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22/7/2022
15
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Investing in the subscription economy

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Rosemary Banyard
Rosemary Banyard

Fund Manager

Downing launches new actively managed liquid alternatives fund aiming to deliver 7% to 10%+ per annum and positive returns in most markets. The new MGTS Downing Active Defined Return Assets Fund (‘Active Defined Returns’, the ‘Fund’), is the first fund from its new Liquid Alternatives team.

The Fund is aimed at institutional investors, Discretionary Fund Managers, IFAs and advised sophisticated individual investors, and will primarily consist of UK Government bonds and large-cap equity index options, which provide significant scalability and strong liquidity. It aims to deliver 7% to 10%+ per annum and positive returns in all markets except for a sustained equity market fall (generally more than 35%), over a period of at least six years.  

The Fund is the first to be launched by the new Liquid Alternatives Team established by Downing. Collectively, the team has over 125 years of experience and sector knowledge, and includes Tony Stenning, who held senior roles at BlackRock and most recently was CEO of Atlantic House Group; Russell Catley, founder and also a former CEO of Atlantic House Group; Huw Price, a former Executive Director at Santander Asset Management, and Paul Adams, former Head of Cash Equities and Derivatives Sales, Royal Bank of Canada.          

The Fund offers investors a compelling building block for multi-asset portfolios, aiming to add consistent and predictable returns, typically secured with a portfolio of UK Government bonds. The unique proposition includes a hybrid approach of using systematic derivative strategies and active management, combining liquid investments with predictable returns, and an equity like risk profile.

Investment strategy: Maximising the probability of delivering predictable defined returns across the economic cycle.

  • Systematic Liquid Derivatives:  Systematic, derivative strategies optimise the equity risk-return profile. The Fund uses rules-based derivative strategies linked to the most liquid, large-cap global equity indices (i.e. FTSE100, S&P500) with the aim of harvesting well-proven consistent returns across a wide corridor of market conditions. 
  • Strong security:  The Fund will hold a high-quality portfolio of assets as secure collateral – typically UK Government bonds.
  • Active benefits: At times, rules-based, passive derivative strategies can underperform when markets move strongly – this is when specialist active management can add incremental gains by monitoring and monetising positions and applying active risk management.

Key benefits

  • Increased consistency and predictability of returns: Positive returns in all markets except for a sustained equity market fall of more than 35% over at least six years.
  • Diversification of risk: The Fund’s risk components are diversified across large, liquid equity indices, observation levels and counterparties. Secured with high-quality assets – typically UK Government bonds.
  • Active management: Our experienced team will actively manage the Fund and its investments to optimise risk and reward for investors.
Russell Catley, Head of Retail, Liquid Alternatives at Downing, said: “Put simply, we focus your investment risk on the probability of receiving the returns you need, not those you don’t.  We target the highest probability of delivering 7% to 10%+ per annum with active management adding material incremental gains. We believe that we are building the next evolution of the proven success of Defined Returns funds
The Downing team is seeing strong demand from clients looking for alternatives to large-cap equity funds which are becoming concentrated in technology stocks, or alternatives to UK equity income funds and illiquid alternatives.”   
Tony Stenning, Head of Liquid Alternatives at Downing, said: “The launch of our Active Defined Return Assets Fund is a significant milestone in the ambitious build-out of our new Liquid Alternatives strategies. It is a solution-focused fund that should deliver stable high single or low double-digit returns across a wide spectrum of equity market conditions, except for a persistent multi-year bear market. The Fund is designed to enhance balanced portfolios by providing consistent, predictable returns and is suitable for accumulation or drawdown.
“We aim to deliver a unique combination of proven systematic derivative strategies and specialist active management, and we are doing so at a very compelling fee level, below our closest competitors and in line with active ETFs.”

How the Fund is expected to perform in different markets

  • In bullish markets:  UK Government bonds secure the capital, and the equity index options deliver a predictable 7-10%+ return per annum – giving up some less likely upside.
  • In neutral markets and normal market corrections:  UK Government bonds secure the capital, and the index options deliver a predictable 7-10%+ return per annum.
  • In a sustained sell-off:  if markets fall more than the cover to capital loss and do not recover for six years. Then capital is eroded 1:1 in line with the worst performing index.
  • The average Cover to Capital Loss is targeted at 35%:  the average cover to capital loss represents the average level the Global indices within the Fund could fall before capital is at risk.

Fund key risks

  • Performance:  Capital is at risk. Investors may not get back the full amount invested.
  • Liquidity:  Access to capital is always subject to liquidity.
  • Counterparty risk: Other parties could default on the contractual obligations.

Fund Structure

  • UK regulated OEIC fund structure, fully UCITS compliant
  • Daily dealing, at published NAV
  • Minimum investment: £100,000
  • SRRI: 6 out of 7
  • Depositary: Bank of New York
  • Authorised corporate Director (‘ACD’): Margetts Fund Management Ltd.
  • I share-class:  SEDOL: BM8J604 / ISIN: GB00BM8J6044
  • F share-class: SEDOL: BM8J615 / ISIN: GB00BM8J6150

Learn more about the Fund here.


Risk warning: Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice. Please refer to the latest full Prospectus and KIID before investing; your attention is drawn to the risk, fees and taxation factors contained therein. Please note that past performance is not a reliable indicator of future results. Capital is at risk. Investments and the income derived from them can fall as well as rise and investors may not get back the full amount invested. Investments in this fund should be held for the long term. 

Important notice: This document is intended for professional investors and has been approved as a financial promotion in line with Section 21 of the FSMA by Downing LLP (“Downing”). This document is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. Downing does not offer investment or tax advice or make recommendations regarding investments. Downing is a trading name of Downing LLP. Downing LLP is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 545025). Registered in England and Wales (No. OC341575). Registered Office: 10 Lower Thames Street, London EC3R 6AF.

The subscription economy goes beyond the consumer (B2C) into the business arena (B2B), and increasingly we are seeing products become services: Software as a Service (SaaS), Equipment as a Service, Infrastructure as a Service. The benefits to businesses from subscription rather than ownership are often similar to those for consumers: reduced obsolescence risk on technology; lower maintenance costs; predictability of costs; revenue rather than capital spend; and a saving of resources such as space, technical staff, and data centres.  

On one estimate, the digital subscription economy was worth $650bn in 20201 and is expected to grow at 18% compound to 2025. It has spawned a series of new three letter acronyms for analysing the financial success of providers, such as ARR (Annual Recurring Revenues), TCV (Total Contract Value), NCC (Net Customer Churn), and CAC vs. LTV (Customer Acquisition Costs vs Lifetime Value).  

Investing is not without risk

Investing in the subscription economy is not without its risks. On the consumer front, investors need to unpick the impact of Covid. Consumers took out multiple video on-demand services during the pandemic but Netflix warned in April this year that its subscriber numbers had fallen back by 200,000, the first decline since 2011. The impact of the upward pressure of fuel, food, and mortgage costs will likely generate more cancellations. In software, suppliers sometimes have to make a painful transition from perpetual or multi-year licence fees, often paid upfront, to a subscription model where revenues are more predictable but initially lower and spread out. For example, in April Aveva Group, which sells software to design, operate and maintain manufacturing plants, warned that an acceleration in Annual Recurring Revenue from moves to subscription and the cloud would negatively impact traditional point-in-time revenue recognition, leading to a near-term impact on reported revenues.  

Companies that should benefit from the trend

I have invested in four companies that should benefit from the growth of the subscription economy in different ways. Alfa Financial Software is a leading global provider of software and services to the automotive and equipment leasing industries. Its software manages the entirety of the life of individual leases, from inception, through changes in interest rates and regulations, to termination or even default. Many of its 31 customers are in the process of rolling out its software globally and it is winning new customers with a “cloud first” approach to its offer. It seems that Electric Vehicles and Autonomous Vehicles are even more likely to be leased than their predecessors, not least because this technology is so new and technological risk, for example around battery life, is therefore higher. Alfa helpfully quotes its next 12 months TCV, but typically actual revenue has come out much higher. 

Another software company that should benefit from the growth in the subscription economy is Aptitude Software. Aptitude actually provides software to manage subscriptions, and its largest customer is T-Mobile. In the company’s own words: “The subscription economy is continuing to expand into new sectors as the benefits of subscription income are increasingly valued more than traditional non-recurring revenues. Organisations require new systems to manage these subscriptions and require new capabilities to address the complexities of revenue recognition inherent with subscriptions2.” Aptitude has seen Annual Recurring Revenues grow from £29.8m in 2019, to £41.8m in 2021, including some from an acquisition part way through 2021. 

The trend for more and more business critical software to be accessed “off-premise” brings with it a shift of network security needs from data centres to the cloud. More users, devices, applications, services and data are now located outside the enterprise than inside. This complexity should create more work for companies that test mobile networks, Wi-Fi and mobile devices and high speed ethernet performance, among which is leading global player Spirent Communications.  

The growth of subscription TV mentioned earlier has generated increasing spend on content creation from the likes of Netflix, Amazon, Apple TV and Disney, as well as defensive spend from traditional broadcasters. This is driving demand for more TV production equipment such as camera systems, mobile power, prompters, lighting, and audio systems. Videndum (formerly known as Vitec) is a leading global provider in these product areas and hence a clear beneficiary of this trend. In addition, the development of the metaverse in industries such as computer games will likely stoke demand for its equipment and its real time streaming capabilities. 

Rosemary Banyard 

Manager VT Downing Unique Opportunities Fund 

July 2022 

(based on a talk given to private investors at Mello in May 2022). 

Find out more information on the VT Downing Unique Opportunities Fund  

1UBS Editorial Team, Investing in digital subscriptions, 11 March 2021 

Risk warning: Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice. Please refer to the latest full Prospectus and KIID before investing; your attention is drawn to the risk, fees and taxation factors contained therein.  

Please note that past performance is not a reliable indicator of future results. Capital is at risk. Investments and the income derived from them can fall as well as rise and investors may not get back the full amount invested. Investments in this fund should be held for the long term and are higher risk compared to investments solely in larger, more established companies.   

Important notice: This document is intended for retail investors and their advisers and has been approved and issued as a financial promotion under the Financial Services and Markets Act 2000 by Downing LLP (“Downing”). This document is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. Downing does not offer investment or tax advice or make recommendations regarding investments. Downing is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 545025). Registered in England No. OC341575. Registered Office: St Magnus House, 3 Lower Thames Street, London EC3R 6HD.    

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