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AG Mortgage Investment Trust (MITT) Q2 2021 Earnings Call Transcript – Motley Fool

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AG Mortgage Investment Trust (NYSE:MITT)
Q2 2021 Earnings Call
Jul 30, 2021, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to AG Mortgage Investment Trust second-quarter 2021 earnings call. My name is Sylvia, and I’ll be your operator for today’s call. [Operator instructions] Please note that this conference is being recorded. I will now turn the call over to Jenny Neslin.

Jenny, you may begin.

Jenny NeslinGeneral Counsel and Secretary

Thank you, Sylvia. Good morning, everyone, and welcome to the second-quarter 2021 earnings call for AG Mortgage Investment Trust. With me on the call today are David Roberts, our chairman and CEO; and T.J. Durkin, our president; Nick Smith, our chief investment officer; and Anthony Rossiello, our chief financial officer.

Before we begin, please note that the information discussed in today’s call may contain forward-looking statements. Any forward-looking statements made during today’s call are subject to certain risks and uncertainties, which are outlined in our SEC filings, including under the headings cautionary statement regarding forward-looking statements, risk factors and management’s discussion and analysis. The company’s actual results may differ materially from these statements. We encourage you to read the disclosure regarding forward-looking statements contained in our SEC filings, including our most recently filed Form 10-K for the year ended December 31, 2020, and our first-quarter 10-Q.

Except as required by law, we are not obligated and do not intend to update or to review or revise any forward-looking statements, whether as a result of new information, future events or otherwise. During the call today, we will refer to certain non-GAAP financial measures. Please refer to our SEC filings for reconciliations to the most comparable GAAP measures. We will also reference the earnings presentation that was posted to our website this morning.

To view the slide presentation, turn to our website, www.agmit.com, and click on the link for the second-quarter 2021 earnings presentation on the home page in the investor presentation section. Again, welcome to the call, and thank you for joining us today. With that, I’d like to turn the call over to David.

David RobertsChairman and Chief Executive Officer

Thank you very much, Jenny, and good morning to everybody. Since our last call, AG Mortgage Investment Trust has made great progress in our transition to a company focused on residential mortgage origination and securitization. On the buy side of our business, in the second quarter, we purchased $446 million of non-QM loans from our affiliate, Arc Home, as well as third parties. In June, we completed a non-QM securitization of $224 million, raising non mark-to-market, non-recourse financing on these assets.

Additionally, Arc Home doubled its production of non-QM loans during this quarter to $376 million. Going forward, we intend for our business model to be fueled primarily by non-QM and other residential origination followed by securitizations on a quarterly or more frequent basis. On the sell side of our business, we have sold all of our CMBS and certain RMBS positions throughout the quarter and subsequent to quarter end, supporting our continued transition. We also have good reason to believe we are progressing toward being paid off on our two remaining commercial real estate loans.

The CMBS sales have resulted in favorable gains during and subsequent to quarter end, and potential payoffs of the commercial loans are expected to be favorable to our second-quarter remarks. These completed and anticipated sales provide ample liquidity to fund continued expansion of our go-forward business model. In terms of our financial results for the quarter, our book value increased by 3%, driven by earnings of $0.70 per share. This is after accounting for the declared second-quarter dividend of $0.21 per share.

Both per share numbers are on a post-split basis. Core earnings for the quarter were approximately breakeven. However, the definition we use for core earnings does not capture important elements of our go-forward business strategy. Specifically, core earnings do not include MITT share of the gain that Arc Home recognizes when it sells loans to us, nor does it include earnings that MITT recognizes when we securitize the loans purchased from both Arc Home and third parties.

As I mentioned before, the sales of commercial assets have and are expected to continue to increase our liquidity. This comes at the short-term cost of reduced net interest margin. But more importantly, in the longer term, this liquidity will enable us to continue growing our origination securitization strategy, a strategy, we believe, offers a superior risk reward to AG Mortgage Investment Trust and its shareholders. For our dividend policy going forward, we will be looking most closely at those earnings metrics that most accurately reflect the evolution of our business strategy.

And as we always do in our dividend policy, we will consider not only the current quarter but our outlook for earnings over the intermediate term. Thanks very much. And with that, I will turn it over to T.J. Durkin.

T.J. DurkinPresident

Thank you, David, and good morning, everyone. To dig a bit deeper into the company’s activity during the quarter, we were active in purchasing $446 million of non-QM loans during the quarter from five originators, including our mortgage affiliate, Arc Home, which originated $376 million during the quarter with MITT purchasing approximately 50% of that production. MITT contributed loans into two securitizations during the quarter, and we intend to be very disciplined with regards to the pacing of our securitizations to de-risk our warehouse lines. In other asset classes, we continue to prudently dispose of non-core assets and repositioning to MITT’s forward-looking strategy by selling CMBS and other RMBS securities where we don’t have any control or access to the underlying whole loans.

During the quarter, we also reduced our exposure to agency MBS as we thought the basis had reached a point where further tightening was unlikely. Subsequent to quarter-end, we sold the remaining CMBS positions and a slight gain from Q2 marks, generating gross proceeds of $34 million, or approximately $15 million of equity proceeds. And moving on to our capital activity during the quarter, we successfully utilized our ATM program to raise $3.1 million of fresh capital by issuing 226,634 shares at an average price of $14.21 per share adjusting for the split. We also completed our fifth exchange with a preferred holder, exchanging 240,861 shares of preferred for 429,802 shares of common.

This brings our cumulative preferred to common exchange notional at approximately $51 million of par value. And lastly, we completed a one-for-three reverse stock split, which went effective July 22 with the ultimate goal of reducing volatility in the stock price into the future. Now, turning to slide six. Our investment portfolio grew slightly over the quarter based on the rotation I previously mentioned out of agency MBS and CMBS into non-QM whole loans.

Turning to slide seven. We made progress increasing our allocation to non-QM by nearly doubling the fair value as a percentage of our investment portfolio from 19% to 37% this quarter. Also, given the strength in the housing market, we are seeing solid performance with regard to our land-related financing, and we expect lot takedowns to run this asset class off organically over the coming 12 to 18 months while we earn a healthy yield. On slide eight, we present our CMBS and commercial real estate exposure.

As previously mentioned, subsequent to quarter end, we exited the single asset, single borrower CMBS securities for gross proceeds of $33.7 million. Currently, MITT only has two remaining commercial real estate loans left under our commercial designation, and we wanted to provide some more detail today. Commercial loan K is a first lien construction loan to a recently completed and fully opened destination hotel in Times Square. The loan continued making interest payments during COVID, but its original maturity date was due in May of this year.

MITT’s loan exposure is part of a larger consortium and is actively engaged with the lender group on working toward a productive resolution in the near term. However, we can’t guarantee such resolution will occur. We are very comfortable with our basis in the finished product. Commercial loan L is a fully drawn loan to a hotel located off the Magnificent Mile in Downtown Chicago.

Immediately following the initial COVID shutdown, we completed a modification with the sponsor in September of 2020, turning off the cash coupon and letting the deferred interest accumulate. However, we did not accrue interest income during this quarter — during this period. In exchange for the interest deferral, we received an additional $2.1 million of equity. We remain in close contact with the sponsor and have seen operating metrics continue to improve into the larger reopening.

On slide nine, you can see we continue to be able to create an agency MBS book with better prepayment performance due to our size and selectiveness when purchasing specified pools. A reduction in agencies was solely based on relative value, not based on performance. We will continue to use agency MBS to absorb excess liquidity when at prudent valuations and to meet our ’40 act tests. And lastly, in June, we entered into an agreement to sell all our remaining excess MSRs, which we’ll settle during the third quarter.

With that, I’ll turn the call over to Nick.

Nick SmithChief Investment Officer

Thank you, T.J., and good morning, everyone. Turning to slide 10. Year to date, we’ve acquired over $650 million of non-QM loans with over $250 million acquired from our affiliate Arc Home. In July, we increased our uncommitted warehouse capacity to $1.1 billion to accommodate future acquisitions while simultaneously terming out approximately $224 million of non mark-to-market and non-recourse debt.

We also securitized approximately $171 million of non-QM loans alongside other Angelo Gordon funds within an unconsolidated joint venture. The remaining assets held in this joint venture are primarily retained interest from other prior — or from prior securitizations. The tables on this page show the continued delinquency curing over the past year for our non-QM portfolio, along with collateral characteristics of our current borrower base. Subsequent to quarter end, we also entered into agreements to acquire GSE-eligible nonowner-occupied pools.

In connection with these acquisitions, we added $500 million of uncommitted warehouse capacity specifically for GSE-eligible loans. We expect these credits to continue to offer attractive risk-adjusted returns and look forward to adding additional sellers and capacity. Moving on to slide 11. This page provides a high-level summary of the performance of our credit-sensitive loan positions over the past 12 months.

As you can see, this portfolio has benefited from strong housing tailwinds and historically low mortgage rates. Prepayment speeds have increased significantly and approximately 75% of the borrowers that received COVID-related assistance are either contractually current or making payments on a loss mitigation plan. Over the past year, approximately 30% of the portfolio has been liquidated through a combination of opportunistic loan sales, voluntary and involuntary prepayments. Turning to slide 12.

As mentioned in previous quarters, Arc Home, our licensed mortgage origination affiliate, continues to benefit from being one of the first originators to reenter the non-QM business. The tables below clearly show the benefit of these early investments as Arc Home’s non-QM volumes offset declines in agency volumes and was able to mitigate margin compression during the quarter. Mark-to-market losses in Arc Home’s MSR portfolio driven by lower nominal yields and a full flattening of the curve generated pre-tax net losses of $3.7 million resulting in $2.7 million of losses from MITT, which does not include $1.4 million of gains recognized by Arc Home in connection with its mortgage loan sales to MITT. With that, I’ll turn it over to Anthony.

Anthony RossielloChief Financial Officer

Thank you, Nick, and good morning. Before providing an update on the second quarter, I wanted to reiterate that we completed a one-for-three reverse stock split post quarter end, which became effective on July 22. This reduced our common shares outstanding from approximately 48.5 million to 16.2 million. As a result, you will see that we adjusted all common share and per share metrics within our press release, earnings presentation and 10-Q on a retroactive basis to reflect the reverse split for all periods presented.

With that being said, during the first quarter, we reported net income available to common stockholders of approximately $10.9 million or $0.70 per fully diluted share. Earnings during the quarter were driven by mark-to-market gains on residential and commercial assets within our portfolio, along with realized gains from the sales of certain RMBS and CMBS. These gains were offset by mark-to-market losses within our interest rate swap portfolio driven by the decline in interest rates during the quarter, as well as the previously mentioned loss from our 45% equity method investment in Arc Home, resulting from mark-to-market losses on its MSR portfolio. Operating expenses increased slightly from the first quarter.

However, this was attributable to transaction expenses related to the non-QM securitization that occurred in June. On slide 14, we provide a reconciliation of our book value per common share, which increased by $0.41 during the quarter. This increase reflects our current quarter earnings offset by the preferred and common dividends declared during the second quarter. And you’ll also see the increases related to a preferred stock exchange transaction entered into during the quarter, as well as net proceeds raised from issuing common stock through our ATM program approximating $3 million.

As discussed on our previous earnings call, we also disclosed adjusted book value per common share of $14.72, which is computed based on total equity less the entire liquidation preference of our preferred stock. Turning to slide 15. We disclosed a reconciliation of GAAP net income to core earnings for the second quarter, where you will see core earnings was breakeven for the quarter. One item to note is that core earnings does not include $1.4 million of gains Arc Home recognized during the quarter on loans sold to us.

Lastly, we ended the quarter with total liquidity of $71 million, which is inclusive of $64 million of cash, and $7 million of unlevered agency RMBS. This improvement in liquidity from the first quarter was a result of the previously mentioned two non-QM securitizations transacted along with the sale proceeds on our MBS portfolio offset by the purchase activity to grow our non-QM portfolio. This concludes our prepared remarks, and we would now like to open the call for questions. Operator?

Questions & Answers:

Operator

[Operator instructions] And our first question comes from Doug Harter from Credit Suisse.

Doug HarterCredit Suisse — Analyst

Thanks. Can you just talk about the level of competition kind of in the QM market today and how that — how returns still look today versus kind of the early days where Arc was one of the first movers?

Nick SmithChief Investment Officer

Of course. There certainly is more competition. That being said, capacity has returned to the market as sort of agency stuff has run off or refis have runoff, and we still see plenty of opportunity to buy these assets and others at attractive levels. And we don’t see that changing in the near future.

Doug HarterCredit Suisse — Analyst

Got it. And then could you just compare the relative attractiveness of returns of kind of non-QM versus nonowner-occupied loans and kind of which is a more attractive opportunity today?

Nick SmithChief Investment Officer

We see them fairly comparable. If anything, in the non-QM side, a lot of those positions are investor properties already and they’re fairly similarly priced. On the agency side, we just — it’s one of those things where we expect that to be opportunistic and to be sort of interesting opportunity for the coming years, and we expect pricing to come in and out, and we’ll obviously keep the relative value between the two products in mind.

Doug HarterCredit Suisse — Analyst

Got it. And then just one kind of accounting question. You mentioned that there was the negative MSR mark at Arc Homes. What was the size of that? And I guess how would the profitability of Arc have looked if you excluded the net MSR mark?

Anthony RossielloChief Financial Officer

The net MSR mark was down about 4 million for the quarter. So if you think about pulling that out from earnings, you’d probably be around plus 2 million — 2 to 3 million during the quarter without the MSR markdown.

Doug HarterCredit Suisse — Analyst

Great. And then so even if you stripped out the 1.4 million of gains, I guess, the contribution to you would be, I guess, closer to slightly positive to closer to breakeven versus the two point — or versus the loss you mentioned?

Anthony RossielloChief Financial Officer

That’s correct. One clarification of the mark-to-market loss that I mentioned was pre our 45% share. So that $4 million, we would only get 45% of that.

Doug HarterCredit Suisse — Analyst

OK. That makes sense. Thank you very much.

Operator

Next question comes from Bose George from KBW.

Bose GeorgeKBW — Analyst

Good morning. Actually, just first, just a clarification. You mentioned that the mid-quarter earnings doesn’t include the sales of the Arc Homes to MITT. Can you just remind me what from Arc is included in the core earnings?

Anthony RossielloChief Financial Officer

Their operating business, which is their gain on sale on the agencies and the non-QM that are not sold to us are included in core.

Bose GeorgeKBW — Analyst

And is there — like, in terms of what you buy from them, is that percentage going to remain stable because it seems like if it increases, you almost kind of hurt your core income, right, because it won’t count?

Anthony RossielloChief Financial Officer

Yeah, that’s correct. It has remained stable. We have bought approximately 50% of the production from non-QM from them, but your thinking is correct.

Bose GeorgeKBW — Analyst

OK. Great. And then if you just — sort of looking forward, I guess what are kind of the things that need to happen to get to a more whatever normalized core number? I mean, obviously, from an economic return, your returns are good, but I feel like a lot of people focus on core. So just what’s the best way to kind of think about that?

David RobertsChairman and Chief Executive Officer

This is David Robert answering that. I think the best way to think about this is that this quarter, and in all likelihood, the next few quarters, we’re in a transition to the new business model or to the go forward, I should say, business model. So it’s a mix of the two. We’ve got legacy assets that we’re rotating into first cash and then into our origination securitization business, and that’s going to take some time.

Bose GeorgeKBW — Analyst

OK. That makes sense. Great. Thanks.

Operator

Our next question comes from Trevor Cranston from JMP Securities.

Trevor CranstonJMP Securities — Analyst

Hey. Thanks, good morning. I wanted to clarify something on the commercial loans, and thanks for all the additional detail on those. In the prepared comments, I think you made the comment that you were hopeful that there could be a payoff on those in the near term.

I just wanted to clarify, was that comment related to both of the loans? Or was that maybe more directed toward the construction loan in particular?

T.J. DurkinPresident

Yeah. I mean, I would say it’s more — it’s obviously, we’re working with the borrower on the maturity issue on that loan in particular. I think obviously on the other loan, we fully anticipate that coming out of the modification period, it will remain contractually current, and they could pursue other financing options at that point.

Trevor CranstonJMP Securities — Analyst

OK. And can you remind us when that period ends?

T.J. DurkinPresident

Yeah. It was a one-year modification from last September. So it will end this September.

Trevor CranstonJMP Securities — Analyst

OK, got it. And then, on the GSE non-owner — GSE-eligible non-owner-occupied loans, can you maybe talk about that opportunity a little bit more and help us think of kind of what the potential market size is there relative to the sort of more traditional non-QM opportunity?

Nick SmithChief Investment Officer

Yeah, certainly. So historically, the supply of — or origination of investor properties via the GSEs or Fannie and Freddie has ranged from approximately 75 to 95 billion a year. It’s not had — it doesn’t have nearly sort of the same sort of cyclical impacts. So if anything, if this refi comes off, essentially, you’re lowering your denominator of other nonowner acquired assets.

So as that denominator goes lower, that 7% cap that’s been instituted in the latest PSPA or amendment with Fannie and Freddie, the assumption is that that will sort of normalize and that excess will be higher. So if — obviously, if the number goes to 12%, you have to solve for that excess of 7%. That being said, even prior to this, a good portion of GSE loans actually best expect and offered attractive returns for investors like ourselves. And our expectation is as originators get more familiar with selling to the private markets away from Fannie and Freddie that this space could grow.

Now, exactly how much of sort of the overall market, we’ll ultimately see, there’s a lot of factors that go into it. But at least it’s a decent sized notional.

Trevor CranstonJMP Securities — Analyst

Got it. OK. That’s very helpful. And then last thing, I think you noted that you guys had a short TBA position in the second quarter.

Can you say how large that position is and if you’re still carrying that into the third quarter?

Anthony RossielloChief Financial Officer

The position size is 130 million notional on the TBA that went on at quarter-end.

Trevor CranstonJMP Securities — Analyst

All right. Thank you.

Operator

Our next question comes from Jason Stewart from JonesTrading.

Jason StewartJonesTrading — Analyst

Hey. Good morning. A couple of follow-ups. On commercial loan, is the mark at 6 30 at 86% of part reflective of the coupon or your confidence in the payoffs?

T.J. DurkinPresident

Well, the mark — we use third-party vendors to help us determine the mark. So it’s 86% of par, which is a $51 million notional.

Jason StewartJonesTrading — Analyst

So is your thinking updated that you’re going to get a full par payoff at September 30 when the modification period is over?

T.J. DurkinPresident

Well, no. At September 30, their coupon will turn back on. And I think we’ll see what pricing vendors, how they view this sort of modifications that are all starting to expire, if you will, right? We’re kind of getting to that point in the calendar from a year ago. So I don’t have any certainty into how they’ll look at that, but we would expect that based on our conversations that the loan will start cash paying come Q4.

Jason StewartJonesTrading — Analyst

OK. So not necessarily a payoff, but it will be turned back on. OK, got it. And then if you can update us on book value quarter to-date, if you don’t mind.

Anthony RossielloChief Financial Officer

Yeah. Book value quarter-to-date was up 3%, approximately, and that was primarily driven by some of the mark-to-market gains that we’ve been talking about in the resi and commercial portfolio, as well as some of the realized gains through the sales that we mentioned during the quarter.

David RobertsChairman and Chief Executive Officer

Was your — I’m sorry, was your question about this third quarter that we’re in now? Or was it looking back to the third quarter?

Jason StewartJonesTrading — Analyst

Yeah, David, to the latest point available.

David RobertsChairman and Chief Executive Officer

Yeah, we’re not — we’re just going to stick with what we’ve reported.

Jason StewartJonesTrading — Analyst

OK. And then on the Arc MSR, when we look at that portfolio, can you give us any detail in terms of what SATO looks like or maybe like what a plus 50 or 100 move in the rates market looks like for the valuation of that MSR?

T.J. DurkinPresident

Well, just to be clear, so we sold the third-party purchased MSR. So the volatility going forward will be lower. And I would say we’re not, at this point, really reporting like SATO or shifts. The goal is really to reduce that volatility in that business and really have them focused on the origination side.

Jason StewartJonesTrading — Analyst

OK. OK. Last one for me then. I guess I understand sort of the rationale for the TBA sort of given valuations in the space, but how does that fit into the overall hedging strategy? And what’s your propensity to carry that position going forward?

Nick SmithChief Investment Officer

This is Nick. So part of the TBA short is the contemplation that we’ll be selling debt off of the recently acquired GSE positions. And when you think about when you sell that debt, it’s benchmarked versus TBA. So when you actually go sell that debt to third parties in the market, your benchmark is TBA because you’re selling loans backed by agency collateral.

So it’s really just a hedge similar to other hedges we put on against non-QM loans.

T.J. DurkinPresident

So Jason, yeah, I mean basically the pricing convention for traditional non-QM debt is off of swaps. And then for AAA seniors on the agency-eligible, it will be benchmarked off TBAs.

Jason StewartJonesTrading — Analyst

OK. Thanks for taking the questions. Appreciate it.

Operator

Our next question comes from Eric Hagen from BTIG.

Eric HagenBTIG — Analyst

Thanks. Good morning. Hope you guys are well. Within the debt and equity of affiliates, can you give a snapshot of what the balance sheet looks like there, including the amount of capital that’s sitting at Arc Home?

Anthony RossielloChief Financial Officer

Sure. In that line item, Arc Home is approximately $51 million of equity in that balance and then we also have approximately $30 million investment in a joint venture where we historically acquired non-QM. If you recall, we’re now acquiring the non-QM directly into the REIT. And then the other asset in there is approximately $80 million of the land-related financing that T.J.

mentioned earlier.

Eric HagenBTIG — Analyst

Got it. OK. That’s helpful. And then on the non-QM securitizations, how much leverage are you guys applying to the retained tranches to get to the return profile that you outlined in the deck?

Nick SmithChief Investment Officer

Somewhere between one and a half to two and a half turns.

Eric HagenBTIG — Analyst

OK. And are those mark-to-market, refill?

Nick SmithChief Investment Officer

Correct.

Eric HagenBTIG — Analyst

Right. All right. Thank you.

Operator

Our next question comes from Jim DeLisle from Seven Canyon [ph].

Unknown speaker

Good morning, folks. The MSI, I’m presuming that Arc continues to carry some MSR on its self-generated portfolio.

Anthony RossielloChief Financial Officer

Yeah, that’s correct.

Unknown speaker

And that would be in the $50 million or so line item you just referenced to Eric Hagen.

Anthony RossielloChief Financial Officer

It’s embedded within — the way that we account for it is we bring — we show the net equity that we own of Arc, we don’t look through into Arc Home’s balance sheet within our financials, but the asset would be flowing up into that net equity.

Unknown speaker

Right. Can you give us some understanding as to what percentage of that $50 million carrying value of your holding of Arc is represented by the MSR of their self-generated portfolio?

T.J. DurkinPresident

Jim, we don’t have that number in front of us, but we can look into that.

Unknown speaker

Great. Thank you very much. That’s my only question.

Operator

We have no further questions at this time. I’ll now turn the call over to our host for closing remarks.

Jenny NeslinGeneral Counsel and Secretary

Thank you, Sylvia. And thank you for — to everyone for joining the call today. Enjoy the rest of your weekend.

Operator

[Operator signoff]

Duration: 35 minutes

Call participants:

Jenny NeslinGeneral Counsel and Secretary

David RobertsChairman and Chief Executive Officer

T.J. DurkinPresident

Nick SmithChief Investment Officer

Anthony RossielloChief Financial Officer

Doug HarterCredit Suisse — Analyst

Bose GeorgeKBW — Analyst

Trevor CranstonJMP Securities — Analyst

Jason StewartJonesTrading — Analyst

Eric HagenBTIG — Analyst

Unknown speaker

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Putting Money Where the Stats Are: The Case for Gender-Balanced Investing – International Banker

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By Nada Shousha, Vice-Chair, Egyptian American Enterprise Fund and Adviser, International Finance Corporation, and Amal Enan, Chief Investment Officer, American University in Cairo

We invest in strong management and solid businesses, regardless of gender”—this is common rhetoric of fund managers, whose industry is historically dominated by men. Less than 1 percent of the $70 trillion of global financial assets is managed by minority- or women-owned firms1U.S. Securities and Exchange Commission: Diversity and Inclusion Report.. As allocators of capital, we’ve become numb to reading management reports of publicly listed companies dominated by men; in fact, only 0.01 percent of all IPOs (initial public offerings) in the United States were led by female founders. We also know that it takes a village to get there, and early backers determine where founders end up. So, where are the investors in female founders along their journeys? Is being gender blind leading us to miss out on the larger opportunities?

Creating inclusive markets that solve problems of limited access to healthcare, education, financial and other services hinges on enabling diverse business leaders. Women are not only half of the market and a large part of the labor force, but they are also drivers of household expenditures. Their inability to access markets excludes entire families from better standards of living.

Countless studies have shown the benefits that materialize from gender diversity in building companies that deliver both financial returns and social benefits. Yet, in the venture-capital and private-equity (VC and PE) industries, which provide entrepreneurs with access to funding when public-equity markets and debt may be less viable sources of capital, women remain severely underrepresented as investment decision-makers and as capable investees and recipients of growth funding.

Billions of dollars are invested in growing startups every year; 2 percent of those dollars go to female founders2Fast Company: “Why it’s incredibly rare for companies led and founded by women to IPO,” Leslie Feinzaig, July 16, 2021.. The lack of diversity is even more pronounced in emerging markets and is dismal in the Middle East and North Africa (MENA), where we both work. Venture funding in the region reached record highs, crossing the billion-dollar mark in 20203Magnitt: “MENA HI 2021 Venture Investment Report.. In contrast, female founders receiving funding represented only 6 percent of the total VC and PE funding available in MENA4International Finance Corporation: “Moving Toward Gender Balance in Private Equity and Venture Capital,” 2019.. This is not just a missed opportunity; it’s a grave market fail.

When talking to women business owners, we often ask why fundraising is a challenge. Looking at their pace of growth, funding remains a critical constraint. The data reveals that the median female-led business receives 65 percent of the funding received by the median male-led business. Female founders tend to receive funding at the earlier stages from accelerators and incubators, then fall out of the arena in later (and larger) funding rounds. Male-led businesses are more likely to receive second-time funding than female-led businesses—17 percent versus 13 percent, respectively.

One often-cited limitation is, sadly, behavioral: “I’m not investor-ready”. Women are significantly more conservative in fundraising and avoid investors until they reach higher milestones in their businesses. Further challenges arise around where to meet with investors—here, culture plays an important role. Since most networking events happen during kids’ bedtime hours or over drinks, women in MENA tend to be excluded from the conversation. Social norms are one reason why women entrepreneurs are less likely to go after growth industries. One MENA female founder openly said on a roadshow, “I’d love to see male founders get asked: ‘Who’s taking care of the kids while you are fundraising?’” During due diligence, the founder of a last-mile delivery company was repeatedly asked, “But isn’t logistics too operations heavy for a woman?”

By and large, the anecdotes are many, and there is limited data to quantify the challenges. A few success stories do exist, placing some of MENA’s female founders in the spotlight, as was the case for the exit of the ecommerce platform Mumzworld or the acquisition of the events-management technology platform Eventtus by a US-based player. Speaking to women business leaders, each has battle scars to show and a common sentiment to share: “It was lonely. We rarely found women investors on the other side of the table.”

The VC and PE industries are still largely homogenous. Men comprise 90 percent and 85 percent of investment committees in both, respectively. That’s where decisions are being made and where the future of what our markets will look like is determined.

A mere 11 percent of senior investment professionals in emerging markets’ private equity and venture capital are women. Representation falls to 8 percent when excluding China and is only 7 percent in MENA. The picture demonstrates a major lag of 17 percent compared to female representation in business leadership within other sectors5Ibid..

Not only are few women found in the leadership of private-equity and venture-capital firms, but few women are in the leadership of the companies in which these firms invest. Just 20 percent of portfolio companies have gender-balanced leadership teams, and almost 70 percent are all male—even though, of the gender-balanced leadership teams in their portfolios, 87 percent have better decision-making, 61 percent show enhanced governance, and 60 percent have greater ability to serve larger, more diverse markets and consumers6Ibid..

Research confirms that the paucity of gender diversity is not good for business and financial returns. A Harvard Business Review study concluded that gender-diverse fund managers deliver an incremental 10 to 20 percent in returns compared to non-gender-diverse peers7Harvard Business Review: Study by Paul Gompers and Silpa Kovvali.. When VC firms increased female-partner hires by 10 percent, they saw 1.5-percent increases in returns for the overall funds and 9.7 percent more profitable exits.8International Finance Corporation: “Moving Toward Gender Balance in Private Equity and Venture Capital,” 2019.

An International Finance Corporation (IFC) study found that investing in gender-balanced leadership teams yielded 25 percent higher valuations. The median gender-balanced portfolio company was found to have a 64-percent increase in company valuation between two rounds of funding or liquidity events compared to 10 percent for imbalanced teams.

The imbalances in portfolio companies are correlated with the imbalances in investment managers’ leadership teams, since networks play active roles in sourcing investment opportunities and selecting senior management for portfolio companies.

Female partners were found to be twice as likely to invest in startups with one female founder and more than three times more likely to invest in a female CEO9Women in Venture Capital 2020 Report. According to a recent Harvard Business Review article, this is in line with the finding that VCs are much more likely to invest if they share the same gender or race as the founder.Without the equal representation of female investors, female founders will continue to be overlooked.

If the research unequivocally supports gender-balanced ecosystems, this is enough reason to turn the tide. We need to acknowledge that the barriers are real, and they range from closed networks, biases and inadequate commitment to gender diversity from allocators. To be overcome, a concerted effort is required from multiple stakeholders.

When it comes to perceptions on gender diversity, a disconnect exists between limited partners (LPs), who allocate capital to funds, and general partners (GPs), who manage a fund and invest the capital raised. According to the IFC study, 65 percent of LPs regarded the gender diversity of a firm’s investment team as important when committing capital to funds. However, GPs reported that less than 30 percent of their LPs emphasized gender diversity when making investment decisions. If only 25 percent asked about gender diversity during due diligence and even fewer made capital commitments conditional on gender outcomes, the pledge to diversity should be perceived as weak at best.

LPs who set clear gender-diversity goals for their investments and underscore diversity outcomes in due diligence send strong signals to GPs that the organization is committed to diversity. The goals then feed into GPs’ portfolio managers’ diversity targets. Fund managers would require gender-disaggregated data from their portfolio companies and commit to improving capital allocation to gender-balanced leadership teams. Reflecting diversity goals in their investment processes and portfolio management is a major action LPs can take towards closing the gender gap while maintaining or increasing returns.

The data demonstrates a clear correlation between the performance of gender-balanced investment teams and higher returns. Despite their vocal interest in diversifying their investment leadership teams, less than 10 percent of GPs have strategies for achieving it. It’s a perpetual cycle, as hiring is dependent on networks. With fewer women in investment leadership roles, there are fewer partners who can tap into the talent pool of junior and senior women who have paths to partnership. Similarly, subjective evaluation criteria such as “cultural fit” in a male-dominated industry place women at a disadvantage and feed the cycle. Committing to internal diversity targets for hiring and promoting female staff and managers levels the playing field and improves women’s access to the opportunities already available to their male peers.

As the research shows, investing in gender-balanced leadership teams yields higher valuation and returns. Yet, less than 40 percent of surveyed general partners track gender-disaggregated employment data, and only 33 percent actively pursue diverse candidates when sourcing talent for portfolio companies10International Finance Corporation: “Moving Toward Gender Balance in Private Equity and Venture Capital,” 2019.. Here again, a concerted focus on achieving gender-diversity outcomes is needed through GPs’ diversity tracking; playing an active role in making the business case for diversity and giving feedback on strategies will go a long way in achieving gender balance.

Accountability toward these actions allows LPs and GPs to make headway in closing the gender gap, generating employment opportunities and providing access to markets, which ultimately results in higher returns.

If you fish in the same pond, you will catch the same fish. Looking beyond the familiar comfort zone and making determined efforts for gender diversity and inclusion will result in growing opportunities across asset classes, investment strategies and geographies. Gender-balanced investors are empowered to deploy their resources within diverse teams and through innovative solutions, creating inclusive markets and bridging the wealth gap. The research on returns on investment is clear—it is worth the effort.

 

ABOUT THE AUTHORS

Nada Shousha is currently a Director on five regional and international companies’ boards as well as Vice Chair of the Egyptian-American Enterprise Fund. She is also an Advisor to the International Finance Corporation’s program Banking on Women. Until 2016, she was Regional Manager for Egypt, Libya and Yemen in the Middle East and North Africa Department of the IFC.

Amal Enan is the Chief Investment Officer of the American University in Cairo’s Endowment and Managing Director at Global Ventures. Prior to joining Global Ventures, Amal was the Executive Director of the Egyptian-American Enterprise Fund, and prior to that, she was part of a team of economists at the Macro-Fiscal Policy Unit in Egypt’s Ministry of Finance.

References

1 U.S. Securities and Exchange Commission: Diversity and Inclusion Report.
2 Fast Company: “Why it’s incredibly rare for companies led and founded by women to IPO,” Leslie Feinzaig, July 16, 2021.
3 Magnitt: “MENA HI 2021 Venture Investment Report.”
4 International Finance Corporation: “Moving Toward Gender Balance in Private Equity and Venture Capital,” 2019.
5 Ibid.
6 Ibid.
7 Harvard Business Review: Study by Paul Gompers and Silpa Kovvali.
8 International Finance Corporation: “Moving Toward Gender Balance in Private Equity and Venture Capital,” 2019.
9 Women in Venture Capital 2020 Report
10 International Finance Corporation: “Moving Toward Gender Balance in Private Equity and Venture Capital,” 2019.

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These five things need changing in the investment world — including free trades – Financial Post

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Peter Hodson: Investing should be rewarded, while trading should be discouraged

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I have (hopefully) picked up a few tidbits of knowledge after about 40 years in the investment industry. But one of the reasons I love this business is that there is always something new to learn. No one will ever know everything about investing, and no one — and we mean no one — really has any idea what is going to happen in the markets tomorrow.

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This makes a career in investments challenging and entertaining. There is never a dull moment. Still, here are five things I would change if I was in charge to make investing life a little more, well, predictable and fair.

Banish analyst price targets

Goldman Sachs this week cut its target on Twitter Inc. to US$62 and called it a “sell.” Why is this noteworthy? Well, in February, the same broker raised its target on Twitter to US$112 and called it a “buy.” In barely seven months, the target price was reduced by 45 per cent. Investors following Goldman’s logic would have gotten completely whipsawed.

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Is Twitter so bad? Not really: the stock is up 11 per cent this year and 54 per cent in 52 weeks. But I really think target prices do a disservice to investors. Ignoring that most are wrong anyway, they encourage excessive trading and set up a case of FUD: fear, uncertainty and doubt.

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Need more proof? How about this quote from an analyst’s report in 2011 on Amazon.com Inc.: “Despite Amazon’s outstanding fundamentals, its stock is overvalued and over loved.” The report had a US$125 per share target. Sure, it’s been a decade since then — not really that much time in market land — but Amazon today is US$3,446.

Change taxes to reward investing 

Let’s face it, taxes are going to go up in Canada. After all, we have to pay for all this pandemic spending, somehow. Right now, capital gains are taxed at 50 per cent. But it doesn’t matter if you hold a stock for five minutes or five years, your tax rate will be the same. Other countries have different methodologies, with some, such as the United States, having a higher tax rate if investments are held for a shorter time period. This makes sense to us, because investing should be rewarded, while trading should be discouraged.

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If you’re day trading, you’re not really supporting any company. You’re just seeking quick profits. Buying shares in a company and holding them for years is harder, but, ultimately, more rewarding and should be encouraged by policy-makers.

A note to whoever wins the election next week: Tax the speculators and day traders, not the real investors who are beneficial to the country.

Rethink free trading

After sweeping across the U.S. these past few years, free stock trading has arrived in Canada, with several brokerages announcing commission-free trades this year. This sounds good, but it’s not as good as you think. We’re all for lower costs, but free trades really, really encourage excessive trading, which results in more taxes (see above) and lowers the amount of capital available to compound.

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Volatile spikes in certain meme stocks have certainly increased because of zero trading costs. If we were in charge, we might ban free trades, but we might not have to if short-term trading taxes were increased. Essentially, we just want people to invest and not trade. After all, how many day traders do you see on all those world’s richest people lists? Answer: None.

Ban the phrase, ‘That stock is so expensive’

We’re kind of sick of how much we’ve heard this phrase this year. Many people are expecting a correction because stocks are so expensive based on historical metrics. Well, guess what? The buyers today obviously do not think stocks are expensive. They’re not buying with the expectation of losing money.

We chuckled after seeing Grit Capital’s recent thoughts on the Shiller P/E index, a measure of market valuation indicating the market’s valuation is 47 per cent higher than its 20-year average. Its comment sounded ominous, until it added that “following the famous P/E rule over the last 40 years, you would have owned equities for a grand total of 7 months (eye roll).”

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Apply investor rules equally

If you are an accredited investor, you know how much of a pain the paperwork can be to invest in a hedge fund. The government wants investors to be protected, so it only lets rich investors access some products, on the thesis that they can take more risks. That’s all fine and great, and, at least in theory, makes sense. But what about extremely risky products that get regulatory approval and trade on stock exchanges? Nearly anyone can buy those, whether they are experienced, rich, young or whatever.

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Sure, brokers still have know-your-client rules, but an investor who calls themselves aggressive can go out and buy double- or triple-leveraged exchange-traded funds (ETFs) all day long. Let’s look at Direxion Daily Junior Gold Miners Index Bear 2X Shares, a leveraged ETF on junior golds. Its three-year annualized return is negative 82.1 per cent. How about the ProShares Ultrashort Bloomberg Natural Gas Index ETF? It’s down 80 per cent this year alone. If I were in charge, I might apply some new restrictions, or at least warning labels, on some of these investments.

Peter Hodson, CFA, is founder and head of Research at 5i Research Inc., an independent investment research network helping do-it-yourself investors reach their investment goals. He is also associate portfolio manager for the i2i Long/Short U.S. Equity Fund. (5i Research staff do not own Canadian stocks. i2i Long/Short Fund may own non-Canadian stocks mentioned.)

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Olaf Carlson-Wee’s Polychain Capital Co-Leads $230 Million Investment In Ethereum Challenger Capitalizing On DeFi – Forbes

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Ethereum challenger Avalanche has raised a $230 million investment led by Singapore-based hedge fund Three Arrows Capital and Olaf Carlson-Wee’s Polychain Capital (Carlson-Wee was the first employee at now the largest cryptocurrency exchange in the U.S., Coinbase, and ultimately led its risk management).

Announced today, the capital raise, conducted as a private sale of the platform’s AVAX token, closed in June and also included investors such as R/Crypto Fund, Dragonfly, CMS Holdings, Collab+Currency, Lvna Capital as well as a group of angel investors and family offices. Similar to initial coin offerings (ICOs) that raised over $20 billion from the public a few years ago, this fundraising mechanism allows blockchain projects to raise capital from accredited investors in exchange for cryptographic tokens. Last year, the project raised approximately $60 million through token sales from prominent venture firms including Andreessen Horowitz (a16z) and Initialized Capital. 

The Singapore-based non-profit Avalanche Foundation, which oversees the blockchain’s ecosystem, will use the funds to subsidize projects building decentralized finance (DeFi), enterprise, and other applications developed on the Avalanche blockchain. The support will include grants, token purchases and other forms of investment, according to Emin Gün Sirer, the founder of the project and director of the foundation.

The investment comes as a number of similar networks dubbed “Ethereum killers”, including Solana, Algorand, Cardano and Polkadot, have exploded in value over the past year and shows a continued appetite for innovation beyond the original blockchain that popularized smart contracts and enabled the next generation of decentralized applications.

“When you have a war chest like this, it’s a very comfortable situation to be in,” says Sirer. “We will certainly have partnership announcements coming up. I am really excited about the new unique deployments that are already in the pipeline.” Sirer also told Forbes that he had recently stepped down from his teaching position at Cornell University to focus on Avalanche. 

Conceived in 2018, the platform claims to process transactions hundreds of times faster than its competitor, more than 4,500 transactions per second vs. Ethereum’s 14, for a fraction of Ethereum’s fees. Commonly known as gas, transaction fees on Ethereum have skyrocketed earlier this year due to the high on-chain activity, peaking near $70 in May. 

Avalanche’s main network launched in September 2020 and has since claimed a stake in the swelling market. Over 225 projects are building on the platform, and the total amount of assets locked in Avalanche’s DeFi ecosystem, encompassing peer-to-peer exchanges and lending applications that operate without intermediaries, grew at the end of last month to over $1.6 billion from about $250 million in mid-August. Avalanche’s AVAX token, 14th largest cryptocurrency with a market capitalization of $13.13 billion, more than doubled in price, reaching an all-time high of $66.45 earlier this week, Messari’s data shows. 

Much of that growth can be attributed to the launch of the “Avalanche Rush” initiative, announced on August 18. Over the next few months, the program will inject $180 million worth of AVAX into the Avalanche ecosystem with the aim to lure blue-chip DeFi applications to the network by providing the tokens as liquidity mining incentives for users of protocols like Aave, which facilitates cryptocurrency lending, and decentralized exchange Curve, though additional integrations may follow. “We’re in talks across the board with every single category of DeFi projects you might imagine,” Sirer says. 

As the program kicked off following the introduction of the Avalanche Bridge, a technology that enables the transfer of assets between blockchains, namely Ethereum, market watchers, including Joseph Young and Nick Chong, authors of the DeFi-focused Forbes newsletter Alpha Alarm, noted the resemblance of Avalanche’s growth with Polygon, a platform for Ethereum scaling and infrastructure development. Many Ethereum-native DeFi applications, including the money market protocol Aave, have migrated to Polygon to escape Ethereum’s rising transaction fees due to the network’s congestion. 

Yet Avalanche is also capitalizing on the burgeoning popularity of non-fungible tokens. On August 11, it was revealed that legacy trading cards and collectibles company Topps partnered with Avalanche to build a marketplace for NFTs and launched the first collection featuring highlights from the German football league’s 2020–2021 season. A few days later, however, it became known that Major League Baseball, Topps’ major partner for 70 years, is ending its licensing agreement with the company in favor of a deal with the up-and-coming sports collectible brand Fanatics. But Sirer says Avalanche has more in store: “We are a big believer in NFTs and their future, and we plan to grow in that area in many different ways.”

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