Press review – A few updates

Recent economic news have provided further substance to some of the topics we covered earlier this year. Selected examples include:

  • Apple revealed earlier this week declining yoy iPhone sales. The decline was however in the higher end of analysts’ expectations and resulted in a share price appreciation. Furthermore the company unveiled a strong increase in R&D spending (now reaching 6% of turnover), highlighting the hunt for the ‘next big thing’ to alleviate the still heavy reliance on iPhone which represents 2/3 of revenues.
  • Twitter’s results, on the other hand, disappointed investors which let the share price drop by 11% after the announcement. User base seems to have reached a plateau and the company has not found a way to profitability yet.
  • ‘Active’ investing is still haemorrhaging money while investors favour low-cost passive strategies.

The future of UK retail in 7 questions (2/2)

[continued from Monday]


5. How can retailers use innovation to stop the decline?

To embrace the change rather than trying to fight it in vain, retailers and department stores have started to invest in homegrown start-ups and accelerators. The win-win deal is clear: retailers remain at the forefront of technological innovation applied to their industry while entrepreneurs get instant access to a huge playing field for their products. Unsurprisingly, corporations have become almost as important as VC funds for the funding of accelerators.

Split of accelerator funding by primary source. Source: OpenAxel in the FT.
Split of accelerator funding by primary source. Source: OpenAxel according to the FT.

As previously mentioned, the online and ‘brick-and-mortar’ worlds will be more and more interlinked and the development and use of multi-channel CRM tools will play a great role in ensuring the coherence of the customer journey. Well-designed and innovative apps, allowing fast navigation, speedy checkout and nicely showcasing products will also boost sales – Asos is often mentioned as a ‘best-in-class’ example in that respect.

6. Should retailers own or rent their walls? Or should retailers simply sell their estate and move to an ‘online only’ model?

For years retailers have been told to own their walls. The cost of purchasing and maintaining their estate more than offset the sum of expected future rents which have been increasing at a fast pace – at least more rapidly than inflation. Furthermore, retailers were making a wise investment given soaring real estate prices across the country and especially in ‘prime locations’. Today, one can wonder if the equation still holds. Commercial real estate is expected to take a hit, crystallised by (but not only due to) Brexit, and rent inflation may cool down as a consequence.

This dilemma is worth considering as the ‘online only’ model represents a very difficult customer proposition which has been mastered so far only by a handful of players, including Asos or Raising brand awareness and subsequently developing a brand image without any physical shop windows has proved an increasingly daunting challenge in an environment already saturated with incumbent brands. Furthermore, brands with a fading image lose pricing power – Uniqlo is one of the most recent victims of that rule.

Conversely a brand without any ecommerce operations is overseeing a strong growth driver. Some retail experts explain Primark’s recent under-performance by its absence of online shopping website – in this particular case, such a website would prove economically unprofitable for Primark given its low price points.

7. What will be the impact on the commercial property market?

The impact is still hard to assess. One could imagine that the change in culture, lifestyle and demographics, partly embodied by the rise of online, has made the need for physical retailers less obvious and therefore would expect a steady increase in the shop vacancy rate. Actually, the opposite is true: according to the Financial Times, the proportion of vacant shops fell to its lowest level since 2009.

Two possible cumulative drivers can be brought forward. First, service providers, such as restaurants, cafés and hairdressers, have taken the spots left vacant by retailers. Second, historically low interest rates have facilitated the access to debt and therefore boosted the creation of small business ventures – which this kind of service providers typically are.

In practice, though, bargaining power has started to move away from the seller. Two shopping developments have been sold at a significant discount to their original price – the transaction was completed pre-Brexit – and investment into retail property was down 54% in Q1 16 compared with Q1 15. More generally, brands will increasingly focus on prime locations where their products can be showcased at the expense of ‘tier 2’ areas such as suburban shopping centres whose transactional role will be increasingly filled by online shipments. As a consequence, some analysts believe that the UK market can now be covered with 80 to 100 stores as opposed to 200 in the past.

The UK retail industry is definitely facing challenges and shops have been asked with new roles. As announced, this will impact the demand for ‘brick-and-mortar’ sales locations – and ultimately the equilibrium of the commercial real estate market.

The future of UK retail in 7 questions (1/2)


Brexit has recently cast light on the future of the commercial real estate market in the UK. We will definitely tackle this topic in the near future. In the meantime, nonetheless, I thought it was worth getting back to the basics of one of the key underlying markets, i.e. retail, and ask ourselves 7 questions to understand the future of this market. Grocers and ‘non-food’ retailers follow different dynamics, I will therefore limit the discussion to the latter.

As usual, I thought this topic would be covered in only one post. In hindsight, I believe it would be more digestible to cut it in two halves – the second part will follow later this week.

  1. What is the current state of the UK ‘non-food’ retail market?

In a couple of words: not great. The recent misfortunes of BHS and Austin Reed are only the visible manifestations of a deeper trend. Total UK retail sales rose 1.2% on a 12-month average basis, the lowest growth since 2009. According to the latest British Retail Consortium – KPMG survey, in-store sales were particularly affected, falling 1.9% over the three months to June, and 2.2% on a like-for-like basis. The industry has been suffering from constant price pressure over the last decade.

CPI evolution for various perimeters. 2008 = 100. Source: ONS
CPI evolution for various perimeters. 2008 = 100. Source: ONS

Note : The informed reader will have spotted the ‘ups & downs’ generated by the bi-annual sales periods.

2. Are there winners though?

As in many other countries, online is the most dynamic segment of the UK retail market, although it is not immune to global market slowdowns – the latest BRC – KPMG online retail sales monitor reported a 9% growth of online in June 2016 compared with 18% a year ago. Massive online marketing initiatives such as ‘Amazon Prime Day‘ generate positive externalities for the online industry as a whole.

Source: FT
Source: FT

Looking at particular brands, Next, Ted Baker, New Look and pure online player Asos have reported relatively positive sales trends compared with their competitors.

3. Is it all about price?

No. Earlier this month Primark reported its first drop in like-for-like sales for 15 years, echoing the similarly difficult times Poundland is facing in the supermarket segment.

4. Can ‘brick-and-mortar’ sales still be considered in isolation from online? And can stores still be considered as pure points of sale?

Historically ‘standalone’ retail sales could be analysed using the following formula:

Sales = Footfall * Conversion rate * Avg. item price * Avg. quantity

Over the last few months, industry insiders have raised the alarm bell based on a drop in footfall and a very modest increase in average item price (see the clothing & footwear inflation chart above as an example) which have not been offset (yet) by a similarly significant increase in conversion rate (i.e. the share of visiting customers who end up making a purchase) and/or the average number of items per basket.

Unfortunately (or fortunately), one corollary of the previous answer is that this formula cannot be considered as valid any more. This is especially true in the UK where consumers buy more online per head than in other developed economies.

Today stores are increasingly considered as showrooms where consumers get to know a brand and its latest products, hence the refocus on prime locations. The trend is likely to accelerate given the progress made in ‘last-mile logistics’ as proved by Amazon or Ocado. Delivery from a warehouse to the end-customer’s house used to be complicated to plan and very often poorly (if not randomly) executed – actually it is still the case for the vast majority of retailers willing to enter the delivery space. As progress keeps being made in that space, we should see customers going to the shop to get information, then shop online and ultimately be delivered at their door or in convenient locations such as Amazon Lockers.

[to be continued on Thursday…]

3 strategic options for funds to maintain their (h)edge


Last month I had the opportunity to write about the difficult times the hedge funds industry was going through, facing quarterly outflows never seen since the last financial crisis – a downward trend that remained vivid in Q1 2016 – and which does not spare top ‘brands’ such as Pimco. Although the outflow only represents 0.5% of the total hedge fund AuM base, experts have been calling for a change in the way hedge funds operate. In summary, all recommendations do not add anything new to classic strategy textbooks which have taught us for decades that a company could build and maintain a competitive edge in three ways: through (i) lower prices and/or through products offering (ii) higher quality and/or (iii) better fit to customer needs (for instance, think about pack sizes in retail). Hedge funds are no different in that respect and I believe each of those three levers is worth investigating.


Lowering prices

The infamous ‘2+20′ mantra which used to drive hedge funds’ remuneration policy (i.e. 2% of annual management fees plus 20% of the share of profits above a certain IRR) cannot be considered as a standard anymore. It should not have become in the first place anyway. The ‘2+20’ was indeed originally designed by private equity fund managers as a reward for the effort they ut into identifying promising investments, negotiating the best deal terms and then developing the companies. The hedge fund manager only adopts a ‘passive’ approach to investing by focusing only on the first point and, to a lesser extent, on the second (although the impact of market timing is limited). As a consequence, one should expect the work of the hedge fund manager to add less value compared with his PE counterpart. In any case, pressure on fees can be felt across asset classes and the ‘2+20’ has left room to the ‘1.5+15’ or even to the ‘1+0’.

Ucits, a regulated and often cheaper alternative investment offering a similar performance to hedge funds, have conversely enjoyed significant inflows since the start of the year – €8bn according to Les Echos. Ucits will come on top of the already mainstream ‘passive’ ETFs to put additional price pressure on ‘traditional’ hedge funds.

tumblr_m28i6joRpj1qcaagjSuch global pressure on fees has obvious consequences on the way asset managers in general operate: low-performing funds have either tightened their expense policies (think about Goldman Sachs Asset Management for instance) or simply closed.


Enhancing existing products

Hedge funds have often been criticised for all following the same active strategies which can in some cases not even be qualified as ‘active’ – see my earlier post on this point. The ‘herd mentality’ comes with two major drawbacks: first, no hedge fund is truly uncorrelated from the market as a result and, second, each position change triggers massive money flows and thus price fluctuations which can destroy returns even if the investment was originally a good idea. To alleviate that risk, hedge funds will likely reduce their size and focus on ‘niche’ strategies away from the mainstream market. To do so, hedge fund managers need to be allowed to suffer short-term losses if that drives long-term profits, in particular if those profits offer low correlation with the way the rest of the market behaves.

And yet, markets are volatile, relatively undecided and we are currently living in a world of ‘lows’ (low inflation, low growth, low interest rates). Are open-ended hedge funds the highest performing asset class in that context? Volatility leads investors to make frequent changes to their money allocation strategy if they are left free to do so. Hedge fund managers are therefore strongly incentivised to maintain a high level of liquidity in their portfolio and adopt a short-term approach in order to avoid heavy redemption and the detrimental asset ‘fire sale’ it generally triggers – a particularly acute problem for real estate funds, as Standard Life showed us yesterday. This strategy will negatively impact returns. As a consequence, some hedge fund managers have started introducing ‘lock-in’ periods (as PE funds already do) to enable them to follow true long-term strategies even if they prove to be losing in the short-term.


Adding or creating more adapted strategies

Private equity as an asset class which not only solves the issue of ‘lock-in’ and offers additional value creation levers for fund managers but also relatively outperforms other alternative asset classes – see a French example below.

Average annual performance for French funds split by asset class type, 2006-2015. Source: Les Echos
Average annual performance for French funds split by asset class type, 2006-2015. Source: Les Echos

As a consequence, despite the already high number of competitors in the industry, some hedge funds have decided to diversify by adding, explicitly or implicitly, a PE arm to their activities. Elliott’s joint acquisition of Dell’s software division last month – funded from their $28bn main fund – is only the tip of the iceberg.

Quant funds benefit from tailwind as well. Despite average performance, investors appreciate the ‘systematic’ (since algorithmic by definition) approach to investing in turbulent times. The Financial Times reports that commodity-trading advisers (CTAs) received $38bn in capital inflow in 2015.

Rob Arnott
Rob Arnott

Finally, hedge funds’ ‘product innovation departments’ have been running full speed over the last few months in an attempt to maintain fees as high as possible – a trick used in retail as well. Factor investing, smart beta, low volatility funds have all attracted money recently but these strategies remain unproven (‘factor investing’ is still nascent given its complexity), non-scalable (what happens to a ‘low volatility’ fund when strong flows generate volatility?) or, worse, dangerous (Rob Arnott, pioneer of ‘smart beta’, recently criticised the excesses of this strategy).


It is unclear which hedge funds will succeed and which ones will be wiped out as a result of the industry transformation movement we are witnessing. Size of the asset base only offers a mediocre indication as in the future the most successful funds may be those able to navigate ‘under the radar’. In any case, investors are becoming increasingly educated and scrupulous on costs – ‘status quo’ is thus not an option.