Transparency & Governance | Apr 2018

I’ve been meditating on transparency and governance rather frequently of late. Not out of a sense of righteousness, mind you, but largely because they are inescapable in my morning reading of the newspaper: Abraaj, Norway (both discussed below), FacebookMartin SorrellSean Hannity, &c.

The only firm conclusion I’ve reached is that quality governance — corporate or otherwise — is the most underappreciated necessity. A world awash in capital is also a world awash in unaccountable bullshit. People just don’t seem keen to ask — let alone field — questions when the money’s rolling in. Plus ça change …

Say what you will about younger generations, but they’re pretty quick to raise the BS flag and ask uncomfortable questions (so much so that it has become a meme, apparently). I was reminded of this recently while giving a guest lecture at UVA’s McIntire School of Commerce. The students were super sharp, and they asked hard-hitting questions … including one that made me ponder some life choices.

In short, they’re awesome. They rekindled my belief that the future is going to be amazing. Hopefully their incessant questioning will continue as they assume positions of leadership, thus contributing to more transparent and accountable governance. On verra bien …

Speaking of the future, Portico’s first product launch is in the works. We’re making it easier than ever for first- (and second-, and third-, &c.) time funds to produce institutional-quality marketing materials, at a price point that delivers enormous value. Stay tuned!

Finally, I’m really looking forward to IFC’s Global Private Equity Conference next month (hosted in association with EMPEA). It’s the 20th anniversary of the event and it should be a good one. I’m excited to reconnect with friends and make new connections. Drop me a line if you’re planning to attend.

If you haven’t registered, you may learn more about the event at this link. Hope to see you there!

Alla prossima,
Mike

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Abraaj: Fin?

[This is the third — and final — in a series; see Part I and Part Deux]

“What a mess. I’m left wondering if investors in the firm’s funds will seek (a) new GP(s) to manage out the assets.”

So read the conclusion to my take on the drama at Abraaj in last month’s newsletter.

I don’t know whether the investors drove the process, but Houlihan Lokey was brought in to find a solution to the Abraaj Growth Markets Health Fund debacle, and the FT reports that Abraaj subsequently offered to step down as manager of the fund. An interim manager is reportedly in the cards until a permanent replacement / solution is found.

A few thoughts / observations:

  • Key Person Provisions — More senior departures were reported over the last month, including those of Sev Vettivetpillai and Mustafa Abdel-Wadood, both of whom reportedly attempted to resign late last year but were asked to stay.The Wall Street Journal reports that “the firm now has lost half its managing partners and a third of its partners in the past year.”At this point, given the flood of senior departures, it stands to reason that Key Person termination provisions likely have been triggered across several Abraaj funds. If so, then I imagine investors will be looking for (a) new GP(s) to manage out the assets.
  • Sharks Circling — The firm is reportedly considering a sale of its private equity business to raise cash, and reducing headcount by 15% to cut costs. It is also moving forward with its planned listing of the South African FMCG company Libstar.
    Kenyan sources report that the firm is evaluating a sale of its stake in Nairobi Java House, which it acquired from ECP last year. (I talked about the deal here). The same article reports that sales of Avenue Hospital, Brookside Dairies, and Seven Seas Technologies may be under consideration as well. With all these headlines, management teams and fund managers may be sensing an opportune moment to scoop up shares at a discount from a stressed seller.
  • Exit Closed — In recent years, Abraaj had become an active buyer of PE-backed companies, particularly in Africa (e.g., Java House, Libstar, Mouka). Had its $6 billion mega fund come to market, I imagine Abraaj would have become a sought-after exit channel for GPs. In a way, it could have become to EM private markets what the SoftBank Vision Fund is to venture investors: a deus ex machina of liquidity.
  • &c. — Its portfolio company Stanford Marine has reportedly breached covenants and is seeking to restructure $325 million in debt. Reuters reports that it is seeking repayment of $12.4 million in loans to Nigeria’s C&I Leasing. Deloitte has been called in to look into its governance and control issues. &c.

I’m tired of writing about Abraaj. I don’t plan on including anything about the firm in next month’s newsletter.

The news articles are likely to keep coming, though, and the developments over the last month suggest that it will take a long time to clean up the detritus from this unfortunate turn of events. Here’s hoping that it doesn’t contribute to investors’ exodus from EM private markets altogether.

Norway: Part Deux

In January’s newsletter, we mentioned that Norway’s sovereign wealth fund had submitted a recommendation to the finance ministry that it be allowed to invest in and alongside private equity funds. At the time, we held out a grandiose vision of a world in which the fund might build a genuinely differentiated approach to EM private markets.

Well, the finance ministry has issued its report, and fund managers’ hopes for a veritable tsunami of cash have been put on hold.

Indefinitely.

The preliminary, unofficial translation of the report provided a fairly damning assessment of the asset class’s fees and opacity:

Low costs are characteristic of the GPFG. External equity management costs in the listed market are about 0.5 percent … measured relative to assets under management. In comparison, the annual cost of investing in private equity funds can be estimated at about 6 percent of assets under management …

Transparency is an important prerequisite for broad support for, and confidence in, the management of the GPFG. Many private equity funds disclose little information about their activities …

High prospective returns aren’t a sufficient argument for new money to come into the asset class — especially when its citizens’ savings. We’ve said it before and we’ll say it again: the industry will not thrive without trust, transparency, and quality corporate governance.

Bain & Co.

Two findings jumped out at me from Bain & Co.’s Global Private Equity Report 2018:

  1. Entry pricing is … inauspicious.As of year-end 2016, the percentage of deals priced at <7x EBITDA (~10%) was the lowest it had been since at least 2007, while 54% of deals were done for >11x EBITDA (compared to ~35% in 2007). “Our presumption is that we’ll be exiting at smaller multiples,” says Alan Jones of Morgan Stanley Global Private Equity. Agree
  2. Long-hold funds can outperform. Bain ran an analysis comparing a theoretical long-hold fund selling an investment after 24 years against a buyout fund selling four successive companies over the same period. Their finding: “By eliminating transaction fees, deferring capital gains taxation and keeping capital fully invested, the long-hold fund outperforms the short-duration fund by almost two times on an after-tax basis.” [emphasis added]

At Portico, we’re privileged to work with firms that are pursuing non-traditional and longer hold strategies. We think it’s only a matter of time before more investors come to see the benefits of these approaches.

Grab Bag

  • Into Africa—The FT reports that the EBRD is considering an expansion into Sub-Saharan Africa. The politics of getting this approved might be tricky, but EBRD could do a lot of good on the continent. 🤞
  • India — IFC’s Ralph Keitel gives a masterclass on PE in India in this interview.
  • Management Fees— Dave Richards of Capria has an interesting view on how GPs should be determining their management fees. Hint: they should be predictable and budgeted, rather than a percentage of committed / invested capital.
  • Theranos— “It has been pretty obvious for a few years now that Theranos Inc. was a huge fraud.” Matt Levine’s take on the Blood Unicorn, Elasmotherium haimatos. And, its solicitation for cash after its CEO settled fraud charges?

From the Bookshelf

Make friends with those who are good and true, not those who are bad and false.

— Eknath Easwaran (trans.), The Dhammapada (Nilgiri Press: 2007).

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The information presented in this newsletter is for informational purposes only. Portico Advisers does not undertake to update this material and the opinions and conclusions contained herein may change without notice. Portico Advisers does not make any warranty that the information in this newsletter is error-free, omission-free, complete, accurate, or reliable. Nothing contained in this newsletter should be construed as legal, tax, securities, or investment advice.

Copyright © by Portico Advisers, LLC 2018, all rights reserved.

The White Stripe | Mar 2018

A small print of Jody Clark’s “Keep Treading” hangs on a wall in my office. It’s a picture that I first saw at the Brazilian Jiu Jitsu (“BJJ”) gym where I started training last fall. It shows a man in a gi trying to stay afloat in the ocean. An eel is wrapping around his legs and pulling him asunder, while a collection of sea nettles threatens to sting him if he reaches out his arms.

It’s an apt metaphor for the travails of a white belt in BJJ. As Sam Harris describes it, “The experience … is akin to falling into deep water without knowing how to swim. You will make a furious effort to stay afloat—and you will fail.”

That is an accurate one-word summation of my first five months in BJJ: failure. Relentless, unmitigated failure. Soul- and ego-crushing failure.

Consider this dispatch from my BJJ journal:

2/10 – Open Mat

Performed poorly. Got smashed. Decent defense but too passive. Need to be more aggressive. Neck got crushed while in turtle. Honestly I just feel dejected.

There are days when the hardest thing is showing up to class or open mat. The certainty of being smashed, submitted, and in pain makes it all seem like a futile exercise. It’s so tempting to quit in the face of near-certain failure.

But, you have to keep treading. It’s all a bit of a metaphor for life as a whole.

Last week, I received my first stripe on my white belt. I know it’s foolish to place much stock in outward signs of progress, but this promotion—this piece of tape—was one of the more hard-earned accomplishments in my life. And yet, it’s merely the first rung on the ladder. Progress. One aching, small step at a time.

In other news, I’m looking forward to joining some folks from General Atlantic next month for a conversation with students at UVA’s McIntire School of Commerce. Should be fun!

I’ve also created a video of the presentation that I delivered at the UNC Alternative Investments Conference last week (some of the slides are featured below). If you’re keen to see a 30-minute overview of EM PE, check it out on YouTube!

Alla prossima,
Mike

Abraaj: Part Deux

In last month’s newsletter we discussed the drama at Abraaj following revelations that four LPs had hired forensic accountants to probe the books of the Abraaj Growth Markets Health Fund.

The situation is serious, indeed:

  • Abraaj’s fund management business is being split off into a separate entity with an independent board “to which internal audit and compliance will directly report.”
  • Abraaj’s founder, Arif Naqvi, relinquished management of the funds business, though he is expected to serve on its investment committee.
  • The firm announced a halt to investment activities.
  • Private Equity News reports that Themis, the energy team that Abraaj acquired in March 2016, sought to end its partnership with the firm as early as mid-2017. Denham Capital announced a new platform agreement with Themis earlier this month.
  • The WSJ reports that the firm is weighing job cuts as its fundraising is put on hold; existing investors in its $6B target mega fund are asking for their money back; investors in other funds are considering selling their stakes; and, lenders are reviewing credit lines for their capital call facilities.
  • The FT reports that the firm’s CFO departed.

Meanwhile, the firm is still unable to secure an exit from K-Electric, a divestiture it announced in October 2016. Abraaj was slated to receive a consideration of $1.77B from Shanghai Electric Power, a subsidiary of the State Power Investment Corporation of China; however, the transaction has been dogged by delays.

According to a local news report dated 9 March, the Pakistani government still had not cleared the sale, in part because it has not received a copy of the sale-purchase agreement, in part on national security grounds, and in part because the company is alleged to owe “dues” upwards of PKR139 billion (~$1.25B). Arif Naqvi is reported to have met with government ministers this week in an attempt to accelerate the sale.

What a mess. I’m left wondering if investors in the firm’s funds will seek (a) new GP(s) to manage out the assets.

EM Fundraising: Coming Full Circle?

 

giphy2

“Coming Full Circle.” So reads the adulatory headline from EMPEA’s year-end 2017 statistics, which show $61 billion in EM fundraising across PE, private credit, and infrastructure and real assets—the highest level since 2008. Break out the champagne glasses and lace up those dancing shoes. EM PE is back!

Or not.

Looking at fundraising for buyout and growth equity funds, the volumes remain stagnant since 2011 (see below). Though 2017 shows a rebound, the aggregate figure is deceptive: KKR Asia III clocked in at $9.3B and Affinity Asia closed on $6B, which means these two funds account for 40% of the capital raised for buyout and growth strategies. That leaves about $20B for the rest of EM. It’s peanuts!

FRchartv2

The trends we highlighted in November 2016 are continuing apace, with only 75 growth equity funds achieving a close in 2017—a 44% decline since 2010. In addition, new entrants are struggling to get traction. EMPEA’s own analyses show that first-time growth equity funds have declined from 30% of the capital raised for the strategy in 2008-09 to less than 10% over the last four years.

At issue is a lack of distributions and a lost decade for LPs in EM buyout and growth equity funds (see below). There is a sharp drop-off in distributions beginning in 2007 / 08 when fundraising exploded. It’s a decade later, and the breakpoint for top-quartile funds beginning in 2008 hasn’t returned investors’ capital.

lostdecade

These performance indicators from Cambridge Associates are damning, and it’s no surprise why LPs have been walking away from “traditional” EM PE in greater numbers.

But there’s something about this exhibit that bothers me. I know many established managers that refuse to provide their performance figures to Cambridge. One global manager was befuddled when I presented these figures; s/he noted that their EM deals generated IRRs well north of 30%.

It’s worth asking whether Cambridge’s benchmarks are a worthy benchmark in EM. I have my doubts.

For example, a quick sketch comparing the universe of EM buyout and growth equity funds—as collected by EMPEA—to those in Cambridge Associates’ database show that CA has between 4% and 21% of the total number of funds by count, and between 29% and 60% by total capitalization (excluding 2011; see below).

cambridge

The industry is poorly served by these benchmarks. I should probably stop using them, but there is no credible alternative.

If only there were an organization that could serve as a utility for the industry—one that provided impartial data on private capital performance … 🤔

In any event, as bearish as I’ve been about the prospects for the EM PE industry, I am cautiously optimistic that we’re close to reaching a bottom. If flows to EM public equities continue, then the exit windows should stay open, managers should distribute cash to their LPs, and then capital can be recycled to new commitments.

While I don’t expect EM-dedicated growth equity and buyout funds to come “full circle” to the $58 billion they raised in 2007 anytime soon, the scarcity of capital allocated to the sub-$1 billion segment portends well for the performance of current vintages. And if history is any guide, LPs will herd back into these markets after the “easy” money has been made.

giphy1

Private Equity: Overvalued and Overrated?

Dan Rasmussen of Verdad is not making friends with many people in private equity. His former colleagues at Bain Capital must wish he’d stop talking. Like him or hate him, Dan puts out thought-provoking, empirically driven takes on the myths and realities of U.S. buyouts (see last December’s newsletter for an example).

In his latest piece, “Private Equity Overvalued and Overrated?”, Dan probes three premises about which there is “near-complete consensus:”

  • PE firms make money by creating value in portfolio companies;
  • PE is less volatile / risky than public equity; and,
  • PE will significantly outperform other investments.

Rasmussen’s most interesting conclusion pertains to the first bullet: the myth of value creation. Verdad constructed a database of 390 deals—representing more than $700 billion in enterprise value—for which the PE firm issued debt to finance the acquisition. This enabled Verdad to compare underlying companies’ financial performance both pre- and post-acquisition. What did they find?

In 54 percent of the transactions we examined, revenue growth slowed. In 45 percent, margins contracted. And in 55 percent, capex spending as a percentage of sales declined. Most private equity firms are cutting long-term investments, not increasing them, resulting in slower growth, not faster growth.

If PE firms are not growing businesses faster, investing more in growth, or gaining much operational efficiency, just what are they doing?

In 70 percent of cases, PE firms are leveraging up the businesses they buy. PE firms typically double the amount of debt on the balance sheet, from 2.5x EBITDA to 5x EBITDA—the biggest financial change apparent from our study.

With $1.7 trillion in dry powder, rising rates, and average U.S. LBO entry multiples hitting 11.2x EBITDA, this just does not seem like an attractive value proposition.

Persistence in Private Equity

McKinsey’s Global Private Markets Review has a fascinating finding on the decline of persistence in private equity performance. Notably, “follow-on performance is converging towards the 25 percent mark—that is, random distribution.”

At a time when capital is flooding to mega-cap funds and, at least in emerging markets, established GPs with a track record, I wonder whether new techniques are needed for manager selection. Perhaps the winning LPs will be those with the liberty to chase a variant perception of value; those less hamstrung by rigid asset allocation buckets and / or institutional constraints.

Je ne sais pas.

From the Bookshelf

A man is born gentle and weak.
At his death he is hard and stiff.
Green plants are tender and filled with sap.
At their death they are withered and dry.

Therefore the stiff and unbending is the disciple of death.
The gentle and yielding is the disciple of life.

Thus an army without flexibility never wins a battle.
A tree that is unbending is easily broken.

The hard and strong will fall.
The soft and weak will overcome.

— Lao Tsu, Tao Te Ching (Vintage: 1989).

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The information presented in this newsletter is for informational purposes only. Portico Advisers does not undertake to update this material and the opinions and conclusions contained herein may change without notice. Portico Advisers does not make any warranty that the information in this newsletter is error-free, omission-free, complete, accurate, or reliable. Nothing contained in this newsletter should be construed as legal, tax, securities, or investment advice.

Copyright © by Portico Advisers, LLC 2018, all rights reserved.

Veritas | Feb 2018

Last month, the New York Times published a fascinating article about the market for followers on Twitter. (Disclosure: shareholder of NYT and TWTR). The manufacture of social capital is something that I hadn’t really thought about before, but now that my eyes have been opened, it’s hard not to notice it.

For example, it’s always been nauseating when someone namedrops to inflate his or her reputation, but I hadn’t considered companies leveraging the brand equity of established firms to magnify their own. Think of all the conferences and august fora where firms’ logos are on display. (Yours, too, could be featured amongst the great and the good for a modest sum).

Or, consider this: have you ever read a profile of a firm or entrepreneur and, en passant, your nose turned up in a visceral reaction? Something just smelled about it? Me too. The article was probably placed. By a PR firm that doesn’t do nuance. Occasionally, these articles include character references from individuals who are compensated by the company being profiled, and yet the credulous journalist didn’t care to ask about potential conflicts.

The currency of currency is all a bit exhausting. I’m reminded of Diogenes the Cynic’s apocryphal confrontation with Plato:

On seeing [Diogenes] washing vegetables, Plato came up to him and quietly remarked, “If you paid court to Dionysius, you wouldn’t need to be washing vegetables,” to which he replied in the same calm tone, “Yes, and if you washed vegetables, you wouldn’t need to be paying court to Dionysius.”

Anyway. Next month, I’ll be at the UNC Alternative Investments Conference, where I will be leading a teach-in session on the role of EM PE in LPs’ portfolios. I’m planning to cover the evolution of emerging markets and explore whether investors are being presented with a richer landscape of opportunities than was available in the past. I’m really looking forward to it. Click here to learn more about the event, and please reach out if you’re planning to attend.

Alla prossima,
Mike

Abraaj

The New York Times and Wall Street Journal report that the Bill and Melinda Gates Foundation, CDC Group plc, IFC, and PROPARCO have hired forensic accountants to probe the books of the Abraaj Group. The investigation is focused on the use of funds within the $1 billion Abraaj Growth Markets Health Fund.

According to the WSJ, which claims to have reviewed the fund’s quarterly reports to investors, Abraaj called $545 million between October 2016 and April 2017, but had invested $266 million by September 2017. In October 2017, the four LPs are said to have asked for bank statements to show what—if anything—was done with the balance of the funds. Abraaj is said not to have provided them. In December, Abraaj is said to have returned $140 million to the fund’s investors.

A reading of the two articles together suggests that there may be some disagreements over the obligation to return called capital—and the time window for doing so—when projects are delayed rather than canceled. Two hospital projects—one in Karachi and one in Lagos—are said to have been delayed.

The WSJ notes that “construction in Karachi was delayed by a ban on new buildings more than two floors high. The planned hospital had 17 floors.” Local media sources report that the ban went into effect in May 2017 due to water shortages and inadequate civil infrastructure in Karachi. Last month, Pakistan’s Supreme Court approved construction for buildings up to seven-storeys high.

Abraaj released a statement on 4 February saying, “recent media reports … are inaccurate and misleading.” The firm states that it appointed KPMG in January 2018 “to verify all receipts and payments made by the Fund,” and that as of 7 February, “KPMG has now completed its findings and reported that all such payments and receipts have been verified, in line with the agreed upon procedures performed, and that unused capital was returned to investors.”

The forensic accountants’ investigation has either not yet been completed, or the findings have not been disclosed publicly.

To an outsider, this looks quite bad. The investor syndicate that hired the forensic accountants isn’t comprised of neophytes to EM PE and impact investing. On the contrary, they’re the most experienced LPs in the industry. IFC alone has invested in over 200 EM funds over the last decade, while CDC is an active investor in 164 funds in 74 countries—including other Abraaj vehicles. These investors have mainstreamed EM PE as an institutionalized investment strategy. If their concerns are in the newspapers, then it’s worth paying attention.

More broadly, this could have knock-on effects across the broader EM private markets landscape. Integrity and transparency are vital, particularly in an opaque industry and in markets where investors confront information asymmetries. To the extent this story encourages managers to improve their operations and reporting, this is a good thing. However, with one of the largest and most visible EM firms coming under scrutiny regarding its use of funds, there is a risk that more investors will just walk away from EM altogether.

The industry will not thrive without trust, transparency, and quality corporate governance.

Abraaj is currently in the market for a $6 billion mega fund. The WSJ’s sources suggest that the firm has collected $3 billion toward its target. I find that incredible; not only because there have been several senior departures from Abraaj of late, but also because it’s hard for me to make the math work from both a top-down and a bottom-up perspective.

  • From a top-down perspective, we explored the absorptive capacity of EM PE in our latest research piece, which, based on an analysis of exits and M&A volumes, suggests that annual flows to traditional fund strategies may need to shrink to $16 billion per year. Can one firm collect a third of that and invest it well? I have my doubts.
  • From a bottom-up perspective, Abraaj built its global platform through the acquisition of Aureos, an SME-focused investor that was writing $10 million checks. In recent years, Abraaj has been securing deals through auctions—outbidding established large-cap firms such as Carlyle and TPG—and secondary buyouts from the likes of Actis, Advent International, ECP, and Metier. It seems reasonable to ask about pricing pressures and style drift.
  • Finally, the firm has raised an estimated $3B across five funds since 2015 and appears to be in the market for upwards of $7.1B across four funds (see exhibit below). Where are they going to put it all?

Of course, all this may just speak to my failure of imagination.

Several institutional investors have read Hamilton Lane’s reports and clearly disagree with the previous assessments. Washington State Investment Board (approved unanimously, up to $250 million) and Teachers’ Retirement System of Louisiana (approved 6-3, up to $50 million) have committed to the mega fund, while PEI reports that Teacher Retirement System of Texas is on board as well.

Scale has its advantages.

Abraaj2

Private Debt in Africa

Runa Alam of Development Partners International co-authored an intriguing article on the prospects for private debt in Africa. There’s clearly demand for more flexible capital solutions amongst local businesses, and my understanding is that some early suppliers of credit / mezzanine solutions on the continent, such as Amethis and Vantage Capital, have done well. As one would expect given the supply-demand imbalance, new entrants emerged:

  • Helios Investment Partners launched Helios Credit, its direct lending platform, in 2015.
  • Ethos acquired Mezzanine Partners in July 2016 and launched Ethos Mezzanine Partners 3 with a target of $150 million.
  • Syntaxis Capital, a Central and Eastern Europe-focused private debt investor launched an Africa strategy in 2016, establishing a presence in Lagos.

Presumably DPI will be joining them.

It’s important to remember, though, as one seasoned private credit manager once put it to me, “leverage is not your friend in emerging markets.” Private credit is more than just a position in the capital stack. It requires a different skillset than growth equity, and a deep understanding of volatility’s impact on balance sheets and cash flows. Choose your partners wisely.

Taking a step back, it’s great to see a broader set of financing options being made available to entrepreneurs on the continent. For LPs willing to look, there are some very interesting managers with vehicles that expand Africa’s investable market. (Drop us a line if you’d like to know more).

Always Low Prices

Walmart, the world’s largest company by revenue, is reportedly shopping around their Brazilian operations. ACON Investments, Advent International, and GP Investments are said to have been pitched.

According to Thomson Reuters, the company’s 471 local stores generated revenues of $9.4 billion in 2016. However, the company “posted operating losses for seven years in a row after an aggressive, decade-long expansion left it with poor locations, inefficient operations, labor troubles and uncompetitive prices.” In short, apart from the labor troubles, they weren’t Walmart.

Apparently, several retailers took a look at Walmart’s assets in the country, but took a pass on them after concluding the suco ain’t worth the squeeze. A consequence, it seems, of Walmart’s poor customer understanding and a bungled expansion strategy.

It will be interesting to see if a private equity buyer can turn things around, but it’s pretty clear they won’t be paying up for the privilege to do so. In that sense, Walmart’s finally operating true to form: offering bric-a-brac at the deeply discounted prices that shoppers have grown to love.

Currency Risk in Emerging Markets

Sarona Asset Management released the final report of its nearly year-long initiative, “Expanding Institutional Investment into Emerging Markets via Currency Risk Mitigation.”

Sponsored by USAID’s Office of Private Capital and Microenterprise, and in partnership with EMPEA and Crystalus Inc., the initiative sought to develop innovative, practicable solutions to FX risk management in EM PE. The final report contains a wealth of data and information on FX hedging in EM, as well as three new “solution pathways” that the project tested with practitioners:

  • New direct currency hedges (i.e., covertures and supported range forwards);
  • Proxy hedges (i.e., baskets of liquid, low-cost interest rate, equity, and commodity options); and,
  • Insurance.

The proxy hedge was piloted through simulated back tests against two EM PE portfolios over 20 years, and the product shows promise. However, as always with hedging, the devil is in the details.

USAID and Sarona have kindly made the report available to the public. Click here to download it.

From the Bookshelf

Recurrent descent into insanity is not a wholly attractive feature of capitalism …

The only remedy, in fact, is an enhanced skepticism that would resolutely associate too evident optimism with probable foolishness and that would not associate intelligence with the acquisition, the deployment, or, for that matter, the administration of large sums of money. Let the following be one of the unfailing rules by which the individual investor and, needless to say, the pension and other institutional-fund manager are guided: there is the possibility, even the likelihood, of self-approving and extravagantly error-prone behavior on the part of those closely associated with money …

A further rule is that when a mood of excitement pervades a market or surrounds an investment prospect, when there is a claim of a unique opportunity based on special foresight, all sensible people should circle the wagons; it is the time for caution. Perhaps, indeed, there is opportunity … A rich history provides proof, however, that, as often or more often, there is only delusion and self-delusion.

— John Kenneth Galbraith, A Short History of Financial Euphoria (Penguin: 1993).

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The information presented in this newsletter is for informational purposes only. Portico Advisers does not undertake to update this material and the opinions and conclusions contained herein may change without notice. Portico Advisers does not make any warranty that the information in this newsletter is error-free, omission-free, complete, accurate, or reliable. Nothing contained in this newsletter should be construed as legal, tax, securities, or investment advice.

Copyright © by Portico Advisers, LLC 2018, all rights reserved.

 

Bulls on Parade | Jan 2018

The animal spirits are palpable. Though U.S. markets have seemed to be fully valued for some time, the price action since the ball dropped on 2018 is saying, “these go to 11.”

Jeremy Grantham of GMO captures the sentiment in his piece, “Bracing Yourself for a Possible Near-Term Melt-Up.” The punchline: Grantham says it’s possible that we’ll see a melt-up to 3,400–3,700 (!) on the S&P 500 over the next nine to 18 months. I mean, it’s possible (probable?) that we won’t, but I think he’s more right than wrong.

If you missed it, Grantham laid down a gauntlet of a thought exercise late last year: imagine that you are Stalin’s pension fund manager and you are told to generate 4.5% real returns for 10 years, or else. Where do you allocate your capital?

Grantham’s answer: EM equity. In size.

I imagine that many investors—particularly those with 7%+ return assumptions—are asking themselves the question: am I sufficiently overweight in EM?

Unfortunately, I don’t think that extends to EM private markets. However, a bull cycle in EM public markets should boost multiples and be conducive for exits. Here’s hoping that we see sustained portfolio and direct investment flows, and GPs seizing the opportunity to distribute capital back to their LPs.

Separately, thanks to those of you who encouraged people to subscribe to our newsletter. Our plea resulted in a donation to Room to Read, so thanks for contributing to children’s literacy.

Finally, If you missed our most recent research piece over the holidays, Does the EM PE Asset Class Scale?, it’s available for free on our website.

Happy new year. Let’s make it a good one.

Alla prossima,
Mike

McVey Calls a Secular Bull Market in EM

KKR’s Henry McVey issued his hefty investment outlook for 2018, “You Can Get What You Need.” The takeaway for readers of this newsletter is his conclusion that EM are in a secular bull market that should last for three to five years. Inshallah.

McVeyEM

Of note, McVey ran a DuPont analysis and discovers “that operating margins are finally improving across all of EM after a five-year bear market, which is now boosting return on equity.” Commodity-related companies are a major driver of this swing, so it pays to keep an eye on commodity prices for a potential turn.

One interesting tidbit in the outlook is his forecast for private equity returns over the next five years, which he estimates will decline to 9.6% (the highest across asset classes; see below).

McVeyReturns

Norway

No, not that story.

Norway’s $1.1 trillion sovereign wealth fund has submitted a recommendation to the finance ministry that it be given greater latitude to invest in and alongside private equity funds. This would be a fairly significant development for the private equity industry, given the volume of capital that it could unlock for the asset class.

In my dreams, I envision them building a team with a global mandate to identify small- and mid-cap managers with compelling strategies. Exploiting the advantage of being a genuinely long-term investor, and seizing the opportunity to build an edge in private markets.

But in my waking hours, I see billions flowing directly to Blackstone.

Brazil on the Move

Brazil’s auto industry is moving product: vehicle exports are expected to hit an all-time high of 750,000 in 2017, according to reports in the FT. We highlighted the bottoming process in Brazil in our April 2017 newsletter, when we juxtaposed the contraction in consumer lending and declining retail sales in the country with the fiesta in Mexico. If one were fishing for a macro long-short idea, this might be one place to look for pairs.

More to the point, we expect some large Brazilian funds to come to market in 2018. Will investors commit, or take a pass?

Not Interested

“Emerging market interest remained low this year.”

So concludes Probitas Partners, the global placement advisory firm, in its Private Equity Institutional Investor Trends for 2018 survey (n=98). Emerging markets are one of the least attractive segments within global private equity, with only 9% of respondents planning to focus their attention on EM this year (see below).

Probitas2

Managers in EM just are not a priority.

Within EM, surveyed LPs find China, India, and Southeast Asia most attractive, while ~15% of respondents express interest in LatAm and Brazil. Notably, 38% of respondents report that they do not invest in EM.

The full survey is available at this link (registration required).

From the Bookshelf

There are Croakers in every Country always boding its Ruin.

— Benjamin Franklin, Autobiography (Oxford World’s Classics: 1993).

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The information presented in this newsletter is for informational purposes only. Portico Advisers does not undertake to update this material and the opinions and conclusions contained herein may change without notice. Portico Advisers does not make any warranty that the information in this newsletter is error-free, omission-free, complete, accurate, or reliable. Nothing contained in this newsletter should be construed as legal, tax, securities, or investment advice.

Copyright © by Portico Advisers, LLC 2018, all rights reserved.

Does EM PE Scale? | Dec 2017

Does the emerging markets private equity asset class scale?

No. I don’t believe it does.

In fact, I think the absorptive capacity of EM PE / VC is as low as $16 billion in new flows per year, compared to the $40 billion in fundraising we’ve seen on average since 2011. At least, that’s my finding in Portico’s most recent research piece: Does the Emerging Markets Private Equity Asset Class Scale?

The inspiration for this think piece comes from Fred Wilson, co-founder of Union Square Ventures, who wrote a fascinating blog post in 2009 on “The Venture Capital Math Problem.” If you haven’t read it, you should. In it, Fred concluded that the volume of exits in U.S. venture right-sized the industry between $15 billion and $17 billion in flows per year, remarkably similar to the conclusion I reached.

While this piece isn’t likely to win me many friends, I hope that it provides some food for thought, and that it sparks some lively conversations. I’d love to hear your feedback!

A humble request. We’re trying to grow our (monthly-ish) newsletter’s audience in 2018. If you enjoy this newsletter and / or know someone who would, then please feel free to share it with them. It’s free to sign up for future issues at www.tinyurl.com/porticonewsletter, while previous editions are available here.

For each new (human) subscriber we get between now and 30 December, we’ll make a donation to Room to Read, a nonprofit active in Africa and Asia that focuses on literacy and gender equality in education.

Happy holidays to you and yours, and best wishes for health and happiness in 2018.

Alla prossima,
Mike

Mea Culpa

A mea culpa is in order. In last month’s newsletter, I (somewhat cheekily) called out IFC for committing $25M to Carlyle’s $5B Asia Partners V; it was actually to their ($1B target) Asia *Growth* Partners V. Sloppy mistake. I apologize. Thank you to the discerning reader who noticed my error and called me out on it.

That said, I still don’t understand why IFC is funding a fifth-series Carlyle fund. According to IFC’s disclosure of the commitment, as of 31 December 2016, Carlyle held approximately $158B in AUM. This figure is ~70% greater than IFC’s total assets, ~4x the value of IFC’s total investments, and nearly 12x the value of IFC’s equity investments (as of 30 June 2017; see IFC’s consolidated balance sheets at this link).

¯\_(ツ)_/¯

KKR Quits Africa

We’ve dedicated a decent number of pixels in our newsletters to the issue of large-cap deal flow in Africa. Late last month, KKR decided to disband its Africa team for good. Several of the team’s dealmakers left earlier this year, in part, it seems, because they were investing out of KKR’s European fund and were losing out to French, German, etc. deals in IC meetings.

But a KKR spokesman breaks it down pretty plainly: “To invest our funds we need deal-flow of a certain size. It was especially the deal-size that wasn’t coming through.”

Invariably, KKR’s spokesman continues, “There was enough deal-flow at a smaller level.”

The Power of Compounding

Albright Capital recently released an enjoyable piece on “The Power of Compounding” in an EM portfolio. The firm compares the returns that three hypothetical long-only investors would have received from the MSCI EM, based on their (in)ability to time the market.

It’s an original thought experiment with results that might surprise you.

Will Robots Disrupt Private Equity?

McKinsey Global Institute released its analysis of the impact of automation on jobs. They estimate that “up to 375 million people may need to switch occupational categories” by 2030, with up to one-third of the U.S. and German workforces—and half of Japan’s—needing to learn new skills and pursue new occupations.

Will “private equity investor” be one of these disrupted occupations? Could robots do a better job at allocating capital? Given the recent performance figures, at least in EM, one could be forgiven for thinking so.

There’s an alluring argument that private markets are less ripe for disruption than public markets: not only is there less data available, but also the manager can apply sophisticated judgment and hard-earned pattern recognition skills to source proprietary deals, construct a quality portfolio, and create value.

I’m not entirely convinced. Consider an analysis from Dan Rasmussen of Verdad, who, whilst at Bain Capital, examined 2,500 deals representing $350 billion of invested capital:

About one-third of the deals analyzed accounted for more than 100% of profits (no surprise there) and the majority of the deals in the sample fell well short of the forecasts built into the financial models. The biggest predictor of whether a company would be a big winner or not was the purchase price paid. The dividing line seemed to be 7x earnings before interest, taxes, depreciation and amortization (EBITDA). When PE firms paid more than 7x EBITDA, their chance of success plummeted — regardless of how much managerial magic they threw at it. The 25% of the cheapest deals accounted for 60% of the profits. The most expensive 50% of deals accounted for only about 10% of profits.

In other words, all the fancy analysis and financial models performed worse than the simple rule “buy all deals at less than 7x EBITDA” [emphasis added]. A simple quantitative rule worked better than expert judgment.

I was recently speaking with Abby Phenix—formerly of Advent International, now assisting PE firms with customer due diligence—and we ended up riffing on this topic for a bit. In the past, she raised some thought-provoking points about the automation prospects for manager selection (think funds of funds) and investment analysis (think associates), which could enhance productivity and reduce costs (think management fees).

What is it that investors want? Cost-effective exposure to the investable asset or the privilege of paying fees to the middleman?

Is it Possible to Short Graduate Schools?

This statistic surprised me: the stock of U.S. student loan debt ($1.3 trillion) is now equal to the size of the U.S. junk bond market. Astonishing.

Estimates from The New America Foundation suggest that upwards of 40% of this is tied to graduate school debt. If I could short the graduate education market directly, I would.

Consider that in 2012, 25% of graduate students were burdened with at least $100,000 of student loan debt. Meanwhile, in 2016, the median incomes for master’s degree holders in the United States were roughly $80,000 for males and $58,000 for females. The math doesn’t work, prospective students know it, and there’s a broad-based slowdown in applications (see below).

ex71

Effectively, the market for graduate education experienced a debt-financed positive demand shock, universities expanded supply, and now there is a negative demand shock. Schools will need to cut tuition and take a hard look at which costs can be cut.

If you’re keen to learn more about just how much of a mess this is, I wrote a piece about this on my personal blog (source of the exhibit above).

Lots of data. Lots of charts. Oodles of other content.

From the Bookshelf

I returned, and saw under the sun, that the race is not to the swift, nor the battle to the strong, neither yet bread to the wise, nor yet riches to men of understanding, nor yet favour to men of skill; but time and chance happeneth to them all.
(Ecclesiastes 9:11)

For what is a man profited, if he shall gain the whole world, and lose his own soul?
(Matthew 16: 26)

The Bible: Authorized King James Version (Oxford World’s Classics: 2008).

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The information presented in this newsletter is for informational purposes only. Portico Advisers does not undertake to update this material and the opinions and conclusions contained herein may change without notice. Portico Advisers does not make any warranty that the information in this newsletter is error-free, omission-free, complete, accurate, or reliable. Nothing contained in this newsletter should be construed as legal, tax, securities, or investment advice.

Copyright © by Portico Advisers, LLC 2017, all rights reserved.

Dumb Money | Nov 2017

In last month’s newsletter, I mentioned that I would be speaking at a conference with a bunch of LPs on the topic of “Global Markets for Buyouts and VC”. I closed saying, “Here’s hoping for an interactive, no-holds-barred session.”

Suffice it to say that my hopes materialized. While discussing the performance of EM PE, one LP said:

The issue with emerging markets is these funds have often been growth equity with minority stakes. The teams have been heavy on investment bankers who don’t know how to do deals. In emerging markets, private equity is the dumb money.

Dang.

Another discussion revolved around whether EM PE is in a cyclical downturn or a structural one. LPs’ commitments are generally pro-cyclical and many herd into markets / strategies at the same time, with predictable results. If so, then—ceteris paribus—the trickle of capital flowing to EMs (apart from mega-cap Asia … more on that below) may well signal a cyclical bottoming. As one conference delegate argued, now would present an optimal time to adopt a contrarian strategy and lean into EM PE.

Two brief rejoinders: First, this is not what LPs are saying they’ll do:

LP Sentiment

Second, this just isn’t how private markets work. Even if you wanted to do so, you can’t buy the index. You have to choose a manager.

Industry cycles and macro need to be disentangled. With that in mind, my view is that the quality of the managers in the market at a given time drives flows more than macro. The nuance is that fundraising is a bit of a coincident indicator: the managers with whom LPs wish to invest frequently come to market (a) at the same time; and, (b) when investor sentiment toward the jurisdiction in question is hot.

Alas, I’m still in the camp of this being a structural downturn. A few reasons I’ve pondered this week include:

  1. “Dumb Money”!
  2. David Swensen’s recent remark that “the breadth of emerging markets that we were interested in 20 years ago has narrowed dramatically.”
  3. DFIs, which historically have supported the development of the industry, are increasingly committing to later, larger funds.
  4. The ongoing emergence of local, non-PE investors that don’t face the same return hurdles / horizons creates greater competition for quality deals.
  5. Tech is disrupting everything; in markets with fewer, ephemeral exit channels, this is a big problem.

More importantly, Happy Thanksgiving to you and yours. One of the great bits of having a toddler is that I’m reminded daily that I have a blessed life. Thank you for being a part of it, and for welcoming this newsletter into your busy day!

Alla prossima,
Mike

The Great Wall of Capital

Fundraising for buyouts in Asia is robusto:

Seven funds. $34 billion. There are others.

That is a lot of granola; it’s on par with the aggregate hauls for EM PE funds in each of the last two years.

In other news, KKR inked a deal this month with Great Wall International to bring leveraged loans to China. There’s a joke in here about Barbarians at the Gate, but I’ll stop.

LP Views on Latin America

LAVCA teamed up with Cambridge Associates for the second time on their annual LP opinion survey. There are some interesting findings the study, such as the discovery that 53% of LPs considering a first investment in Latin America view currency volatility as the biggest impediment to investing in the region. (Recency bias?)

My favorite exhibit explores LPs’ preferred means of accessing LatAm:

LAVCA.jpeg

  • Most LPs plan to access LatAm via pan-regional funds
  • Brazil is the country of the future …
  • Proportionally, more Latin American LPs expect to access LatAm PE via global funds than international LPs (statistically insignificant, but the fact that they’re close strikes me as interesting)

Facebank

The societal parasite that is Facebook is entering the small business lending space, starting with merchant cash advances. This is a fairly fascinating development. The company has already effectively become the Internet for a large number of people; will it become a lender of first resort for small businesses? Given the vast swathes of data that Facebook collects, one might surmise that they could develop an edge in credit scoring that could benefit businesses with lower rates and Facebook with a large loan book. My interest is piqued.

In related news, EMPEA’s Q3 data show that capital invested in fintech companies through September ($416M) has already exceeded last year’s total ($379M). Aggregate fintech deal value is on track to match or exceed those for 2014 ($470M) and 2015 ($509M).

Turkey Resurgent?

Every so often, a leader steps up and makes a bold pronouncement, and market sentiment shifts. Think of Warren Buffet going long Goldman in the depths of the crisis, or Jamie Dimon plunking $26 million of his own cash on JPM shares in February 2016 (now up ~70%).

Has Seymur Tari of Turkven made a gambit to shift opinion in Turkey? Following a summer IPO of jeans retailer Mavi, Tari appears to be getting bulled-up on the market. Last month, Tari announced that the firm plans to list Medical Park Group in an offering that could fetch $1B. (Maybe?) Moreover, Turkven is planning to execute “three to four acquisitions of $50-400 million each in 2018 … and to start a new fund of more than $1 billion in one or two years,” according to Reuters.

I admire the verve. Turkey has been in the doldrums, and local business and consumer sentiment has been in a downtrend for seven years (see below). Is the tide turning?

Turkey2

From the Bookshelf

The quality of ideas seems to play a minor role in mass movement leadership. What counts is the arrogant gesture, the complete disregard of the opinion of others, the singlehanded defiance of the world.

Charlatanism of some degree is indispensable to effective leadership. There can be no mass movement without some deliberate misrepresentation of facts.

— Eric Hoffer, The True Believer (Perennial: 1966).

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The information presented in this newsletter is for informational purposes only. Portico Advisers does not undertake to update this material and the opinions and conclusions contained herein may change without notice. Portico Advisers does not make any warranty that the information in this newsletter is error-free, omission-free, complete, accurate, or reliable. Nothing contained in this newsletter should be construed as legal, tax, securities, or investment advice.

 

Copyright © by Portico Advisers, LLC 2017, all rights reserved. 

 

Super Sized | Oct 2017

Earlier this month I spoke with an MD at one of the largest private markets advisory firms about the landscape of managers in EM. While discussing the consolidation of capital in fewer, larger EM funds, he raised the question of whether this dynamic is a function of greater distributions from these funds.

While the data were too close to call in The Mid-Market Squeeze (DPI of ~0.5x across fund size segments), I decided to run a fresh analysis incorporating greater granularity on fund size and vintage year. The figure below shows that EM funds >$1B (orange) are not reliably distributing cash at higher rates than smaller EM funds (shades of blue). In addition, they are generally underperforming their >$1B peers in Asia, Western Europe and the United States (shades of grey).

DPI.jpeg

All in all, I’m not convinced that distributions from larger funds are driving industry consolidation. That said, analyses based on Cambridge Associates’ benchmarks do have their limitations. A fund-by-fund analysis may very well tell a different story.

In any event, this is one of several topics I’m looking forward to discussing next month in a closed-door session with ~100 LPs at the Private Equity Research Consortium Conference. I’ll be on a panel exploring “Global Markets for Buyouts and VC” with Professor Steven Kaplan from Chicago Booth, as well as representatives from Warburg Pincus and Adams Street Partners. Here’s hoping for an interactive, no-holds-barred session.

Alla prossima,
Mike

Indonesia’s First Startup IPO

Last month’s newsletter asked the question: Who Will Make Money in EM Venture? This month, we learned that Indonesia’s first IPO by a startup was … not venture backed.

“The path that startups take is normally to look for venture capital, angel investors and so on … We feel that by taking the IPO route, that’s the method that is the most fair and transparent,” said Jasin Halim, CEO of O2O e-commerce firm Kioson. Throwing shade on VCs, he continued, “Let the market value our company.”

And so it did, at an issuance price of IDR300 / share with a book that was 10x oversubscribed. It promptly proceeded to shoot the moon.

Regulators stepped in and temporarily halted trading this Tuesday (16 Oct.) to allow for a “cooling off” period. It resumed trading on Wednesday and closed at IDR2,650 / share. #9bagger

🎉

If the valuations for startups that go public trade at a premium to those held in private hands, Indonesia may be in store for a redux of the pre-IPO craze that hit China a few years back: alchemy in the form of public-private multiple arbitrage. The China parallel is a sentiment I heard from VCs in Jakarta over the summer, and though I’m always skeptical of comparisons to China, this is a space worth watching.

SoftBank

The PwC / CB Insights Q3 data are in and SoftBank, managers of the $93 billion Unicorn Bailout Fund—sorry, Vision Fund—took the top three spots on the league table for largest deals in the United States, and the top four spots on the league table for the largest global deals (Grab, WeWork, Flipkart, Roivant Sciences). And they’re just getting warmed up!

In other news, last month SoftBank placed a $20 billion bond sale (in 7- and 10-years), with the 10s priced at 5.125%. Market participants’ comments in the FT’s write-up of the sale should be preserved for future historians so that they fully appreciate the degree to which, in 2017, all caution had been thrown to the wind:

Everyone is asking the same question: what am I investing in here? Am I investing in a company’s operations or am I providing unsecured financing to fund equity contributions to the Vision Fund?

My view is that bond investors are thoroughly unimpressed, but they’re being sucked in by the price. I find the whole structure of the Vision Fund completely perplexing, but as it’s my job to make money, we were in the [order] book.

¯\_(ツ)_/¯

(SME) Death and Taxes in India

Saurabh Mukherjea of Ambit Capital is a bit of a downer on the impacts of New Delhi’s economic reforms on India’s (relatively unproductive) small businesses:

My reckoning is that for a substantial number of SMEs, their margin was tax evasion. As the government steps up forcing people to comply with GST, a lot of small businesses that managed to stay in the shadows will find themselves sucked into the tax net. Either their profitability will be vastly diminished — or it will go away completely.

How many companies globally would lose their margin if they actually paid taxes? I wonder.

Heavy Stuff

Last month the New York Times ran a provocative piece tying Nestlé to the rise of obesity in Brazil, which they followed up with an in-depth article on KFC in Ghana [full disclosure: Mike is a shareholder of NYT]. Regardless of one’s views on who / what is culpable for the deteriorating health of Brazilians and Ghanaians, (I mean, processed foods are certainly part of the problem), the fact is that Brazil and Ghana are not exceptions: lifestyle diseases are increasing rapidly across the emerging markets.

To wit, obesity rates are skyrocketing in each EM region (see below for a sampling). In China, the number of obese adults (≥ 30% body mass index, or BMI) has compounded at 9% since 1976, growing from ~3 million to more than 80 million, while the number of overweight adults (≥ 25% BMI) grew 7x over the period to nearly 400 million. There are more overweight adult Chinese than there are people in the United States and Canada combined. Astonishingly, on a global basis, the number of obese children and teenagers has increased 10-fold over the last 40 years.

Calories

In a similar vein, the number of deaths due to diabetes is growing rapidly. While roughly 62,000 people in Europe and the United States died from diabetes in 2015, representing a 6.4% increase on the figure for 2000 (entirely driven by Americans), nearly 600,000 died across EMs, representing a 64% increase over the same period (see below).

Lifestyles

It’s not solely multinationals that are driving the ubiquity in unhealthy eating habits and processed foods. Private equity firms have been enablers of these trends, tapping into the “emerging consumer” through deals in FMCG, quick service restaurants (QSR), etc. For example, Thomson Reuters data show PE firms have invested in 61 EM QSR companies over the last decade.

That said, you can’t say PE firms aren’t also investing in potential solutions—GPs inked twice as many deals (138) in hospitals and clinics over the same period. Nevertheless, one wonders about the firms that are “investing across the lifecycle”—selling obesity-inducing foods to local populations on the front end, and lifestyle disease solutions on the back end. A fairly perverse way of creating demand where none should exist, no?

From the Bookshelf

In the West, and among some in the Indian elite, this word, corruption, had purely negative connotations; it was seen as blocking India’s modern, global ambitions. But for the poor of a country where corruption thieved a great deal of opportunity, corruption was one of the genuine opportunities that remained.

— Katherine Boo, Behind the Beautiful Forevers (Random House: 2014).

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The information presented in this newsletter is for informational purposes only. Portico Advisers does not undertake to update this material and the opinions and conclusions contained herein may change without notice. Portico Advisers does not make any warranty that the information in this newsletter is error-free, omission-free, complete, accurate, or reliable. Nothing contained in this newsletter should be construed as legal, tax, securities, or investment advice.

 

Copyright © by Portico Advisers, LLC 2017, all rights reserved.