Dear Friends and Clients,
The Chinese used to wish their enemies “May you live in interesting times.” Well, I do not want to wish anyone any ill will, but we do indeed live in interesting times. We have chaos in the Middle East (but the Middle East has always been a mess). We have historical highs in the stock market which tells us we are due for a correction (i.e. a pullback or a decline in most market sectors). We have a bizarre and uncertain political process in the US right now making many to ask “Is this really the best America can offer?” Most Democrats and Republicans with whom I have spoken think both candidates are moral failures. And last, several people are feeling uncertain with our future with OPEC’s problems, with Iran and Saudi Arabia squaring off (fighting a small proxy war in Syria), with future wars in Syria and Iraq, with Putin’s erratic behavior on the world stage invading Georgia , Eastern Ukraine and the Crimea, with radical Muslims killing French citizens and creating chaos and causing death in the streets of Paris and Nice, and with China and Japan flexing their muscles at each other over shipping lanes, island claims and military programs (recently China just obtained their first aircraft carrier to project sea and air power against Japan). We indeed have been in more trying times, like when our country was ripped apart by the Civil War (1861-1865) or when the markets melted down in 2008. Yet, we must always be mindful of the past if we do not want it to repeat itself. Although we have had tougher times does not mean we are not headed for a worse time than the worse in our history. In the end, the truism that “prepare for the worse and hope for the best” is appropriate in these contemporary affairs. I do not think we are headed for anything like the Civil War, but I do think the next few years are going to be trying to say the least.
In this report, I will review the many meetings I have had this past year with AJC (American Jewish Committee). In April, I was awarded to go on the Konrad-Adenauer Exchange Program when I traveled to Germany and met many business and political leaders there and got a good understanding for what is going on in Europe. I then will tell you about the AJC Global Forum which I took part in Washington DC in June and the consulate marathon meetings in Houston which took place in September. These events help one learn more about the world and the climate of investing which in turns helps clients with their portfolios. In conclusion, I will give some market analysis of where I think we need to be focusing our investing efforts and overall review of what to think about for the future.
First, when traveling in Germany during April, things look good for the country. The productive energy of the Germans is evident everywhere which is no surprise to anyone. In Berlin, buildings are going up throughout the city and the economy seems to be thriving even with the huge influx of foreigners into the land (Germany is roughly half the size of Texas so it does not have space like the US for the immigrants to some degree). Many of the politicians and businessmen discussing this issue (one who is an advisor to Merkel) support the immigrants to Germany—around 1.2 million total. Many outside Germany as well as inside are concerned about this “islamicnization” of Germany, but many Germans said they, in a sense, owe this to the Americans who gave them the Marshal Plan after World War II and re-trained a former Nazi nation to become one of the strongest democracies in the world with an incredible human rights record. Germans today, claim, they want to repay that debt to America so to speak by helping others in need. They said that most of the people who come, albeit very uneducated, just want a better life in another place not devastated by war. Officials say that actually it is not the Syrians who are causing problems in their country whom they say are largely law abiding, but it is the Afghanis and Iraqis who are lawless and causing problems (rarely do I hear anything positive about Afghanis, especially from all my Marine Corps buddies who were stationed there—however, I do hear countless positive stories about Iraqis and Syrians). Luckily for Germany, the majority of their refugees are Syrian. Germany is putting these people in apartments and sending them to school to learn German for free—this country is indeed very different than the one who would have killed these people as Untermenschen just seventy years ago. This huge wave of immigrants will indeed change the demographics of the country. However, in the end, another argument which is given that is good is that this influx of people will help Germany’s decreasing birth rate right itself which now is negative, thus keeping population numbers positive which facilitates, in the end, economic growth. Whenever you see negative birth rates in a First World Country, like France, you see economic downturns. One is reminded of what China, with its decades of forcing the “one child per family” law, has created for its growing economy when the next generation is not big enough to take over the jobs being created today. As a result, China has repealed the one child per family law and now the Chinese population is growing at a faster rate than it has for decades (however, how will a larger population feed and educate itself?) As one can see, we have many issues when it comes to how a nation deals with moving populations (immigration as we so clearly see in the US as well) and as a nation deals with its own population (family size, food supply, housing, education, abortion, etc.). These are enduring issues of humanity and there are no fixed answers, but these questions do continue to be raised and debated because population swings effect economic realities and should be planned for accordingly. For us, population growth worldwide is growing and this means there will be several opportunities for investing especially in developing infrastructure and energy (so the energy and commodity world should be closely analyzed).
At the AJC conference in Washington DC in June, several senators and even Israeli leader Netanyahu addressed us either in person or via video feed. They all echoed that there is a lot of uncertainty in the air worldwide, but praised organizations like the US and AJC which are striving to promote diplomacy and human rights. Yes, America struggles with many policies throughout its past and nowadays, but in the end, as Winston Churchill said, “After exploring all other options, America usually does the right thing.” Allowing groups like AJC to thrive in the US is just one organization this democracy supports which helps the world become a better place just like UNICEF or Doctors Without Borders or the Peace Corps.
Several leaders addressed the issue of ISIS and that Europe, and American for that matter, has failed in its duty to defeat this fanatical, racist religious cult. Although the organization is only made up of around 40,000 men, many of them foreign and poorly train militarily, they have created a situation of chaos in Syria and Iraq and committed genocide ever brutal as that of the SS Deathhead units of Nazi Germany. In fact, some estimate that at least 300,000 people out of a population of 23 million have died due to the bloodshed and war in Syria started by ISIS. Yet, we did heard about an amazing story of how AJC helped the tiny minority in norther Iraq called the Yazidis who are being hunted down and killed by ISIS (over 5,000 murdered to date) and how some of our efforts are protecting them. Due to our efforts, thousands have been saved and cared for—there are indeed good people in the world doing amazing things and practicing in action the motto “Never Again.” One could argue that the Yazidis are like the Mormons of Christianity and viewed by most Muslims as heretical just like most Christians view the Mormons as—in other words, they are a new and different Islamic sect most view as strange and weird, although, like the Mormons, they are largely peace loving and hard working.
The German Armed forces were also discussed since they will bear the brunt for the European powers of any military intervention by Russia in mainland Europe or further conflicts in the Balkans or further war in the Middle East. However, the Bundeswehr is pathetically weak. In fact, the United States Marine Corps is bigger than the entire German military. Many authorities, both German military officers and politicians, recognize that Germany has relied too much on Big Brother of the United States and needs to increase its spending on the military if peace is to continue in Western Europe.
In the meetings with consulates from Turkey, Germany, Italy, China and others this past month, we learned that Turkey has actually deployed troops inside Syria to fight ISIS. So now you have a bizarre situation where you have the Allies fighting Assad and ISIS and helping the Rebel national forces, Turkey fighting ISIS, Russia fighting with Assad against ISIS and the Rebel national forces, Iran sending troops and generals to fight ISIS and support Assad and ISIS fighting everyone not ISIS. It is like putting six people in a ring and telling them to fight each other immediately. Moreover, the consul from Turkey assured us that the recent coupe attempt against Erdogan was rightly put down to keep the forces of the government in order. In other words, there is no threat of Civil War in Turkey, although some felt this could have happened. And to be fair to the many who have been handled without justice, Erdogan has arrested and imprisoned more journalist than China which is quite an accomplishment and an injustice to the freedom of speech.
In the Far East, China wants to be more of an economic power with the United States but does not understand why we do not work more with them. Of course, their Communist State has historically been at odds with our humane and democratic ideals. China has one of the worse human rights records—under the reign of Mao, at least 70 million people were murdered making him worse than Hitler, Tojo/Hirohito and Stalin combined. However basically one in four people speak Chinese today and they are expanding their military and economic power throughout the world. They are building artificial islands all throughout the south China seas and they are expanding their navy. Their military is no match for the United States in many areas, but they have made incredible improvements in the last decade. Many may not be excited to work with China, a country that routinely steals our intellectual property, but it is nonetheless such a huge presence on the world stage that we will continue to have to deal with them in a more regular manner than we ever have before. We cannot avoid dealing with them and we cannot afford to ignore them any longer. How we force them to play by the rules will be a trying matter to say the least.
So what does all this mean? It means, that the world is as it always has been—a place of conflict, murder, evolution, change, war and economics. It is also one of hope as we see Western Europe, in the first time in its history experiencing widespread peace in that it has not had a war on its lands for over 70 years. In the future, we will have to look more at how we fight fanatic and genocidal movements like ISIS or threats to world peace like North Korea, but the threat of massive world wars like we saw with World War I or World War II seem remote. As Edmund Burke said, “For Evil Men to triumph, good men must do nothing” so we still have to be vigilant, but the evil regimes today seem small and less threatening represented by North Korean than the regimes the world faced a few decades ago with Hitler’s Germany and Hirohito’s Japan. But even with these lesser threats, Europe and the United States will have to continue to train and support their militaries. Furthermore, Europe and the United States will have to engage China more and more as a partner in not only economics, but also in how to maintain world peace. The day we see Chinese and American troops shoulder to shoulder might be a sign that things are getting stronger on the earth.
As far as investing is concerned, I still see incredible potential opportunity in energy and senior loans. Energy is still trading at historical lows so for those it may be suitable for, I will be focusing their portfolios into index funds and investments that support the infrastructure of the energy industry (the old adage—“Buy low and sell high” is appropriate here). Senior Loans are also trading below book value and may be a good area to focus on in this current market and they generally provide good cash flow.
The reason I have placed my clients with this asset class is that Senior Loans tend to float with inflation and Fed hikes. As a result, they seem to place my clients in a defensive position for two things that will likely happen, especially with all the quantitative easy in particular and the inflation pressures on the economy in general. Moreover, the Fed cannot keep the Fed rate at .5% forever. When they decide to change, the value of bonds will be hit and depending on how much they raise the rates, bonds could be actually “devalued dramatically.” Of course, past performance does not guarantee future results. Senior Loans may “provide a hedge against rising rates at a time of historically low interest rates.” As Tim Jenkins at Angelo, Gordan & Company writes, these instruments are “senior secured debt instruments that sit at the top of a corporate issuer’s capital structure. They are senior to the unsecured or subordinate bonds, and, of course, to the preferred stock and equity.” Senior Loans “currently pay investors more than bonds for taking what is actually less credit risk.” Moreover, the income provided to my clients by current publicity traded equity holdings that bundle Senior Loans is keeping many of my client’s portfolios above inflation and preserving their purchasing power. As Jenkins continues “within a representative company’s capital structure, loans have the most secure and dependable income stream of any corporate security, debt or equity.” Ironically, as bonds will get devalued when the Fed raises rates, these Senior Loans’ “economic value will actually increase.” Moreover, the equity holdings I like usually have hundreds of positions within their entity providing increased diversification with these senior Loans by investing in hundreds of companies. They also have “low correlation” to REITS, stocks, commodities and bonds which helps me with diversifying the portfolios of my clients even more. Some of the holdings I like are also within a structure of BDC’s organized under the 1940 ACT, and no company under this act has been found guilty of fraud as a result of how this 1940 ACT requires entities under it to administer its dealings with outside checks and balances.
In addition, if we have a crisis as we did in 2008, Senior Loans are positioned to protect my clients more than bond portfolios can. For example, Senior Loans from 2008-2010 made about 6% annually “despite some of the highest default rates in history.” As bonds experienced severe problems with defaults and the Reserve Fund debacle with the Lehman demise almost created a run on the banks, Senior Loans performed well. Jenkins explains that the reason why Senior Loans do better than bonds, especially High Yielding bonds, is that “loans are most often secured by the borrowers’ assets as well as by protective covenants that are incorporated into the loan documents, whereas high yield bonds are almost always unsecured and sometimes even explicitly subordinated to other debt. As a result of the additional protections, loans tend to default slightly less often than bonds, since companies will often go to great lengths to keep paying the lenders even if they can’t keep up payments to unsecured and subordinated creditors who are further down the capital structure. Consequently when companies do default or go into bankruptcy, loan investors typically collect 60% to 70% of their principal, versus 25% to 40% for unsecured or subordinated creditors.” One case study of GM’s bankruptcy showed Senior Loans are at the top of the food chain. All those who owned GM Senior Loans got 100% of the principle back. Those who owned Senior Unsecured Bonds received 20% of their principle and the equity holders obviously received 0% of their principle back. While there are never guarantees in life, investing of this nature can help put the owners at the top of the food chain as best as an advisor can in this space.
In conclusion, we have many issues to deal with—an uncertain, and strange election, the growing threat of ISIS to world peace and economic growth, the rise of Communist China and its role in the world and inflation. Moreover, we continue to struggle with global issues of hunger, famine, war, nuclear holocaust potential and the lack of women’s rights in most of the globe. We have much to improve. We take for granted our great nation and its rule of law failing to realize we are only 5% of the world’s population. In the end though, the world is becoming more connected economically and this is helping the whole floor of society medically, educationally and sociologically to improve. When I applied to Yale University, in 1991 there were around 10,000 applicants for 1,000 slots and most were all Americans. Now there are over 30,000 applicants per year and a large segment of them are foreigners. A few decades ago, most the companies in the S&P 500 were based in the United States. Now a large portion of them are overseas. The world is becoming more flat like Thomas Friedman writes and there is more wealth being generated every year. Who would have thought a few decades ago that a 1,000 millionaires are being generated every week in China? In some respect, we have won the ideological war there too like we did against with the Soviet Union or Vietnam in the sense that capitalisms and free trade, albeit imperfect, has a strong foothold and is growing in these areas of the world. In the end, I feel as long as America stays strong militarily and we have checks and balances in government, we will thrive. If we study the vast majority of our ancestors throughout the centuries, most of us are living in a time of incredible prosperity, medical care and peace. And that we know about many of the issues globally and can criticize, even ridicule, our leaders is a right that is truly a blessing. We should be thankful. If you have any thoughts and questions, please feel free to contact me.
Bryan Mark Rigg
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 Ever since Sykes and Pinchot drew the lines of Middle East countries after World War I according to European imperialistic designs and not according to ethnicities, culture and religion, the Middle East was destined to have conflict and war. It would be like putting Dallas Cowboy and Philadelphia football fanatic fans together in one auditorium and told to get along while a game is playing.
 For an excellent book on the meltdown of 2008 and how it was prevented from being worse, see Sorkin’s book To Big To Fail.
 For an excellent book on Mao, see Jung and Halloway’s recent biography on the leader entitled Mao.
 Interview, Ryan Connelly, Franklin Square CFO, 27 August 2012.
 Tim Jenkins, Angelo, Gordan & Company, Through the Cycle: Senior Secured Loans Posed to Perform, 2011, p. 10.
 Jenkins, 10.
 Ibid., 10.
 Ibid., 4.
 For example of companies they invest in, please see Franklin Square Prospectus 2011, pp. 90-93, 124-140.
 Franklin Educational Forum, San Francisco, fall 2011, Track One, Franklin Square Capital Partners, page, 37.
Ibid., pp., 16-17.
 Jenkins, p. 5.
 See Andrew Sorkin’s “Too Big to Fail.”
 Jenkins, p. 8.
 Franklin Educational Forum, San Francisco, fall 2011, Track One, Franklin Square Capital Partners, p. 11.