Alternative Asset Trust Quarterly Report: September 30, 2016


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, private equity, and multi-strategy hedge funds. Combined, the Alternative Trust is invested in more than 150 separate real estate projects, hedge funds and private securities. The advantage of combining different alternative asset classes and high yield investments into one fund include tremendous diversification, improved 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




The goals of the Alternative Asset 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 period ending September 30, 2016 the Trust (E Class) has met its primary goals by generating positive returns that have exceeded inflation, while delivering a 5 year return of 11.8% and 10.0% return since inception.  Chart 2 below highlights the annual compound total returns for the Trust for each of the periods indicated ending on September 30, 2016, along with each underlying limited partnership.





Looking ahead, we are anticipating improved  liquidity from the Trust’s private equity holdings and continued steady results from the Trust’s real estate holdings and hedge funds. During the period, we continued to rebalance the Alternative Trust, reducing its private equity exposure and correspondingly increasing its exposure to real estate as we currently prefer the cash flowing nature of real estate and reduced risk profile over private equity.   The environment for hedge funds also seems to have gradually improved throughout the year and our core positions remain intact.  Chart 3 below highlights the asset mix of the Trust as at September 30, 2016.





MacNicol 360 Degree Realty Income Fund


The Alternative Asset Trust invests in North American private real estate through its MacNicol 360 Degree Realty Income Fund holdings (“360 Fund”). In order to achieve its objectives, the 360 Fund will invest primarily in several core (low tenant turnover and predictable cash flows) and value added (opportunity to enhance the physical property itself) private real estate strategies focussed in the United States and Canada and managed by experienced and successful US and Canadian operators and sponsors (“partners”). These partners are chosen for their high degree of local knowledge and experience in deal sourcing, finance, construction, property management, along with an in depth understanding of asset type. Through its partners, the Trust has exposure to multiple real estate projects and  asset classes across North America. Chart 4 below highlights the regions of North America in which our real estate projects are located.


The private real estate market in recent years has provided strong returns driven by overall improved fundamentals and increased pricing. However, of late property fundamentals are more divided across asset classes and geographic regions making property type and geographic choices more important.  In addition to our partners facing more competition from institutional investors committing capital directly, more and more of our partners are considering moving away from acquiring the largest assets essentially avoiding the high levels of competition for trophy assets, and instead looking for opportunities that might fly below the radar of other interested buyers. Our overall strategy is to continue to invest alongside partners and their vision of identifying attractive income producing assets with development repositioning and/or operational optionality in the fastest growing regions of Canada and the United States including Texas, Florida, Georgia, Phoenix, Las Vegas and California. The key theme remains that the private real estate market is very competitive and as such, we continue to see strong valuation support. Recent transactions illustrate that good real estate sells, and sells at aggressive terms. Our view is while the Fed may begin to raise interest rates sooner than later, provided economic growth remains on track and the global financial system does not endure additional shocks, the overall policy should nonetheless remain accommodative. Thus, barring a dramatic deterioration in fundamentals, or a seismic shift in interest rates, we are of the view private market fundamentals will remain firm across most property types, as evidenced by recent transactions in office, multifamily and industrial markets.  Our real estate mandate will continue to be greatly diversified across Plan Partners, asset classes, and geographic regions and provides periodic cash flow that improves our margin of safety profile.


360 Fund Third Quarter Highlights:  During the period, the Fund recycled some capital and expressed interest in Carroll Co-Invest Fund IV, LP as Carroll Co-Invest Fund I, LP transitions into its winding down phase. The strategy for Fund IV is to buy well located, defensible multi-family assets that produce strong predictable cash flow with the opportunity for capital appreciation through renovations and proactive management.  We also established a relationship with a team based out of South Florida, IPCP Florida Realty (“IPCP”), a Florida based real estate fund manager focused on office, industrial and retail.  Through selective investment decisions IPCP will key on opportunities that are underperforming/troubled assets, maturing loans or are quality assets with neglected capital needs where significant value can be created.  We will monitor this group’s progress and, if warranted, hope to establish an investment on one of their next raises. All existing holdings continue to perform as expected with portfolio gains likely as the year progresses. The US economy, in which the majority of the 360 Fund’s investments reside, continues to expand at a modest pace, which in turn will drive real estate valuations and cash flows higher. In addition, inflation in the US remains well contained and mortgage rates remain near record lows.







Commercial Real Estate Outlook


Commercial real estate market fundamentals continue to improve across the board in the United States and, with the exception of Alberta, are holding steady in much of Canada. A resilient U.S. economy is leading to healthy tenant demand in all property types. Vacancy rates continued to fall in 2016, 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, to a lesser extent, retail spaces.  In Western Canada, specifically Calgary, the energy market over committed in the past and is now experiencing significant softness.  Over the long term this area will be re-organized and strength and stability will return.

Multifamily:  We have a positive outlook for multifamily in Canada (ex-Alberta) and the U.S due to strong demographics, a growing propensity to rent and manageable new supply. In our view, demand for rental will be supported by millennials looking for flexibility and affordability and by baby boomers looking to downsize. While capitalization rate (“cap rate”) compression improved the valuations of the multifamily space strong fundamentals and demand for product are likely to continue to support the sector and provide for an improved risk reward profile.  Most economists expect the homeownership rate in the US to keep declining over the next decade due to tougher lending standards and the younger generation of potential buyers mired in student debt and less interested to own homes.  The 360 Degree Fund’s multifamily exposure is primarily through its investments in Carroll Funds of Atlanta, Georgia and 13th Floor of Florida. The Carroll Funds invest in Class “A” and Class “B” multifamily complexes in Tier I and Tier II metropolitans in Florida, Texas, Georgia and the Carolinas. In addition to commercial and mixed use, 13th Floor Funds invest in single family home development, multifamily value add and developments, and condo development with a geographic focus on Florida and South Florida concentration. With the enhanced focus on core and value add initiatives and continued potential for margin improvement along with some development projects, the Carroll Funds and 13th Floor will continue to make up a healthy weighting in the portfolio going forward.


Office: With the recovery in the US office market firmly 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. Underlying demand from existing tenants expanding and new tenants coming on board will absorb supply confidently. Transactions for office properties still account for the largest proportion of the total number of private equity real estate deals since 2015, followed by deals for residential, retail, mixed use and industrial.  This asset class has also continued to command premium valuations on foreign investment and pension fund demand. We continue to invest alongside partners that will focus on underperforming properties in stable markets, improve property through re-development, capital investments and re-leasing efforts.  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 of New York, 13th Floor of Florida, and the Ameritus Real Estate Fund of Chicago.


Industrial: The Fund’s exposure to the stable industrial class continues to perform well with rising rents and lower capitalization rates driving returns. As with the office market in the US, income growth is benefiting from the roll up of expiring leases to higher market rents. Though strong market fundamentals have stimulated additional supply in some markets, the current positive upward move in rents are expected to continue at a measured pace in the second half of 2016.  On average, quality industrial product remains in high demand.


Retail. Though malls and grocery-anchored shopping centers have demonstrated resilient net operating income growth of late, the overall performance of the sector is expected to slightly 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). However, as long as employment growth remains positive and new supply is limited we expect occupancy levels to continue to improve at a measured pace.  Given our view the environment for landlords is expected to remain competitive we continue to favor necessity based tenants (grocery anchored/discounted retailers) and well located urban portfolios. The 360 Fund has several core (low tenant turnover and predictable cash flows) and value-add (opportunity to enhance the physical property itself) retail investments through its investments with KingSett, Slate Retail and a regional mall in Jacksonville, Fl. which is managed by the Sierra Building Group of Toronto.  KingSett invests in retail assets across Canada focused on building value through creative leasing, sustainable operations and redevelopment activities. Slate Retail is a pure play US grocery anchored REIT with operations mainly in the southern and eastern US.  Slate Retail’s conservative payout ratio provides stability and frees up cash flow for reinvestment.  At the same time, unitholder distributions have been increased three times in the past 2 years.  We continue to maintain Slate Retail as a holding and more specifically in the group’s ability to execute on their private/public real estate vision.


Private Equity – MacNicol Emergence Fund


The investment objective of the MacNicol Emergence Fund is to generate capital gains and income by investing in a portfolio of private equity funds. In order to achieve its objectives, the Emergence Fund will invest in several strategies in the United States and Canada managed by experienced and successful partners. These partners are chosen for their high degree of knowledge and experience in deal sourcing, marketing, finance, and execution, and their established network of partnerships.  Investments will largely focus on profitable companies with high levels of proprietary technology addressing large target markets.


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 sectors, most notably software, digital media, healthcare technology and telecommunications, through an investment in a US-based fund (Multiplier Capital Fund I) 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 Capital Fund I is currently paying approximately a 15% annual distribution and its underlying portfolio is performing well across the board. Multiplier Capital Fund II is now being organized, applying essentially the same strategy as Multiplier Capital Fund I, to provide secured loans to established and growing businesses backed by venture capitalists and other sponsors in return for an estimated 18-20% target internal rate of return.  Subsequent to the quarter end, the Emergence Fund has expressed interest in Multiplier Capital Fund II as Multiplier Capital Fund I transitions into its harvesting phase.


Liquidity: During the third quarter of 2016, Georgian Partners Fund I sold approximately an additional 50% of its sizable position in Shopify, taking advantage of a rebound in the NASDAQ stock market and a strong second quarter earning’s report from Shopify. As Georgian continues to sell Shopify, it will distribute the proceeds to its investors, including the MacNicol Emergence Fund. To date Georgian has sold off, and distributed to its investors, approximately 95% its original position in Shopify.



Hedge Funds – MacNicol Absolute Return Fund


The investment objective of the MacNicol Absolute Return Fund is to generate positive absolute returns under most market and economic conditions with 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 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 first half of 2016, we added to our investment in the Sankaty European Opportunities Fund (“Sankaty”) which we expect to continue to generate a high-teens net return for its investors. Sankaty (rebranded Bain Capital post quarter end) 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. The environment for hedge funds seems to have gradually improved throughout the year and our core positions remain intact.


Closing Comments


We continue to be pleased with the progress of the private real estate, private equity, and hedge fund components of the Alternative Trust which continue to perform to our objectives. 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 the ability to recycle capital. The 360 Fund mandate is diversified across Plan Partners, asset classes, and geographic regions and provides periodic cash flow that improves our margin of safety profile. The environment for hedge funds seems to have gradually improved throughout the year and our core positions remain intact.


In the normal course of business, the Trust is exposed to currency risk.  Currency risk is the risk that the NAV will fluctuate due to changes in foreign exchange rates.  The weakness of the US dollar during the first half of the year has been a headwind but we are of the opinion the CAD dollar may have reached its high and weakness is expected. Since the Brexit vote in June the USD has stabilized and now with the upcoming US election uncertainty surrounding the outcome there is a general risk off attitude as investors flock to the relative safety of the US dollar.  As at September 30th the Trust’s underlying investments were approximately 60% USD and 40% CAD.


The Alternative Trust and all of its components remain open to new investors and is available for purchase on a monthly basis.





MacNicol & Associates Asset Management Inc.