Economic Update
It has been a season of geopolitical uncertainty. Business spending has decreased in the more advanced economies, while those reliant on commodities such as the emerging markets have been equally struck. Notably, the World Bank revised its 2016 global growth outlook from 2.9% down to 2.4% – a telling sign of tepid growth ahead.
Persistently low interest rates have continued to buoy the real estate market in many regions. Although low rates have been advantageous for borrowers, the investors searching for yield have been hard-pressed to find it in the current bond market. After the losses endured in 2015 and the first quarter of 2016 we began to see a recovery in the stock market; but many held their breath in anticipation of the June 23rd referendum in the UK.
As June approached, media sources were in agreement that the Brexit vote would be close. During the final days before the vote, investors began to wager that the statusquo would be upheld: the UK would remain in the EU. The world’s markets shook as the landmark decision in favour of Brexit was confirmed. Investors were left to measure the unchartered waters ahead.
Uncertainty will always breed market volatility. The British Pound dropped to values not seen for three decades! While most stock markets in the world opened down, the USD, yen, and gold rallied as investors fled for safety.
Interestingly, the FTSE 100 (UK’s blue-chip stock market) quickly rallied after the initial shock; the low currency was anticipated to benefit many companies that had international exposure. In addition to that, global investors took advantage of the low currency to buy into a stock market that was suddenly cheap.
The issues resulting in the UK’s vote to leave the EU are complex and have been compounding for years. High unemployment and immigration issues combined with social security concerns were all chief contributors to the decision. In addition, the European Central Bank held interest rates below zero (punishing the saving countries to support the fiscally needy regions) while propping up insolvent banks. These measures have distorted financial markets and fueled a deep dissatisfaction which has led to an increase in nationalism over loyalty to the EU.
The UK is not the only country experiencing a rise of national protectionism. France has a leadership election next April and Marine Le Pen’s popularity is rising quickly. As leader of the National Front, the nationalconservative party in France, she is basing her campaign on a leave referendum. Le Pen states that support of the referendum is prompted by frustration with the “massive immigration and arrogant finance.” In addition to France, Eurosceptic parties in the Netherlands, Austria, Denmark and Poland are gaining a stronger voice.
Will the Brexit decision have a negative financial and political impact on the rest of the EU in the years to come? Many experts believe so. A more positive outlook would see the EU taking this as a sign to work harder to address the underlying issued that have plagued their union. There may still be time to fix the issues that have caused such deep dissatisfaction among members. It isthe hope of many that strong leadership will prevail and that all countries, unified or not, will negotiate fairly.
We believe that policy and geopolitical risks are going to remain key themes over the years to come. While it may be tempting to trust that the risks are contained to Europe, it would be foolish to think that we are immune. The US presidential election later this year may be additional fodder for market instability, as the candidates present two very polarizing options. The Brexit vote serves as a clear demonstration that the final choice of the people is not always predictable. Prudent investors should remain diversified, take advantage of asset sales when they present themselves, and never bet too heavily on an unknown outcome, regardless of what the polls suggest.
Portfolio Update
In the first quarter, we highlighted our real estate exposure in Texas because it is a unique and profitable investment that has provided great diversification to our investors. Another interesting holding that we consider an exceptional contribution to our portfolio is infrastructure. This quarter we turn our attention to the Covenant Fixed Income Pool, or specifically, the infrastructure investments within.
Infrastructure refers to the underlying framework, systems, and services needed in order for a community to effectively function. With a commitment to spending $125 billion over the next ten years, it is no secret that infrastructure will be taking center stage under our new government’s leadership. Those who are able to finance these projects have the advantage of participating in reliable, long term income streams. Income is generated either by revenue production, e.g., a toll bridge, or by maintenance and servicing contracts issued by government agencies to support existing structures, e.g., a courthouse or highway. This broad class of investment can be broken out into the following categories: Energy, Social and Transportation. It can include structures and facilities such as roads, buildings and power supplies.
At Covenant, we have chosen to include infrastructure investments within our Covenant Fixed Income Pool. The infrastructure component of our pool is holding stakes in the Sea to Sky Highway, Billy Bishop Pedestrian Tunnel, Edmonton Ring Road, two solar assets, nine wind assets, and a couple of courthouses and penitentiaries. Our investment within each project ranges all the way from the design and planning of a new building project (greenfield), to the long term maintenance of existing projects (brownfield).
Infrastructure is by nature a very challenging investment to gain access to. The majority of infrastructure projects are large in scale, very expensive and extremely illiquid for long periods of time. In order to maximize on the opportunity, investors are typically required to commit to an exceptionally large capital outlay with a long term lockup period. As a result, the majority of investors are unable to access this valuable investment. By including it in our Pool, we provide the opportunity for the average investor to access an investment arena that is largely inaccessible because of the high barriers of entry.
Covenant’s infrastructure exposure is targeting a stable, long-term return of 6%. Since the Pool is diversified with other traditional and non-traditional positions, we have the unique ability to offer liquidity for those who cannot hold the position indefinitely. In addition, infrastructure is entirely uncorrelated to the other traditional fixed income assets in the Pool, such as bonds, which lowers the pool’s risk profile and improves overall stability. An asset class of its own, Infrastructure has the value to provide long term cash flow & portfolio diversification.
Editorial
The past few months have been marked by tragedy, but they have also been dominated by mass media coverage and opinions. We began the quarter with the crash of an EgyptAir flight into the Mediterranean Sea which led to the death of all 66 people on board. Following that incident, we witnessed the horror of the Orlando nightclub shooting, which claimed many lives and brought devastation to a number of communities. Since then, we have seen one injustice after another with racial tensions ignited after the killing of Alton Sterling, a young black man in the United States.
Increased access to information and the rise of social media have made it all too easy for us to weigh in on current news events. When tragedy strikes, we turn to social media and see people lining up to pick sides. How common it is to see an onslaught of judgments, adding further devastation onto those already suffering from loss. This barrage of opinions not only creates division, but points to an increasingly disturbing online trend of ‘blaming and shaming’. This too is a tragedy – so counter to how Jesus would act.
How then shall we respond? Having an opinion is human and it is important to think critically about major news events. However, our response and handling of the news is what sets us apart. Recognizing that we are a fallen people living in a fallen world, we need to be ever striving to contribute to our community through love – including our online community. If we are to represent God’s love for us, we must replace judgment with love: love for those who are hurting, love for those who offer differing opinions to our own, and love for sinners, such as we are.
“A new command I give you: Love one another. As I have loved you, so you must love one another. By this everyone will know that you are my disciples, if you love one another.”
John 13:34-35 (NIV)