Market review

January was a positive one for financials in absolute terms and relative to wider equity markets, as the very strong performance during November and December continued into the new year. However, government bonds posted negative returns, as yields rose marginally over the month in response to higher-than-expected inflation data in the UK and the US, as well as very strong fourth-quarter US GDP data and December retail sales. Federal Reserve commentary was also more hawkish, suggesting interest rates would stay higher to tackle inflation. Against this background, the Trust’s net asset value rose 1.4%, while our benchmark, the MSCI All Country World Financials Index, rose 1.2%.

Alternative asset managers

In January, having publicly stated a number of times that it was on the hunt for an acquisition, BlackRock, in which we have a holding, and the largest asset manager globally, announced the acquisition of Global Infrastructure Partners which, as its name suggests, is focused on the infrastructure sector, for $12.6bn in cash and shares. This will make the combined group the second largest infrastructure manager in the world. Larry Fink, the CEO, described it as another “truly transformational moment for BlackRock” and compared it to previous transactions such as the iShares business it bought from Barclays Bank during the global financial crisis which has since grown tenfold.

He continued at length on the opportunity stating: “Infrastructure is a $1trn market, forecasted to be one of the fastest growing segments of private markets in the years ahead. These include upgrading digital infrastructure, like fibre broadband, cell towers, and data centres. Renewed investments in logistical hubs, such as airports, railroads, shipping ports and supply chains are rewired. And a movement towards increased energy independence, supported by decarbonisation infrastructure [and] a public need for greater investment in infrastructure. This growing need creates significant investment opportunities for clients [as] coupled with the record-high government deficits means that private capital will be needed like never before.”

Infrastructure is a $1trn market, forecasted to be one of the fastest growing segments of private markets in the years ahead.

Over the past couple of months, we have increased our exposure to alternative asset managers, due to our more positive outlook for interest rates and financial markets and it now represents around 7.5% of the portfolio. We see this area of the sector as incredibly attractive and last year we purchased a holding in Antin Infrastructure Partners, a French listed manager focused on mid-cap infrastructure assets. It had continued to perform poorly and we took the opportunity in December to significantly add to the holding. The announcement of BlackRock’s acquisition unsurprisingly led to a sharp rally in its shares. In December, we also bought a holding in EQT, a Swedish listed private equity manager that is also a very large infrastructure manager as well.

The Trust has had a longstanding position in Blackstone, the largest alternative asset manager globally with assets under management of over $1trn, albeit not known for infrastructure investing. We significantly reduced our holding towards the end of 2021 and beginning of 2022 due to reservations about valuations of the subsector at the time and its sensitivity to any downturn in economic activity, and the effect financial markets would have on shorter-term ability to generate performance fees and maintain a level of fund raising. With one of Blackstone’s founders also selling several hundred million dollars of stock this seemed a sensible decision.

At the end of 2022 we switched our holding into Ares Management, a smaller peer focused on private lending, where we saw much more compelling tailwinds with the rise in interest rates, albeit it also had strategies in private equity and real estate where the fundamentals were less good in the shorter-term. We liked Ares as well, as it would be less sensitive to a sharper fall in financial markets, as a much lower percentage of its revenues were performance fee-related. That switch worked well though we missed the opportunity to buy back into Blackstone last year, which has benefited from being included in the S&P 500 Index and performed well despite weak earnings revisions.

Last year we also started a holding in Intermediate Capital Group, a UK-listed alternative asset manager with a 35-year track record and similar exposure as Ares, but trading at what we believe to be a significant discount. ICG was founded primarily as a balance sheet lender and, while it has grown its third-party funds business to over $80bn in assets, it has been penalised for still having a relatively large balance sheet relative to peers. This we saw as nonsensical, as the balance sheet was very diversified across its own funds, which it seeds, and with an excellent track record – management were highlighting their ability to lend at double-digit rates for senior secured debt.

Attractive fundamentals of alternative asset managers

The reason we like the sector is that it boasts some incredibly attractive fundamentals. First, the assets they manage are locked up for many years, with a significant shift recently to permanent capital vehicles or vehicles with only limited redemption rights so they are not as vulnerable as their traditional asset management peers to outflows. Second, fees are much higher and yet have not come under pressure from passive alternatives. Third, the returns they deliver have, for good managers, been for the most part consistently very good relative to listed financial markets and that has led to performance fees or carried interest in which the asset management groups and therefore shareholders have benefitted.

In the past couple of years, these attractive dynamics have had a further boost from the sector’s push into offering wealth management products, where allocations to the asset class are a fraction of institutional investors. A move into managing insurance assets has also led to significant inflows albeit we have some reservations about this part of their business and the risks that those who have gone down this route are taking. Finally, the disruption in banking has led to opportunities for the sector to partner with or acquire assets from banks. This was seen last year when a number of US regional banks in particular looked to offload assets to bolster their capital ratios.

Our caution in not having a higher position until recently was the criticism of ‘volatility laundering’ as private equity managers are slow to mark to market and the more private equity-heavy alternative asset managers would see pressure on earnings from lower returns in their underlying funds as valuations came under pressure. Furthermore, their ability to raise new funds due to the so-called ‘numerator/denominator’ issue where institutions had reached the cap on their allocation to the asset class and, until the flywheel of M&A activity picked up again and private equity firms could sell or IPO some of their investments and return cash to them, they could not allocate to new funds so reducing growth in assets looking forward.