Peter Kraus Year-End Letter 2021

Dear Friend,?

With the start of any new year, I always find it interesting to look back at the past, and ahead to the future.???

Looking Back at 2021?

Equity returns in 2021 were strong in most large markets, but not all.? For most of the year, credit spreads tightened, reflecting a low volatility environment. Yields showed signs of moving higher despite a few false starts.? And in the global marketplace, equity beta was undeniably the dominant source of return.? Flows to equity exceeded the total of the ten previous years combined, and we saw this enthusiasm play out clearly in developed markets.? Returns for the largest market – the US – were over 25%,1 and they were dominated by an increasingly narrow group of companies.? In this environment, more than half of active managers did not outpace their benchmarks; meanwhile small cap equities proved the exception, a category in which a stunning 85% of managers beat the benchmark.2? In global portfolios, geographic mix was critical as China significantly underperformed against the US, Europe and Japan; and given China’s size, if you did not get China positioning “right,” performance was hard to come by.?

Credit investors continued to battle low-to-negative real yields and historically tight spreads across investment grade and high yield segments.? This made it a challenge to find absolute returns, to say the least.? We saw allocations to private credit continue, as well as to levered credit vehicles where absolute returns were more acceptable.?

Aperture’s AUM grew by just over 30% as a result of net new third-party assets, market appreciation, and additional seed capital committed to our managers.? Over our seven strategies, three successfully beat their benchmarks, and four underperformed their benchmarks in 2021; inception-to-date, five of seven are exceeding their respective benchmarks.? While we have only been investing money for three years (starting when we launched our emerging markets debt strategy on January 2, 2019), we are proud of what our managers have accomplished in that time. We also continue to believe that our fee structure is the foundation of an ecosystem that will deliver more reliable outperformance net-of-fees over time.? Over the course of 2021, we improved the supporting infrastructure for our managers, implemented a fulcrum fee model in Europe on our UCITS platform, grew third party assets and are implementing ESG practices throughout the firm.??

Looking Forward to 2022?

2022 will reflect the impact of normalization.??

We should expect interest rates to normalize along with the Fed and other central bank balance sheets. We should experience a period of normalization of inflation rates; high transitory inflation will give way to more normalized levels. The global effects of the pandemic should recede as vaccination prevalence continues to increase, new vaccines and protocols are introduced and herd immunity develops. Equity markets should also normalize. The 26% compound annual growth rate, or CAGR, for the S&P 500 over the past three years is well above long-term historical levels. The last time we saw this kind of inflated return was in the late 1990s when CAGR for 1997-1999 was 26%. Returns for the five-year period from 1995-1999 were also 26%.? And although the down year in 2018 makes the three-year return ending 2021 quite flattering, the five years ending 2021 produced an 18% CAGR, less than previous periods of high return but still much higher than the long-term average. Ten-year US Treasury rates averaged 1.9% over the past five years, proving that higher absolute levels do not necessarily prevent equity markets from outperforming. Equity performance is all about earnings growth rates, and whether those growth rates are accelerating, stabilizing or declining.???

Rising rates, strong labor markets and stable-to-growing wages, higher input price inflation, slowing of pandemic-induced fiscal spending and normalized growth in consumption all lead me to the following conclusion: equity markets should expand over this coming year, albeit with drawdowns and a 12-month total return that, while positive, is likely much closer to long-term historical averages. Equity risk premiums will increase but equity returns will still exceed those of fixed income. In my view, investors should think about gaining exposure to real assets that benefit from normalized inflation. Longer-duration assets will continue to experience drawdowns and total return headwinds. Carry trades funded with short term capital will struggle with the normalization of short rates as the Fed moves its lending rate higher over the year. Carry trades funded with floating rate debt will still experience some pressure from spread expansion as rates rise.?

Forecasting Chinese markets in 2022 is a bit more challenging given the sizable impact of unknowable government actions on everything from growing technology firms, to unregulated sectors which the government may decide to rein in, to property markets and their related lending activities where supporting (or not) policy can materially change underlying risk. In this context, under- or over-allocating to China feels like a risk not worth taking. In my opinion, these are prudent portfolio modifications for 2022: 1) greater exposure to real assets, 2) neutral exposure to China, and 3) recognizing that the Fed will sell assets in an attempt to normalize its balance sheet, neutral exposure to financials that benefit from rising rates and loan growth.?

Over the past five years, markets have been relatively less discerning when it comes to earnings growth rates. Given the expected change in these rates, active managers with a proven ability to evaluate earnings growth will outperform. Assuming that fast-growing companies will continue to underperform is not rational; investors will continue to prefer earnings streams with persistently faster growth than the alternative. Higher rates do not undermine this idea nor render it irrelevant. That is why we believe equity markets appreciate even when interest rates are increasing from low levels.?

In closing, I want to thank all of you for entrusting us with your capital.? We take our charge seriously and believe our objective is to deliver investment returns in excess of our benchmarks. If we do not do that over time then we are not delivering on our value proposition. So far, we believe we are meeting that objective.? Let’s see how we do in 2022. Best wishes for a profitable, healthy and successful year.?

Best regards,?

Peter Kraus?

Aperture Investors Founder & CEO?

P.S. A word about NFTs?

NFTs (or Non-fungible Tokens) have certainly captured investors' imaginations, but there is not yet a proven way to value them quantitatively.??

In the case of the visual arts market, legal rights and copyrights for the image encoded in an NFT have not been tested, and these issues are not widely understood. I would therefore characterize any large investment in an NFT as highly speculative.?

Having said that, NFTs do contribute to the democratization of the visual art form by substantially reducing distribution friction inherent in the existing business model. I would expect investors to continue purchasing visual art NFTs to experiment with new distribution platforms and ownership vehicles.?

NFTs are also helping to drive the world of fractional ownership. Here, the underlying collectible asset may or may not have a more measurable value. But whether it does or does not, the trading value of the fractional ownership interest is very much driven by supply and demand at the point of pricing. Because values tend to be volatile there can be a great deal of speculation, but they also enable a broader group of investors to own pieces of an asset that might otherwise have been out of reach. And the structure also provides liquidity for an otherwise illiquid holding.? I would expect this market to continue growing as collectors find more ways to own and trade fractions of more assets.?

P.P.S. A modest proposal for ESG?

ESG has been an important theme for some time. But over the last few years investor and regulatory interest has skyrocketed. Increasing capital flows to good ESG companies while depriving poor ESG companies of it does seem like good public policy.??

But the increasing prevalence of ESG products and messaging has become quite messy for the end investor. A multitude of data providers, standards and objectives muddy the waters. So, I would propose something similar to what we have for financial statements – a standardized regulatory framework for ESG reporting. We have a Reg SX so we can reliably compare one company’s financial statements to another. There’s no reason we shouldn’t also have a Reg ESG so that we can just as reliably compare one company’s environmental impact, social impact and governance with another.?

This kind of rationalization is critical because incentivizing or forcing companies to better exhibit E, S, and G qualities undeniably has a cost. And frankly, this cost is unknown. If, for example, socio-economically disadvantaged people are denied heat in the dead of winter because, it could be argued, ESG standards played a role in creating an under-production of coal power in their region, then we’ve not only failed from an ESG perspective, but we’ve created tragic harm to a vulnerable community. Better data driven by clearer ESG standards and requirements can help. A little daylight goes a long way.?

As investors, we have always been interested in ESG factors and the assessment of the ethical standards and culture of management teams and organizations. We believe that more ESG information, not less, would empower investors to evaluate impact far more effectively. Relying on outsiders to extract, uncover or otherwise divine this information without consistent standards, by definition, leads to inconsistent data between companies and potentially inappropriate valuations.?

We should recognize that ESG is in its infancy. But the change we need to see in our world and in our markets will not wait for it to mature. We need to act now. Investors should demand that regulators and companies create an ecosystem that provides for a level playing field and accurate, relevant and audited information so that investors can allocate their capital in a way that results in optimal cost of capital.??

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IMPORTANT INFORMATION?

This letter is for information purposes only and does not provide any professional investment, legal, accounting nor tax advice. All information and opinions contained in this note represent the judgment of Aperture Investors, LLC (“Aperture”) at the time of publication and are subject to change without notice. For more information about costs, risks and conditions in relation to an investment or a service, please always read the relevant legal documents. This note may not be reproduced (in whole or in part), transmitted, modified, or used for any public or commercial purpose without the prior written permission of Aperture. Recipients of this information are deemed to be investment professionals and/or qualified investors that have employed appropriately qualified individuals to manage their financial assets and/or are appropriately informed and experienced as to understand the associated risks of investment. To the extent that any opinions or forecasts are provided, they are as of the dates indicated, are subject to change without notice and may not be revised, may not be accurate and do not represent a recommendation or offer of any investment. Although all reasonable care and attention has been given to the data provided, no liability is accepted for any omissions or errors. Data contained herein should not be relied upon as the basis for any investment decision.?