fact sheets, Aranca Research Larger players attract major portion of investments in listed infrastructure The S&P Global Infrastructure Index comprises 76 companies, with a combined market capitalization of nearly USD1.2 trillion. The top 10 companies account for a large portion of the market capitalization. In terms of sector classification, Industrials accounts for 40.7% of the total index weight, followed by Utilities (39.3%) and Energy (20.0%). The key index players attract higher investments from global fund managers. S&P Global Infrastructure Index Country Number of constituents Index weight (%) US 22 35.1% Canada 7 7.9% Australia 4 7.8% Italy 4 7.1% UK 4 6.9% France 3 6.9% China 8 5.9% Spain 2 5.2% Japan 4 4.1% Germany 2 2.7% Singapore 3 2.6% Mexico 2 2.3% New Zealand 1 1.3% Switzerland 1 1.3% Brazil 3 1.1% Chile 2 0.7% Austria 1 0.4% Hong Kong 2 0.4% Netherlands 1 0.3% Source: Index fact sheet Listed infrastructure – an attractive alternative investment in current scenario Listed infrastructure assets have high potential for steady returns, low volatility, diversification, higher income, longer duration, and abundant capacity. Such investment options were traditionally considered off-market activities; however, listed infrastructure is an upcoming and promising real estate investment alternative, and is likely to be widely accepted globally. We believe the asset class is not overvalued and is trading at a fair projected 12-month P/E of 8.05x (P/E of S&P Global Infrastructure Index) compared with 15.2x P/E of S&P 500, offering significant opportunities for investors. Emerging investment opportunities in the water, communications and transmission, transportation, and distribution sectors are expected to substantially influence the listed infrastructure segment, driving growth in this segment and attracting long-term investors. Upgrading infrastructure is expected to become one of the key focus areas for governments of emerging economies. Demand for electricity, water, and sanitation would significantly increase due to higher population growth and urbanization. Hence, despite the recent drop in commodity prices, resource-rich governments would continue investing significant capital into infrastructure investments. Key drivers of listed infrastructure assets across the world are: Global population growth: According to the IMF projections, the global population is expected to grow over 8 billion by 2020. Increasing population requires additional housing and power supply, public transport, clean water, healthcare, and education facilities, which would further increase demand for public spending in the infrastructure sector. Increasing wealth: With per capital income growing in developing countries, the population would start expecting world-class infrastructure facilities. Economic expansion: Economic expansion in Brazil, Russia, India, and China (BRIC nations) and Southeast Asia would boost government spending on social infrastructure. Urbanization: With growing urbanization in the developed as well as developing countries, demand for road transportation, telecom, and energy utilities is expected to significantly rise. Climate change: Improved long-distance infrastructure is essential not only for more efficient provision of energy but also for potentially remote and renewable energy resources such as solar and wind. Climate change represents both a challenge and an opportunity for development in emerging markets. Limited supply: Roads, airports, and pipelines can only operate up to a fixed maximum capacity, beyond which additional assets are required. As emerging markets develop, governments typically focus on ensuring the transport infrastructure is sufficiently robust to support growth. Shift in financing: As governments worldwide increasingly face fiscal constraints, particularly in the developed world, the private sector is expected to be involved greatly in construction responsibilities through the PPP route. The private sector is actively involved through PPP into listed infrastructure projects in Australia, Europe, Canada, and the US, and this trend is expected to continue. Performance of two of the largest listed infrastructure funds Source: Fund fact sheets Major listed infrastructure funds and their asset size (click to enlarge) Source: Fund fact sheets, Aranca Research Breakdown of the listed infrastructure investment universe Source: Aranca Research.

Finding Value With The Piotroski F-Score Year 2: Part 1

Summary The Piotroski F-Score was designed to find companies that are cheap and recovering. The first year showed mixed results. This year the portfolio has been adjusted in an attempt to improve performance. This is the first article of the second series of articles looking at the investment performance of the Piotroski F-Score. In the first series, I covered the performance of a Piotroski F-Score long only strategy over the space of twelve months. The results were extremely disappointing. The value of the portfolio declined by 49.3% over the period . Still, giving up on the strategy after only one year wouldn’t accomplish much. So, this year two of the study. The details of the study are below. Finding value In the world of value investing, there are many ways to hunt for value opportunities. However, few are as well defined as the Piotroski F-Score, which aims to identify the healthiest companies amongst a basket of value stocks through applying a set of nine accounting-based stock selection criteria. The F-Score was designed to hunt out value opportunities that are profit-making, have improving margins, don’t employ any accounting tricks and have strengthening balance sheets. However, as usual, this strategy cannot be employed alone, it needs to be combined with another screening tool to produce a suitable set of results. One point is awarded for each criterion the company passes and the stocks that score the highest, eight, or nine are regarded as being the strongest candidates for recovery. Piotroski recommended scoring the bottom 20% of the market in terms of price to book value and then working from there. Using the following system, Piotroski’s April 2000 paper Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers , demonstrated that the Piotroski score method would have seen a 23% annual return between 1976 and 1996 if the expected winners were bought and expected losers shorted. According to the American Association of Individual Investors , year to date the F-score screening criteria with a low P/B value would have returned 3.4%. Over the past five years this return would have been 33.9% and the ten-year return was 26.7%. The screen I’m testing the F-Score, as both a way to discover value stocks and trade them without fundamental analysis. The screening criteria and investments are based purely on the financials in an attempt to remove any emotional bias — something that holds back investment performance. The F-Score screening criteria are as follows: Profitability Signals 1. Net Income – Score 1 if there is positive net income in the current year. 2. Operating Cash Flow – Score 1 if there is positive cashflow from operations in the current year. 3. Return on Assets – Score 1 if the ROA is higher in the current period compared to the previous year. 4. Quality of Earnings – Score 1 if the cash flow from operations exceeds net income before extraordinary items. Leverage, Liquidity and Source of Funds 5. Decrease in Leverage – Score 1 if there is a lower ratio of long term debt to in the current period compared value in the previous year. 6. Increase in Liquidity – Score 1 if there is a higher current ratio this year compared to the previous year. 7. Absence of Dilution – Score 1 if the Firm did not issue new shares/equity in the preceding year. Operating Efficiency 8. Gross Margin – Score 1 if there is a higher gross margin compared to the previous year. 9. Asset Turnover – Score 1 if there is a higher asset turnover ratio year on year (as a measure of productivity). And the 20 largest companies that qualify in the current environment are as follows (in order of mkt. cap): NRG Energy Inc (NYSE: NRG ), Noble Corp plc (NYSE: NE ), Darling Ingredients Inc (NYSE: DAR ), EP Energy Corp (NYSE: EPE ), DigitalGlobe Inc (NYSE: DGI ), McDermott International (NYSE: MDR ), Atwood Oceanics, Inc. (NYSE: ATW ), Cash America International Inc (NYSE: CSH ), Navigator Holdings Ltd (NYSE: NVGS ), Danaos Corporation (NYSE: DAC ), DHT Holdings Inc (NYSE: DHT ), Roadrunner Transportation Systems Inc (NYSE: RRTS ), Century Aluminum Co (NASDAQ: CENX ), Ocean Rig UDW Inc (NASDAQ: ORIG ), West Marine, Inc. (NASDAQ: WMAR ), Marchex, Inc. (NASDAQ: MCHX ), Luby’s, Inc. (NYSE: LUB ), Manning and Napier Inc (NYSE: MN ), Hardinge Inc. (NASDAQ: HDNG ), Trans World Entertainment Corporation (NASDAQ: TWMC ). P/B figures rounded to the nearest whole number. To assess the F-Score, I’m starting a hypothetical portfolio with a $1,000 investment in each company. Investment prices are based on the closing price on 11/20/2015. These positions are based on financial data only; there’s no weighting to fundamental factors. I’ve decided to use this method in an attempt to take all of the emotion out of the trading and running of the portfolio, only when a stock qualifies under the set criteria will it be included in the portfolio and held for the next 12 months until rebalancing. Like the original Piotroski F-Score, as well as buying a basket of stocks that qualify for the screen, I’m also shorting a hypothetical basket of stocks. The short basket will be composed of companies that have the lowest F-Score in my screen. For liquidity issues, I’m excluding any companies with a market cap. of less than $100m from my short basket. Here are the short candidates, in order of market cap: Vertex Pharmaceuticals Incorporated (NASDAQ: VRTX ), Tesla Motors Inc (NASDAQ: TSLA ), Under Armour Inc (NYSE: UA ), Ctrip.com International, Ltd. (ADR) (NASDAQ: CTRP ), BioMarin Pharmaceutical Inc. (NASDAQ: BMRN ), Endo International plc (NASDAQ: ENDP ), Annaly Capital Management, Inc. (NYSE: NLY ), OneMain Holdings Inc (NYSE: LEAF ), Seattle Genetics, Inc. (NASDAQ: SGEN ), STERIS Corp (NYSE: STE ), Renren Inc (NYSE: RENN ), Southwestern Energy Company (NYSE: SWN ), Impax Laboratories Inc (NASDAQ: IPXL ), bluebird bio Inc (NASDAQ: BLUE ), The Medicines Company (NASDAQ: MDCO ), SolarCity Corp (NASDAQ: SCTY ), HRG Group Inc (NYSE: HRG ), Federal National Mortgage Assctn Fnni Me ( OTCQB:FNMA ), Prothena Corporation PLC (NASDAQ: PRTA ), Nord Anglia Education Inc (NYSE: NORD ). The short portfolio is being run with the same rules as the long portfolio. The companies have been selected based on financial data only; there’s no weighting to fundamental factors. Stocks will be included in the portfolio and held for the next 12 months until rebalancing. To reiterate, there’s no bias here. The companies selected are only included because they have the lowest F-Score of the largest 11,300 US companies my screen covers. The number of shares sold short will have an initial value of $1,000. Putting it altogether Here are the two initial portfolios based on the closing prices as of 11/20/2015. The bottom line Those are the 40 picks. I will admit that some of the companies mentioned above are risky bets but on a purely financial basis, they conform to the F-Score criteria, so they have been included. I’m tempted to include some fundamental analysis for each company, but that’s not the point of this study. Research has shown that emotional bias is one of the investors’ worst enemies; the F-Score tries to eliminate that That’s the introduction, over the next few months I will be assessing the portfolio’s performance on a regular basis with a final round-up this time next year. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Portfolio Development – My Approach

Summary Standard portfolio development theory provides a great foundation. Unfortunately, the stock and bond markets don’t always cooperate. Take the approach of accepting what the markets offer to improve total return. Introduction There are literally dozens of articles and books written on the subject of portfolio development theory. Most of those articles and books approach the development of a portfolio using a mix of stocks and bonds with the mix dependent on the investors tolerance for risk and the investor’s age. I think that this “standard” approach to portfolio development is great if you have the luxury of time to build that portfolio over a number of years and business cycles. Without the luxury of time, I don’t believe the “standard” approach works all that well. Making things even more difficult, today we have a unique investment environment. Yes, it really is different this time. We are currently in a period of ultra low interest rates with the most likely course going forward being slowly rising rates. Bonds may not return much over the next few years and if the economy and inflation accelerate, total return could be negative. What is an investor to do? My approach is to accept what the market has to offer. Standard Portfolio Development As stated in the introduction, there is a lot of information available on portfolio development theory. It is not my intent to provide a detailed discussion on the subject of standard portfolio development. I will summarize what I consider to be the standard approach in this section and refer the reader to articles available on the internet if more detail on the standard approach is desired. Most portfolio development starts with identifying the investor’s tolerance for risk. Because the risk of having poor or even negative returns can be mitigated with time invested, an investors risk tolerance also has an age component. Younger investors can generally tolerate more risk because they have many years to invest and accumulate wealth. To see the market behavior over various time periods, you could look at available charts . Another option is to use a market return calculator to look at various time periods. While you might be able to find a 30 year period with a slightly lower return if you work at it, the stock market has returned 8% – 9% average per year for any 30 year period since 1900. The bottom line is that time in the market lowers your risk of having a poor return provided you have a reasonably diversified portfolio of stocks. The standard portfolio model also uses diversification between asset classes to mitigate risk. Assets are typically divided primarily between stocks and bonds with a cash account outside the portfolio sufficient to cover 3 – 6 months of living expenses or for other emergencies. The rationale behind splitting the main portfolio between stocks and bonds is that the two asset classes typically complement each other. If equities have a terrible year, the investor should still receive a positive return from their bond holdings. One long standing rule of thumb for the split between stocks and bonds is to use 120 minus the investors age as the percentage for equities in the portfolio. As an investor ages, the portfolio percentage dedicated to stocks drops. The table below illustrates the portfolio stock percentage as a function of age. While this is a decent rule of thumb to follow, there is no universally agreed split between stocks and bonds and some recent thinking is that the typical split between stocks and bonds as a function of the age of the investor may need to weight more heavily stocks versus bonds. The reason for this shift to a relatively higher asset allocation to stocks is because we have had a long bull market in bonds and current yields are extraordinarily low. This makes it less likely that bonds will provide adequate returns going forward at least relative to historical returns. Stocks and bonds should also be diversified within the respective asset class. Depending on the value of the portfolio, it may not be practical for an individual investor to achieve the level of diversification necessary to adequately mitigate risk. Diversification in stocks is easier to achieve because stocks can typically be purchased in small increments. This is not the case with individual bonds. As an example, a round lot for a stock investment is 100 shares and the cost penalty for an odd lot (