In short, Titian identified clean energy, water, infrastructure and natural resources as four of the biggest investment themes we will see driving global markets going forwards. A further diversified strategy was developed to include other emerging themes the managers might identify going forwards, as well as serving as a diversified macro component of the portfolio. This includes certain tactical opportunities the portfolio managers might pick up on.
According to Alessandro Di Soccio, Managing Partner and Portfolio Manager at Titian: “World economies have reached a very challenging transition phase following the major political, social and economic transformations undertaken by several of the largest population blocks in developing economies. We thought it was now time to think about solutions that address the new equilibrium that must be reached between these developing economies and the developed economies.”
“It seems like the European Union and in particular the United States are in a state of denial,” Di Soccio continues. “Initially they enjoyed the growth that was associated with the emerging markets, the opportunity to make money over there for their corporations, and also the fact that emerging markets’ growth was deflationary for the global financial system (through the lower priced goods and services they produced). Now it is as if western economies, when suddenly faced with the ‘cost’ of these developments, would like to see this process reversed. Why? Because they have suddenly realised that the intense desire of billions of people to have a different life, though understandable, is changing the way things are for us. Rising incomes, changing eating habits, urbanisation, improving lifestyles, digitisation, increasing domestic demand for goods and services, increasing energy and power demand in these high growth economies are driving energy, food and metal prices higher which are in turn eroding profits of western corporations.”
These economies are now upgrading themselves, and using more raw materials in the process. These are major secular changes that are most probably irreversible. Over the long term large population countries will become the largest sources of global demand and in the process of arriving at this status, they will consume more energy, resources, food and water. Failing to understand this will mean the transition phase is going to be complicated and painful.
The clean energy story is already one that has been gathering pace in the venture capital space. It draws on concerns regarding climate change, energy security and independence, and the declining cost of clean energy generation as we transition towards a lower carbon economy. This segment of the Titian portfolio includes opportunities in the solar and wind power subsectors, as well as hydro, geo-thermal and energy efficiency plays. Titian keeps biofuels as part of its clean energy bucket, primarily, at this stage, on the strength of short ideas, but also argues that there is widespread misunderstanding about the value of biofuels over the medium to long term.
“Bad publicity doesn’t distinguish between the different types of biofuel one is looking at,” says Marco Fasoli, Managing Partner and co-Founder with Di Soccio of Titian. “The debate doesn’t distinguish between flawed business models centred around the creation of biofuels from feedstock that would otherwise be destined for food (eg. corn) and second generation biofuel technologies that rely on non-food feedstock (eg. plant waste). These have no impact on the food chain and make absolute sense once they can be proven to be commercially viable.”
The Titian natural resources thesis is based on agricultural supply reaching a ‘tipping point’; energy markets undergoing structural changes due to rising demand; and the demand for metals that is being driven by Asian modernisation. Titian is arguing that commodities and natural resourcesrelated industries are at the centre of several macro-economic changes now underway in the world economy. The inter-relationships between commodities, demographics, infrastructure spending, water shortages and the environment present what Titian considers to be “a wealth of investment opportunities.”
An example: the Middle East is facing a growing water crisis and experiencing heavy demand for more energy intensive desalination plants in line with rising electricity demand due to high population, economic and infrastructure growth. Result: over the next 10-15 years the region will need an extra 50-60 billion cubic feet of water annually and use 1 million barrels of oil per day, only for desalination.
Water is the ultimate demand and supply story, and the investment case here looks pretty solid, given that the world has a finite, and eroding supply of potable water becoming gradually more polluted at source. The world’s annual excess water supply has been dropping steadily since 1960, and continues to suffer from poor irrigation practices, leakage in water delivery systems and inefficient use by industry and individuals. There is also a pressing need to replace or upgrade existing water and wastewater infrastructure, as well as the additional water-based infrastructure required to support future economic development. According to Titian, the global water industry is a US$320 billion market, and the cost of improving the world’s water infrastructure to keep pace with growing urbanisation trends is estimated at a staggering US$180 billion per annum. That’s a lot of pipes, valves, pumps and other specialised equipment and applications.
A further US$21 trillion is expected to be spent on infrastructure generally in emerging markets between now and 2017 if current growth rates are sustained. The lion’s share of this, or should it be the dragon’s share, will be spent in Asia. Of the US$11.2 trillion projected spend on global power infrastructure between 2005 and 2030, some 26% will be lavished on China alone, compared with 15% in Europe and 9% in India. Governments and private sector players are already deploying unprecedented amounts of capital to upgrade existing, or add new, infrastructure to sustain economic development. Bear in mind that many countries that were running large current account and balance of payment deficits in the 1990s are now running surpluses and have become significant creditors to the rest of the world. For them, infrastructure investment is more affordable than for others.
To capitalise on these future trends, Titian has created a universe composed of multiple liquid asset classes, with the primary focus on equities and commodities. “We’re really looking at the value chains across the different themes,” says Di Soccio. “We’re very top-down driven in terms of identifying long and short investment themes within each of those areas and then we carry out bottom-up assessments to tease out the most interesting opportunities at the individual security level.”
Natural resources and clean energy represent two of the biggest opportunity sets for the Titian Integra fund, reflected in the way they are represented in the asset allocation parameters (ie. with a 40% maximum ceiling rather than 30%). “If you really look at the water industry when compared to the clean energy space, it is much more concentrated,” says Fasoli. “By contrast clean energy is not even an industry, but more of an umbrella term covering 19 different industries we can group together into three macro-investment themes that span 64 distinct value chain segments. In infrastructure, we tend to focus on specialised infrastructure: we avoid opportunities like ports, airports or roads. We tend to focus on power, energy, water and clean energy infrastructure and also in highly specialist areas such as mobile telephony and broadcasting tower operators.”
A lot of these industries are in a state of dynamic evolution with, on the equities side, continual capital formation in the form of primary issues and privatisations. The number of stocks available in the universe to enable the simultaneous implementation of long and short investment themes is constantly expanding, and thus, Fasoli says, he expects that this will impact the current allocation parameters.
What makes it interesting is that once the universe has been established through careful fundamentals-driven analysis, the tactical optimisation of the pre-selected positions involves the use of a quantitative system based on the MATLAB programming language. Its models now use over 54,000 lines of code. “Our approach is distinctive,” argues Fasoli. “You tend to have a very clear dichotomy between fundamentals-only managers and the black box approach of many quant funds. We think there is a more intelligent approach, combining the best of both worlds. We apply our fundamentals-based knowledge in the segmentation and the analysis of the long and short investment themes and positions we like, and once we’ve pre-selected the underlying instruments we’re comfortable with, we then use models to guide us in the tactical allocation of capital across that pre-approved universe.”
Obviously the key elements there are points of entry and exit, and weights across the positions. It is impossible for the human mind to be smart and have an efficient way of optimising the portfolio on a tactical level. Even if it was a single portfolio, with inter-relationships and externalities, it is impossible for an individual to capture the complexities of those inter-relationships in a dynamic way. This is where these mathematical models add additional value.
While Titian has identified its long term goals, its investment framework involves developing medium term strategic goals that reflect the relative attraction of each investment theme over a one to three month period. Short term added value is then captured through the use of its advanced optimisation methods, which can include intra-day holdings. The fund managers are combining the discretionary input of continuous analysis of the investable universe, and the allocation boundaries of the portfolio, with a quantitative proprietary portfolio optimisation model based on return forecast and risk minimisation.
Titian’s in-house quant team has tellingly been recruited out of academia rather than the investment banking sector to steer clear of some of the inbred bias which we continue to see from those quants emerging from banks. It is led by Partner Fabrizio Lacalandra, formerly the technical director of the energy optimisation unit at MBI, the European specialist in mission critical software. At MBI, Lacalandra was responsible for the development of a specialised software suite for tactical optimisation in the free electricity markets which is still used by one of Europe’s largest utilities to manage the loading and pricing of electricity across its national grid.
“That was a deliberate choice on our part,” says Fasoli. “We wanted to move away from preconceptions about the optimisation models associated with modern portfolio theory which are generally of low efficiency.”
The reason why there is this binary (black box quant vs fundamentals-only) approach within fund management, is partly because of the mentality of the managers; they either come from a purely quant background or from a fundamental fund management background. It is also very difficult to source truly smart mathematical resources; a firm can carry out a great deal of low-level, simple optimisation without these, but often this can do more damage than good. Titian wanted, from its inception, to integrate its mathematical models with its discretionary expertise. It has taken almost four years.
Part of the strategy’s stress when compiling the available asset universe is on liquidity and it typically takes few equity positions on board that are lower than US$500 million in market capitalisation. Portfolio monitoring is performed on a daily basis, with the support of proprietary trading systems. Technical factors are used to determine exit and entry points, and the actual sizing of positions is advised by the internal optimisation and risk management models.
Titian represents an interesting hybrid opportunity, combining both quantitative and discretionary methodologies to capitalise on a solid thematic framework. While thematic funds exist in the market, as well as quantitative vehicles, managers who can successfully combine both are few and far between. Its Integra fund, within which this strategy is being managed, is part of Titian’s Absolute Return Fund Platform SPC, domiciled in the Cayman Islands, and with an Irish Stock Exchange listing. It has a 10% high water mark incentive fee, which will be raised to 20% on 1 October 2008. The minimum initial subscription is US$1 million of either euro, US dollars, or sterling.
Alessandro Di Soccio is Managing Partner and Portfolio Managerof Titian. Prior to co-founding Titian, Di Soccio was a Director of Citi Alternative Investments, Citigroup’s division for alternative asset classes, and sat on its global product development committee. Prior to this, he was an associate director with London-based Asset Alliance, specialising in buying equity interests in hedge fund managers and managing alternative portfolios. He co-designed and launched Asset Alliance’s diversified hedge fund and commodities portfolios as well as building out its advisory business. Earlier in his career, he was a research analyst at Ermgassen & Co, an independent investment banking advisory firm focusing on M&A and corporate finance. He worked on cross-border transactions across several industries, with special emphasis on the mining, forestry, paper and technology sectors.
Marco Fasoli is Managing Partner and Portfolio Manager at Titian. Fasoli spent the five years prior to founding Titian advising or analysing companies in the clean energy sector and other high growth industries. In his previous role he was a managing director of Jefferies, based in London, joining the firm as part of its acquisition of Broadview in 2003. He led European investment banking activities in the telecommunications services and information technology services sectors at both firms over a period of 10 years. Prior to joining Broadview, he was a partner and director at Putnam, Hayes & Bartlett, an economic and management consultancy specialising in infrastructure, transportation, telecoms and media. From 1989 to 1993 he was an associate and then a senior associate at Booz Allen Hamilton, the management consultancy, working out of their London and Milan offices. Fasoli has advised over 100 public and private companies and investors across Europe, North America and Asia in the past 18 years.