Are you not a sophisticated investor?
September 12, 2019

Blain's Morning Porridge

"Sophisticated investors buy negative yielding bonds – are you not a sophisticated investor?"

What madness will today bring?

From up in Shard's Eyrie in the Walkie Talkie Building we can see Marquees and Tents going up on the Tower of London lawn. What can they be for? Press tents to cover the beheading of the Prime Minister perhaps? The rebellious Scots judges have declared the suspension of parliament to be unlawful – meaning Boris has betrayed the crown? Naughty. Let's see what the English courts say. Brilliant. I mean, it's only 360 years since our last proper Civil War, although Scotland vs England tends to be a more regular fixture.

Meanwhile, I suppose we should be thinking what President Trump delaying some tariffs means. Absolutely nothing I suspect.

Today is going to be about waiting for what the European Central Bank says, and my guess is as I described yesterday: the ECB will disappoint markets expecting a further cut and resumption of asset purchases in order to move the euro agenda on to a discussion of fiscal policies under the new ECB head, Christine Lagarde, in November. Watch this space. The world is changing.

At last.. what do I do during the day? Most mornings I finish the Porridge with "out of time, and back to the day job". The unanswered question is: what is my day job?

Regular readers of the Porridge know that quantitative easing and monetary experimentation have left me highly sceptical of bond and stock market valuations. I much prefer the attractions of real assets: diversification away from distorted financial assets, into real things that earn real positive returns.

My day job – once I've got the strategy stuff out of the way each morning - is to originate and finance "alternative" assets like property, infrastructure, renewable energy and other real opportunities to institutional investors.

Typically, I have to demonstrate such assets are realistic propositions, backed by serious and effective management, with business strategies likely to ensure predictable and sustainable returns.

At the moment I'm working on deals in carbon sequestration, impact investments in renewable energy, commercial property, coal, helium and a bunch of other stuff. Most deals we look at, we turn down because they fail at least one of our key tests. We focus entirely on deals aimed at institutional investors – I don't get involved in retail targeted deals like mini-bonds!

What fascinates me most are the reasons investors reject deals. It may be structure, or asset class, or often its profile: they don't fit ESG (environmental, social and governance) guidelines or compliance concerns. Most often it's liquidity. Real/alternative assets tend to be very illiquid, but I'd argue that most corporate bonds will prove equally difficult to shift when the crunch inevitably comes.

One of the real asset areas I've always been interested in is aircraft. Most airlines don't own their planes. Specialised leasing companies own the aircraft and rent them to airlines, which results in very predictable returns. Airplanes may depreciate as they age, but it's a large market and fairly easy to estimate their future value at any point in their life cycle. We also know there are large order backlogs for popular models and older aircraft are perfectly safe. Demand outstrips supply.

To invest in aircraft, you really need to know two things: what is the credit risk of the airline renting the plane, and what is the likely value of the plane when the lease ends – the metal risk. There are lots of refinements – like how simple it will be to repossess the plane if the airline defaults on the rental or goes bust, and how quickly it can be rented to another airline and start earning money again.

When it comes to the metal risk, it's questions like what is the usage on the plane (how many cycles has it completed?), how popular the aircraft type is and the routes it can efficiently service, and issues like what kind of engine it uses. The basics are simple, but the underlying details are critically important to understanding any investment.

At the moment aviation investment is tough. Many observers fear a global slowdown will reduce passenger demand, triggering a rising number of airline defaults, slashing demand for new aircraft and impacting the valuations on older planes.

Others think the Chinese – where a massive number of aircraft are on order – will shelve demand for Boeing and Airbus in favour of their own new aircraft. Other investors think aviation has simply reached the top its cycle, pointing to leasing companies selling stock or firms quietly exiting the market.

However, there are great opportunities out there for the brave. For instance, there is the perennially troubled Norwegian Air. It seems to dance between "about to collapse" and "shareholder rescue" on a quarterly basis.

Bondholders rejected poorly conceived proposals to extend two senior deals totalling US$380 million – even with the sweetener of security on landing slots. Now the company is eyeing some sort of conversion from debt to equity, or yet another capital call – just as the airline goes into its quieter off-summer season and lower cash inflows. It's been a troubled name for years.

Yet it's also a great airline. I've flown business to the United States on a brand new Dreamliner for less than the price of a tiny economy seat on a creaking 30-year old BA Jumbo. It works. But its rapid expansion to become Europe's largest low-cost long-haul intercontinental airline didn't meet the same success as Ryan Air becoming the regional money-making machine.

It's been unlucky. It can't sell surplus older inefficient aircraft because the new B737 Max aircraft they expected to keep the costs down are still grounded, while their Dreamliners still have engine problems!

Although rumours of its imminent demise are heard almost daily…Norwegian may be exactly what other airlines, like IAG (the British Airways parent) needs. This week's BA strikes – triggered by highly paid pilots demanding an 11 percent pay hike to over £200k per annum (which is actually low compared to Air France, Lufthansa or KLM), sum up the airline's problem: high costs and an ageing fleet.

Acquiring Norwegian would give them a new fleet and frankly cheaper crews – a ready-made low-cost model - plus lots of critical landing slots at Gatwick! It might be worth doing some more work on Norwegian risks.

Meanwhile, what about Boeing? An aviation finance pal of mine was recently flying in the states. As she got onto a regional flight, a young mother with two small children was asking the flight attendant what kind of aircraft it is. "Oh, this is an Airbus 320", he answered. "Oh, that's good, I wouldn't feel safe flying on a Boeing." That's pretty damning for what once was the world's greatest airplane manufacturer. Can you think of a single other major manufacturer that has had a successful play and movie named after it?

Boeing still looks a horrible mess. The B737 Max programme is utterly discredited with few signs of when the growing fleet of parked and unpaid for planes will finally enter service. It is also pushing back its new plane – the large B777x which recently failed a critical wing safety test causing the plane to depressurise and a door to fly off. At 30,000 feet, everyone would be dead.

Airlines have given up planning for its introduction to service. And there are still problems with Dreamliner engines. Even demand for the Dreamliner has stalled – which the manufacturer has still not cost-covered. Boeing will be looking to cut production in a few years time unless new orders come in. It's a plane all the airlines and passengers like – but no new Chinese orders have come in since 2017!

For such a challenged company, the stock price remains robust. Why? Because there really is no alternative supplier aside from Boeing and Airbus. Over the next 20 years China will need over 7,400 new aircraft (according to Airbus) to replace the current fleet and grow capacity to account for the rising wealth and mobility of the expanding Chinese middle class.

Some analysts say the Chinese will simply cancel orders of foreign planes and buy their own new domestically built Comac 919 – but that's pure fantasy. The new Chinese plane is some 15 years behind the western tech curve, and to ramp up the logistics to manufacture them in large numbers will take decades.

While the threat of China slowdown from 6 percent growth to a normal 2 percent-4 percent will likely happen, the whole of Asia is playing catch-up as supply chains evolve. New economies are spawning new opportunities – recently we're working on a vertically integrated holiday firm into one of fastest growing tourist destinations: they want to launch an airline, and want someone to buy them the aircraft. Nice returns available! And demand for older aircraft, which suit smaller carriers, is also strong.

While the picture for aviation looks cloudy, that's not unusual. Back in 2008, BA forced its staff to accept pay cuts to survive the slowdown. Now its making nearly $3 billion per annum – and that's why it's pilots are striking – after suffering the downside, they want the upside! It's a cyclical industry – but it does produce real returns.

Yesterday I was asking about real/alternative asset funds to stick in my own portfolio – some great suggestions, but since my fund is restricted in size, I'm unlikely to put £100k into any single investment, which is pretty much the minimum size for most funds.

I was very amused by some videos produced by boutique investment manager WoodHill Asset Management. Their description of why "sophisticated" investors buy negative yielding sovereign bonds is priceless. They take a bit of getting into before you realize how clever they are!

Porridge may be delayed or very late tomorrow as a result of travel plans.

Out of time…back to the day job…

Bill Blain

Shard Capital





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Blain's Morning Porridge

"Sophisticated investors buy negative yielding bonds – are you not a sophisticated investor?"

What madness will today bring?

From up in Shard's Eyrie in the Walkie Talkie Building we can see Marquees and Tents going up on the Tower of London lawn. What can they be for? Press tents to cover the beheading of the Prime Minister perhaps? The rebellious Scots judges have declared the suspension of parliament to be unlawful – meaning Boris has betrayed the crown? Naughty. Let's see what the English courts say. Brilliant. I mean, it's only 360 years since our last proper Civil War, although Scotland vs England tends to be a more regular fixture.

Meanwhile, I suppose we should be thinking what President Trump delaying some tariffs means. Absolutely nothing I suspect.

Today is going to be about waiting for what the European Central Bank says, and my guess is as I described yesterday: the ECB will disappoint markets expecting a further cut and resumption of asset purchases in order to move the euro agenda on to a discussion of fiscal policies under the new ECB head, Christine Lagarde, in November. Watch this space. The world is changing.

At last.. what do I do during the day? Most mornings I finish the Porridge with "out of time, and back to the day job". The unanswered question is: what is my day job?

Regular readers of the Porridge know that quantitative easing and monetary experimentation have left me highly sceptical of bond and stock market valuations. I much prefer the attractions of real assets: diversification away from distorted financial assets, into real things that earn real positive returns.

My day job – once I've got the strategy stuff out of the way each morning - is to originate and finance "alternative" assets like property, infrastructure, renewable energy and other real opportunities to institutional investors.

Typically, I have to demonstrate such assets are realistic propositions, backed by serious and effective management, with business strategies likely to ensure predictable and sustainable returns.

At the moment I'm working on deals in carbon sequestration, impact investments in renewable energy, commercial property, coal, helium and a bunch of other stuff. Most deals we look at, we turn down because they fail at least one of our key tests. We focus entirely on deals aimed at institutional investors – I don't get involved in retail targeted deals like mini-bonds!

What fascinates me most are the reasons investors reject deals. It may be structure, or asset class, or often its profile: they don't fit ESG (environmental, social and governance) guidelines or compliance concerns. Most often it's liquidity. Real/alternative assets tend to be very illiquid, but I'd argue that most corporate bonds will prove equally difficult to shift when the crunch inevitably comes.

One of the real asset areas I've always been interested in is aircraft. Most airlines don't own their planes. Specialised leasing companies own the aircraft and rent them to airlines, which results in very predictable returns. Airplanes may depreciate as they age, but it's a large market and fairly easy to estimate their future value at any point in their life cycle. We also know there are large order backlogs for popular models and older aircraft are perfectly safe. Demand outstrips supply.

To invest in aircraft, you really need to know two things: what is the credit risk of the airline renting the plane, and what is the likely value of the plane when the lease ends – the metal risk. There are lots of refinements – like how simple it will be to repossess the plane if the airline defaults on the rental or goes bust, and how quickly it can be rented to another airline and start earning money again.

When it comes to the metal risk, it's questions like what is the usage on the plane (how many cycles has it completed?), how popular the aircraft type is and the routes it can efficiently service, and issues like what kind of engine it uses. The basics are simple, but the underlying details are critically important to understanding any investment.

At the moment aviation investment is tough. Many observers fear a global slowdown will reduce passenger demand, triggering a rising number of airline defaults, slashing demand for new aircraft and impacting the valuations on older planes.

Others think the Chinese – where a massive number of aircraft are on order – will shelve demand for Boeing and Airbus in favour of their own new aircraft. Other investors think aviation has simply reached the top its cycle, pointing to leasing companies selling stock or firms quietly exiting the market.

However, there are great opportunities out there for the brave. For instance, there is the perennially troubled Norwegian Air. It seems to dance between "about to collapse" and "shareholder rescue" on a quarterly basis.

Bondholders rejected poorly conceived proposals to extend two senior deals totalling US$380 million – even with the sweetener of security on landing slots. Now the company is eyeing some sort of conversion from debt to equity, or yet another capital call – just as the airline goes into its quieter off-summer season and lower cash inflows. It's been a troubled name for years.

Yet it's also a great airline. I've flown business to the United States on a brand new Dreamliner for less than the price of a tiny economy seat on a creaking 30-year old BA Jumbo. It works. But its rapid expansion to become Europe's largest low-cost long-haul intercontinental airline didn't meet the same success as Ryan Air becoming the regional money-making machine.

It's been unlucky. It can't sell surplus older inefficient aircraft because the new B737 Max aircraft they expected to keep the costs down are still grounded, while their Dreamliners still have engine problems!

Although rumours of its imminent demise are heard almost daily…Norwegian may be exactly what other airlines, like IAG (the British Airways parent) needs. This week's BA strikes – triggered by highly paid pilots demanding an 11 percent pay hike to over £200k per annum (which is actually low compared to Air France, Lufthansa or KLM), sum up the airline's problem: high costs and an ageing fleet.

Acquiring Norwegian would give them a new fleet and frankly cheaper crews – a ready-made low-cost model - plus lots of critical landing slots at Gatwick! It might be worth doing some more work on Norwegian risks.

Meanwhile, what about Boeing? An aviation finance pal of mine was recently flying in the states. As she got onto a regional flight, a young mother with two small children was asking the flight attendant what kind of aircraft it is. "Oh, this is an Airbus 320", he answered. "Oh, that's good, I wouldn't feel safe flying on a Boeing." That's pretty damning for what once was the world's greatest airplane manufacturer. Can you think of a single other major manufacturer that has had a successful play and movie named after it?

Boeing still looks a horrible mess. The B737 Max programme is utterly discredited with few signs of when the growing fleet of parked and unpaid for planes will finally enter service. It is also pushing back its new plane – the large B777x which recently failed a critical wing safety test causing the plane to depressurise and a door to fly off. At 30,000 feet, everyone would be dead.

Airlines have given up planning for its introduction to service. And there are still problems with Dreamliner engines. Even demand for the Dreamliner has stalled – which the manufacturer has still not cost-covered. Boeing will be looking to cut production in a few years time unless new orders come in. It's a plane all the airlines and passengers like – but no new Chinese orders have come in since 2017!

For such a challenged company, the stock price remains robust. Why? Because there really is no alternative supplier aside from Boeing and Airbus. Over the next 20 years China will need over 7,400 new aircraft (according to Airbus) to replace the current fleet and grow capacity to account for the rising wealth and mobility of the expanding Chinese middle class.

Some analysts say the Chinese will simply cancel orders of foreign planes and buy their own new domestically built Comac 919 – but that's pure fantasy. The new Chinese plane is some 15 years behind the western tech curve, and to ramp up the logistics to manufacture them in large numbers will take decades.

While the threat of China slowdown from 6 percent growth to a normal 2 percent-4 percent will likely happen, the whole of Asia is playing catch-up as supply chains evolve. New economies are spawning new opportunities – recently we're working on a vertically integrated holiday firm into one of fastest growing tourist destinations: they want to launch an airline, and want someone to buy them the aircraft. Nice returns available! And demand for older aircraft, which suit smaller carriers, is also strong.

While the picture for aviation looks cloudy, that's not unusual. Back in 2008, BA forced its staff to accept pay cuts to survive the slowdown. Now its making nearly $3 billion per annum – and that's why it's pilots are striking – after suffering the downside, they want the upside! It's a cyclical industry – but it does produce real returns.

Yesterday I was asking about real/alternative asset funds to stick in my own portfolio – some great suggestions, but since my fund is restricted in size, I'm unlikely to put £100k into any single investment, which is pretty much the minimum size for most funds.

I was very amused by some videos produced by boutique investment manager WoodHill Asset Management. Their description of why "sophisticated" investors buy negative yielding sovereign bonds is priceless. They take a bit of getting into before you realize how clever they are!

Porridge may be delayed or very late tomorrow as a result of travel plans.

Out of time…back to the day job…

Bill Blain

Shard Capital



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