Deutsche Bank Global Transaction Banking Institutional Cash & Securities Services Separately Managed Accounts: The DR Opportunity 1
In Brief Identifying the right investors to target is a key step towards maximizing the impact of your DR program Issuers should direct their efforts towards investors who offer Separately Managed Account (SMA) portfolios focused on DRs a growing asset base of more than $100bn Understanding the issues that are important to these investors such as proactive communication, liquidity, and regional considerations will help you more effectively structure and market your DR program One of the major issues for us as [DR] investors is liquidity. Our advice for potential issuers would be to issue a fully sponsored Level 3 DR. This will create liquidity here in the US market. Yarek Aranowicz, Portfolio Manager Lord, Abbett & Co. 2
Depositary receipts (DRs) represent a compelling option for non-us corporates and investors alike. For corporate issuers, DRs can be an effective way to tap the US equity capital markets and attract new shareholders. DRs also provide US-based investors with an efficient means of investing in foreign shares. Benefits for Issuers Increase a non-us company s visibility and presence in the US investor community May increase liquidity of the underlying shares May broaden and diversify investor base A new avenue for raising equity capital* An equity financing tool for M&A transactions and ESOPs (Employee Stock Option Plan) for US employees Improve communication with shareholders globally Benefits for Investors Trade and settle in the same manner as any other security in the investor s home market May offer lower trading and custody costs than shares purchased in the local market Minimize foreign exchange issues with dividend payments in US dollars Recognized as US securities so allowed in portfolios where foreign securities might be prohibited Voting rights facilitated by the depositary bank *Through some types of DR programs 3
Targeting US-based DR Investors Once a corporate has decided to issue a DR, one of the most effective ways to maximize the program and market shares is to focus on USbased investment managers that offer Separately Managed Account (SMA) portfolios to their clients. What is a Separately Managed Account (SMA)? Many investment managers offer their capabilities in multiple formats in order to meet the varying needs of their clients. For example, an investment manager may offer its non-us equity capability in two formats - a mutual fund and an SMA. In contrast to a mutual fund in which the assets of multiple investors are pooled into a single portfolio (investors receive shares of the mutual fund on a pro-rata basis), SMAs are personal portfolios in which individual investors have direct ownership of securities and, potentially, opportunities for customization. The table on the next page summarizes some of the key differences between mutual funds and SMAs that invest in non-us equities. 4
Exhibit 1 Mutual Fund vs. SMA Mutual Fund Pooled assets (investor owns shares of mutual fund) Lower minimum initial investment* Typically invested in ordinary shares No customization SMA Segregated assets (investor owns individual securities) Higher minimum initial investment* Typically invested in depositary receipts Potential customization *Minimal initial investments will vary according to a number of factors, including mutual fund share class and SMA sponsor platform Investment managers offering SMAs direct a large and growing pool of assets. Exhibit 2 Traditional Separately Managed Account Assets ($billions) $800 $799.3 $700 $600 $500 $400 2009 2010 2011 2012 2013 1Q 2014 Sources: Money Management Institute, Dover Financial Research, 2014 The above chart illustrates assets in Traditional SMA accounts only. MMI estimates an additional $127bn in Model SMA accounts as of 1Q 2014, bringing the total SMA asset pool to approximately $926bn. Please see footnote below for definitions of Traditional and Model SMA accounts.** **With a Traditional SMA account, the investment manager (e.g. Lord Abbett) determines investment direction which securities to buy or sell and executes the trades. In contrast, with Model SMA accounts the investment manager determines direction while a broker dealer (e.g. Merrill Lynch) executes the trades based on a model delivered by the investment manager. 5
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The DR Advantage Investment managers offering their non-us equity capabilities in SMA format often choose to invest in DRs instead of ordinary shares. According to Yarek Aranowicz, Portfolio Manager at Lord, Abbett & Co. one of the industry s largest SMA managers US-based investors have historically looked to DRs to help minimize certain legal and operational risks. While cross-border investment tools have improved over time, investing in DRs remains a compelling option. Retail and institutional investors can invest abroad without any problem today but there are many investors who prefer to buy US dollar-denominated assets, possibly because of the due diligence involved [in purchasing ordinary shares]. The only way to do this is to invest in common shares of foreign companies listed on a US exchange or DRs. Because DRs trade and settle in the same manner as any other security on a US exchange, they may offer lower trading and custody costs than shares purchased in local, non-us markets. As a result, while an investment manager may have the ability to own ordinary shares in an SMA, there are potential drawbacks. First, Aranowicz explains, every buy and sell would necessitate currency exchanges which would result in major expense to the client over time. Custody is also a consideration. The individual client account would have to allow for custody of non-us shares, says Aranowicz, something certain brokerage accounts may not permit. In addition, DRs pay dividends in US dollars, potentially minimizing foreign exchange issues. Finally, DRs are recognized as US securities and would therefore be permitted in portfolios in which foreign securities are prohibited. 7
Targeting the Right SMA Investment Managers Like mutual funds, SMAs are offered in multiple non-us investment styles. As illustrated in Exhibit 3 below, MMI estimates that International Equity capabilities represent approximately 11.6%, or $107bn, of the $926bn in total SMA assets. Exhibit 3 Market Share and Assets by International Investment Discipline, 1Q 2014 Discipline - International Equity Market Share Assets ($bn) International Large Value 3.9% $36.1 International Large Core 2.9% $26.9 Global Equity 1.7% $15.7 International Large Growth 1.6% $14.8 International Other 1.5% $13.9 Subtotal 11.6% $107.4 Sources: Money Management Institute, Dover Financial Research, 2014 While SMA strategies with a US focus e.g. US Large Cap Value, may occasionally invest in DRs, foreign issuers should focus their attention and marketing efforts on investment managers offering the above SMA disciplines as these strategies are more likely to utilize DRs in a meaningful way. 8
Of the 25 largest US-based investment managers offering SMA portfolios, 23 run products that invest in DRs. Deutsche Bank can connect issuers with many of these managers. Exhibit 4 Total Traditional SMA Plus Model Portfolio Assets: Top 25 Managers ($billions), 1Q 2014 Manager Assets Offers SMA DR Product(s) 1. BlackRock Financial Management $65.1 2. Legg Mason $43.4 3. Nuveen Investment Management $39.7 4. J.P. Morgan Investment Management $21.3 5. Eaton Vance $20.9 6. Neuberger Berman $18.7 7. PIMCO $18.2 8. Allianz Global Investors $14.9 9. Federated Investors $13.0 10. Lazard Asset Management $12.9 11. UBS Global Asset Management $10.9 12. Pacific Income Advisors $10.4 13. Lord Abbett $10.4 14. Columbia Management Advisors $9.8 15. Delaware Capital Management $9.5 16. Invesco Aim $8.8 17. Natixis Global Associates $8.4 18. Thornburg Investment Management $8.2 19. Manning & Napier Advisors $8.0 20. MFS Investment Management $8.0 21. Dreyfus Investments $8.0 22. Madison Investment Advisors $7.2 23. Franklin Templeton Advisors $6.5 24. Principal Global Investors $6.2 25. Brandes Investment Partners $5.9 Total Top 25 Managers $394.3 Total All Managers $898.1 Sources: Money Management Institute, Dover Financial Research, 2014 9
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The Opportunity Ahead While non-us equities now represent more than half of the global stock market universe, SMA investors remain substantially underinvested on a relative basis a phenomenon known as the home-country bias. Exhibit 5 Weights in MSCI All Country World Index*, 2014 SMA Market Share by Investment Objective, 1Q 2014 International Equity 20% International 51% Domestic 49% Domestic Equity 80% *% global market capitalization, float adjusted Source: MSCI, as of July 31, 2014 Sources: Money Management Institute, Dover Financial Research, 2014 Some research indicates, however, that this bias has been declining over time see Exhibit 6 below. Should US-based investors elect to further diversify their equity allocations through SMA portfolios, this could potentially be supportive of DR demand. Exhibit 6 Evolution of Equity Home Country Bias Weights (%) 34% 54% 88% 31% 48% 79% 29% 43% 72% Overweighting to Domestic Domestic Market as % of World Market Domestic Allocation U.S. 2001 U.S. 2005 U.S. 2010 Source: Vanguard, June 2012 11
Maximizing Your ADR Program Deutsche Bank s DR group works with issuers to ensure that marketing efforts are directed towards activities that can have a meaningful impact on program success. Be Proactive Management teams should communicate early and often with potential DR investors. For example, Lord Abbett s Aranowicz meets with corporates regularly and advises senior management to communicate immediately that they offer both ordinary shares and DRs in the US. If this seems like basic advice, consider the fact that Aranowicz and his colleagues meet with hundreds of corporates every year, yet many neglect to actively promote their DR program. Management teams rarely talk about the DRs says Aranowicz, I usually have to ask them. For corporates that do not currently offer a DR, Aranowicz recommends engaging with investment managers to uncover potential demand. If [corporates] don t have a DR, I d like to know why. I ll tell them, We have an SMA product and would love to have a DR issued! Aranowicz also suggests that management teams consider communicating with prospective investors before issuing DRs. I am on most of the releases for corporate earnings results. If [management] communicates through an earnings release that they are planning a DR issuance, that will definitely reach me and I will immediately put them on my news screen. They ll now be on my radar. 12 Getting the attention of portfolio managers prior to issuing a DR could potentially kickstart the research process and reduce the length of the manager s due diligence process once the DR is issued.
Focus on Liquidity Liquidity the ease with which a security can be bought and sold is a key consideration for portfolio managers when evaluating a DR investment. DRs are important to us, says Aranowicz, but if they don t trade at all, we can t buy them.the biggest challenge we have [with DRs] is liquidity. According to Aranowicz, a Level 3 sponsored program is typically preferred because these DRs tend to be the most liquid. One of the major issues for us as [DR] investors is liquidity. Our advice for potential issuers would be to issue a fully sponsored Level 3 DR. This will create liquidity here in the US market. At Deutsche Bank, we believe this perspective underscores the importance of working with a proactive depositary bank. Special Situations For corporates based in certain countries like India and China, DRs may complement more traditional issuance practices and help diversify an existing investor base. In India for example, corporates typically issue Global Depositary Receipts, or GDRs, which are listed in London. As a result, US-based investment managers may not be able to purchase these securities on behalf of their clients. For our SMA product, GDRs don t work even if they re denominated in US dollars, Aranowicz explains. We cannot participate because they are not listed here in the US. For Indian corporates, the message would be to issue US DRs You re already doing this, just in London. For China-based corporates offering shares that are generally available to mainland citizens only, issuing a US-listed DR may help broaden the shareholder base. There are some companies with A shares that are listed only in China, but they also have DRs. We d buy the DRs because we can t buy the A shares. There are also instances as is the case of Taiwanese issuers in which DRs may be seen as offering advantages over ordinaries within both SMAs and mutual funds. In order to purchase local shares, we would need Taiwanese dollars, says Aranowicz. For instance, if we want to buy Taiwan Semiconductor Manufacturing overnight in Taiwan and we don t already have Taiwanese dollars in an overseas account, we can t do it. We d have to wait three days until the US dollars are converted into Taiwanese dollars and then we can buy. After three days, the stock could have moved five or ten percent. In the case of a Taiwanese company with a liquid DR, we would definitely buy the DR [instead of the ordinary]. In Taiwan, we will always buy DRs. 13
Deutsche Bank - A Focused Approach By leveraging Deutsche Bank s strength and expertise in the following areas, issuers can develop a coordinated approach to targeting SMA managers investing in DRs. We serve as the depositary bank for more than 350 sponsored programs and more than 700 unsponsored programs, globally We maintain close communication and cooperation with our regional equity sales and research teams We have a leading Corporate Access franchise, with regular collaboration between the regional teams and Deutsche Bank s DR IR Advisory team We ensure an ongoing dialogue between Deutsche Bank s Broker Services and IR Advisory teams and external investment managers In addition to access to the DR team s proprietary databases for targeting capabilities both at the mutual fund and SMA levels Deutsche Bank will facilitate next steps to connecting with investors. These may include: 14 Comprehensive ownership and peer analysis to identify and prioritize DR-focused investment managers Recommendations on structuring multi-city roadshows in the US and abroad Market intelligence and trading insights, ensuring issuers are in front of the true decision-makers Introductions to industry contacts, including key investment manager contacts Candid post-meeting feedback
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For further information please contact: Zafar Aziz Issuer Services Head of Depositary Receipts Market Solutions +44 20-7545-6619 zafar.aziz@db.com Michele Backman Issuer Services Depositary Receipts IR Advisory +1 212-250-4085 michele.backman@db.com This brochure is for information purposes only and is designed to serve as a general overview regarding the services of Global Transaction Banking. The general description in this brochure relates to the Global Transaction Banking services offered to customers as of March 2014, which may be subject to change in the future. This brochure and the general description of the services of Global Transaction Banking are in their nature only illustrative and do not therefore contain or cannot result in any contractual or non-contractual obligation or liability of Deutsche Bank AG or any of its affiliates. Copyright September 2014 Deutsche Bank AG. All rights reserved. 16