Q&A – Newport Business and Investment Update
April 2, 2020
How can the investments that pay dividends based on rents continue when business and people can no longer afford to pay rent?
We view the inability to pay (office/commercial/retail) rents due to closed operations as a temporary phenomenon. Typically, the balance sheets of the quality REITs – and certainly our real estate partners – are strong enough to continue distributions, particularly given that the vast majority of the unpaid rents should be a receivable that will ultimately be collected. While there may be some tenant bankruptcies, the best-in-class REITs with well-located, well-managed properties should be able to re-lease the space – albeit at lower rents, potentially. There is also the possibility that REITs may take the opportunity to reduce or suspend distributions, given their depressed share prices, which have been oversold in our view. It is not uncommon for REITs to cut their distributions if the market is not rewarding them for their high yields. The market will often respond in a positive manner to a distribution cut as it is viewed as a measure of balance sheet prudence. In fact, we have already seen some REITs decide that it is more prudent to buy back their own shares than distribute cash to unit holders. Should share prices fall further on reduced or halted distributions, this would enhance the opportunity to invest capital in this space.
As for the multi-family residential sector, given historically high occupancy rates in quality properties, it is unlikely that this pandemic will negatively impact long term net operating income in a material manner. Government subsidies could also help cushion the shortfall.
In Canada, we do expect the pandemic to result in lower levels of immigration. As new arrivals to Canada have been one of the factors driving upward pressure on rental rates, this may mean we will see some abatement in rental growth in the medium-term. Lastly, many of our investments have lower levels of leverage which means they have some capital flexibility to manage through the pandemic-related challenges they might face.
What percentage do your private assets currently represent? Will there be any lag in that will show up in the next quarter?
In a Balanced mandate, private investments currently represent approximately 31%. As their valuations are not marked to market daily, the impact of the virus-induced slowdown will not be fully apparent for several quarters. Much depends on the length of the slowdown and how quickly the economy re-starts. We know from our recent meetings with the private asset class specialists we retain, that they had been preparing for a correction, they are laser-focused on monitoring their existing investments and they have good liquidity to support the underlying investments where needed. The private asset class specialists we retain are well-capitalized (e.g. Brookfield, Timbercreek, etc.) and maintain low levels of leverage – factors that will serve them well not only in weathering the slow down, but in emerging from it, they believe, in a stronger competitive position.
What is the Newport view on the value of the Canadian dollar and oil prices? How is Newport protecting us from a further drop in the Canadian Dollar? What percentage of the portfolios are hedged? At this time are you considering placing a greater proportion of the investment portfolio in the U.S.?
All else equal, the U.S. dollar becomes a safe harbor in periods of economic and market uncertainty. As such, all other currencies tend to lag in comparison. Given this reality, we are not predicting a near-term rally in the Canadian dollar. However, given the Loonie’s 9% year-to-date fall, we believe that selling pressure should slow down and that our dollar is fairly valued at current levels.
We started the year with about 25% of our exposure hedged and have increased this to 42% as of the end of March. Oil prices have fallen significantly due to the price war between Russia and the Saudi’s creating a supply/demand imbalance. While we see this normalizing over time, we do not see it providing a material boost to the Canadian dollar at this time.
Approximately 50% of our portfolio is currently invested outside Canada. The majority of the equity investments that we plan to make going forward will be outside Canada as we believe it will provide more attractive returns.
Your overall strategy sounds like a sound one, but you haven’t discussed client withdrawals? Could you provide an overview of client withdrawals since March 1?
Our withdrawals during March were not materially different than January or February. Clients typically withdraw funds for living expenses, to pay taxes, etc. By contrast, we have seen net inflows of assets in March at amounts that slightly exceed those of the previous two months. Where additional cash is available to be put to work, some clients are using this as an opportunity to invest monies they have had on the sidelines but were previously reluctant to invest due to high valuations.
Does your current investment philosophy differ based on our respective levels of risk tolerance?
Yes. We have five defined client risk profiles (three for Lonsdale Portfolios) and allocations to each of the 12 asset classes that we invest in are based on the client’s mandate. On the webinar, we spoke mostly about our Balanced mandate, which is in the middle of our five mandates from a risk standpoint. Within each mandate, we also make tactical changes over time that reflect our outlook and desired positioning to earn the best return for the level of risk commensurate with the mandate. These are modest adjustments and would not lead to a wholesale change. If you want to review your risk profile, we would encourage you to speak to your Portfolio Manager.
What is Newport’s current % of total funds in Public investments (Stocks & Bonds) compared to Real Estate, Debt, Infrastructure, and Private Equity?
In our Balanced mandate, we currently have approximately 68% of the portfolio in public investments and cash, and 31% in private investments, which includes private debt, mortgages, real estate, private equity and infrastructure.
Any particular industries/assets you’re avoiding at this time?
Yes, we are avoiding travel, energy, hospitality, consumer discretionary, services, raw land and anything with high leverage.
Do the big banks have enough capital to withstand the crisis?
Canadian banks managed through the global financial crisis extremely well. In fact, they became a standard-bearer for many financial institutions around the world. Given that this crisis will have more of a domestic impact than 2008, it is very likely that our banks will have loans – corporate and personal – that will need to be managed. Some will just require time to work themselves out, others will require foreclosure. Despite the obvious challenges, we believe that our banks are well capitalized, will manage through this and we do not expect dividend cuts at this time.
If you look longer term, what and where do you think the manufacturing sector will be? This crisis may motivate the restart of North American manufacturing of goods that have been moved to China and other countries. Will Newport be considering this as an investment opportunity?
There has been a good deal of speculation about this, though it would be premature to consider it an inevitable outcome of the current crisis. We would not be surprised to see companies that have experienced supply chain disruption explore options to consolidate their manufacturing facilities domestically or look to diversify supply networks around the world. It is also possible that there will be pressure for increased domestic production of essential items like medical supplies. Ultimately, however, cost competitiveness will likely continue to drive decisions in the future. We have been participating, indirectly, in the “onshoring” theme through our investment in garden-style apartment complexes in southeastern U.S. cities with robust manufacturing and population growth patterns. Beyond that, the selection of which individual businesses to own is a decision made by our asset class specialist managers.
What do you believe the equity markets have factored into the current prices? Do markets believe the world will be shut down for one more month, two more months, three more months or longer?
We believe that markets have factored in a shut-down of North America through until the end of May. How markets react will depend on future stimulus and economic expectations into the start of the summer as well as any positive news on potential drug treatments or a vaccine to prevent the spread of the virus.
What is the one issue that scares you that has not been asked?
We fear what everyone fears: that this pandemic lasts for longer than people are currently considering, that the death toll is higher, and that the return of jobs is slower than anticipated. If economies end up being frozen for the entire year, job losses would multiply significantly and the resulting spillover to housing, consumer spending, and bankruptcies would have a material impact on the markets. We do believe, however, in the resilience and creativity of capitalism – and specifically the entrepreneurial class – to adapt and innovate. Indeed, it is likely that the promise of research and discovery will be our way out.
Will the high levels of debt that governments are accumulating do more harm than good i.e. inflation, higher taxes etc.?
Using 2008 as a potential parallel, (though different), the consensus was that government intervention was dramatic, and necessary to save the global banking system. Policy response to the current situation should be viewed through the lenses of, “whatever it takes” and “failure is not an option”. Drastic action is called for in the face of this challenge. Certainly, there will be fall out or unintended consequences, but that is the price of taking action to help people today.
Quantitative Easing (QE) programs means a lot of governments are printing money. Taxes may not need to rise if governments can replace the lost revenue in the economy by printing money. Despite $10 Trillion of QE around the globe, we have seen low rates of inflation. While the current impacts remain to be seen, there is no argument for automatically building in a high inflation scenario portfolio strategy at this stage.
What about the recently identified security issues with Zoom? How are you addressing this?
We are aware of some security issues with the Zoom technology – specifically subject to “Zoombombing” wherein unauthorized participants join and interrupt meetings. It appears this is due to a lack of familiarity and training of users insofar as it pertains to setting up a secure meeting. Our staff attended several tutorials and live training prior to using implementing the technology. With the license we purchased, we have access to a personal Zoom account manager who reviewed the protective features for setting up our meetings. If you would like to know more, you can read this note from the CEO that was sent to us.
We continue to monitor the security of the technology and are having our technology consultants review it before we use it again.