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2018 August Newsletter

Zach Liggett, CFA®
By: Zach Liggett, CFA®

Notes from the Field

June really flew by for me – quite literally. Over the course of two and a half weeks, I boarded planes bound for three of my favorite international cities: Vancouver, Hong Kong, and Tokyo. My mission: to visit with two dozen or so portfolio companies and prospective investments as part of our team’s due diligence process. Writing now, a couple of weeks since returning from this tire-kicking tour, it seems the last remnants of jet lag are finally gone. The weeds that went wild in the Liggett family backyard garden are also (sort of) back to a manageable level. And our investment team at FIM has been discussing highlights from the trip, so I thought I would share a few of the takeaways here.

Now That’s Some Pricey Dirt!

Real estate in each of the three cities I visited commands some of the steepest prices among markets we track globally. As my cabbie from the airport in Vancouver bemoaned, unless you can write a seven-figure offer, forget about finding any habitable, single-family homes there. Bloomberg recently posted a chart (see below) illustrating how pricey Vancouver homes are relative to average household earnings. As the authors put it, “Want to pay San Francisco housing prices on a Columbus, Ohio, income? Move to Vancouver.”

Over in sushi-land, executives at the commercial Japanese real estate firm Ichigo, Inc. (a FIM Group holding) noted the strong seller’s market for the Tokyo office buildings they target. While these conditions are driving nice profits on Ichigo’s property sales, the flip side is the challenge it creates for finding new acquisition candidates at reasonable prices. Good deals can still be found in specialty areas like self-storage, but more often than not, Ichigo’s team is passing on properties offered to them, because the numbers simply don’t pencil out. 

And in “Honkers,” well, one real estate niche has gone just plain bonkers: parking spots. In fact, local media there recently reported a record high price for a single parking space in one of Hong Kong’s booming luxury districts. 

The damage? A cool HK$6 million, or three quarters of a million American buckaroos. Prices there for the limited supply of parking spots are so nuts that some local luxury car collectors are shipping their prized possessions to California, just to save money on storage.

Key take-away: Years of ultra-loose monetary policy simultaneously pursued by each of the world’s major central banks have provided considerable support for speculators in many parts of the world. Now that the U.S. Federal Reserve is leading the way to reverse course on such policies, it seems logical to expect that the areas that have surged the most, like Vancouver home prices and Hong Kong parking spots, may soon be approaching their Wiley E. Coyote moment. 

Time to Look Closer at China Opportunities?

While Hong Kong parking lot speculators are cheering on new record highs, stock investors over on the mainland have been far more subdued. In fact, as I checked in one morning on the market action from my hotel in Hong Kong, the main Chinese stock market index had technically entered bear market territory (a 20% price drop off its 52-week highs). As of this writing, stocks there remain in bear market mode.

While much of the financial media focuses on the “Trump factor” and the prospects for a prolonged trade war, other domestic variables in China seem to be at work, as well. For one, fears have grown that Chinese economic growth rates will continue to decelerate under President Xi Jinping’s ongoing antigraft campaign. This campaign has already punished more than 1.5 million corrupt Communist Party officials.

Tough new environmental rules are also affecting a slew of industrial companies, forcing many to close or suspend operations (see graphic below). And, perhaps most impactful for the economy and investor sentiment, Beijing has been directing regulators to clamp down on the highest-flying parts of the Chinese financial system. These efforts aim to reduce the risk of a Chinese-style Lehman Brothers shock by bringing down overall financial leverage in the system and reducing interdependencies between financial institutions there. 

Most of the Hong Kong–listed com­panies I met with on this trip do most, if not all, of their business in mainland China. Somewhat surprisingly, few seemed worried about potential impacts to their businesses from either the regulator crackdowns or the trade war noise. In fact, several pointed to China policy initiatives’ presenting significant opportunities for their businesses in the years ahead. Management at FIM Group holding Yip’s Chemical, for example, noted that China’s antipollution laws are beginning to push out of business some smaller makers of the inks, paints, and solvents it competes with. These com­panies simply lack the capital to comply with the new laws, and their exits may help Yip’s win further market share while improving its ability to maintain and even raise prices. 

Stricter environmental regulations may also help Hengan International, another company I visited in Hong Kong (not currently a FIM Group holding). Hengan is a leading Chinese maker of tissue, diapers, and sanitary napkins. Like Yip’s, the company is seeing a real impact in its sector from the anti­pollution campaign. Hengan officials told me that nearly 10% of industry capacity (mostly smaller players) has been effectively shut down due to the tighter environmental regulations, with further closures likely to come in the years ahead. In addition, the company also stands to benefit from rule changes in another area: China’s notorious one-child policy. From 2016, in response to rising demographic pressures, rules there were changed to allow up to two children per family. With the demographic challenges persisting, officials are now considering the removal of all family-size limits, a move that could give a boost to China’s population and increase demand for the range of products Hengan offers.

Key take-away: The combination of negative near-term investor sentiment and long-term tailwinds (especially in areas with policy support like environmental protection) makes the greater China region an interesting hunting ground for potential investments. Our current direct portfolio exposures to the Chinese economy are quite low, but I expect we will continue dedicating research effort in this area to identify targets that fit our criteria.

Japan’s E-Commerce Godzillas

Another area of investment research we regularly devote time to is conglomerate and holding company structures. While these can take more time to analyze, the effort can sometimes produce the coveted combination of excellent long-term growth potential and an above-average margin of safety. In Japan, two of the dominant companies in e-commerce, a sector where growth dynamics look quite positive, are complex conglomerates. I visited both on this trip, as well as some of their competitors, and I remain positive on each of their long-term outlooks. 

Rakuten, which runs one of Japan’s largest e-commerce platforms, also owns a string of “fintech” companies and several professional sports teams among its 70+ businesses. The fintech businesses include a leading credit card company, an online brokerage firm, and online banking and insurance operations. As if that weren’t enough, it is also preparing a full-blown entry into Japan’s mobile telecommunications market. The market hasn’t reacted favorably to this latest strategic thrust, which adds more complexity to a business that already has multiple spinning plates. 

At this point, Rakuten management is somewhat reluctant to disclose its full plans for the telco business, but in general the goal is to better position the company for the future convergence of network platforms, content, services, and transactions. Rakuten already has a significant “ecosystem” of more than 95 million members in Japan. These members earn Rakuten Super Points on purchases of goods and services that can be redeemed toward other purchases. Rakuten’s loyalty rewards system provides an advantage for its telco entry that we believe will ultimately help drive its success. With the market seemingly ascribing a significant negative value to this new business, we see compelling investment opportunity. In appropriate accounts, we added to our position after discussing the power of Rakuten’s platform and this valuation disconnect.

Softbank is an even more complex beast that today competes directly with Rakuten in Japanese e-commerce (via its significant investment in Yahoo Japan, which I visited as well). The company’s portfolio of operating companies also features Japan’s #3 mobile phone services company, so it will soon face Rakuten on this front, too. But in addition to these domestic assets, Softbank has stakes in a wide swath of the world’s leading Internet and technology companies. These include established companies like Alibaba (China e-commerce) and Arm Holdings (processors for mobile phones), as well as earlier-stage companies like construction startup Katerra. It is also building positions in most of the leading global ride-sharing companies like Uber and Didi, an industry in its infancy yet growing rapidly. 

Softbank trades at a significant discount to our estimate of its intrinsic value. I discussed this during my meeting at its Tokyo headquarters. Officials there acknowledged that the share price discount is unusually large, likely on concerns that Softbank’s reported debt levels are too high. They counter that the value of the company’s investment portfolio far exceeds this debt, but nonetheless they have embarked on a set of actions to address what many investors perceive to be a flaw with the model. First, they intend to list their valuable Japan mobile phone unit later this year. This should put a market price on that asset while also bringing a cash windfall to the balance sheet. Second, they are now in the process of merging Sprint (Softbank owns 82%) with T-Mobile. If they successfully close the deal, their ownership of the combined entity will fall to a point where they no longer need to consolidate Sprint’s debt. Third, they plan to sell some of their privately held ride-sharing investments to the Softbank Vision Fund that they are managing for other investors like the Saudi Arabia Public Investment Fund, Apple, and Qualcomm. Combined, these actions should meaningfully improve Softbank’s balance sheet optics and eventually help close the gap between the company’s market value and the fundamental value within its portfolio. 

Key take-away: Visits with two of Japan’s most forward-looking technology com­panies helped reinforce my belief that both have a significant growth runway ahead. Over the next couple of years, each will have multiple opportunities to address the investor concerns weighing on their share prices today. I expect that investors like us at the FIM Group who are willing to be patient through this process will be rewarded as these companies prove the value of both their business models and long-term strategic thinking.

Lucas Schwaller, CTFA®, CES®
By: Lucas Schwaller, CTFA®, CES®

Introducing FIM Group Private Trust

We are proud to announce FIM Group Private Trust, our company’s new trust services entity. FIM Group Private Trust is a Trust Representative Office of National Advisors Trust Company, one of the nation’s largest federally chartered advisor-owned independent trust company. With the launch of FIM Group Private Trust we have expanded our holistic planning and investment management to now include trust services for clients whose financial, family, or business needs require the services of a professional fiduciary.

Why Offer Trust Services?

A trust is a legal agreement established by an individual known as the grantor in which an individual or an entity known as a trustee holds property for bene­ficiaries. The roles and responsibilities of a trustee are expansive, and the decisions they make often require in-depth knowledge of complex legal, investment, and accounting practices. These roles and responsibilities include:

  • File Tax Returns
  • Distribute Assets Per the Terms of the Document
  • Properly Fund Any and All Sub-Trusts
  • Determine If Probate Is Necessary
  • Invest Assets in a Prudent Manner
  • Read and Interpret Trust Documents
  • Track All Expenditures and Additions to Income and Principal
  • Sell or Retain Unique Assets (Examples: Home, Cars, Boats, LLC Interests, Artwork)
  • Act in the Best Interest of All Beneficiaries
  • Collect All Death Benefits (Life Insurance, Retirement Plans)
  • Notify All Beneficiaries/Charities of Your Position
  • Issue Statements to All Beneficiaries
  • Keep Accurate and Detailed Records
  • Obtain Appraisals on Certain Assets
  • Determine Who the Beneficiaries Are
  • Decide If Partial Distributions Are Prudent
  • Preserve Trust Assets
  • Assess Beneficiaries’ Needs and Assets to Approve Distributions
  • Create and Distribute Final Accountings to Beneficiaries
  • Use Discretionary Power to Make Distributions to Beneficiaries
  • Close All Accounts
  • Manage Assets so They Result in Reasonable Growth with Minimal Risk
  • Obtain Beneficiaries’ Consent for Final Distribution
  • Diversify Trust Assets
  • Inventory All Assets and Determine Value
  • Issue Notices Required Under State Statute and the Trust Document
  • Verify and Pay All Final Bills and Taxes
  • Keep Beneficiaries Informed of Activity Within the Trust
  • Notify Banks, Brokerage Firms, and Other Financial Institutions of Death
  • Obtain Tax ID for Trust
  • Order Death Certificates
  • Pay Funeral Expenses
  • Transact Necessary Business
  • Transfer Titles
  • Treat Beneficiaries Equally and Impartially
  • Update Cost Basis to Date of Death Value

Traditionally, banks have bundled the abovementioned trustee services and charged a fee based on the assets held in trust. Over time, as the overhead and internal bureaucracy of these monolithic banks increased, so did their minimums and fees, which forced more and more grantors to select family members to serve as trustee. While familiar with the family and their dynamics, these individuals often lack the knowledge required to effectively administer a trust, which requires them to seek out and pay fees to investment, taxation, and legal professionals. Over the years, we wit­nessed numerous clients choosing one of these two paths. For a few, it worked. However, more often than not, they experienced diminished service, bloated fees, conflicts of interest, and legal battles that tarnished legacies and created family disharmony. We knew there had to be a better way.

The Directed Trust Model 

Often, traditional trust companies utilize “in-house” funds that may not be cost-, performance-, or tax-efficient, in addition to the numerous instances of questionable practices in which propriety investment products are encouraged. As asset allocation investors utilizing individual securities, we have a flexibility that enables us to construct portfolios to achieve income generation, growth of principal, or a balance of the two in a tax-efficient manner. This company-by-company, bottom-up approach to our analysis brings tax efficiency to the forefront, as opposed to a mutual fund model with embedded taxes and fees that are too often accepted as the cost of doing business. 

Enter the new paradigm of the directed trust model, which bifurcates the role of investment management from that of the custodian and trust administration. In a directed trust, a trust company/bank like National Advisors Trust Company oversees the administrative and legal components, while a wealth manager such as FIM Group handles the invest­ment management. The trust company doesn’t have to worry about managing exotic assets, the investment manager doesn’t have to worry about trust administration, and the client doesn’t have to worry at all, secure in the knowledge that trusted experts held to the fiduciary standard* oversee every aspect of their wealth.

Why National Advisors Trust Company?

National Advisors Trust Company is the premier leader in directed trust administration, with the experience, size (over $12B in custody and trust), and scope to service you, our clients. In addition to being nationally chartered, National Advisors Trust Company has a state charter in South Dakota, which is arguably the most favorable state to situs a trust, with laws that maximize privacy and asset protection.

The ownership structure of National Advisors Trust Company was also something we considered when seeking out a partner for this endeavor. With Registered Investment Advisors such as us comprising the majority of share­holders, we know that their focus is exactly where it should be: on the best interests of our mutual clients.

National Advisors Trust Company also has exceptional infrastructure, partnerships, and systems in place, thereby allowing us to serve trust clients no differently than our traditional investment management clients. With this partnership, we are able to utilize the trading platforms of Fidelity or Charles Schwab for managing trust assets, which both have excellent investment reporting, security, and pricing.

Finally, and perhaps most importantly, this relationship gives us the opportunity to expand our offerings to clients without compromising who we are or what we do best. Committed to enrich­ing lifelong relationships, National Advisors Trust Company is a true partner, and their Trust Representative Office program provides us with the ability to market and deliver trust services under the FIM Group Private Trust brand. 

Taking Action

While the goals may vary, some of the most common reasons to create trusts are as follows:

  • Preserve confidentiality of financial affairs
  • Provide for close friends, third parties, and aging parents
  • Shift income taxes to beneficiaries in lower tax brackets
  • Provide for personal care in the event of incapacity or serious illness
  • Protect family assets from poor management by beneficiaries who are not capable or experienced
  • Preserve family assets (farm, closely held business, etc.) and provide for continuity of operations
  • Support multiple generations, including children and grandchildren
  • Reduce expenses and maintain assets by avoiding probate costs and minimizing estate taxes
  • Provide a permanent legacy for a charitable organization
  • Prevent loss of assets due to divorce, bankruptcy, or lawsuit against an heir

These goals can sometimes be accomplished outside of a trust, but often not with the same tax efficiency and certainty. At other times, these goals can only be met using a trust, because trusts are legal entities created speci­fically to hold certain assets for the benefit of a beneficiary or a class of beneficiaries.

If you haven’t done so already, please contact your FIM Group advisor to discuss your estate plan and whether a trust solution might fit your situation. Whether your estate plan requires revisions or you’re starting fresh, we can work with the estate plan attorney you’re most comfortable with to design and implement an estate plan that meets your needs.

* The fiduciary standard of care is both a legal and an ethical responsibility that requires a party to act solely in the client’s best interest, with strict care taken to ensure that no conflicts of interest arise. Under the directed trust model, both the investment manager and the corporate trustee act as fiduciaries, which is the highest legal duty of one party to another.

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