EFGAM INVEST November 2012

EFG Asset Management

monthly

In Vino Veritas Toast avant-garde wine investments

11 / 2012

Investment Hot Topic: Spotlight: Fixed income Bonds: blended, ETPs not stirred

Some track while others go off the rails

New Capital Asia Pacific Bond Fund

01/02

contents

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02 03 05 06 07 09 10

uring an uncertain global market and economic time, investors look to alternative and avant-garde asset classes to increase portfolio diversification and boost returns. This Invest issue presents a diverse range of topics, discussing investments in wine, classic cars, Commodity Trading Advisors and Exchange Traded Products.

Portfolio Management Gold: The Barbarous Relic A Toast to Wine Investing Avant-garde investments can enhance returns Long Live CTAs The evolution of Commodities Trading Advisors Investment Spotlight New Capital Asia Pacific Bond Fund Hot Topic Merits of active and passive approaches in fixed income

QE Infinity?

Don’t fight the Fed

Moz Afzal, Chief Investment Officer

In the Driver’s Seat Investing in the classic car market

After three years, still Breaking the traditional boundaries of fixed income investing EFGAM’s New Capital Wealthy Nations Bond Fund

3 year Track record

$1 billion In AUM

The New Capital Wealthy Nations Bond Fund seeks capital appreciation through investments in a broadly diversified range of debt securities issued by governments, institutions and corporations in both developed and developing markets.

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 views expressed herein should not be relied upon when making investment decisions; you should read the fund’s prospectus and relevant Key Investor Information Document before investing. Issued by EFG Private Bank, which is authorised and regulated by the Financial Services Authority.

invest monthly / 11 / 2012

Portfolio Management

Gold: The Barbarous Relic G

old, as an asset class, divides opinion. Some investors can’t get enough of it whilst others seek to avoid it at all costs. At the heart of the debate lies the observation that gold is difficult to value.

Most financial securities have cash flows associated with them. An investor can estimate what those cash flows might be in the future and then discount back to the present day to develop an appropriate price for a security. However, with gold there are no cash flows, making it difficult to value.

An alternative approach would be to analyse the supply and demand dynamics. The supply tends to change relatively slowly because it is contingent on new sources being found and mines becoming operational. Some estimate that the entire amount of gold ever mined in the history of the world could fit into a tennis court sized cube.

The demand side is more variable. Unlike other precious metals, the industrial and commercial uses of gold are rather limited.

For example, 47% of the demand for silver in 2011 was for industrial applications (such as batteries, electronics and the auto industry) while only 15% was for jewellery1.

Contrast this with the market for gold, where 48% of 2011 demand was for jewellery and only 11% for industrial uses (mostly electronics)2 with almost all of the rest of demand attributable to gold bars and coins. Therefore the fundamental driver of the gold market is related to the demand for jewellery, which can be erratic.

Furthermore, India and China combined account for about two-thirds of the jewellery demand for gold.

Given the valuation difficulties, why would anyone want to own gold? The answer lies in that much overused investment word ‘diversification’. In the ten years to end September 2012, the spot price of gold has appreciated by nearly 450% compared with a little more than 115% for the MSCI World Equity index (net dividends reinvested) and about 55% for the Citigroup World Government Bond Index (hedged), all in US$. Even if these returns are not repeated, gold has exhibited low correlations to other asset classes; the monthly returns between gold, world equities and world government bonds have been correlated 15.0% and 14.4% respectively over the past ten years.

What is even more appealing is the relatively large negative correlation (-48.3%) gold has exhibited with the US dollar over the past ten years. In a world where the Federal Reserve remains committed to asset purchases, owning gold may therefore serve as something of a hedge against dollar debasement.

John Maynard Keynes famously described gold as a barbarous relic. Whether you are a barbarian or not, there remains a role for gold in modern portfolio management.

by Luke Downes, MCSI Senior Portfolio Manager London office

What is even more appealing is the relatively large negative correlation gold has exhibited with the US dollar over the past ten years.

¹ Source: The Silver Institute ² Source: The World Gold Council

03/04

In Vino Veritas

by Daniel Murray, CFA Global Head of Research London office

a toast Here's

A

gainst an uncertain global economic and market backdrop, investors have expanded their search for alternative and avant-garde asset classes that are capable of aiding portfolio diversification whilst also enhancing returns.

In this context, the fine wine market has earned increased investor attention.

In the ten years ending September 2012, the S&P500 index returned 116.0% (including dividends), the Citigroup US Government Bond Index rose 59.5% and the Liv-ex Fine Wine 1001 Index gained a whopping 165.5%. In terms of diversification, fine wine also exhibits pleasing characteristics. The correlation between monthly returns of the Liv-ex Fine Wine 100 Index and the S&P500 is a lowly 26.2%; the correlation of the wine index with the Citigroup US Government Bond Index is -17.7%.

From a fundamental perspective fine wine also has certain pleasing characteristics, aside from its obvious sensory pleasures.

For example, the supply of any particular vintage tends to decline over time due to consumption, breakages and natural deterioration. The primary driver on the demand side has been the growth of global interest and demand for fine wines, especially among the new emerging market wealthy. These factors have been supportive of prices.

However, fine wine investing is not without risk. From its peak in June 2011, the Liv-ex Fine Wine 100 Index has declined by a little under 30% compared with gains of about 10% in both US equities and US government bonds. Moreover, and without wishing to be ironic, the market liquidity associated with fine wine is much worse than for financial assets. If you want to off load your wine portfolio it is likely to take some time to do so whereas most financial assets can be sold quickly, easily and with relatively low cost.

So what are the investment prospects for fine wine? I am no expert on viticulture, but

invest monthly / 11 / 2012

For a patient investor with an appropriate risk and liquidity profile, fine wine may be useful both as a diversifier as well as a return enhancer within an investment portfolio.

to wine investing! it doesn’t take a genius to understand that the quality of wine is dependent on the quality and character of the grapes used to produce it. In turn, grape quality is a function of the soil in which the vines are grown, the geography and orientation of the vineyards as well as the climatic conditions. To the respected oenologist there are probably a host of other important factors but these are the ones on which we will concentrate in this article.

The soil, geography and orientation of each vineyard are well known and do not change (much) from year-to-year. However the weather does change. Academic research has established that there is a good linkage between three weather-related factors and the future price of a particular vintage: (i) the temperature during the growing season (hotter = better), (ii) the amount of rain during the six months preceding the growing season (more = better) and (iii) rainfall during the harvest (less = better)2.

Because of its perceived high quality and consistency, Bordeaux wines tend to make up a large proportion of the fine wine investment universe with some indices

being dedicated entirely to Bordeaux.

Temperatures in the Bordeaux region have been in a rising trend for the past 30 years or so with the average of the past ten years being 2°C higher than the average in the 1960s. Rainfall has been more variable but we note that Q4 2010/Q1 2011 exhibited roughly average rainfall while the 2011 harvest season was relatively dry. Based purely on these criteria, 2011 should be a good vintage. In fact a high proportion of years over the past decade have exhibited favourable weather conditions for grape growing in the Bordeaux region.

Bordeaux wines take many years to mature so uncertainty over quality is greatest in the early years. Tasting a wine when young may give a misleading impression of how it will eventually turn out. This uncertainty leads to variations in the price, which may or may not reflect true eventual quality. The opinions of various high profile wine experts such as Robert Parker also play an important role in determining price variability. Being human, opinions can and do change. In some respects then investing in wine is not like investing in other commodities because of the

aesthetic dimension. Nevertheless, the aforementioned academic research suggests that analysing weather related factors can help to reduce uncertainty.

Wine investing is not for everyone. The market for wine is illiquid in comparison with financial securities. Investors may have to wait a great many years to realise a return, during which time costs may be incurred with no offsetting income.

However, for a patient investor with an appropriate risk and liquidity profile, fine wine may be useful both as a diversifier as well as a return enhancer within an investment portfolio. The consolation prize if I am wrong is that you will have plenty of wine in which to drown your sorrows. I’ll raise a glass to that.

Source: ¹ This index consists of “100 of the most sought-after fine wines for which there is a strong secondary market” made up mostly of Bordeaux (89/100 at time of writing) but also including wines from Burgundy, Champagne, the Rhone and Italy.

See www.liv-ex.com for more information. ² See “Predicting the Quality and Prices of Bordeaux wines” by Orley Ashenfleter, American Association of Wine Economists, Working Paper No. 4.

05/06

Long Live

by Matias Ringel, CFA New York office

CTAs

A

n old dog can learn a new trick. Commodity Trading Advisors (CTAs) have evolved significantly in recent years, and despite their lackluster performance in the recent past, they remain the most liquid, diversifying hedge fund strategy available in the market.

For years, CTAs implemented one of the oldest hedge fund strategies when trading futures either in a discretionary or systematic fashion. Managed futures have developed significantly since the 1970s and today represent over 15% of all hedge fund assets under management, accounting for well over $300 billion. At the same time, CTAs became quantitative model based systems, with nearly 75% of their assets pursuing trend following opportunities in the marketplace, which tried to benefit from persistent direction in the markets1. It is precisely that focus on trends that resulted in mediocre returns for the strategy in the last three years. Especially, given the significant trendlessness we have witnessed in the marketplace.

Many investors wrongly still shy away from managed futures strategies because they equate them with a 'black box' of sorts that lacks transparency. However, arguments like these are often counterbalanced by the fact that the underlying instruments are all exchange traded, and represent the most liquid asset classes such as currencies, commodities and financial indices.

Furthermore, most long-term investors have identified three key benefits of pursuing managed futures strategies as follows, 1. low correlation to more traditional asset classes; 2. risk protection characteristics within a portfolio and their historical absolute return attributes.

A number of papers on the role of CTAs in a portfolio have been written over the last decade and most of them reach similar conclusions, namely that CTAs lower portfolio tail risk and further increase the chances of returns surprising on the upside rather than the downside. These properties can best be described in the chart below, where there are significant

benefits in terms of risk and return tradeoff derived from including managed futures as part of a diversified portfolio.

Today the CTA offering has improved significantly. Trend followers are more actively controlling their time frames to take advantage of market dynamics (Winton Capital Management is a good example of this) and a new hybrid class of systematic macro managers has emerged which uses fundamental principles while trading on these in a quantitative model based systematic fashion (Cantab Capital Partners has become a leader in this substrategy). To those who may think that CTAs are dead we say, "Long live CTAs".

Portfolio Efficient Frontier June 2001 – December 2011 50% Hedge Funds 50% Managed Futures

45% Hedge Funds 45% Managed Futures 5% Stocks 5% Bonds

50% Stocks 50% Bonds

Source: Revisi-ng Kat’s Managed Futures and Hedge Funds: A Match made in Heaven, Working

Source: Revisiting Kat’s Managed Futures and Hedge Funds: A Match made in Heaven, Working Paper, September 2012 paper, September 2012 Source: HFR

1

invest monthly / 11 / 2012

Investment Spotlight

by Michael Leithead, CFA Senior Portfolio Manager London office

Bonds: Blended, not stirred New Capital Asia Pacific Bond Fund

S

ince the European debt crisis began, fixed income investors have become increasingly concerned about an overleveraged western society.

Their solution, take a "shotgun approach" to investing outside this region and simply buy emerging markets.

We believe that in the future, investors will target specific markets and not just buy into broad arbitrary classifications that may not offer the exposure they really intend.

EFGAM’s blended approach believes that fixed income allocations to structurally strong economies should be accompanied with an understanding that these economies will experience cycles, which will favour some fixed income assets over others.

allowing it to target assets that will benefit from the prevailing macro economic conditions, whilst maintaining exposure to the region as a whole.

Here’s how it works. First, consider the macro factors that drive returns. Local rate exposure may provide attractive returns as inflation falls but higher inflation rates could prompt interest rate hikes and fixed income losses in time of economic growth. Economic growth and inflation may favour corporate entities and credit returns are likely to be strong. Logically, switching from local government bond exposure to credit exposure would be a sensible strategy, but local currency funds cannot switch to credit even if returns are more attractive. A blended approach offers this flexibility.

Asia best reflects how a homogenous view of fixed income markets outside Europe, North America and Japan, can lead investors to miss opportunities. The Asian structural development story will certainly be interspersed with cyclical highs and lows but the diversity of the economies and breadth of fixed income markets allow a dynamic blended fixed income approach to capitalise on the opportunities that the cycle provides.

Developed markets in the region will provide more defensive positioning in times of economic weakness, whilst emerging economies will be more heavily geared to a turn around.

A blended approach also allows investing in both local and hard currency credit. Managers can allocate across the spectrum of countries, not just those with deep local markets, or just in crowded hard currency trades.

Furthermore, different countries will react to prevailing economic conditions in different ways, so where a rise in food prices may have a large positive impact on Indonesian inflation, the impact on Korea may be far more muted. This could lead to a decision to avoid Indonesian local bonds and favour Korean. Rising food inflation may be indicative of improving economic conditions, as such this may favour Indonesian companies as they stand to benefit to a greater extent than their Korean counterparts.

The New Capital Asia Pacific Bond Fund is designed to invest across the region, in both local currency and hard currency markets

Whilst we have highlighted the benefit of having flexibility across the cycle, the structural economic growth story remains

a draw to the region. One aspect that may be underestimated is the development of financial markets. We believe that the crisis that has engulfed the West has been a catalyst for Asian countries to develop their own markets. With investors increasingly preferring their local markets away from traditional “safe” geographies, the opportunity for new issuers and the development of local markets has never been better. We believe that deeper and more diverse markets will offer investors new and exciting opportunities and managing these within a macro strategic fund will enable investors to exploit the best of these opportunities at the most favourable times. ,

The New Capital Asia Pacific Bond Fund is designed to invest across the region, in both local and hard currency markets, allowing it to target assets that will benefit from the prevailing macro economic conditions, whilst maintaining exposure to the region as a whole.

07/08

Hot Topic Fixed Income ETPs:

“Some track Merits of active and passive approaches in fixed income

O

ver the last decade Exchange Traded Products (ETPs) have become a ubiquitous investment vehicle in the market place and now have $1.8 trillion of assets across 4,748 products. Within EFGAM we believe ETPs can play a useful role in portfolios but use them selectively. This article explores the efficacy of fixed income ETPs. Evidence shows that some fixed income asset classes are better suited to ETPs than others. In more liquid markets tracking problems are less of a concern.

For example the Ishare Barclays 7-10 year Treasury Bond Fund has tracked the associated index very closely since launch in 2002 with only 4bp of underperformance. However we are not convinced by the merits of fixed income ETPs in less liquid parts of the market such as US high yield.

Source: Bloomberg

The largest ETPs in US high yield are the Ishares Iboxx H/Y Corporate Bond (HYG) at $17bn and the Barclays SPDR (JNK) at $12bn. In the case of HYG, this fund seeks to track the Iboxx $ Liquid High Yield Index. While tracking against this index has been fine, by using more liquid indices the full returns of the broader high yield market are not being captured.

The first chart shows that Iboxx $ Liquid HY Index has trailed the broad BOAML High Yield Index (HOAO) by 12.8% since April 2007. It is fairly commonplace for corporate & high yield ETPs to track more liquid indices as tracking would be too high and performance shortfall would be more visible to investors. JNK follows the Barclays Capital High Yield Very Liquid Index but has lagged this index by 3% annualised since launch (November 2007) and the broader BOAML Index by 3.2% annualised. While fees will inevitably result in some underperformance (approx 0.5% per annum) it is transaction costs which explain a significant amount of this underperformance. High yield by its nature is a less liquid asset class resulting in wider bid offer spreads. Given the exceptionally high levels of fund turnover within ETPs, high levels of transaction costs are ultimately reflected in weaker fund performance. By way of example,

annualised turnover in the Ishares Iboxx Investment Grade Corporate Bond ETP is currently 490%. A further issue is that of ETP transaction costs and more specifically bid/offer spreads during periods of market stress.

While active bond funds face the same transaction costs, fund turnover levels will be significantly lower than ETPs. Furthermore, active funds can invest outside the most liquid issues which ETPs are forced to focus on. Given this, EFGAM believes active bond funds offer stronger performance potential in the high yield arena. Several managers have commented that ETP flows can cause distortions in bond prices which can be exploited and used to generate alpha.

EFGAM’s preferred funds in the US high yield area are Neuberger Berman which has outperformed the broad BOAML Index by 9.7% and JNK by 30% since January 2008. We have also added some shorter duration high yield funds to the list such as Axa and Sky Harbor. Given the strong performance of high yield in 2012 and spread tightening we believe the timing is right for an allocation to short duration which offers high levels of yield with greater downside protection.

invest monthly / 11 / 2012

by Andrew Harradine Head of Long Only Research London office

while others go off the rails�

Interestingly, global flows into fixed income mutual funds this year at $283bn have dwarfed fixed income ETP flows at $54bn. This suggests the market appreciates the short comings of fixed income ETPs.

Evidence shows that some fixed income asset classes are better suited to ETPs than others. In more liquid markets tracking problems are less of a concern. However we are not convinced by the merits of fixed income ETPs in less liquid parts of the market such as US high yield.

09/10

“ Don’t

All information is provided by Smith Breeden and is being provided for informational purposes only and should not be deemed as a recommendation to buy or sell securities. Some of the information is taken from sources outside Smith Breeden. We deem these sources to be reliable, but no warranty is made as to accuracy.

fight the Fed”

D

on’t fight the Fed is a Wall Street adage that holds true with regard to the Central Bank’s most recent accommodative tool.

The Fed currently owns 18% of the fixed-rate mortgage backed security (MBS) market and will now be adding 0.83% more each month, indefinitely.

Its purchases are focused on the new loan origination rates, and are not driven by relative value, which creates attractive opportunities for investors with security selection expertise and knowledge of the MBS market.

QE3 program, gross MBS production has averaged $130 billion/month for the last six months and the Fed will initiate an openended purchase program of an additional $40 billion/month in addition to the current $30 billion/month reinvestment program (totalling over $70 billion/month in total purchases).

On the supply side of the equation, net production is fairly flat (the graph shows recent and projected net MBS production, with and without Fed purchases). The Fed’s objective of this policy tool, in part, is to boost job creation by fueling spending and promoting investment in risky assets, and in general trying to sustain what has been a tepid recovery. Excitement should be tempered, however – the Fed could throttle back and end the program if the outlook for

the labour market improves, or is warranted by improving market conditions.

While QE1 and QE2 programs entailed US Treasury purchases, QE3 is distinct in its focus on the US MBS market. At $5.1 trillion, the Agency MBS market is nearly as deep and liquid as the $5.8 trillion UST market, and was well-bid during the 2008 financial crisis.

More importantly, and perhaps lesser known to some investors, is that Agency MBS offer higher returns while exhibiting less volatility over various time periods (as shown in the accompanying table), which makes them an attractive “safe haven” investment alternative.

The early stages of the program have proven to be a good environment for MBS spreads, and we anticipate this trend to continue.

On 13 September 2012, the Federal Reserve unveiled a third round of quantitative easing (QE3) that included purchases of agency mortgage-backed securities, turning our spotlight on the MBS sector. This announcement ­– well-telegraphed by Fed Chairman Bernanke – should be viewed as a strong positive for mortgage spreads.

This stimulus plan is providing two-pronged support of the MBS sector: (1) It is improving the technicals by making the supply/demand equation extremely favourable. (2) It is removing volatility from the market, given the Fed’s commitment through its Zero Interest Rate Policy (ZIRP) to keep rates low through (at least) 2015. (Stable interest rates reduce the value of the borrower’s prepayment option, boosting the return to mortgage investors.) To quantify the magnitude of the

As of August 31, 2012. Source: eMBS and Federal Reserve. Fed Purchase program began in January 2009.

Fed reinvestment program began in October 2011. This information is taken from sources that we deem reliable but no warranty is made as to accuracy.

invest monthly / 11 / 2012

In the Driver’s Seat A new class of collectable automobiles has emerged as 'investment grade' which refers to their rarity, desirability and place at the pinnacle of the classic car market.

Don’t park your money

when you could be on

the road to riches

Some of the most important 'investment grade' cars in the world fetched recordbreaking prices this August at the Concours d’Elegance in Pebble Beach, California. The highest ever percentage of lots sold at this year’s automobile auction flagship event, which featured about 200 cars.

While these statistics are undoubtedly correct, the auction houses worked hard to achieve these results. In one case, bids were taken in only $50k increments pushing the price on one car alone between $9m to $9.5m.

So is the classic car market a good investment? Figures show an ever-increasing rise in the value of collectable and rare classic cars. The Historic Auto Group (HAGI) in London (historicautogroup.com) tracks a worldwide basket of cars using a similar method to other major financial market indices. It showed a 12.9% increase for August for the top 50 collector grade cars (21.49% YTD) and a 14.91% increase for its Ferrari only indices (26.39% YTD). A small correction (-2.2%) has occurred in the Top 50’s September numbers, but this should be seen in the context of the strong performance across the board in August.

Meanwhile, the HAGI F-Index, designed to measure the rare collectors' Ferrari market,

continues to rise. The Index was up 1.58% in September and 28.39% overall between January and the end of September. Add in the fact that many classic cars are capital gains tax exempt, and it's clear that informed collectors are turning passion into profit.

At the Concours d’Elegance auction, two determined bidders pushed the price of a Ford GT40, previously-used as a camera car on the film “Le Mans" to a world record price of $11m. An alloy bodied 250 California Spyder far outstripped its high estimate of $9m to achieve another world record of $11.275m, which was $4m more than was paid for a similar car 18 months prior. And a 1928 Bentley ‘Bobtail’ sold for $6.05m, having been purchased in 2004 for $2m, a circa 14% compound increase over the intervening eight years. Records were also set for a Mercedes Benz 300SL Alloy blocked roadster, a LHD Bentley R-Type Continental and Porsche RS60 among others.

As with all alternative investing, however caveat emptor still holds true. At this same auction, three Ferrari 246GTS Dinos were sold, the first for $467,000, the sister car the following day for $231,000 and a third for $363,000. Even allowing for variances in condition and provenance, it is a surprising

differential. A Daimler Double Six sold for $2.97m, the same price that was paid three years ago, and a beautiful Talbot–Lago T23 Teardrop sold for $2.64m which was $200,000 less than it fetched two years earlier. As always, some cars failed to make their reserve, such as the Bentley Blower which stalled at $7m having been bought for $4.51m in 2007, a full $1m short of its low estimate.

Interesting to note were the prices achieved by restoration projects, such a 1956 Lancia Aurellia B24S for $242,000. A similar but restored car is being offered for sale at a London winter sale, estimate between $185,000-$220,000.

For the top end of the market, this strong price growth seems sustainable to many collectors. One reason is that the rarest of cars are entering collections that seem unlikely to be offered for sale any time soon.

For example, the $11m Ford GT40 purchased at Pebble Beach has entered the Larry H Miller Museum in Utah. So the stock of the very best cars is decreasing, while the stock of investors looking for alternative vehicles, especially ones that are as beautiful, rare and drivable as these, is increasing!

Contributed by Jonathon Burford, a London-based automobile collection curator and regular competitor in classic car events.

The private bank for historic motor racing Proud sponsors of: Le Mans Classic; Classic Endurance Racing; Pau Historique; Spa Classic; Dix Mille Tours; Donington Historic Festival; Chelsea AutoLegends; Salon Privé; HERO Scottish Malts; Tour Britannia; RAC Woodcote Trophy; Wilton Classic and Supercar Day; Kop Hill Climb; London to Brighton Run; Gstaad Classic; DolderClassics. www.efgmotorracing.com

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