Current Economic Outlook & Its Impact on the EuroWest Capital Fund

ECONOMIC CRISIS & OUTLOOK

The current Real Estate and Financial Crisis in the US has leading economists considering the financial crisis of 2007–2009 the worst financial crisis since the one of the Great Depression in the 1930s. Many causes – with varying weight – have been proposed by experts. Both market-based and regulatory factors have been indicated or are under consideration as causes, and significant risks remain for the world’s economy. The immediate cause of the financial crisis was the bursting of the United States` housing bubble, which peaked in approximately 2006–2007. Between 1997 and 2006, the price of the typical American house increased by 124%. During the two decades ending 2001, the national median house price ranged from 2.9 to 3.1 times median household income. The ratio rose to 4.0 in 2004 and 4.6 in 2006. This housing bubble resulted in  homeowners refinancing their homes at lower interest rates, and, further, homeowners taking out second mortgages secured by the price appreciation in their homes, which further resulted in unprecedented consumer spending . By September 2008, housing prices had declined by over 20% from their mid-2006 peak. Easy credit, and a belief that house prices would continue to appreciate, had encouraged many sub-prime borrowers to obtain adjustable-rate mortgages (ARM). These mortgages enticed borrowers with a below market interest rate for some predetermined period, followed by higher market interest rates for the remainder of the mortgages term. Borrowers who could not make the higher payments once the initial grace period ended would try to refinance their mortgages. Refinancing became difficult, if not impossible once house prices began to fall in many parts of the US. Borrowers who found themselves unable to escape higher monthly payments by refinancing began to default. This free cash used by consumers from housing equity extraction contributed greatly to economic growth in the Unites States and worldwide. The flip-side of the coin, however, was that US home mortgage debt relative to GDP increased from an average of 46% during 1990s to 73% during 2008.

This financial crisis - the first recession in the globalized world economy - is fundamentally different from those in the past. Previous recessions were generally a result of monetary squeezes that were put in place to deal with excess demand and rising inflation. As a result, once monetary conditions were relaxed, recessions soon came to an end. The current cycle (which climaxed in 2008) has been associated with supply excesses as well as demand excesses and it has been more of a deflationary than inflationary environment. Furthermore, in previous cycles at least one major region was not in recession and provided a certain support to the regions affected by the economic slump; this time all major economies are simultaneously in recession, so the external sector offers little relief. 

The massive market de-leveraging is still going on and for the upcoming two years we expect continued sluggish growth with erratic capital markets with practically no clear-cut long-lasting price trends. Even if the general economy starts to recover, real estate fundamentals will lag behind, being dependent to a large degree on job growth and the strength of the banking sector.

Although the previous market devastation, and subsequently projected slow recovery is dismal news to many, it is the "window of opportunity" (the "Perfect Storm") that the EuroWest Capital Opportunity Growth Fund was designed to exploit.

INVESTMENT STRATEGY AND POLICY OF THE FUND

The  EuroWest Capital Opportunity Growth Fund’s investment objective is to achieve a consistently high rate of return for our investors through long-term capital appreciation. The Fund constantly seeks to identify unrecognized asset value, principally in the real estate debt and equity markets, as well as senior life settlement policies, and pursues opportunistic investments in these two sectors The Fund’s return performance is the result of our conscious commitment to a balanced investment strategy designed to withstand market volatility and economic cycles, and painstaking attention to the fundamentals of our value enhancement activities.

Sector 1: Real Estate

EuroWest Capital applies a contrarian investment style to seek event-driven transactions in which the Fund Managers identify a significant gap between the market value and the intrinsic value of an asset. The Fund pursues opportunities focusing on the US single-family residential (first-time home buyer) real estate debt and equity markets. As a result of the bursting of the United States housing bubble in 2006–2007 and the following financial and economic crises of 2007–2009 in the US and worldwide, the Fund has an almost unlimited pipeline of transactions which, together with intensive economic and financial research, forms the basis of its ability to find price distortions and inefficiencies in the distressed US real estate markets. The flow of distressed real estate properties to the markets in the United States, originating from banks, insurance companies, hedge funds and similar institutions, will continue for several years to come. There is a consensus of opinion among experts that an investor’s aim at capitalizing on the current distress in the US real estate markets, which will last long into the middle of the second decade, will be highly profitable. The Real Estate market in the US offers a wide range of distress opportunities. Central to these is the potential to acquire assets at high discounts to their intrinsic value, such as the residential properties EuroWest is focusing on, under less extreme market and economic conditions. Therefore, the focus of the Funds strategy is to invest in distressed real estate properties at significant discount. The generated capital gains on the real estate assets in the Fund, reaching a certain level, are regularly realized. For that reason, the typical investment horizon/life of the Funds assets is no longer than the three year term of the Fund. By reducing the degree of distress of the bought real estate properties during the holding period (e.g. renting of empty houses and apartments, on-going maintenance, and similar measures carried out by the management of the Fund), the intrinsic value of the real estate properties can be increased, resulting in a possibly higher selling price of the investment and increased capital gains for the Fund. The intrinsic value of the real estate assets in the Fund and their selling price is, of course, also pre-dominantly influenced by the economic environment. Economists and real estate experts expect stabilization of the US real estate markets to commence in 2012–2013 followed by a gradual recovery.

Sector 2: Life Settlement Policies

One of the consequences of the recent banking and financial crisis has been a severe shortage of lending, affecting both consumers and businesses. Over the years the primary buyers of Life Settlement Policies have been individuals and institutions who were financed in one way or another. Now that credit has dried up, the prices of policies available in the marketplace have fallen, creating very attractive buying opportunities for those with the capital. In addition to gaining control of the pricing mechanism for policies, buyers can afford to be very selective in the type and quality of policies to be purchased, which translates into the ability to construct very high quality portfolios at attractive valuations.

Because of this scenario the Fund is in a unique position to make purchases of Life Settlement Policies with superior risk/return characteristics, targeting those policies with the best combination of quality, type, size and term to construct a portfolio poised to deliver attractive medium-term returns. Once the markets begin to return to normal, and lenders re-enter the marketplace, we expect prices to firm and provide the Fund an opportunity to sell policies back into the marketplace. By pro-actively taking advantage of changing market realities, we will continue to position the Fund to outperform the traditional financial markets, providing a superior risk-adjusted return to our shareholders.

It is this creative, contrarian investment strategy, coupled with the Fund’s ability to efficiently execute on that strategy, which enables the Fund to take advantage of the value-oriented opportunities resulting from the current economic environment.

We believe that the Fund is exceptionally well positioned to take advantage of the exciting new opportunities that are being generated by today’s volatile times. The pool of available opportunities that provide the potential for superior risk-adjusted returns is increasing because current economic conditions are driving increases in delinquency rates (which tend to lag behind the general economic cycle) and bankruptcy filings. By pro-actively taking advantage of changing market realities, we will continue to position the Fund to outperform the traditional debt and equity markets, providing a superior risk-adjusted return to our investors. The timing for the Fund with its strategic aim of exploiting the distress of the US real estate market, and weakened life settlement policies market, is optimal.