Global Outlook September

Author

Craig Hoyda, Senior Quantitative Analyst and Graduate Stream Head for Multi-Asset Solutions

Foreword

When asked to summarise the state of Russia’s economy in one word, then-president Yeltsin responded “good”. When asked to summarise the economy in two words, he responded “not good”. While this is an apocryphal tale, a similar answer can be applied to 2020. Investors in the top-five US companies, technology stocks, gold and government bonds have had a very good year so far. However, for the global economy it has been a different story, with output estimated to have contracted by its largest amount since the Second World War, coupled with a sharp rise in unemployment.

Understanding and analysing markets is obviously critical to the investment process, but never more so during times of high volatility. We believe that diversity of thought enhances the investment process and can potentially lead to improved returns. In this edition of Global Outlook, all articles are written by analysts who are early in their investment careers. Their invaluable contribution to the investment process through their analysis and fresh way of examining markets is crucial to navigating what surely will be a turbulent few months to year end.

A key driver of the global economy and markets will be the development of a vaccination against Covid-19. Russia has already approved ‘Sputnik V’, named after the world’s first artificial satellite which Russia (as part of the USSR) launched in 1957 at the start of the so-called space race. The competition for space has moved on from being only a domain of nation-states, to one which companies can exploit for commercial purposes. As such, Tzoulianna Leventi, Investment Analyst, Multi-Asset Solutions, examines the case for sectors that might benefit from the commercialisation of space, and discusses potential investment opportunities.

Traditional metrics used in analysis may no longer be effective under current market conditions. In the UK Asset Backed Securities market, current spread levels and market liquidity conditions indicate that default probabilities are back at pre-Covid levels. Helen Zheng, Investment Analyst, Fixed Income, explains that payment holidays are distorting these traditional metrics. One must dive deeper into payment-holiday data to ascertain where areas of value - and stress - are located within the market. While Covid-19 has distorted some areas of the market, it has created many opportunities where structural trends can be identified. Eimear McKeown and Johnny Liu, Investment Analysts in the Multi-Asset Solutions team, examine such trends and provide investment theses.

Environmental, Social and Corporate Governance (ESG) factors have been around for a while, but have moved far further up investors’ list of priorities, with one driver being pressure exerted by younger generations. Eimear McKeown examines investment opportunities within Europe that have arisen from the shifts to implement climate-friendly policies. Johnny Liu examines another thematic trend: the rise of the video games industry. His article analyses the drivers of growth in the market and discusses the investment opportunities the sector provides.

The old mantra ‘there is no alternative’ (to stocks) is again being used. The US stock market is at all-time highs, driven by the aforementioned technology stocks and unprecedentedly low (or even negative) developed market government bond yields. Omar Ene, Investment Analyst, Multi-Asset Solutions, believes there is no alternative to alternative asset classes. Specifically, he examines investing in listed alternative asset managers as a compelling method to capitalise on the growth in private markets.

RISK WARNING

The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.
 

The sky is not the limit - is half a century long enough for space commercialisation?

Spotlight

Author

Tzoulianna Leventi, Investment Analyst, Multi-Asset Solutions

Space, once accessible only to government-run entities, is now increasingly being accessed by private corporations, thanks to technological improvements and falling costs. We consider which sectors are most likely to benefit from the commercialisation of space.

The final frontier

The space industry has evolved rapidly since the first objects were launched from earth in the 1900s. More than half a century after humans first stepped on lunar ground, space is still a vast unknown territory. However, with uncertainty comes opportunity. What in the 1950s and 1960s constituted space exploration, has now grown into, not only a national security and geopolitically sensitive domain, but also a vital dimension for the success and implementation of numerous terrestrial operations, products and services. Activities on earth depend on satellite operations, data and signals. The digitalisation process, robotics and Internet of Things (IoT) have transformed the space industry dramatically in its upstream, midstream and downstream phases in recent years (Table 1).

Table 1: Cycles of Space Development

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Source: OECD (as of 2016)

Given the nature, sensitivity and cost of space missions, the first actors involved in the industry were national governments. Captive to government funding, the exploitation of space has been, until some years ago, a faraway, costly and niche attainment. However this outlook has already started to change with the increased involvement and cooperation of public and private players.

The United Nations Office of Outer Space Affairs (UNOOSA) estimates that almost half of the satellites launched in 2017 were non-governmental. The space economy, estimated by UNOOSA at US$415 billion in 2018, is providing significant benefits to the global economy, some of these linked to the three pillars of sustainable development: economic, social and environmental. Space has secured a pre-eminent role in the long-term sustainability agenda, crystallised under the Paris Agreement and the United Nations Agenda for 2030, addressing 17 Sustainability Goals (SDGs) and their respective targets. According to UNOOSA, 40% of the SDG targets are facilitated by space. Moreover, the coronavirus pandemic has shown that, in practice, space-enabled solutions and applications have proved to be a viable tool at the different stages of the pandemic, from monitoring to assessment and management. The tri-agency cooperation between ESA, NASA, JAXA (the European, US and Japanese space agencies respectively) on the Earth Observation Dashboard assisted with the fight against coronavirus. The dashboard tracked the effects of Covid-19 on changes in air and water quality, climate, economic activity and agriculture. It also provided solutions such as satellite imagery.

Star Wars to Star Trek?

Since December 2019, there has been a large rise in the number of space missions, along with increased evidence of international cooperation for outer space. Examples are the creation of the US Space Force and the NATO declaration of space as a new operational domain. The successful launch and repatriation of the SpaceX Crew Dragon followed the first collaboration of a private entity with NASA and the cooperation of national space agencies, and provided evidence of the large increase in interest in space.

A selected number of innovative investors see outer space as a high-risk/high-return lifetime opportunity in line with the context of the Schumpeterian theory of business and economic cycles driven by innovation. For other investors, it is a premature dream. It is impossible to say which view is correct. However, to quote the poet William Blake, “What is now proved was once only imagined”. This is exactly the purpose of this article. It is an attempt to highlight the investment opportunities provided by the commercialisation of space.

Many sectors and industries rely on technology that is hosted in space. This is precisely why we are talking about the ‘space economy’ rather than just the ‘space industry’

Many sectors and industries rely on technology that is hosted in space (Chart 1). This is precisely why we are talking about the ‘space economy’ rather than just the ‘space industry’. The space economy involves many interlinked industries driven by innovation. This is enough to revolutionise current trends and open up a new economic cycle, especially in tandem with the trend of responsible investing. Indeed, Morgan Stanley forecasts that the base and upside cases for the global space economy are over US$1 trillion.

Chart 1: Selected sectors benefiting from socio-economic effects from Space investments

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Source: OECD: The Space Economy in figures - How Space contributes to the Global Economy, Aberdeen Standard Investments, (as of 2019)

To remain innovative, companies must allocate more capital towards space-based technologies. As the manufacturing and launch costs of space vehicles fall through time, a number of other sectors and industries can benefit from this tailwind. The defence sector, given its nature and proximity to national interests, is traditionally close to space activities and should be one of the first areas to benefit. Other industries that will benefit are satellite operators, broadband/internet providers, ground infrastructure, hypersonic travelling and space tourism.

Technological improvements have led to the collapse in the cost of launching satellites, from around US$100,000/tonne in 1980 to US$1,000/tonne today, with the expectation it will drop below US$100/tonne by 2035. Global satellite capacity is forecasted to expand from 2 Gbps in 2019 to over 200,000 Gbps* by 2025 (*Gbps is a data transfer speed measurement for high-speed networks). The analogy with the telecoms industry, as broadband penetration increased and speeds rose, is very appropriate.

Space tourism is another area which has attracted a lot of attention. Virgin Galactic’s plans to transform the nature of tourism add a new dimension to the industry, securing deposits from 600 people for seats costing US$250,000, with the hope of reaching space in early 2021. Along with Virgin Galactic, Space X is also involved in space tourism and it, too, is scheduling to begin service in 2021.

On an even longer term timeframe, hypersonic travel could become a possibility, significantly reducing flight times. A number of companies are working on this technology, with Space-X forecasting it will have a hypersonic prototype flying in three-to-six years.

Light-speed internet

Consumer broadband is another industry apparently at the centre of the transition towards space commercialisation. Currently, four billion people in the world lack access to broadband. This is at a time when internet connectivity is key to generating economic activity, especially following the Covid-19 disruption. Internet connectivity is seen as a human right in some jurisdictions, such as Finland. As a means of making internet connectivity more widely accessible, satellite broadband seems a viable and efficient solution. It has the potential to reach rural areas in developed countries and emerging market countries that lack digital infrastructure (Chart 2). This will not only help make the internet more inclusive, but will also improve the transfer of big data, paving the way for future innovative adaptations/developments. These include driverless cars which require enormous quantities of data to function safely, and the IoT, linking together interrelated devices on a virtual cloud network without human intervention.

Smart cities and smart home concepts are the most familiar to us, but industrial opportunities are also very significant. The IoT is the focus for large-scale investments and depends on the transfer of enormous quantities of data. New services that utilise cheap satellite capacity are growing quickly, such as agricultural, environmental and economic services. Last but not least, space has been contributing and will continue to contribute towards a more sustainable interrelated world by aiding in humanitarian crises - such as conflicts, environmental catastrophes, and pandemics - with real-time exchange of data.

Chart 2: Faster internet across the world

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Source: Company Data, Morgan Stanley Research International Telecommunication Union, Aberdeen Standard Investments, (as of October 2017)

Unknown unknowns

There will be products and services developed, as well as opportunities and risks which we cannot foresee, as has happened with the increase in internet bandwidth and the cyber threats that followed. Despite the potential trillion-dollar return, these extra-terrestrial projects carry high risks which we must certainly not dismiss. Government funding and execution failures are two of the most pressing risks that accompany the benefits.

With regard to government funding for space missions, projects and R&D, the current recessionary environment brought about by Covid-19 is stretching the funding willingness and ability of governments. If space expenditure is limited then the space economy will come under pressure, despite the fact that space is a vital domain for some countries. Private funding alone will not be enough to stop the brakes on developments in the field.

Execution and mission failure risks are frequent occurrences. The nature of space and the requirements for innovation and research are very high and sophisticated, especially where manned space missions are concerned. A single execution risk will not only be extremely painful on the balance-sheet of a company but can cost human lives - a risk that few companies will be able or willing to undertake.

To the stars

Despite the risks and the fact that space is still largely uncharted, it is a fascinating platform for current and future investment growth opportunities. The industry is at an exciting point of development with significant possibilities for returns. Careful consideration of the opportunities and risks, and an open-minded approach can provide early exposure to the evolving space economy - especially in terms of downstream products and services. The current timing might strike some investors as premature for investing directly through public equity markets, as the vast majority of the companies involved in the theme are not publically traded. However, the intention of this article is not to argue otherwise.Rather it seeks to recognise these limitations while also highlighting the possibility of obtaining indirect exposure to the theme through existing publicly traded equity.

It is still too early to accurately forecast the future of space, what returns might ultimately be realised and how much of this will be translated into growth and shareholder returns. The unforeseeable global disruption triggered by Covid-19 has made this attempt even more challenging. However, we must not forget that challenges also create opportunities, especially at stock level and over longer-term investment horizons. Timing is important in investing and, as things currently stand, the blossoming of the space economy is still in its infancy. The sky is certainly not the limit.

Many sectors and industries rely on technology that is hosted in space. This is precisely why we are talking about the ‘space economy’ rather than just the ‘space industry’
 

How have payment holidays dictated the UK ABS market?

Fixed Income

Author

Helen Zheng, Investment Analyst, Fixed Income

The signals from traditional default indicators in ABS markets have been distorted by payment holidays. We dive deeper into payment holiday data to determine areas of value and stress.

A spread of metrics

The Covid-19 pandemic disrupted most asset classes in March; the Asset Backed Security Market (ABS) market was no different. New issuance ground to a halt in all sectors as spreads across the board blew out. Furthermore in secondary markets, most of the transaction volume was in the higher cash price sectors and tranches, i.e. UK prime Residential Mortgage Backed Securities (RMBS) and short-dated autos and credit cards. Secondary spreads decompressed dramatically across the capital stack due to the limited activity in credit markets.

Our research focus turned to liquidity analysis in response to the Covid-19 outbreak. In ABS structures, reserve funds are usually available to cover interest in case no cash comes into the structure. Our analysis indicates that, on average, RMBS bonds and consumer ABS bonds have sufficient cash reserves to cover interest expenditure for seven quarters and five quarters respectively. This strong liquidity in ABS structures has been recognised by the rating agencies as well, resulting in very few downgrades in March and April.

As we worked through April, spreads began tightening from their widest points as the kneejerk reaction was reassessed by investors. Reasonable liquidity began to return across all investment grade-rated bonds, leading to spread compression creeping back into the mezzanine part of the capital stack. At the same time, many jurisdictions across Europe have adopted payment holidays on mortgage payments. However, loans under these conditions are not counted as being in arrears. Hence, the arrears or outstanding repossessions that are used to indicate probability of default remained at pre-crisis levels. That led us to track payment holiday data for deals in order to find value in stressed markets.

Trends and findings

On 20th March, the Financial Conduct Authority (FCA) announced guidance that mortgage lenders should grant borrowers a payment holiday for three months with no additional fee or charge (other than additional interest). From 2nd April, customers were also able to ask for a three-month payment freeze on credit cards, store cards, catalogue credit and personal loans. A similar three-month payment freeze for motor finance was announced on 24th April. Furthermore, on 22nd May, the FCA extended the mortgage payment holiday application period to the end of October, while also imposing a ban on lender repossession of homes until 31st October. The same extension and repossession ban for consumer finance came into effect on 3rd July.

From our contact with mortgage lenders, even before the FCA guidance, we were aware that firms had already started to grant payment holidays. To deal with the high volume of applications, most lenders have agreed upon a standardised approach (e.g. online forms) and approved self-certified payment holidays.

Table 1: Going on a (summer) payment holiday

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INTEX, ABERDEEN STANDARD INVESTMENTS (AS OF JULY 2020)
On average, auto and consumer asset backed securities have shown lower rates of payment holidays compared to residential mortgage backed securities

Table 1 shows the take-up rate of payment holidays for different ABS sectors. On average, auto ABS and consumer ABS have shown lower rates of payment holidays compared to RMBS. One possible reason is that the average consumer loan size is significantly lower than a typical mortgage. In other words, people tend to apply for payment freezes for larger payments. Another explanation is that auto ABS originators have been relatively supportive of their ABS programmes. For example, Volkswagen Financial Services (VWFS) said it would not levy additional interest or charges as a result of taking a payment deferral. Also, any loans subject to Covid-19 extension will be repurchased at the full principal amount plus arrears. BMW, Mercedes and Vauxhall have all issued similar statements. Accordingly, there has been a lower impact in auto loans and this is the reason why we hold positive views for senior auto ABS.

A more surprising result is that buy-to-let deals have a lower impact rate than other RMBS sectors. This is because on average half of buy-to-let borrowers are professional landlords who manage properties for a living. They are less likely to be in the vulnerable group, who are typically self-employed with less stable income streams. Although there is no negative impact on credit scores for taking payment holidays, lenders may take such holidays into account when making future lending decisions. So ‘savvy’ buy-to-let borrowers may not be willing to take the risk. In our view, mezzanine bonds in the sector may outperform and show resilience during this crisis.

In terms of dispersion within sector, prime RMBS shows a more dispersed profile, as evidenced by a higher standard deviation. Looking deeper into prime RMBS, we see a clear positive linear relationship between the percentage of Covid-19-impacted loans and the exposure to self-employed borrowers (Chart 1). Other dictating factors include structure (e.g. master trust or stand-alone) and geographical diversification. We view dispersion as an opportunity, as smart positioning in a highly dispersed sector could lead to superior security selection. Therefore, comprehensive analysis is necessary for every prime deal and we only initiate overweight positions in instances with lower exposure to self-employed borrowers, and which have enhanced structures and diversified profiles.

Chart 1: Identifying potential relationships

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INTEX, ABERDEEN STANDARD INVESTMENTS (AS OF JULY 2020)

Not all deals have reported Covid-19 payment holiday exposure. Ratings agency Fitch is pushing for greater transparency, and encouraged issuers to provide a detailed Covid-19 impact report. On 2nd June, the European Banking Authority (EBA) also published its guidelines on reporting and disclosure of exposures subject to measures applied in response to the COVID-19 crisis (‘the EBA Guidelines’), intended to address gaps in reporting data and public information by credit institutions in the context of Covid-19. At this point, only a few credit card and auto deals, such as Penarth from Lloyds and Globaldrive from Ford Bank, decided not to disclose this information, which is also a potential risk in our view.

What happens next?

Do all the people who apply for payment holiday actually need it? Probably not, as it can be interpreted as an act of planning for uncertainties. Some issuers disclosed that 80% of their borrowers on payment holidays resumed full payment in July, and the rest applied for further 3-month payment freeze. With the help of generous government support programmes, in the shape of Coronavirus Job Retention Scheme (CJRS) and Self-Employed Income Support Scheme (SEISS), we expect the payment holiday percentage to stabilize in July and then either recover or fall into arrears. At this point, we cannot forecast the exact re-performing share, but we will keep track of available data and steer away from deals that have high exposure to Covid-19 risk.

Opportunities in ABS markets

In July the new issue market came back to life, with 10 deals priced in the week from 17th July. UK prime RMBS is trading at pre-crisis tights on a spread basis and UK autos and other RMBS have also recovered to only 10-15 basis points over their February levels. Investors may have recalled that the ABS market was heavily stressed during the global financial crisis. This time, however, even in mid-March when the equity market collapsed, there was no forced selling as cash calls never materialised in a way to cause the market to ‘release’ bonds (a testament to the change in the ABS investor base from highly levered vehicles to more real money accounts). Investors are better protected because of higher-quality collateral pools and ample liquidity in structures. A high degree of professionalism is manifested in the industry, which could potentially attract more credit lenders to use securitisation tools going forward.

On average, auto and consumer asset backed securities have shown lower rates of payment holidays compared to residential mortgage backed securities
 

The green lining of lockdown

ESG

Author

Eimear McKeown, Investment Analyst, Multi-Asset Solutions

While the coronavirus pandemic has damaged economies, it has provided a one-off opportunity to implement climate friendly policies. Europe is leading this charge, and there are investment opportunities on the continent which can benefit from the shift to renewable energy.

European green infrastructure

While the coronavirus crisis has damaged economies all over the world in past six months, there has been a silver lining of lower pollution: clearer skies, halted cities, quietened roads, cleaner canals and slashed emissions. Can we learn from, and continue with, some of the positive environmental outcomes of the ongoing lockdowns? Global energy demand this year is set to fall by 6% (seven times the decline seen in the immediate aftermath of the 2008 global financial crisis), along with 10 million metric tonnes less CO₂ emitted from aviation. Previous dogma dictated that this emission reduction was impossible, but has now happened in a matter months (Chart 1); it begs the question is permanent change possible?

CHART 1: 2.6 Billion Metric tonnes of CO2 never emitted:

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Source: International Energy Agency (IEA), Bloomberg
As countries begin to emerge and recover from the crisis, Europe in particular has placed the fight against climate change at the heart of its recovery plans

As countries begin to emerge and recover from the crisis, Europe in particular has placed the fight against climate change at the heart of its recovery plans. In July 2020 the European Commission agreed on a €750 billion recovery fund with 30% allocated for climate investment (increased from 25% originally proposed). The deal is captioned: ‘Striving to be the first climate-neutral continent’ and Commission President Ursula von der Leyen has made the Green Deal her top priority, with the aim of eliminating net emissions of greenhouse gases by 2050. The deal includes a vast range of allocations - €91 billion a year for home energy efficiency and green heating, €25 billion for renewable energy, €20 billion for clean cars and €60 billion for zero-emissions trains; furthermore, two million electric vehicle charging points are to be added and one million tonnes of clean hydrogen is to be produced to replace existing CO₂ emissions. The European Union also has aims to reach further than just its member states with a proposed border tax on carbon-intensive industrial imports, raising money as well as promoting the green agenda to a wider audience. The EU recognises Europe’s competitive advantage in this area and in ensuring European companies become leaders in the transition. The deal is estimated to create over one million jobs as well as allowing European green leaders to become direct beneficiaries as other developed markets make the move to climate friendly alternatives.

Zeroing in on net zero

European green infrastructure and utilities have been relatively insulated from the recent market slump in March. The sector’s outperformance in the stock market has been driven by the turn in its earnings cycle, low bond yields, increasing investor confidence, along with social and political ESG enthusiasm. This sector is in a strong position to lead the charge in the transition to clean energy, which is becoming even more topical. The International Energy Agency forecasts that renewable energy capacity will rise 50% by 2024 versus 2019 levels, driven by increased regulations and political and social demands to curb climate change. It’s estimated that in order to be carbon neutral by 2050, over 80% of European electricity will have to come from renewable sources; renewables only generated 30% of total production in 2019.

Technological advances continue to allow the cost of power generation from gas and wind to collapse. This, along with the boost to capital expenditure by NEPs (National Energy Plans – by the 27 EU member states), implies around a 65% capital expenditure increase on clean infrastructure in Europe compared today, with visible effects evident within two years. Leading the way in this transition is onshore wind and solar power – both having experienced plummeting levelised cost of energy (LCOE – a commonly used measure of how the cost of energy generation system compares to what it provides).

Other important areas set to benefit from the green investment windfall will be the transport sector; the French government has outlined an €8 billion support package for automotive development, with over €1 billion to be directed towards electric vehicles. Electrification of heating, transport and industry will lead to further decarbonisation of economies as well as reducing total energy consumption. Electric vehicles use only 25% of the energy consumed by conventional vehicles, and electric heat pumps perform 4-5 times better than their traditional counterparts.

Singing to the same tune

There have been dramatic change in approaches across more traditional infrastructure and energy companies, for example, the conventional oil and gas company BP announced a considerable change to its business strategy, diverting resources into low carbon investments with a detailed 10-year plan of action to align itself with the net-zero emissions goal. The announcement by BP was positively taken by investors, and more companies are likely to follow suit, with oil and gas production expected to fall by 40% this decade.

While companies are realigning themselves to a greener future, there are important developments elsewhere; Democratic presidential candidate Joe Biden has recently published his own green agenda in July 2020. Mr Biden has promised, if elected, to put clean energy and green infrastructure at the centre of a $2 trillion plan to revive the US economy, pledging to the country that he would take “irreversible steps” to cut emissions. Under Joe Biden’s plan, the US would re-join the Paris climate accord. He has pledged to decarbonise US power generation by 2035, electrify large portions of the county’s transport network and crack down on pollution. His main goal is to link the green agenda to jobs and economic recovery.

The future is green

In a year with global lockdowns, unprecedented monetary and fiscal stimulus and hugely volatile markets, countries are slowly beginning to emerge from the coronavirus crisis. As they do, it is evident that the climate question is becoming even more important. While the green narrative is growing globally, Europe is set to continue to lead the climate battle, with many industries and companies well positioned to benefit.

As countries begin to emerge and recover from the crisis, Europe in particular has placed the fight against climate change at the heart of its recovery plans
 

Gotta catch ‘em all

Equities

Author

Johnny Liu,Investment Analyst, Multi-Asset Solutions

The recent expansion of the video games industry has created many opportunities within the sector. We analyse the drivers of the growth in the market and discuss the themes that can be played.

Welcome to the Battlefield

If I begin with the words “video games”, some readers are bound to find memories – whether of the thrilling chases in Pac-Man, or driving along Rainbow Road in Mario Kart – flooding back. But while the nostalgia is pleasant, it’s important to realise that the video game industry has greatly evolved over the past two decades. Technological improvements, especially the exponential growth in computing power, have let play morph from standalone consoles to online via mobile phones (a microcosm of globalisation). The resulting increase in sociability has created many opportunities for monetisation.

We look at video games’ new ecosystem, the growth of the market, evolving business models and the new opportunities.

World 1-1

With better CPU processors making home gaming feasible, the days of loading up on coins and visiting the local arcade are far behind us. Faster and more reliable internet connection has been vital to the gaming markets’ growth. While traditional media industries such as television and newspapers have struggled in the age of the internet, video-game publishers and developers have leveraged it, selling in-game downloadable content (DLCs) directly to consumers and venturing into the smartphone market. New types of games, such as Free-To-Play (FTP), have emerged as a result of the shift from hardware to software gaming. The ecosystem has developed extensively, to the point where gamers can venture into new “uncharted” lands, like eSports and streaming services.

Chart 1: A Link Between Worlds

Chart 1: A Link Between Worlds

Source: Hackernoon, Aberdeen Standard Investments

Breath of the Wild

Industry research company Newzoo highlights that the global gamer market has grown by 35% in the past five years, and is forecast to reach 3.2 billion in three years’ time

Gaming’s popularity as a source of entertainment has had a supercharged acceleration in recent years, regardless of age, gender or income. Industry research company Newzoo highlights that the global gamer market has grown by 35% in the past five years, and is forecast to reach 3.2 billion in three years’ time. Over the past ten years, the proportion of female gamers in the US has increased from 38% to 45%. Meanwhile, the age distribution has become less skewed towards the younger generation. Indeed, some studies have highlighted that video games can improve cognitive function of healthy older adults, and even their well-being relative to non-gamers. A new wave of entertainment and source of income has emerged - streaming video gamers - with Covid-19 lockdown restrictions accelerating its popularity.

Although competitive gaming has been around for many years, the recent astronomical rise of eSports has been unprecedented. Younger audiences are seeing the appeal, with sponsor and media rights driving up revenues. Previously, eSports attracted a lot of negative press – with, “Why watch others play video games?” being the question traditional media outlets asked repeatedly. Sentiment is now shifting. For example, the Dota 2 finals tournament, “The International 2019”, pay out made headlines, as the top five players took home $3.1 million. To provide context, this is only $750,000 less than Rafael Nadal’s prize when he won the US Open Tennis Championship in 2019. Reports indicate that overall viewership, which includes both casual/occasional views and eSports enthusiasts, grew from roughly 205 million to 440 million over the past five years. It is forecasted to reach over 600 million in 2023. Over the short term, as a result of Covid-19, TwitchTracker has calculated that the average number of concurrent viewers increased over 60% in April 2020, and roughly 100% over the year. Even as restrictions have eased up, viewership remains strong – averaging 2 million per day.

Chart 2: Overwatching Overwatch?

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Source: Newzoo, TwitchTracker (as of 2020)

Level Up

Much like Pokѐmon evolution, the business models have continued to level up - publishers have noticed online sales of their games through digital platforms are growing. This is partly as a result of increased popularity, but more importantly via cannibalisation of hardware sales at brick-and-mortar stores. Software sales provide enhanced profitability; rather than receiving wholesale revenue via third party distributors, publishers can receive more through selling games over the web for retail price – a mark-up of roughly 20-40%. Moreover, associated costs with hardware disc sales such as warehousing and printing discs/cases means software sales are more attractive. This has partly contributed to the average EBITDA margin of major publishers Ubisoft, EA and Activision Blizzard increasing from roughly 17% to 36% over the past 10 years.

eSports, too, has created a new business model. It offers new sources of income for game publishers as they earn money through sponsorship, TV rights (media companies buy rights to host the leagues) and organisers. Mobile eSports saw massive growth in Asia, with millions of viewers across the globe (e.g. Tencent’s “King of Glory” Pro League Fall Season 2018 Playoffs had 20 million peak viewers). There are over five billion smartphone users in the world. Assuming 30% of them play mobile games, with a monetisation rate per person of $2 per month (advertising revenue and in-game purchases) this equates to over $36 billion a year. More traditional video game publishers have been able to sell franchise team spots in their eSports leagues, similar to many traditional sport leagues. Activision Blizzard previously made headlines for selling spots in their Overwatch League – the first franchised eSports league launched by them – for $20 million each.

Continue? Yes/No

There are many ways to invest within this ecosystem. The most direct way would be through publishers such as Activision Blizzard and EA. Then there are hardware providers such as Nvidia and AMD who develop the graphics processing units (GPUs) and System-on-Chips (SoCs), crucial components for gaming monitors, mobiles and consoles. Another hardware play would be through gaming consoles – with Sony and Microsoft releasing their new offerings later in 2020.

Accessing the eSports theme via streaming platforms tends to be trickier as many have been snapped up, for example Amazon acquired Twitch for $970 million in 2014. There are some pure-play streaming platforms listed such as Huya and Bilibili. Nevertheless, the future for this industry looks bright, the emergence of cloud gaming and continued emergence of eSports would provide many opportunities. The recent lockdown has accelerated ongoing trends, highlighted by the MVIS Global Video Gaming and eSports Index outperforming even technology based indices such as NASDAQ and MSCI World IT by 23% since March 2020 – we currently hold a selective basket of gaming stocks in our funds.

The constituents of these indices have been surprisingly defensive in the aftermath of the market crash.

In addition, developments in cloud Gaming allow opportunities for a subscription based revenue platform, thereby shifting to a rental-type business model which would provide a more stable stream of revenue for companies. The younger generation have already been exposed to monthly recurring expenses through Spotify and Netflix, which remain popular. Again, faster broadband speeds will play into the hands of these cloud-gaming providers. Better stock up on the Pokѐballs – there are lots of opportunities out there to catch.

Chart 3: Pay to Play

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Indices rebased at 100 as of 3 February 2020

Source: Bloomberg, Aberdeen Standard Investments (as of 14 August 2020)

Image credit: iStock.com/CHENG FENG CHIANG

Industry research company Newzoo highlights that the global gamer market has grown by 35% in the past five years, and is forecast to reach 3.2 billion in three years’ time
 

No alternative to alternatives

Alternatives

Author

Omar Ene, Investment Analyst, Multi-Asset Solutions

Based on structural tailwinds, which are exacerbated by the Covid-19 pandemic, alternative asset classes offer attractive opportunities for investors. We view investing in listed alternative managers as a compelling way to capitalise on the growth in private markets.

The case for going alternative

For several years now, practitioners in the alternative investment space have benefited from a number of structural tailwinds. These include falling interest rates, low return expectations for traditional assets and diversification benefits. The democratisation of alternative investing, as investor access eases, and the declining role of banks and public markets as sources of capital have also contributed to the increasing attractiveness of alternative asset classes.

The Covid-19 pandemic has exacerbated some of these trends – most notably, the sharp decline in policy rates, driven by an unprecedented amount of monetary easing, as policy makers try to get ahead of a potentially catastrophic economic situation. At the same time, dividends have been cut in public equity markets. This has emphasised the already significant hunt for yield by investors. Combined with the extreme bouts of market volatility, this has proven conducive to the investment case for alternative asset classes.

Credit where credit is due

Publicly traded US alternative asset managers raised US$67 billion in new funds during the second quarter of 2020

Despite a challenging Covid-19 environment and with managers not being able to meet clients face-to-face, alternative managers have demonstrated resilient fundraising capabilities. Several managers have reported record quarterly inflows. This has mostly been attributable to the leveraging of existing investor relationships. Publicly traded US alternative asset managers raised US$67 billion in new funds during the second quarter of 2020. This compares with the inflows in the previous three quarters, which were in the range of US$50-55 billion. Of the new funds raised, around 80% came from non-flagship fund raisings, of which around 60% came from a range of credit strategies. This emphasises investors’ demand for yield.

The quantum of funds raised for opportunistic credit strategies in the second quarter underscores another trend that this pandemic has emphasised: the increased need for private lenders to fill the void as banks leave parts of the lending business. A key priority following the financial crisis was to scale back the activity of big banks and to encourage new entrants into the lending market. Many alternative investment managers have embraced this opportunity. Covid-19 has caused significant liquidity issues for many companies. Historically, small- and medium-sized enterprises (SMEs) used to source funding from banks. But alternative managers, with distressed and direct lending capabilities, are now stepping-in to fill this void and to provide bespoke solutions for companies with such funding requirements.

Structural ‘bull’ case not going unnoticed

The long-term ‘bull’ case for listed alternative managers has not been lost on investors. Publically listed alternative managers have enjoyed a rapid rebound in performance, following the sharp sell-off in the first quarter of 2020, where their average value nearly halved. The group is now trading back near all-time highs (achieved in February 2020). For comparison, traditional asset managers, listed private equity companies, business development companies (listed, private debt companies), and the broader global financial sector are all down around 10-25% from their February highs (Chart 1).

Chart 1: An alternative return path

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Share price performance, rebased to 100 to 31 December 2019

Source: Bloomberg, Aberdeen Standard Investments (as at August 2020)

The impact of the tailwinds on the growth in assets under management (AUM) is further magnified by alternative managers’ unique business models. Due to the illiquid nature of the underlying investments, funds are usually required to be locked-in for a number of years. This provides the manager with a sticky asset base from which to charge management fees; essentially ensuring a stable fee revenue stream for the foreseeable future. Given the specialist nature of the investment strategies, managers tend to charge a higher management fee than their traditional manager counterparts. In addition, if alternative managers perform well, they are often entitled to a share of excess profits generated (termed ‘carried interest’).

As a result of these tailwinds and the beneficial business model characteristics, the market places a much larger premium on alternative managers when compared to traditional managers. The former currently trades around a 20x forward price-to-earnings multiple and the latter trades around a 10x multiple.

Looking through the listings

We view investing in listed alternative managers as a compelling method to capitalise on the growth in private markets. These businesses derive their value from both the management of, and the investment in, alternative asset classes on behalf of both the company and external clients. It is often the case that such managers will hold significant investments in their own underlying strategies on their balance sheets. As such, these businesses can be viewed as a hybrid between an asset manager and a listed private investment trust.

Our preference for alternative asset managers with significant balance sheet investments is three-fold:

  1. our analysis indicates that the market often does not fully appreciate the value of these balance sheet assets;
  2. investing in such a manager provides indirect exposure to the underlying strategies of their funds without the associated fees;
  3. listed managers tend to be larger and more liquid than other vehicles employed to gain exposure to the private space.

We utilise a sum-of-the-parts (SOTP) methodology in our analysis of the universe. Here, we adjust the current market capitalisation of the manager by accounting for their estimated balance sheet value. From this, we calculate an implied valuation of the asset management business as a multiple of income (Table 1).

In relative analysis, we also take into consideration several other factors. These include the growth rate of AUM and fees, the diversification of AUM by asset class, the proportion of total income represented by management fees, and the proportion of perpetual AUM.

The aim of this analysis is to identify those listed managers who trade at attractive valuations and who have the potential to deliver profitable growth from the generation of management fees, carried interest and performance gains on the strategies they manage.

To that end, from the names that we follow, we currently view BAM, ICP and KKR as providing the most attractive investment opportunities for investors.

Maintain discipline

The key trends supporting the growth of private markets remain in place, and we see a clear case for investors to continue to explore ways of gaining exposure to these strategies. The continued innovation in the space is also a reason to think that these opportunities to invest will continue to be of interest, and to grow. By applying a disciplined approach to investing in the listed universe of managers, investment opportunities can continue to be extracted and this discipline will be rewarded over time.

Table 1: Sum of the Parts Analysis

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Source: Bloomberg, Aberdeen Standard Investments (as of 13 August 2020)

Publicly traded US alternative asset managers raised US$67 billion in new funds during the second quarter of 2020
 

Tactical Asset Allocation

Multi-asset

The Multi-Asset Tactical Asset Allocation (TAA) team’s view on bonds, equities, commercial property and other assets will affect asset allocation over the coming months. When making these asset-allocation decisions, we first consider the outlook for each asset class (e.g. government bonds), followed by views within that market (e.g. the US versus Europe, or European core economies against peripheral countries).

The views of individual asset class teams may differ to this multi-asset TAA view.

ASSET CLASS POSITION COMMENT
Government Bonds Negative

Our underweight position in government bonds reflects our expectation that monetary policy will remain accommodative, offsetting a challenging growth outlook.

  • We expect this environment to prevail across EM and DM as we believe this shock is net disinflationary, allowing a looser monetary policy stance in order to support the economic recovery.
  • In this environment we identify the opportunities emerging from the combination of the policy measures in place and the inflation outlook: for example, we are taking advantage that Government yields in the Eurozone have been supported by the ECB and we are using this asset to access more attractive yields in Investment Grade and High Yield Debt space, where policy support will help contain defaults.
  • Additionally, we are expressing a view that the US break-even inflation rate will rise by an overweight stance in US TIPS and an underweight in nominal US Treasuries.
  • In the UK, we expect the yield curve to steepen hence our underweight position in UK Index (inflation) Linked gilts and our overweight allocation to UK Investment Grade corporate bonds.
  • The longer duration of the Index Linked market lends itself well with a steeping yield curve.
  • Finally, the overweight in Australian govt. bonds reflects a desire to hedge against economic disappointment in Asia should the Covid-19 pandemic intensify.
UK Gilts Neutral
US Treasuries Negative
European Core Negative
European Periphery Negative
Japan Negative
Australia Positive
UK Index Linked Negative
US TIPS Positive
Credit Markets Positive

In line with accommodative monetary policy that is keeping nominal rates low, and policy packages (QE) supportive of corporate debt we continue to favour an overweight position in Credit spreads, with this stance funded by an underweight in Government bonds.

  • Overall, policy support is in place across most DM, and while we perceive that EM central banks have less ability and capacity in following the QE route, EM debt space has a much improved fundamental picture compared to previous crisis. Hence we favour all credit regions.
  • More recently, the team's discussions have led to a small allocation away from Emerging Market (EM) hard currency into local (soft) currency debt.
  • While EM economies face considerable challenges, those which are most challenged have seen material currency weakness and have lagged in the recovery that other asset classes have experienced.
  • An improvement in the global economic cycle over the next 12-24 months should gradually improve sentiment towards unloved EM currencies, and we wish to start positioning the portfolio ahead of this becoming reality.
  • However, there remains some concern that cyclical risks for Latin American economics in particular will remain elevated in the short-term, with less room for governments to provide assistance, with the broader geopolitical backdrop likely to remain tense in the run up to the US presidential election in November. These factors explain why we have only made a small initial allocation.
UK Investment Grade Positive
US Investment Grade Positive
Euro Investment Grade Positive
US High Yield Positive
Euro High Yield Positive
Emerging Market (Hard Currency) Positive
Emerging Market (Local Currency) Positive
Equities Positive

We retain a modest overweight stance in equities; while behavioural 'buy' signals have essentially moved to a more neutral stance, we are still far away from our indicators signalling greed and complacency.

  • Moreover, as the growth outlook remains uncertain we have confidence in corporate earnings in those sectors and regions with strong fundamentals and linked to covid favoured changes in life style, namely technology.
  • We recognise the narrow leadership of the US market, supported by their extremely profitable technology sector, and its relentless appreciation made us worry that a period of consolidation might well be in order.
  • Given the fragile growth outlook, our preference is to take a barbell approach, by overweighting the US and Continental European markets and in the process gain exposure to both quality growth and value.
  • A more pro-cyclical bias will only be rewarded once conditions are in place for a sustained period of economic and profit growth, and it is too soon to make a bolder portfolio statement.
UK Neutral
US Positive
Europe ex. UK Positive
Japan Neutral
Pacific Asia ex. Japan Neutral
Emerging Market equity Neutral
Property Neutral

A significant portion of the REIT investment universe has been severely disrupted by lockdown and social distancing policies and while long-term value exists in some areas, the outlook remains too uncertain to express an overweight stance.

  • There is a huge divergence of fundamentals depending on the sector (e.g. data centres vs. retail), but at some point confidence in cash flows should improve in some of the challenged sectors.
  • While low interest rates are supportive of REITs outperforming equities, the essential condition for this to trigger is a benign and stable growth outlook, but a catalyst for this to happen remains outside our investment time horizon.
US Neutral
Europe Neutral
Cash Negative

With interest rates so low, cash remains the preferred funding source for risk-on positions.

CURRENCY OVERLAY POSITION COMMENT
Dollar Negative

The global compression of interest and bond yield spreads means that monetary factors are a less powerful driver of relative currency performance; nonetheless, the sharp decline in US interest rates relative to other major currencies has not been fully discounted and would support further modest US dollar depreciation.

  • At the same time, a re-acceleration of global growth (beyond any short-term pause related to containing Covid-19 using localised lockdown policies) should also, at the margin, benefit pro-cyclical currencies such as the Euro and Emerging Markets.
  • We therefore retain an underweight in the US dollar, mainly against the Japanese yen - as the Yen can provide portfolio diversification - especially now that it makes sense for Japanese investors to hedge their overseas bond investments.
  • We are using the Australian dollar UW as a potential cyclical hedge given its strong performance in recent months.
Euro Positive
Yen Positive
Australian Dollar Negative
Emerging Market currencies Positive
Sterling Neutral

The views and conclusions expressed in this communication are for general interest only and should not be taken as investment advice or as an invitation to purchase or sell any specific security.

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Risk warning

Risk Warning

The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.