Foresight Capital Partners

Whenever I am asked about property investment I usual suggest that people take a look at the Berlin market. The reason has simply been that I understood it was possible to obtain a 10% rental yield and there was the possibility of a more Anglo-Saxon mortgage market (i.e. prices could get more debt inflated, in addition to the earnings growth inflation). Now firstly it seems you could get a 10% yield but rental yields have been coming down due to investors entering the market and pushing up prices over the past few years, and that now a 6-8% yield is more realistic. What is particularly interesting with this market is that over the past fews years even the smart money, early movers like Morgan Stanley and Blackstone, have found it hard to get a decent return.

Over the past few years there have been a number of trades which have gone through where usually a US Investment Bank or Private Equity Group buys a large block a private residential property in order to reseller it at some point directly within the private market. Now the trade has generally been as follows you buy at the whole sale level (i.e. 300+ flats at once) from Corporations, housing associations etc then resell to owner-occupiers. Apparently the whole sale price at present is around 800 Euro per square meter and the end-user price can be up to 1,000 Euro per square meter. Hence, at least on paper there is something of an arbitrage, at least if you want to get involved in being a real estate agent. However, even with all the investment banking financing tricks people like Morgan Stanley can muster the deals just do not seem to stack up.

Remember JP Morgan is a real business and hence they want 20%+ return on capital, and hence when I say stack up, it means this business does not provide a 20%+ return on capital. Some of the problem’s which such parties have experienced when buying at the wholesale level in order to resell, is that some tenants just do not want to buy, hence you cannot get a clean exit, and you end up having apartment blocks which are partially sold and the ones which are not only provide 6-8% yield. Moreover, if you want to push up the rents in order to try to get the numbers to stack up (or the tenants to leave) then there are municipal rent caps. Hence, you end up being stuck with residential property with a 6-8% rental yield which not really the sort of asset which Morgan Stanley (or people like me) are looking for.

You never make friends (or get customers) by telling people what they do not want to hear and hence the sales people (including sales staff in the financial sector) just tell people what they want to hear. Which is probably the reason why I have always been such a miserable salesman since I always just tell people what I think irrespective of the consequences. Now, just to get my position out in the open, I think property at present is a bad investment and the worst market I know of is the UK. If anyone wants to know my personal rule of thumb with property, it is:

“you take the monthly rent multiply to 100 (maybe 120) to give you a target buying price”

That is, I always think property as an investment should offer a 10%+ rental yield. The reason for this is just that in order to have a 6% real (gross) income, with a 2% vacant/management, and 2% cost of up keep, you need 10%+ gross rental income. To me taking less than 6% income with real inflation around 5%, just does not make much sense. Remember when the property developer programs are not on the TV each night and everyone (and there dog) is not pushing property investments (i.e. when the music stops), it is the rental yield (i.e. the earnings) which will count.

Please, before anyone tells me, I really do not care what the market prices are, or what other persons are doing… what I care about with any investment is entering into positions where I expect to obtain a 25%+ compound return per year on my investment. And even an entry price of 100X rent, the numbers only stack up with gearing.

Making such comments is not going to earn me much popularity but since my no.1 source of income over the past 10 years have been investments, I cannot afford to dilute my approach in the name of popularity. Please also note that this is exactly the line I have been telling family members over the past few years, with differing degrees of success.

Since all my family members know I am involved in investment markets I always get people coming up to me at family gatherings and lettering me know about there latest investment activities. And one can guess this discussion recently often centers around property investments. At one end I have people telling me at such gatherings “I am going to just keep on buying and never sell”, and at the other end I have, “I am glad I sold and now rent”. Guess which one of these two camps made the most money over the past 3 years…. Well its the guy who sold his UK house and invested the monies on the stock market. In fact, in the UK over the last one, two and three year periods, the FTSE index has out-performed the housing index.

There have been numerous investment companies launched onto the AIM exchange over the past few years. Since these firm are under researched (in comparison to there Investment Trust counterparts) mis-pricings may appear leading to opportunities for out-performance over time. One area which has particularly interested myself (and an area which other have drawn my attension to) is that of clean energy. As the FT pointed out today, onshore wind farms are getting very close to being viable without state aid and hence this sector may very soon offer an realistic alternatives to hydrocarbon energy sources. Below I list two firms which allow one to gain exposure to clean energy technologies with the assistance of specialist fund management:

Imperial Innovations

Commercialization of Imperial College London Universities IP. The University spends a fortune development intellectual property which general is just published in academic journals, the Imperial Innovations offers an alternative where the University and individual can get a kick back to IP developments which are commercialized. After looking at there site it just looks like is very cost effective means by which the buy up IP assets in the biotechnology and re-newable energy fields.

http://www.imperialinnovations.co.uk
http://www.investegate.co.uk/Index.aspx?searchtype=3&words=IVO&Go=search

Low Carbon Accelerator

Guernsey-domiciled Closed-end private equity AIM fund specializing in green energy sector. Fund run by Mark Shorrock, former CEO and founder of Wind Energy, a UK-based independent wind farm developer.

http://www.lowcarbonaccelerator.com

With operations like BNP Paribas Arbitrage SNC today buying stakes in closed-end funds like Aurora Investment Trust plc at a discount of under 7%, you really need to ask yourself whether closed-end fund arbitrage is a strategy worth applying anymore. This is not an isolated event and parties such as ‘The Cayenne Trust Plc’ another fund arb are quite happy to build positions in funds such as Perpetual Income and Growth, Electric & General Investment trust at “discounts in excess of 7%” (see September 06 Factsheet). Such parties would have wanted 15-20% (or higher) discount levels 3-5 years ago, and now they are happy on wafer thin margins which seem to the outside observer that in terms of the expected return the entire activity is hardly worth it. In my judgment I would suggest that at discount level under 10%, would render to closed-end fund arbitrage strategy insufficient to justify. Moreover, if you are paying hedge fund/absolute return like fees then the whole strategy becomes a bit of a disaster (at least for the investors in such funds) when the discounts go sub-10%.

As has been widely reported (for example in the FT), the dilution of potential returns from many hedge fund strategies (such as closed-end fund arbitrage) is being diluted by the simple fact that there is too much money chasing the same opportunities. Closed-end fund arbitrage is a clear example of this where parties are deploying capital in trades with ever lower return expectations. This lowering expectation is also very much born out by the figures where according to Credit Suisse Tremont, the hedge funds as a whole have returned 7.64% over the past year, where as five years ago most strategies offered double digit returns. Saying this, even though the performance each year has been getting weaker and now stands at levels not much higher than a bank account, people are still all to keen to throw money at hedge fund strategies. In particular, according to Hedge Fund Research a record $44.5B has flowed into hedge funds over the last quarter, which is only likely to push returns to even lower levels.

Back in 98′ I clearly recall the day when Russia defaulted on its national debt. I also recall reasonably clearly the collapse of pyramid “investment” schemes in Central Europe, and the collapse of numerous retail banks which resulted from the mis-management and out-right fraud associated with the banks lending activities. These events happened just 10 to 15 years ago. The consequence of such events at the time in terms of banking services was that the populous just did not trust the system. This resulted in large amounts of capital just flowing out the country into foreign bank accounts and in many cases people just keeping the cash (in a hard currency) and literally stuffing it under the mattress.

Though global financial service firms have exquisitely complex accounts the basic business model really boils down the something very simple. Namely, they take deposits and make loans, and the interest they pay on the deposits is less than the interest they charge on the loans and their profit is the difference. For example, RBS.L has an interest rate differential of around 2.6% (i.e. loans on average are charged at 2.6% higher interest rate than is paid on average on deposits), there are approximately 400B GBP of loans and 400B GBP of deposits, hence the profit each year is 400B GBP * 2.6% = 10B GBP. In short, a bank’s profits result from two driving factors loan/deposit volume and interest rate differential.

Returning to our example, after 50 years of communism one would expect any nation state’s economy will take years to transform the infrastructure and mentality of the population to become more in line with established capitalist societies. However, what has surprised me is the speed at which this transformation has taken place. Just recently Sberbank (Russia’s no.1 bank) has been running trials of credit cards to retail customers, according to Sberbank they expect to start issuing credit cards by Christmas. Yesterday a much smaller Russian bank MDM Bank managed to securitised $430M of car loans. That is, the bank sold car loans to private individuals and then resold these loans on within financial markets. The pricing of the notes where as follows:

$270.9M, Baa1/A-minus note, priced at 100 basis points over one-month dollar Libor
$77.4M, Baa2/BBB note, priced at 160bp over one-month Libor
$54.8M, Ba2/BB note, priced at 330bp over one-month Libor

now though my Russia is almost non-existent it would seem from:

http://www.mdmbank.ru/private/loans/car/conditions/ontime/

that the car loan run with a 9.99% interest rate, and hence the above prices provide descent margins and moreover the bank does not even hold the default risk. The point is banking is Russia and Central/Eastern Europe really has come a very long way since the dark days of the 1990s.

Now getting back to the issue at hand the point I am trying to make is that the US banking sector has traveled a similar path from banking panics and collapses to the mass adoption of credit and other financial services. However, in the case of the US this evolution has taken about a hundred years going back to the formation of the FED in accordance with the Federal Reserve Act of 1913 (see http://www.ny.frb.org/aboutthefed/history_article.html), the breaking up of the Breton Woods agreement in the 1970s, to the recent post Thatcher-Regan monetarism which had its ultimate expression in the “Greenspan put”. The result of these developments has resulted in the credit and banking services being ever more widely available. However, as you can see from the time span detailed above this transformation has taken about 100 years, where as in Russia and Central/Eastern Europe which are well on the way to making the same transformation in just a 10 year period.

The Isle of Man (Manx) trust law is very similar to the trust law within England, and the taxation of trusts can be rather complex. Saying this, in order to simplify matters the Isle of Man Tax authorities divide trusts into Manx Trusts and non-Manx Trusts.

What are Manx and non-Manx Trusts?

A Marx Trust is any trust where either one of the trustees is an Isle of Man resident, or where the trustees have delegated the management of the trust to a person who is an Isle of Man resident.

A non-Manx Trust is a trust where none of the trustees are resident if the Isle of Man, and where the management of the trust has not been delegated to an Isle of Man resident.

Tax Trust Income not Capital

With regard to Trusts the Manx tax system will only tax income of the Trust and/or beneficiaries and does not tax the capital/wealth of the Trust or the beneficiaries. For this reason in the following discussion we will only refer to the procedures used for the taxation of the income.

Types of Manx Trust and how they are taxed?

Manx Accumulation Trusts

Where part or the entire income of the trust is accumulated and where the beneficiaries are Manx resident. In this instance the trustees are taxed on the accumulated income. Distributions of taxed income to the Isle of Man beneficiaries are treated as capital distributions and hence the beneficiaries are not due to additional tax. Note that it may not possible to allot income as ‘distributed’ to a beneficiaries even if it is not paid out.

In instances where the income in distributed (gross) to the Isle of Man resident beneficiaries, the distributions will be treated as income distributions with the beneficiaries accessed accordingly.

Tax Free Manx Trust

A Manx Trust will not be taxed in the following circumstances:

1. Where the settlor and the beneficiaries are not resident in the Isle of Man and the income is not Isle of Man sourced. Where a proportion of the income of sourced from the Isle of Man then only that income will the accessed.
2. Where the settlor is resident on the Isle of Man but the beneficiaries are not. The tax free status can also be preserved if any Isle of Man beneficiaries are excluded from any benefit from the Trust.

My personal goal/guideline in terms of performance with regard to investment is that I intend to earn a return of 25% (ideally more) consistently each calendar year. As with any business activity you should have a clear idea with regard to its profitability before you start. For me the 25% compound return level is the level which I believe is the long-term level of profitability which I should expect. Thankfully, I have just passed this bench mark for the year so I can look out of my office window tonight (as shown below) and feel slightly more relaxed.