Twice a year, the Wigmore Association – a group of eight family offices – meets to exchange views on the outlook for the global economy and financial markets, share insights on investment strategies and managers, and discuss best practices for serving wealthy families.
In September the group held its meeting of Chief Investment Officers across New York and Washington D.C. to discuss the investment implications of disruptive technology, cybersecurity, political developments in the US and the general investment environment. Discussions are held under ‘Chatham House Rules’ but below are some general views and my personal observations from an interesting couple of days.
Technological Disruption Destroys Value as Well as Creating It
A disruptive technology is something which either replaces or shakes up an existing technology and creates upheaval in the related industry. Whilst the principal investment focus tends to be selecting the next disruptive winner, the group expressed concern that a greater investment risk was disruptive technologies would suddenly undercut the value of established companies. A recent example were bonds issued by Toys R Us; at the beginning of September 2017, the bonds were trading at 97 cents on the dollar but by the end of September, they were down to 18 cents on the dollar. The speedy collapse of this mainstream company, launched in the 1950s, owned by a savvy and experienced private equity firm since 2005 through a $6.6bn deal, focussed our minds. The cause of the collapse was deemed to be competition from internet-based companies, such as Amazon, which posed both price and convenience challenges to the traditional bricks and mortar shop.
We were informed by a succession of industry specialists, representing a variety of technology companies in different sectors of the economy, that the speed of technological changes in the fields of healthcare, logistics, energy and finance was accelerating. Consequently, the potential for current businesses to be disrupted, as a result of a change in the market structure, is increasing. A potential area for close examination is infrastructure bonds backed by utilities. One such sector ripe for change is energy, as the supply of new cheaper forms of energy increases. Furthermore, the proportion of electricity consumed from the national grid will decline as more energy is produced on-site, by solar panels for example, and stored locally in batteries. Commercial real estate valuation was another sector highlighted given the changes to logistics and consumer purchasing patterns.
It was a shared opinion amongst the group, that selecting winners in the fast changing area of technology was difficult, but it was necessary for members to be well informed of developments. The bifurcation in the US stock market between the so-called FAAN stocks (Facebook, Amazon, Alphabet and Netflix) and the rest of the market was symptomatic of the technological valuation divide in the broader economy and private markets. The astonishing $93bn capital raise by Softbank for their latest technology private equity fund highlighted the abundance of capital available for private equity investment. The very low interest rates and highly valued public markets were thought to be the principal reasons for the influx of capital to the private markets. However, this comes at a cost because private equity firms need to invest in larger deals to make it worth their while. This has driven up the valuations of late-stage private companies but correspondingly it remains relatively difficult for start-up and early stage firms to raise capital. The corollary is that valuations of earlier stage companies remain comparatively attractive.
Us Politics – Better Times Ahead?
The discussion on US politics took place on the rooftop overlooking the majestic congressional building. We felt like the Greek gods overlooking the acropolis. The current incumbents of Congress are certainly as mischievous as any Greek god!
Presentations by governors on each side of the house rued the poor working relations in both houses of Congress and hoped for an improvement but were unclear as to how that might occur. Acknowledging that the unusually non-partisanship of President Trump made policymaking trickier, there was a surprising consensus that the Trump administration is now stronger, as Trump has finally landed himself with a high calibre cabinet. Additionally, the Republican Party knows that having failed to repeal the Obama Health Care Act, it is imperative that they pass a tax reform bill by the first quarter of 2018, ahead of the mid-term elections in November.
The President’s sketchy tax bill proposal had just been released, so we were able to gauge the immediate reaction to it. Inevitably corporations liked the significant tax cuts whilst there was concern that personal tax arrangements would favour the wealthy and not the middle class. The US budget process is generally a complex legislative affair. The particular and unusual quirk this time is allowing the budget to progress as a reconciliation bill with a deficit-increasing instruction as opposed to the normal practice of being deficit neutral – in other words, the budget proposals do not increase the fiscal deficit. If it proceeds on this basis, which our discussants thought possible, the bill can pass through the Senate on a majority vote rather than needing 60 votes, which are a stretch for the Republicans as they have only 54 seats of the 99 Senate seats.
The striking feature of the budget discussion was the view that the problems of low wage growth, rising inequality and the rise of populism were attributed to the slow 2% rate of growth of the US economy. The blame was laid at the door steps of poor tax structure and burdensome regulation which stifled capital spending, especially in the energy sector. Hopes were expressed that the tax reform bill and lighter regulation would ‘significantly’ boost economic growth and correct the economic ailments.
The predictions by how much the proposed tax reforms would boost GDP growth varied but frequent reference was made to the Reagan tax cuts in 1981 which saw 7% economic growth in 1984. This ignores the fact that this was a very large outlier; the average growth for the 1980s was around 4%, not very different to the 1970s. Even getting economic growth to a sustained 3% seems to be a stretch given the strong headwinds that exist today of demographics, mature markets and high debt levels.
Still, the tone of the conversation was considerably more optimistic than anticipated on the likelihood of a tax reform bill being passed and the cohesiveness of the Trump administration. This optimism is likely to spill-over into the financial markets.
Any political discussion in D.C. eventually comes around to Russia and the on-going special counsel investigation into whether Russia interfered in the 2016 US election. No-one is expecting an early conclusion to the investigation, with 2019 thought to be the most likely reporting date for the investigations findings. Some ventured that a connection was bound to be found between Russia and Trump’s team but it is impossible to say if it would threaten Trump’s Presidency or his re-election hopes in 2020.
Cybersecurity Is So Large It Has Become a Distinct Investible Sector
The focussed session on cybersecurity was mind-boggling in terms of the scale of the industry, the amount of money being invested and innovation that is taking place. The group was fortunate to have a number of cyber security company CEOs and a high ranking military person around the table. Some of the stand out points were that cybercrime:
- makes more revenue than narcotics.
- has facilitated the largest transfer of wealth in the history of mankind.
- is reported or prosecuted less than 1% of the time
- is the number 1 national security threat, greater than terrorism.
- There are cyber armies in many countries.
- The US government spent nearly $30bn on cyber security in 2016, up from $7.5bn in 2007.
- Company response to cyber crime is sub optimal because it is treated as a compliance issue rather than a security issue which means risks are not properly balanced.
- CEOs will spend whatever it takes to prevent cyber breaches because they know it will often cost them their job. The latest example is the cybersecurity breach of US company Equifax, a credit reporting company founded in 1899, which publicly announced on 7th September that customer data had been stolen and by the end of the month the CEO had retired.
- Machine learning and artificial intelligence is critical to develop real-time cyber security defences as there are numerous daily attacks.
Cyber security is perhaps the inevitable cost of a digital world and it is an expensive business, whereas cyberattacks are cheap to mount. This area is certainly a rich investment theme but knowing where to invest in such a technical and complex field is the challenge.
Commonality of Investment Views
The general discussion on investment positioning by Wigmore members showed a high degree of uniformity. The economic landscape was conducive to risk taking, although a weather eye had to be kept on the consequences of quantitative tightening. Emerging equity markets were a favoured area providing neither the US dollar nor US interest rates rose too quickly. Interest in private equity remains high and the group’s discussion on both disruptive technology and cyber security reinforced the interest.
My own thoughts were that the US equity market will get a short term boost if tax cuts are delivered. At the same time, bond yields could move significantly higher due to expected stronger economic growth at a time when the economy is already operating near full capacity. A possible change of leadership at the Federal Reserve Board (the US Central Bank which sets interest rates) might also set the tone for higher interest rates. The benign environment that has benefitted financial markets for so long might become more challenging.
The Wigmore Association is an innovative collaboration of eight leading family offices from seven countries and four continents around the world. The members include HQ Trust(Germany), The Myer Family Company (Australia), Northwood Family Office (Canada), Pitcairn (US), Progeny 3 (US), Sandaire (UK), Turim Family Office and Investment Management (Brazil) and Promecap (Mexico).
Wigmore was founded in 2011 with the goal of enhancing the understanding of issues that are important to the families we serve. The group is composed of members from each family office and meets twice a year to exchange views on the outlook for the global economy and markets, share insights on investment strategies and managers, and discuss best practices for serving wealthy families.
Visit the Wigmore Association website for further information.