Yin Yang Year
2016 was one of those years: great for some, awful for others. For HCG, our investment process delivered discipline and clear direction. For example:
- Macroeconomic Assessment: Our analysis directed us to put the brakes on an imminent UK platform opportunity given that Brexit was, in our opinion, a likely possibility. This same assessment also gave us confidence in the underlying U.S. economy, and to expand our small business exposure throughout the year.
- Platform Selection: After a year-long due diligence effort, we added a fourth platform to the HCG ecosystem, Square Capital, as a source of small business loans. At the same time, this process led to the rejection of other platforms that while seemingly attractive on the surface, did not pass our investment criteria.
- Credit Selection: Our rigorous process helped us avoid chasing yield at the expense of poor underwriting standards and/or bad credit, thereby avoiding credit quality issues that emerged at the tail of prime consumer credit. The same credit selection process helped us take advantage of two unique consumer credit opportunities: an attractive one-time opportunity in the summer, as well as a distressed opportunity offered to HCG on a proprietary basis in early 2016.
Outlook for 2017… But Not Much Beyond
HCG will begin 2017 with several exciting initiatives in the face of a new policy, geopolitical, and socioeconomic architecture, spearheaded by the incoming U.S. administration. We believe we should watch what the new President does, and not what he says. If (emphasis added) the President can achieve a modicum of financial deregulation and/or cuts household and corporate taxes and/or invites U.S. corporate profit repatriation at minimal cost to those American companies, then U.S. economic growth should continue and will likely expand, at least in the near term. Given the near-total Republican control of the White House and Congress, we assign high probability to this scenario, or a variant of it, playing out. This scenario should be good for the consumer, residential real estate, and especially small businesses.
It is within this macro context that we are spending more time evaluating small business platforms and looking to expand our participation in residential real estate… as credit buyers, not equity owners. The reflationary scenario described above may persist for a year or two (or until the mid-term U.S. elections?) but eventually an unintended consequence or two will emerge, usually when least expected, to ruin the party, test our mettle and remind us that large global economies cannot leave the economic system electively to live in a walled-off garden reaping bountiful harvest, with perfect weather, forever.
We are not offering the above viewpoint because we are hedging our pro-growth near term outlook, but rather to try and underscore the importance of an investment metric—Time (measured by tenor, term, average life, duration, or something else)—that often gets overshadowed by its more prominent cousins Return and Risk. Above we painted the scenario that the coming year could be a pro-growth, reflationary, strong return environment, only to be followed shortly thereafter by the disappointing inverse. It is also possible that neither will materialize and we experience a different economic future.
These ranges of uncertain outcomes and the speed with which they can fluctuate demands that we keep a handle on the time dimension as we invest. This is what drives our bias to investment opportunities in short-tenor credit or amortizing credit that reduces duration and average life. By focusing on managing time, we derive flexibility to manage risk and to seek unique return opportunities; for an illiquid credit strategy, we can raise cash relatively quickly, and can choose to de-risk or to take advantage of attractive distressed situations brought on by forced sellers.
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By focusing on managing time, we derive flexibility to manage risk and to seek unique return opportunities