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Macro Trends

We have spent decades in research, consulting and fund management roles
The founding partners of Weisshorn Capital have spent decades in liquid capital markets in fund management, consulting, sales and research roles. The liquidity of these markets should be one of the major reasons why these markets are prone to short- and long-term bubbles and volatility. Further particularly because of the availability of data and the research performed on this basis these markets are volatile yet based on the lack of consistent outperformance, very efficient.

Now we focus only on investing in long-term, stable and self-propagating trends
Conversely, macro-trends, the way we understand them are rather like tectonic shifts. They arise because many powers converge and produce a self-propagating trend which is hard or impossible to revert for at least ten years.

Population growth and societal aging are example
Two very similar examples are population growth on the one hand and societal aging on the other. The former is the result of improving conditions (e.g. food, sanitation, health-care) in countries transcending the developing into the developed world. The latter phenomenon on the other hand is largely the result of universally observable societal changes or lifestyle choices. With only very few exceptions Western societies, by choice have a total fertility rate below 2 which, ceteris paribus, implies population decline, aging of the population and, eventually, extinction.

The west will increasingly need nursing homes.
Both trends and their investment opportunities are typical for our focus. For decades to come there is little chance that Western habits and life styles are changing. The same is likely to be true about transitional countries’ fertility rate. Consequently, the West will increasingly require nursing homes, needs more health-care, will experience ever greater immigration and experience an aggregate decline of population outside the metropolitan regions.

It remains to be seen how quickly the developing nations adapt to Western fertility rates
The transitional countries on the other hand, with the grand exception of China (due to its past one child policy) all show fertility rates above reproduction and so it is not surprising that population growth is forecasted to occur in those countries and not in the political West. It remains to be seen how quickly the developing world’s adaptation to Western family planning preferences converge. As women’s role changes and education levels increase fertility usually declines. Consequently, further economic development seems to solve the population problem. Unfortunately, there is a catch-22 built-into this thinking as higher education and income requires continued growth and, in absolute terms, at ever greater rates.

Demographics, politics and social changes are all relevant to economics and investing.
The latter point illustrates the interconnectedness even of macro-trends, in this case demographics and economics. And as these are only different paradigmatic views on the world all this is additionally embedded in the social, political and environmental realm. In other words, a macro-trend in one realm has to have a representation in the others.

Predictions are difficult, especially about the future (Yogi Barra)
We continuously observe the present unfold and we seem to be able to analyse past forces and decisions that lead to the state of the world at this very moment. However, literally billions of decisions are made at every instance and things can change quite radically as could be observed over history of mankind. This complexity is so great that, speaking with the words of Yogi Berra “prediction is very hard, especially about the future”.

In order not to contradict our own focus we believe that the underlying driver of some trends are so inert and coincide and compound each other that for the relevant investment horizon they should prevail and possibly even gain in momentum. For example, world population growth will continue for at least another 20 years and demand for food and other goods by definition has to increase

The increase in wealth in the transitional nations will determine how many people join the middle-classes and so how many more cars will be built and tonnes of meat more be eaten etc. At the same time it’s only a question by how much climate will change and temperature will increase. The chances for a mere 2 degrees are heavily doubted and chances appear on the upside. How much exactly nobody knows but the direction is clear. Similarly, we cannot be sure how this will affect temperature volatility, rain fall and allocation, hurricane likelihoods, floods, soil erosion, water scarcity and hence agricultural productivity. We guess though, the direction is quite clear.

The risks to the world equal investment opportunities
Many different investment-ideas could be distilled only from this very shallow view on these trends. For example, renewable energy infrastructure or carbon capture investments to slow down carbon-dioxide emissions and so slow down global warming. Weather options or other insurance products may spring to mind. New, genetically modified crops with greater drought resistance could improve food production.

Farmland, as an example.
While all of the above could be projects we would work on we are currently very keen on farmland investments. In theory farmland can be bought anywhere but given the long-term nature of this investment and the overall uncertainty (political, ecological, economical) we find that such an investment should be conservative in all aspects. After extensive research and many discussions with industry insiders we believe that Uruguay offers a perfect combination of political stability, future proof water supply, grand soils, social stability and all that at a discount to US, European and Latin American soils.Uruguay aside, we believe that agricultural assets are very well positioned to benefit from these macro-trends and are likely to attract more liquidity. This leads us from “natural” drivers to the higher-level economic macro trends e.g. inflation and asset allocation.

Inflation? What kind of inflation?
With regards to the former, the bets are out whether we will experience increased (hyper-) inflation and for what reasons. Clearly the most consensual expectation is that of monetary expansion or quantitative easing. Less consensual is inflation from increasing demand e.g. from the 80 million of additional human beings on earth per year. Other factors like soil erosion, higher cost of exploration (e.g. oil), scarcity of resources, increasing political tension etc

Not all assets protect against all kinds of inflation.
Depending on the type or combinations of inflation different assets are likely to perform differently as they provide different protection against inflation. For example, mid-market retail properties are not likely to do well in a stagflation environment in our eyes. Unemployment will hit the mass-market hardest and the low bargaining power of these classes is likely to lead to continued real-income decline. Low savings add to demand decline and the high-competition-low-margin situation will push many retailers over the edge. Those that stay will ask for rebates with good chances of success . Food demand on the other hand is largely insensitive to economic swings. Lower economic growth or even recession will impact disposable income and spending patterns. Most certainly prices for agricultural commodities will fall as the meat-increase-trend partly reverts and works through the system. However, population growth should underpin demand and spending on food is likely to suffer less. Further, agricultural produce is rather likely to be a cause and crystallisation point of inflation and should hence offer protection. As a non-listed asset the lack of visible price signals may in fact reduce its asset volatility and so risk of capital losses. The expectation that there is an underlying long-term trend coupled with long-term investment goals should further support prices of agricultural assets. Particularly when leased, farmlands provide income above current high-grade sovereign debt and so, we believe, huge amounts of capital will be redistributed into this asset class.

Asset re-allocation as a long-term trend.
The latter high-level trend was already an undertone to the above theme: Asset allocation. We have had the questionable privilege to have front-row seats in an economic and political spectacle of biblical proportions. One may be tempted to dub today’s world as coined by a sovereign debt crisis but this would, in our eyes be a far too narrow definition. Excessive amounts of government debt are not built over night but, as in this case, over decades. Economic excesses usually do not lead to a correction instantly but only when enough pressure has built-up and mostly, the implosion is ignited by an unrelated event, potentially by the burst of another bubble that built along with the other.

In economics cause and effect over time are impossible to prove. For example, was it the debtors fault to accept a 110% LTV loan on a house or the bank’s for granting it? Have the banks overleveraged or just literally played by the regulatory book? Should they have known that this is all built on sand or should the government have enacted “better” regulation? Is it all a failure of a system driven by greed or shareholder value? Ultimately these are political questions that require a political answer and this is what we are about to get.

The demise of the risk-free rate.
We will elaborate more about the political implications but from an asset allocation standpoint the current market and expectations are a datum. The cornerstones of this, in our eyes are. firstly, the notion of risk-free government bonds is dead. What has been deemed risk-free in the past i.e. the USA, Japan, Germany, France has or is on the brink of losing its AAA status or has already lost it.

Re-denomination risk.
Downgrades only represent an ex-post signal and so it can be argued that all of the above have already lost their risk-free status, not to mention sovereign debt  of Greece or Italy. For European sovereign debt additional risk has emerged i.e. that of a re-denomination of the currency. What will investors get back in ten years? Lira? Pesetas? Escudos?

With the risk-free asset went the most important benchmark of modern capital market theory. Investors’ need for safe haven assets have driven Danish short-term interest rates in negative territory. Investments into the safest long-term asset, 10 year German government bonds  get zero real-return and are likely to lose money in real terms if inflation picks up. Consequently, while the intrinsic risk of losses in these assets has increased tremendously they yield practically nil or even require payment for storage.

The above observation should have different far reaching consequences for asset allocation. Firstly, the past and coming downgrades of government and most likely corporate bonds conflicts with investment regulations for insurance and pension fund investors to invest in AAA rated bonds. Either these monies have to flow in the ever smaller pool of AAA rated assets with ever lower yields or, which we find more likely, have to be channelled into different assets.

.Regulation aside, the yield of these assets is unlikely to be in tune with risk and so it appears unlikely that this situation prevails for too long. Return relative to risk is one thing but  at the same time, an absolute rationale applies. Life insurance companies with guaranteed returns on their books as well as pension funds with defined benefit plans need a higher level of cash yield than what is on offer of good quality sovereign debt. As the chart depicts using Allianz as an example, these gigantic asset pools are heavily invested in (sovereign debt) bonds. Unsurprisingly, the same forces are at work when it comes to the spread between investment grade and junk-bonds.

It may well happen that downgrades of nations will not infect corporate bond ratings and some of the AAA globals may absorb outflows from sovereign capital. This is nicely illustrated by AAA corporate bond yields trading only slightly above the treasury counterpart .

These tendencies are certainly valid at the moment but in order to have a lasting influence on  “our” assets, they need to be of more long-term nature. The relevant question is: How long can risk aversion and ultra-high-damage event risk prevail?  Firstly, accommodating central bank conditions are likely to prevail as long as the global economy has not stabilised. Given the huge amount of government debt that needs to be repaid this may take a long time.

Chances for recession are very high and, as government revenues decrease as GDP declines governmental defaults are, ceteris paribus, increasing. Naturally, this makes the fat  tail risks even more likely.

Further, it appears increasingly unlikely that China will be able to bail-out the west again, neither financially nor by imports. The imbalances that have built-up in the residential property market, the out-of-control “black” lending sector, high food inflation and a political system that completely rests on the increasing  and inclusive wealth of  the people represent an additional  and potentially destructive risk.

In line with our belief that forecasting is of little value we abstain from doing just that. That said, it appears likely that the described dynamics will be at work for more than just 2012. Consequently, there should be liquidity outflows from huge asset pools which need to find a new home. We see this happening mostly outside the cash bond and equity markets.

Capital is likely to flow into safe-haven economies.
Clearly, from a European perspective marginal money is unlikely to flow to €-zone drop-outs like Greece, Portugal but even Italy may be shunned as chances are one may pay in € and get Lira back. Further, inflation protection will be another filter that we believe will be applied. We are so far not convinced that a consensus has been reached what kind of inflation is likely to dominate but, most people we talk to find a QE-related cause most likely. As huge sums will rotate out of income generating assets and as a large part of investors require income-generating assets in their portfolios assets with regular, and low-risk cash flows should be on top of investors’ agenda.

Germany, Switzerland and Scandinavia should experience net-inflows.
Working top-down we believe that Germany, Switzerland and pretty much the whole of Scandinavia will receive massive inflows. The safe-haven Swiss Franc was the obvious choice first but we now see this happening in Germany. We believe that momentum will build-up  in Scandinavia as they are politically stable, well-run, have low public-debt to GDP ratios, a competitive corporate sector and all but Finland their own currency and central bank.

With regards to inflation protection we believe that only indexation and strong bargaining power will truly keep the promise. Wherever there is choice and wherever terms are likely to be weaker rents will decline.

Top location commercial property with non-cyclical, quality tenants.
We had already pointed out that mid-market retail is unlikely to protect. Conversely, we find that AAA tenant, long-term leases in prime locations of Munich, Oslo, Zurich, Stockholm and Copenhagen will perform very well. This is not only because rent-indexation clauses will not be renegotiated but because their relative attractiveness should drive down yields even more. In the beginning of the crisis Danish 10 year government bonds were still trading at a premium to their German equivalent, now they trade at a discount and, as mentioned before, at negative rates in the short-term segment.  We see this as a corroboration of our thesis and an early signal of an unfolding theme.

German and Scandinavian residential should perform well.
There are certainly many other assets and naturally this is not the place to discuss them all. However, with regards to our activities we believe that residential properties in prime locations in the above regions stand out as highly attractive recipients of cash inflows. Due to its size we see this predominantly happening in Germany.

Due to its relative size re-allocation into renewable infrastructure might have a significant effect.
Further, infrastructure assets and here renewable energy infrastructure in our eyes appear to stand out as highly attractive investments. Again, from a relative standpoint photovoltaic installations in Germany offer long-term high and stable returns on equity.  Even though investment volumes in this asset class have increased substantially, compared to other assets like government bonds it is miniscule. In other words, even small re-allocations to renewable energy infrastructure may have a significant effects, particularly when the funds are channelled into Germany.

In analogy to German PV we believe that Scandinavian wind infrastructure will be attractive relative and in its own right. Firstly, legislation appears to move to become more supportive. Secondly, at least in comparison to Germany, Scandinavian wind is stronger and varies less around historic averages.

.Renewable energy infrastructure in general rides on another long-term trend and is an attractive asset class per se and in relative terms. Political support, as a function of public pressure has increased substantially and is unlikely to vanish. In fact, what have been radical positions decades ago is now consensus in all camps of the political spectrum. Even though in tough economic times long-term goals are often sacrificed for short-term improvement we believe that RE policies are too deeply entrenched to be abandoned.

Further, the industry is still on a steep part of the learning curve and economics continuously improve. In other words, governmental support will be ever less necessary as technologies approach grid-parity.  Consequently,  political risk is likely to decrease as a result of that. Renewable energy investments are therefore supported by political drivers, public conscience, energy  security, scarcity and cost,  technological progress and of course, the increasing awareness of  climate change and its impact on all our lives. Of course, RE not only consists of PV and wind but includes biomass, geothermal, wave energy and more exotic methods like waste to energy. We will explain more about our activities in these fields here.

Summary
To sum up, we focus on long-term tectonic trends that are supported by many sub-trends which have a reinforcing effect on one another. These trends provide investment opportunities and among these we focus on non-listed ones in the low to middle risk bracket.

 

 

 

 

 


 

 

 

 

 

 

 

 


Renewable energy

 

 

 

 


Capital market activities