Alternative Asset Trust Quarterly Report: September 30,2017
The MacNicol Alternative Asset Trust is a multi-strategy, alternative investment platform designed to generate positive and uncorrelated returns against the public stock and bond markets. The Trust, through its underlying limited partnerships, is invested in private real estate and mortgages, private equity and multi-strategy hedge funds. Combined, the Alternative Trust is invested in more than 150 separate real estate projects, mortgages, hedge funds and private securities. The advantage of combining different alternative asset classes and high yield investments into one Fund include tremendous diversification, enhanced liquidity, and a more predictable and less volatile pattern of returns when compared against the performance of the individual asset classes themselves.
Alternative Trust Review: The goals of the Alternative Trust are to generate positive “real” returns (after-taxes and inflation) each year, and to generate annualized nominal returns of 6%-8% over rolling five-year periods. We are pleased to report that as of September 2017 the Trust has met its primary goals by generating positive calendar-year returns that have exceeded inflation, while delivering annual returns of 8.83% since inception.
In the past 3 months, the Alternative Trust had no growth in the face of fiscal policy uncertainty and currency head winds in August and September. Geopolitical tensions and weather related challenges in the United States also possed challenges to the Trust in the third quarter. Looking forward, we are anticipating positive returns and more liquidity from the Trust’s private equity holdings (see Emergence Fund commentary, page 8), as well as, cash flows from property realizations in the real estate fund.
Alternative Trust Quarterly Highlights
During the quarter ending September 30th, 2017 the Alternative Trust was flat while remaining positive for the year. Currency headwinds continued to be a factor in the quarter but abated in September as the US Dollar gained 3% relative to the Loonie on expectations that the US Federal Reserve [FED] will continue quantitative tappering in late 2017.
North American Real Estate
The Alternative Asset Trust invests in North American real estate through the MacNicol 360 Degree Realty Income Fund. This fund focuses on value-added projects in the United States and Canada. The Fund also invests in mortgage funds through an expanding number of carefully selected operators and sponsors. All partners in the fund are chosen for their high degree of local knowledge and experience in deal sourcing, finance, construction, and property management. Through its partners, the fund has exposure to more than 120 separate real estate projects and six asset classes across North America. Chart 3 on page 4 highlights the regions of North America in which our real estate projects are located. The overall strategy is to invest in growing regions of the United States that possess favorable demographics, modern infrastructure and access to the global markets. More recently the fund has begun exploring opportunities in Europe as the outlook for the region continues to improve.
360 Fund Third Quarter Highlights: For the third quarter of 2017, the fund declined by 3.8% in Canadian dollar terms while positing positive US dollar returns of +0.9%. Canadian dollar returns were impacted in July and August by a strong move in our currency. However, a reversal in the trend of Canadian dollar strength now appears to be underway as investors look towards further tightening from the US FED. Indeed, the US Dollar Index [our preferred measure of US Dollar Strength] appears to have put in a bottom in early September.
The fund recently observed transactions that contradict the pretense of elevated valuations: California’s tech empire expanding into new state-of-the-art “campuses”. Examples of these transactions are described in the Portfolio Activity section but confirm our view that good real estate in great locations commands strong multiples.
Importantly, damages from recent Hurricanes Harvey and Irma did not materially impact the fund’s holdings and we have worked closely with plan sponsors in the United States to confirm that the fund’s assets are insured against flood and named storm damage. The MAAM investment team’s thoughts continue to be with the people of Houston and many communities in Florida.
Commercial Real Estate Outlook (U.S.)
Commercial real estate market fundamentals remain stable across the United States and strong in Canada. A resilient U.S. economy is leading to healthy tenant demand in all property types. A robust Canadian economy and strong industry fundamentals continue to propel investment activity in the Canadian commercial property sector with many suggesting that 2017 will be a banner year for commercial activity in Canada. Vacancy rates continue to fall and rents are rising modestly in most markets setting up conditions for what we believe will be an elevated level of transactional activity. However, given the later phases of the broader market cycle the fund will avoid tertiary malls and “last mile” retailers whose valuations rely more heavily on the land they sit on rather than growth or development potential.
Multifamily: While capitalization (“Cap”) rate compression has improved the valuations of the multifamily space earlier this year, decelerating Net Operating Income (NOI) growth reduced total returns. Success in the multifamily space is about being strategic and those sponsors with mixed use assets and developmental alpha will utilize opportunities to invest, re-tenant and roll rents forward. The 360 Fund’s US exposures to multifamily projects are primarily through its investments in Carroll Funds II and III of Atlanta, Georgia.
Industrial: We remain constructive on the industrial space as it is a terrific place to park capital in an inflationary environment. Industrial assets mark their rent increases to market more quickly than other asset classes in the space and risks associated with establishing industrial facilities are low once built. From an operations perspective, industrial assets are less demanding once established.
Office: With the recovery in the U.S. office market finally taking hold, the office sector is now at the point in the cycle where expiring contract rents will likely roll up to market, which, in combination with rent abatements burning down, will put upward pressure on income growth and valuations. The 360 fund is broadly exposed to the North American office space through its investments in the KingSett Income Fund of Toronto, Rockwood IX Fund out of New York and the Ameritus Real Estate Fund of Chicago. Given the timing in the market cycle, office is likely a single-digit return asset class for the foreseeable future with certain properties in key jurisdictions trading at premium multiples.
Retail. Although malls demonstrated resilient NOI growth in 2017 the overall performance of the sector is expected to lag the other property types during the next five years. This under-performance for income growth is primarily due to the longer lease durations inherent for retail tenants (though mall leases allow for percentage rents that allow retail owners to capture higher retail sales growth). The 360 Fund has several “value-add” retail investments through its investments with KingSett, Slate and a regional mall in Jacksonville, Florida managed by the Sierra Building Group of Toronto. Our review on retail is more sanguine now that earlier in the year as redevelopment opportunities appear to be well underway in several areas. Our view is that tenant type matters and that some of the changes now underway in core retail will continue to provide value for the foreseeable future.
Real Estate Portfolio Activity
During the third quarter of 2017, the 360 fund initiated new positions in Inter Rent REIT [IIP.UN-TSX] and Northview Apartment REIT [NVU.UN-TSX]. While the fund remains concentrated in private real estate projects, publicly traded multifamily residential REITs trading near private valuations form attractive long-term investment options with a liquidity premium and currency neutrality.
As mentioned earlier tech titans are looking at a number of commercial property sites for their new state-of-the-art campuses. A recent example of such a transaction is the sale of 237 on Moffett (South of San Francisco), to Google.
237 on Moffett sold to Google for $225 million for an estimated fund-level multiple of 2.2x and a fund-level IRR of 37.6%. Google has bought roughly four dozen properties in recently with a combined value of around $800 million, setting the stage for what may be another major expansion of the tech titan’s Silicon Valley operations. Rockwood IX Fund were the Principals behind this excellent return.
The Florida Real Estate Value Fund exited Hemingway Point. The fund acquired 54 acres of vacant, entitled land in Southern Miami in 2013. The land was originally approved for 221 single family homes and 113 townhomes. 13th Floor Investments obtained approvals for 321 single family homes and sold the property to DR Horton over 4 years realizing a fund level IRR of 25% and multiple of 2.0x on proceeds of approximately $20 million.
Private Equity – MacNicol Emergence Fund:
The investment objective of the Emergence Fund is to generate capital gains and income by investing in a portfolio of fast-growing public companies and private equity funds. The Fund seeks opportunities in private equity where capital exit strategies are clearly defined, and are likely to occur within a 3-5 year time frame. The Emergence Fund invests in established private equity funds with a focus on companies with defensible franchises, high growth profiles and proven management. Investments will largely focus on profitable companies with high levels of proprietary technology addressing large target markets.
The Emergence Fund achieves its objectives by investing in well-respected and managed third-party private equity funds including the Georgian Partners Funds I and II, Northleaf Secondary Private Equity Fund and the Northleaf Private Venture Catalyst Fund. Applied artificial intelligence, conversational business and security continue to form the bulk of the fund’s focus from a strategic business perspective.
Earlier in the Quarter the fund initiated a position in Nextblock Global a private company focused on digital blockchain technology and founded by Alex and Don Tapscott.
On August 12, 2017, eSentire a company held in Georgian Fund II entered into a definitive agreement pursuant to which it would be sold for USD $150M in cash. The company was acquired by Warburg Pincus, a large private equity firm. The price reflects a 5.6x multiple on revenue of USD $26.6M for the trailing 12 months. Georgian Fund II invested CAD $12.3M into the company. This transaction values our investment at CAD $23.1M, representing a multiple of 1.9x invested capital and a gross IRR of approximately 27%.
Hedge Funds – Absolute Return Fund
The investment objective of the Absolute Return Fund is to generate positive returns under most market and economic conditions, and to have little or no correlation to the US and Canadian stock markets. In order to achieve its objectives, the Absolute Return Fund invests in several value-added strategies managed by experienced and successful Canadian, US and U.K. hedge fund managers. Most of these investments are not available in the public market and are typically not accessible to individuals and smaller institutions because of high minimum investment thresholds, often in excess of five-million dollars.
Emerging markets performed well led by exposure to Latin America. Global demand for industrial commodities were a key driver of growth in this area. The Long/Short Equity strategy was the largest contributor to the fund’s performance on absolute terms. This strategy substantially outperformed its net exposure to equity markets generating significant Alpha. Alpha generation was both from the Long and the Short portfolios. We expect that as central banks start to pull out of Quantitative Easing and interest rates gradually normalize, the Alpha generation from the Short side of the portfolio should become a more positive and material driver of performance going forward.
The Statistical Arbitrage strategy was the largest contributor to performance on a capital weighted basis. The strategy benefitted from a pickup in equity volatility in August, albeit from depressed levels.
The Multi-Strategy sector had a contribution for the month. Performance drivers were broad based. Long/Short Equity, Statistical Arbitrage and Fixed Income Arbitrage were the main contributors.
After months of positive performance, credit markets were nearly flat in August after experiencing heightened volatility. Macro concerns led investors to safe-haven assets and pushed 10-year US Treasury yields to their year-to-date lows. The US 10 year Bond Yield started the month at 2.30% and ended the month at 2.12%. The Event Driven/Credit strategy was flat for the month as the fund has only a marginal direct exposure to this strategy.
We are pleased with the durability of the alternative asset trust given the challenges faced to date including currency headwinds, weather related challenges, monetary policy incongruence and geopolitical risk. The Alternative Asset Trust will continue to provide effective diversification relative to traditional stock and bond markets. The trust remains open to new investors and is available for purchase on a monthly basis.
MacNicol & Associates Asset Management Inc.