Alternative Asset Trust Quarterly Report: September 30, 2015

 

The MacNicol Alternative Asset Trust is a multi-strategy, alternative investment platform designed to generate positive and uncorrelated returns against the public stock and bond markets. The Trust, through its underlying limited partnerships, is invested in private real estate and mortgages, private equity, high yield bonds and multi-strategy hedge funds. Combined, the Alternative Trust is invested in more than 150 separate real estate projects, mortgages, hedge funds and private securities. The advantage of combining different alternative asset classes and high yield investments into one Fund include tremendous diversification, enhanced liquidity, and a more predictable and less volatile pattern of returns when compared against the performance of the individual asset classes themselves.

 

Chart 1 – Investment Structure MacNicol Alternative Trust

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Alternative Trust Review: The goals of the Alternative Trust are to generate positive “real” returns (after-taxes and inflation) each year, and to generate annualized nominal returns of 6%-8% over rolling five-year periods. We are pleased to report that as of September 30, 2015 the Trust (E Class)  has met its primary goals by generating positive calendar-year returns that have exceeded inflation, while delivering  annual returns of  11.9% from inception.

For the past 12 months, the Alternative Trust (Class E) returned 35% with strong contributions coming from private equity, real estate and hedge funds. Looking forward, we are anticipating positive returns and more liquidity from the Trust’s private equity holdings (see Emergence Fund commentary, page 8),  and continued steady results from the Trust’s real estate holdings and hedge funds.

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Alternative Trust Third Quarter Highlights

 

During the third quarter of 2015 ending September 30th, the Alternative Trust increased in value by 8.2% driven by the successful public debut of Shopify Inc. of Ottawa which rose by approximately 50% on its first day of trading and continued climbing through the Q3 reporting period. As private investors in the company, the Emergence Fund (and the Trust) are subject to a six-month “lock up” of its notional Shopify shares which ends in November of this year. Shopify is now subject to the day-to-day ups and downs of a public company, and hence we are expecting continued greater than normal volatility in the Alternative Trust and the Emergence Fund until these shares are ultimately sold.

 

In addition to Shopify, the Emergence Fund and the Alternative Trust benefitted in the third quarter from the successful “exits” of three other private companies to strategic buyers. Of these, two have been announced publically, Razorsight of Arlington, Virginia and Silanis Inc. of Montreal, while the third sale has not yet been publically disclosed by the acquiring company.

 

 

North American Private Real Estate

 

The Alternative Asset Trust invests in North American private real estate through its MacNicol 360 Degree Realty Income Fund holdings. The “360 Fund” is a private real estate fund focussing on value-added projects in the United States and Canada.

The 360 Fund invests in real estate projects and mortgage funds through an expanding number of carefully selected operators and sponsors. These partners are chosen for their high degree of local knowledge and experience in deal sourcing, finance, construction, and property management. Through its partners, the Trust has exposure to more than 120 separate real estate projects and six asset classes across North America. Chart 3 on page 4 highlights the regions of North America in which our real estate projects are located. The overall strategy is to invest in the fastest growing regions of the United States including Texas, Florida, Georgia, Phoenix, Las Vegas and California.

 

360 Fund Third Quarter Highlights: For the third quarter of 2015, the 360 Degree Fund (D Class) gained 3.5% in USD terms. For the past 12 months, the 360 Fund is ahead by 9.5% in USD terms and 29% in Canadian dollar terms. The $USD gains were a combination of an increase in the valuations of our multifamily, office and mortgage portfolios as well as ongoing distributions of rental and interest income from our real estate sponsors.

 

Commercial Real Estate Outlook (U.S.)

 

Commercial real estate market fundamentals continue to improve across the board in the United States and are holding steady in much of Canada. A resilient U.S. economy is leading to healthy tenant demand in all property types. Vacancy rates continue to fall and rents are rising in most markets setting up conditions for what we believe will be sustained income growth in the multifamily, industrial, office and retail spaces.

 

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Multifamily:  While capitalization (“Cap”) rate compression has improved the valuations of the multifamily space this year, decelerating Net Operating Income (NOI) growth and lower yields reduced the total return. This trend is expected to continue in the near term as the apartment sector shifts to the mature phase of the real estate cycle. In addition, apartment cap rates remain low relative to the other property sectors. Though apartments still provide an excellent source of income and long term value, new supply remains a major concern, especially in the core of Tier I metropolitan areas. The 360 Degree Fund’s exposures to multifamily projects are primarily through its investments in Carroll Funds I and II of Atlanta, Georgia. The Carroll Funds primarily invest in Class “A” multifamily complexes in Tier II and Tier II metropolitans in Florida, Texas, Georgia and the Carolinas.

 

 Industrial: The industrial sector continues to perform well with rising rents and lower capitalization rates driving returns. As with the office market in the U.S., income growth is benefiting from the roll up of expiring leases to higher market rents. Though strong

market fundamentals have stimulated a supply response, the current development cycle is expected to continue to progress at a measured pace.

 

Office: With the recovery in the U.S. office market finally taking hold, the office sector is now at the point in the cycle where expiring contract rents will likely roll up to market, which, in combination with rent abatements burning down, will put upward pressure on income growth and valuations. The 360 Fund is broadly exposed to the North American office space through its investments in the KingSett Income Fund of Toronto, Rockwood IX Fund out of New York and the Ameritus Real Estate Fund of Chicago.

 

Retail. Though malls demonstrated resilient NOI growth this year, the overall performance of the sector is expected to lag the other property types during the next five years. This under-performance for income growth is primarily due to the longer lease durations inherent for retail tenants (though mall leases allow for percentage rents that allow retail owners to capture higher retail sales growth). The 360 Fund has several “value-add” retail investments through its investments with KingSett, Slate and a regional mall in Jacksonville, Fl. which is managed by the Sierra Building Group of Toronto.

 

Real Estate Portfolio Activity

 

During the third quarter of 2015, the 360 Fund made an initial investment in the McAlister Opportunity Fund of Dallas, Texas, as well as two co-investments projects sponsored by 13th Floor of Miami including “The Harbour” development in North Miami Beach.

 

The McAlister Opportunity Fund was formed to pursue opportunistic investments in undeveloped real estate, primarily in larger markets in Texas. The land is purchased with a targeted 12-24 month hold and with a focus on undeveloped land suitable for commercial, single-family or multifamily residential development. The McAlister Fund capitalizes on its strong cash position to take advantage of buying opportunities as they arise. Prior to acquiring land, McAlister generally enters into option agreements with developers, locking in attractive rates of return once zoning approvals are in place and the developer options are exercised.

 

Artist Rendering “The Harbour” Co-Investment Miami

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Despite a softening in the condominium market in Miami, The Harbour fills a void in the North Miami Beach/Sunny Isles/Aventura sub-market by offering smaller waterfront units at a lower absolute price point than its neighboring projects. The Harbour is a 2-Tower, 425-unit luxury waterfront condominium development in North Miami Beach on Terrace Street. The project is substantially pre-sold with binding purchase agreements.  13th Floor and Key International along with Sloan Capital will develop the Towers with a targeted completion date in Q3, 2018. The Harbour delivers affordably-priced luxury product that is in high-demand in the marketplace.

 

A significant portion of eligible costs will be funded with buyer deposits. The sponsor is collecting buyer deposits on sold units that ultimately equal 50% of the unit sale price. The 1st Deposit (20% of unit sale price) is currently being collected at contract signing. Per Florida statute, half (10% of the unit sale price) will be placed in escrow, while the remainder will be available to cover eligible costs. The 2nd Deposit (20% of unit sale price) will be collected at ground-breaking and the 3rd Deposit (10% of unit sale price) will be collected when the Building reaches its first elevated deck.

 

Currently the JV for Harbour has collected hard-money on 60% of the units and ultimately will collect 50% non-refundable deposits as a partial means of financing the project. The JV expects total equity requirements of $35 million with an expected Internal Rate of Return (IRR) of 35% and a (gross) equity multiple of 2.6X invested capital.

 

Our core Canadian real estate investment continues to be with KingSett Capital of Toronto. KingSett management, led by Jon Love, are disciplined capital allocators and are adept at incremental improvements leading to above-inflation rental gains in their properties. Outside of this investment, we continue to believe that the risk/return for US real estate is superior to most of what we see in Canada especially in multifamily, distressed mortgages, and Class B office space in gateway cities.

 

The KingSett portfolio is comprised of more than 50 Class A and Class B office, multifamily, retail and industrial properties across Canada. These properties include 2 St. Thomas of Toronto, the Bayshore Shopping Centre in Ottawa, 130 Bloor Street West retail/condominium complexes in Toronto, and the Cherry Hill apartments in London, Ontario.

 

KingSett Income Fund 2 St. Thomas Development

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The 2 St. Thomas luxury rental development is a joint venture between Bentall Kennedy and KingSett and is scheduled for completion in 2017. The project was designed by Minto of Toronto, and is a twenty-three story residential tower at the corner of St. Thomas and Charles in the Bloor Yorkville neighbourhood of downtown Toronto. The apartment is a luxury boutique development with forty-eight private residences. The prime Yorkville address sets itself apart from many other rental developments in the city and 2 St. Thomas will focus on services and lifestyle – offering hotel style living in a boutique private setting. The project when completed in late 2017, will add high-quality rental income to the KingSett Income Fund and the MacNicol 360 Fund.

Private Equity – MacNicol Emergence Fund:

 

The investment objective of the Emergence Fund is to generate capital gains and income by investing in a portfolio of fast-growing public companies and private equity funds. The Fund seeks opportunities in private equity where capital exit strategies are clearly defined, and are likely to occur within a 3-5 year time frame. The Emergence Fund invests in established private equity funds with a focus on companies with defensible franchises, high growth profiles and proven management. Investments will largely focus on profitable companies with high levels of proprietary technology addressing large target markets.

 

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The Emergence Fund achieves its objectives by investing in well-respected and managed third-party private equity funds including the Georgian Partners Funds I and II, Northleaf Secondary Private Equity Fund and the Northleaf Private Venture Catalyst Fund. Northleaf is one of the largest and most established private equity firms in Canada with clients that include the Canadian Pension Plan (CPP) and the Toronto Dominion Bank. The Emergence Fund is also invested in technology growth companies through an investment in a US-based fund (Multiplier Capital) that specializes in providing convertible debt loans to private companies. This strategy is highly lucrative with less risk than conventional private equity investing because of the senior position of its loans. Multiplier is currently paying a 10% annual distribution and its portfolio is performing extremely well across the board.

 

Hedge Funds – Absolute Return Fund

 

The investment objective of the Absolute Return Fund is to generate positive returns under most market and economic conditions, and to have little or no correlation to the US and Canadian stock markets. In order to achieve its objectives, the Absolute Return Fund invests in several value-added strategies managed by experienced and successful Canadian, US and U.K. hedge fund managers. Most of these investments are not available in the public market and are typically not accessible to individuals and smaller institutions because of high minimum investment thresholds, often in excess of five-million dollars. During the year, we continued to add to our investment in the Sankaty European Opportunities Fund which we expect to continue to generate a high-teens net return for its investors. Sankaty is one of the largest restructuring and secondary funds in Europe. It seeks to restructure and recapitalize companies and LBO funds (levered buyout funds) that have found themselves with too much debt post the 2009 economic downturn.

 

Closing Comments

 

We are very pleased with the progress of the private equity, real estate and hedge fund components of the Alternative Trust which continue to perform to our objectives while showing positive growth in both up and down stock markets. With respect to the private equity component of the Trust, we believe we are at an important inflection point for several of our investments which will in turn drive significant positive returns for the Trust in the quarters and years ahead. The Alternative Trust remains open to new investors and is available for purchase on a monthly basis.

 

Sincerely,

 

MacNicol & Associates Asset Management Inc.