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Private and Confidential

Quarterly Note 2004 Q1

Review of Activities

The blossoming of spring is an exciting and rewarding time in the garden – flowers are blooming but summer growth has not yet inundated the garden. I am struck by the relevance of lessons learned in the garden where patience, discipline and nurturing are required to produce good results. Unexpected weather conditions continue to surprise as it seems that seasonal norms are breached and we have to watch early growth carefully. And this volatility seems to be felt globally and not just in climate conditions. (For more BT news see the site here.)

The intensity of springtime nature at Ballin Temple has been imitated by GRI Equity activity in the first three months of the year. The beginning of 2004 has been busy on the investment and advisory front. Private investment opportunities are gestating and two opportunities are coming to fruition while interesting proposals continue to be reviewed. Summary information on the most active opportunities may be seen in the member's section. Listed investment management activity was launched in March, despite a risky environment exacerbated by Madrid bombings. We were pleasantly surprised to see our Outlook 2004 quoted twice in the World Future Society UK chapter's recent newsletter. We have added a forum to the website which will enable discussion of issues of investment and sustainability by a public audience.

We have been very fortunate to have Marc van Strydonck and Pietrojan Gilardini become involved as informal advisors during the past quarter. Marc, who lives on a century old barge, is an agronomist by training and runs agricultural commodities finance business for Rabobank. Pietrojan is a seasoned telecoms banker who developed a passion for nature when diving with Jacques Cousteau. You can see brief bios on our website here.

Listed equity management was initiated in March. Initially launched as a customised service, this is being expanded to satisfy demand. Our listed screen has focused on SRI index screened companies and modest valuations. The geographical and sector emphasis has taken into account our clients requirements in the context of other holdings. A more general portfolio would be somewhat more diversified, but similar principles of triple bottom line screening and valuation will be applied. It is not intended that the portfolio should be traded significantly (or churned), although reconsideration of holdings will be regular and restructuring of the portfolio will happen in response to changing prices and risk expectations.

While we are managing a listed portfolio, we continue to recommend private investment in selected opportunities. We are negotiating investment with a number of growing businesses that are attracted by the prospect of a financial partner, empathetic with their objectives. This enables a leading opportunity to partner and fair investment structuring that offers companies the value they seek provided targets are met. Established businesses seeking private capital are attractive because we can understand the problems faced and price risk accordingly. Interesting businesses seeking expansion capital are being reviewed in organic foods and distribution, software, bioengineering, biofuels and waste management. The newly established businesses are more challenging but none are clean startups and we can point to track records in critical areas. The number of startups seen reflects the demand for sustainable technologies in areas of waste management, alternative energy and natural products and points to an attractive exit route – trade sale. These businesses are often established by seasoned executives who have created opportunities that larger companies are trying to realise themselves. Overall, our deal flow is greater than our resources and we are declining opportunities which would otherwise warrant further investigation. A valuable flow of sensible businesses with good management and exit opportunities is growing.

(Members may see reports on current opportunities in the member's section. Please forward questions and observations to members of the investment committee.)

Perspective and Market Commentary

As mentioned in the 2004 Outlook stock markets appreciated significantly in 2003 against a background of growing global economic tensions. The first three months of 2004 have seen this illustrated in market volatility with rapid appreciation of most markets in the first half of the quarter with a sell-off in the latter half. It is a challenging environment in which to invest because valuations are high and sentiment can turn negative quickly. The Madrid bombings resulted in a selloff which seems to have moderated by quarter end.


MSCI World Index Q1 2004

FTSE All Share Q1 2004

FTSE 100 Q1 2004

A bullish market would have been the general theme for the quarter had bombings in Madrid not curtailed enthusiasm. Performance for the quarter was generally flat. Our generally cautious mindset induces the view that good companies are fairly priced and few compelling opportunities are available. Benchmarks of performance suggest that companies are fully valued and often this is on an optimistic basis. There is a greater realism among managers than before 2000 about the prospects for earnings growth but optimism still sells. Even without unexpected events, like a terrorist attack, the earning power of established businesses often does not seem to support valuations. Nevertheless diversified portfolios of index companies and/or of selected companies are expected to offer fair appreciation for an acceptable risk.

Terror Risk and War

The Madrid bombings catalysed revaluation of markets. Although terrorist threats have been absorbed into many managers' outlook and scenario planning, the real costs of terror risks is now becoming more clearly priced in the market. We believe that these risks will be seen to be greater than anticipated, as it is recognised that creating scares (real or fictional) is easy and the disruptive effect on economic activity can be great. Politcal events, like elections, will be high priority targets, especially because of the latent discontent with the cause and rationalisation for war. The costs are showing up already in higher security costs, booming business for security firms, and higher insurance costs. It is not likely that these risks will diminish – the Iraq war continues to fester, the US administration appears ignorant of the moral and human issues of its foreign policy (Richard Clarke's testimony has forced skeletons in the closet to shake) and Israel/Palestinian tension is not abating. Investment opportunities may be sought in businesses offering security goods and services and in general community based businesses, which are not exposed to global scares.

The political fallout from the war is affecting the US and UK administration and has already had a significant impact on Spanish elections. While incumbents seem to resist acceptance that the Iraq invasion was certainly engaged under bad information and possibly false pretexts, whether or not Iraq invasion was “good” (which we do not believe), most of the rest of us recognise that integrity has been compromised and this type of action is untenable in the 21st century.

Investment Management and Venture Capital

Investment management in the UK reached a milestone as the saga of Equitable Life sees its end in sight. Final recommendations have been made by Paul Myners, Lord Penrose and others who have reviewed Equitable and the pensions industry during the recent years. They were asked to investigate possible distortions in institutional investment decision-making, largely as a result of the demise of Equitable Life which produced a STG 4.4 billion hole in its accounts. Principal recommendations involve facilitating the exercise of proxy voting by beneficial shareholders, changing/eliminating the Minimum Funding Requirement and replacing it with other methods for aligning shareholder and managers interests.

The most important change may be increasing caution among investors who have been told “caveat emptor” or “buyer beware” in the new world of personal investment management. Individuals increasingly are required to build personal pensions because state pensions are insufficient. Although losses at Equitable resulted from poor management under the noses of regulators, they have been generally excused (so far). This shift to taking responsibility for ones own investment decisions will benefit market efficiencies but is forcing individuals to upgrade their investment management skills. Another aspect is the recommendation to improve the relevance of skills and experience of fund advisors, particularly in allocation of venture capital. This is another example of a trend to more sophisticated investment management encompassing issues of governance and community as well as economic analysis.

Venture capital is increasingly exciting. It is playing an increasing role in investment allocation decisions as investors realise that investment in private companies can provide a stable portfolio, reasonable income opportunities and good capital appreciation, provided risks are managed. On the other hand listed businesses are under increasing scrutiny and many appear to be fully priced. VC fund raising is picking up and the outlook for 2004 is positive. Selecting managers remains an area where too few resources are invested, but the pain of crashing stock markets in 2000-2002 has made asset allocators and private investors more cautious.

Interest and FX

Interest rates remain low and continue to fuel credit expansion but are now expected to rise in the short to medium term. Upward pressure is being felt and managers should consider the effects of increases from the third quarter. Stock market investors should consider the effects on sectors like banking and property which will be affected.

The dollar has remained weak and foreign currency exposure should have been hedged. Fluctuations in currency will be enough to wipe out profits of many businesses with exposure to unfavourable swings in exchange rates. The principal currency risks appear to be US dollar volatility and Asian currency appreciation pressure. While the US dollar may appreciate in the coming quarters, the movement of the Remnimbi or Rupee would be a domestic policy change and is not expected this year. Nevertheless, businesses exposed to these currencies may expect big changes in the trading landscape which will impact long term investment decisions made today.

Energy

Life in Iraq continues to look like war, even if it is "gorilla" warfare. This conflict, combined with OPEC policy, is keeping oil prices high. This is and will continue to have a dampening effect on economic vitality. Energy is the dominant area of investment for sustainable funds and is becoming more of an issue as oil reserves are questioned, and energy demand booms in Asia and other emerging markets. Opportunities in alternative energy and micro-power may become increasingly attractive as mineral oil based energy remains expensive and alternatives continue to become more efficient and less costly.

Europe

EU growth is high on the agenda as 10 states join in May. With 25 states, the challenges of balancing demographic and cultural diversity with common policies will be made more difficult. Racing against this deadline the President (Ireland currently) is hoping to conclude constitutional negotiations. How these projects are developed will provide references for long term strategic planning in Europe. However, much of the harmonisation of economic and social standards that integration will provide, will not be seen for some time.

It appears that NATO expansion in Eastern Europe, where affected states include significant Islamic populations, may be being encouraged by US Strategy for Iraq and for addressing terrorism. It also provides some counterweight to the EU expansion happening this second quarter. The principal affect is likely to be money flowing to these countries which will generally raise standards in Europe.

Asia

Asia remains attractive for the simple reason that the infrastructure for a developed economy is well on its way to being implemented but there is still massive opportunity to catch up with developed economies' standard of living. The Asian Crisis was an appropriate breathing space for development of efficient systems but there is a long way to go in the reduction of corruption to allow efficient allocation of resources. The trend toward universal suffrage and democracy must continue in parallel with the development of market based economies if massive disruptions are to be avoided. And signs are that it will continue. Notwithstanding the pain of political maturation and industrial development, Asia offers growth. Proven technologies can be implemented in an environment of increasing wealth and demand. The risks of corruption can be managed and may be not so different from those in developed markets. Certainly low cost bases will rise, but so will productivity. And local markets will continue to raise demand. In particular China should be watched for its significant middle income purchasing power and its massive consumption of commodities like copper, steel, aluminium, lead and zinc on a global scale, enough to move markets. India also seems to be rising as its large industrial companies begin to compete internationally, following the example of the software business which has been the beneficiary of outsourcing in US and Europe. Signs of liberalising investment regulations are now apparent and if politics matures the resulting stability will advance India's economic profile.

IT and CT

A quick note on a favoured subject – open source IT. Hewlett Packard announced that it will be shipping PCs loaded with linux in Asia from June. This plus the recent ruling by the EU against Microsoft requiring them to unbundle their media player are significant signs that the viability of moving to open systems on the desktop is good and should be considered by businesses. We continue to question the amount spent on upgrading software which could be put to more productive uses because a suitable alternative is available.

LOHAS

And Ireland, the land of Guinness, has committed to the LOHAS movement by following America and banning tobacco smoking in public places. Many will associate “Irish hospitality” with porter, smokey pubs and folk music. While there is natural displeasure among smokers it seems that this change is more popular than might be expected. Apparently a majority of people support this legislation. It will certainly have a positive effect on health and culture in the medium term and suits the modern Ireland of enterprise and sustainable development. Great traditional music can still be heard in the pub.

Outsourcing

As the US (as well as other developed economies) recognises and tackles the changing economic landscape, leading commentary is often given on outsourcing of jobs to Asia. This is not a new phenomenon but has been put in the spotlight by the US election. This must be a positive change because it indicates a rising of skills and productivity in developing countries and allows developed economies to move on to newer industries and economic systems. Trade is good and allocating productive resources to where they are most efficiently utilised is good (comparative advantage theory). The challenge faced by developed economies is to ensure that their populations have the skills and incentives to move beyond current industrial opportunities. Education is critical to the continued development of leading economies but, by many accounts, is insufficiently resourced. The UK recently reported on another review of its education system which recommended an overhaul, the result of which would allow flexibility in the pace of learning to suit individuals and would refocus curricula and grades on practical objectives. The challenge in the US is well illustrated in this personal story related by Dan Primark of Private Equity Week:

My wife is currently a PhD candidate in clinical psychology at a reputable university here in Massachusetts. Part of the program includes some teaching assistant responsibilities for undergraduate psychology courses, which generally means that she grades papers, holds office hours and gives a few lectures. The first part of that trifecta occurred last week, as her class had been given an exam split up into two parts: multiple choice and short essay responses. Most of the class did lousy on both sections, and my dutiful wife handed the tests to the professor with an assortment of Cs and Ds (plus a few Bs, As and Fs). The professor was displeased with the results, and immediately went to work revising the grades upwards. Not on a predetermined or formal curve, mind you, but on a scattershot system that included giving a student 80% credit for a two-part question in which the student had only bothered to answer one part. My wife protested (she'll probably make an unpopular professor someday), and mentioned that some of the students had not even bothered to pick up the semester's readings (on which the test was largely based) until just the day before the exam was given. But it was all in vain, and students who bombed the test ? including those who hadn't paid attention in class or studied hard ? were rewarded without ever knowing that their accolades were gained by dubious means.

Why am I sharing this with you? Because it made me think about one of the arguments that readers make when supporting the outsourcing of technology jobs overseas (or to Canada, which counts as off-shore despite what a cartographer might say). They believe that the U.S. can afford to lose jobs in current technologies, because this country is industrious and innovative enough to create new jobs in as-of-yet undiscovered technologies. In other words, we're number one and will always stay that way due to our superior intellects and training. The problem, though, is that the converse argument also is being made: that offshoring works precisely because people in countries like India (thanks to schools like IIT) are equally, if not better, trained than U.S. workers.

My wife's recent experience lends credence to the second notion, and it concerns me greatly. When people discuss educational problems in America, it generally involves decrepit public schools and the horrors that can lie within. This certainly is worrisome, but it has unfairly overshadowed the way in which colleges also are failing their students by not preparing them for a competitive workforce where real results are rewarded (except in the case of Enron), while failure is accompanied by poor salaries and/or pink slips. Teaching such lessons is the least that our universities should do, especially when one considers how much undergraduates pay to learn them.

This issue is felt at the top of the hierarchy of learning. But the issue is reflected throughout the educational system and poses a long term challenge for development in an economy where the work force can only demonstrate competitive advantage in technology development, and is losing its advantage in industrial application to emerging economies. Of course it will take years for the effects to be felt, but policy must address the issue today. Parents certainly are doing so and seeking better educational environments for their children. These, like the recent proposals for UK education, are often developed using cooperative learning methods rather than competitive hierarchies. This attention to education is increasing the potential attraction of the sector.

Conclusion

The second quarter is likely to see general improvement of sentiment which may be reflected in valuations. However, this may be easily upset by continuing negative news in international relations, the war in Iraq or a terrorist event. A high risk investment strategy, through opportunity trading or leverage, should be managed with great caution. A selective approach or long term strategy should yield fair returns with modest heartache. Naturally, it being our preferred target, we would encourage commitment to private investment if the size of a portfolio justifies it. Unsystematic risk is more transparent, valuations can be attractive and realisation through cash flow/dividends and exit are viable.

This report has been prepared for information purposes and is not an offer, or an invitation or solicitation to make an offer to buy or sell any securities. This report has not been made with regard to the specific investment objectives, financial situation or the particular needs of any specific persons who may receive this report. It does not purport to be a complete description of the securities, markets or developments or any other material referred to herein. The information on which this report is based, has been obtained from publicly available sources and private sources which may have vested interests in the material referred to herein. Although GRI Equity and the distributors have no specific reasons for believing such information to be false, neither GRI Equity nor the distributors have independently verified such information and no representation or warranty is given that it is up-to-date, accurate and complete. GRI Equity, associates of GRI Equity, the distributors, and/or their affiliates and/or their directors, officers and employees may from time to time have a position in the securities mentioned in this report and may buy or sell securities described or recommended in this report. GRI Equity, associates of GRI Equity, the distributors, and/or their affiliates may provide investment banking services, or other services, for any company and/or affiliates or subsidiaries of such company whose securities are described or recommended in this report. Neither GRI Equity nor the distributors nor any of their affiliates and/or directors, officers and employees shall in any way be responsible or liable for any losses or damages whatsoever which any person may suffer or incur as a result of acting or otherwise relying upon anything stated or inferred in or omitted from this report.

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