Issue 29: 2015

Investment Spotlight

The Way of Clough

The co-founder of Clough Capital shares his views on healthcare, China, big banks and more.

Photograph by Michael Warren

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For this issue’s Investment Spotlight, Capital Acumen talked with Charles I. “Chuck” Clough Jr., co-founder, chairman and chief executive officer of the Boston-based investment company Clough Capital Partners, LP. The firm manages several hedge funds and three closed-end funds. To learn more about the specific funds, including their suitability for your investment portfolio, contact your U.S. Trust advisor.

Chuck, tell us about your firm.

Chuck Clough: I co-founded the company in 2000, with James E. Canty and Eric A. Brock. We started with $100 million in assets under management and now have roughly $4.5 billion in the firm, with about half of that in a series of closed-end funds and $1.5 billion in our equity-based hedge funds managed with a global long-short strategy. We also have a number of other hedge funds and separately managed accounts.

What are some of the themes that

guide your investments?

Clough: We’re emphasizing a number of themes at the moment in our global long-short strategies. The four main ones are healthcare, China, supply shortages and financial companies.

What do you look for when considering

investing in a company?

Clough: Something we often look for is companies that have healthy cash positions, can generate excess free cash flow and have “moats to entry,” which lower the potential for competition. We think cash flow is a good measure of the health of a company and a good measure of the supply and demand it faces. When a company is generating a high free cash flow yield — that’s cash after all expenditures and capital spending — and that number is 7% or more a year, this is significant. If they invest that cash wisely, the power of compound interest can typically work to their favor. To put it simply, if the cash flow is 7%, the value of that corporate entity has the potential to rise at a 7% rate every year.

We like hospitals and think the Affordable Care Act has provided a strong tailwind for them.

What sort of business or industry is attracting your interest?

Clough: Lately we’ve been interested in a number of media companies, including a provider of phone, Internet and cable TV services. We’re following some transport-related companies that include a large used car retailer and a major manufacturer of truck transmissions, as well as some names in the hotel and hospitality industries. What’s important to us is that they’re all generating levels of free cash flow that we think are high and sustainable.

Why is healthcare a big theme for you?

Clough: This is an extraordinary time for healthcare. We’re seeing advances in areas such as oncology, generic drug approvals and healthcare insurer exchanges. With the Affordable Care Act, there are millions of new customers. We’re seeing many companies with big opportunities that appear positioned to sustain growth for the foreseeable future. Our methodology is to identify them, follow them closely and determine whether and when the investment risk-to-reward ratio is most attractive.

China by the Numbers

A closer look at China's population and economic breakdown, according to 2014 estimates from the World Bank.

China by the Numbers

A closer look at China's population and economic breakdown, according to 2014 estimates from the World Bank.

China by the Numbers

A closer look at China's population and economic breakdown, according to 2014 estimates from the World Bank.

China by the Numbers

A closer look at China's population and economic breakdown, according to 2014 estimates from the World Bank.

China by the Numbers

A closer look at China's population and economic breakdown, according to 2014 estimates from the World Bank.

Where do you see healthcare opportunities right now?

Clough: We like hospitals and think the Affordable Care Act has provided a strong tailwind for them. We estimate that the use of medical services is continuing to rise, now that millions of new Americans are insured, and hospitals’ debt loads appear to be in decline. Lately, we’ve been focused on identifying how hospitals might spend any additional cash flow. We believe it will lead to a capital-expenditure cycle, spurring investment in areas such as information technology, surgery performed by robots and equipment for radiation oncology. Let’s talk about China.

How do you keep abreast of events there?

Clough: We have a Hong Kong office and our team there provides us with substantial research and analysis. They give us a strong fundamental understanding of what’s going on — not only in the general economy but also within Chinese companies.

What are some factors that might contribute

to long-term growth in China?

Clough: Millions of Chinese are migrating from the countryside to the cities. They’re earning more, helping to expand the middle class and drive demand for cars, electronics, consumer durables and housing. For example, almost 19 million passenger cars were sold in China last year vs. 16.5 million in the United States.1,2 On top of that, several years ago China’s government enacted policies designed to redirect the economy to be more consumer-driven and less export-driven. Plus, the Chinese have traditionally had a culture of saving, with households socking away more than 50% of the country’s gross domestic product (GDP) annually over the past few years, according to World Bank estimates. And, at the same time, our experience suggests that interest in investing may be on the rise there.

WE’RE INTERESTED IN SOME CONSUMER-FOCUSED BANKS BECAUSE WE THINK THEY’RE UNDERVALUED.

What would you say to investors who are interested in China but also reticent to invest there?

Clough: If they’re concerned about the long-standing underperformance of Chinese equity markets, I would say that those markets have been faring much better of late. The Shanghai Stock Exchange Composite Index, for example, a widely used indicator of Chinese stock performance, showed significant relative strength last year, climbing from 2115 to 3234 from the end of 2013 to the end of 2014. The index widened opportunities for foreign investors last year and that probably contributed to the climb and could provide a long-term benefit for some of the composite’s companies.

What’s the appeal of shortages?

Clough: We always look for shortages, which are mismatches between supply and demand. More specifically, we look for industries where the manufacturing of a product has been depressed or the market demand for the product is ticking upward. That kind of supply-and-demand imbalance often pushes up prices and profitability.

What about financial companies?

Clough: We’re particularly interested in some consumer-focused banks because we think they’re undervalued in the market, possibly by as much as a third, and potentially very valuable enterprises. For example, major banks with strong credit card operations can have millions of accounts. They tend to dominate the payment system, and it’s that kind of large payment structure that is likely to become critical as Internet banking continues to grow in popularity. We think these large franchises, especially those with international footprints, could create a significant portion of profit in the banking sector, and pay significant dividends to shareholders, over the next few years.

What are some of the risks you foresee

over the next 12 to 18 months?

Clough: The U.S. dollar has been strong for some time now, and to the extent that it remains strong, it could continue to create a potential headwind for those U.S.-based international companies whose products may be too expensive for consumers abroad. We think there could be more market volatility ahead, in part because the Federal Reserve has been signaling that in mid-2015 it might raise its benchmark interest rate, a move that may unnerve some investors. At the same time, volatility can be a positive for long-short strategies and can point to the value of active investment management versus passive management.

 

1 China Passenger Car Association, 2015.

2 Automotive News, 2015.

IMPORTANT INFORMATION

Investing involves risk. There is always the potential of losing money when you invest in securities.

Some of the featured participants are not employees of U.S. Trust. The opinions and conclusions expressed are not necessarily those of U.S. Trust or its personnel. Any of their discussions concerning investments should not be considered a solicitation or recommendation by U.S. Trust and may not be profitable.

Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

OTHER IMPORTANT INFORMATION

Equities Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.

Alternative Investments Alternative investments are intended for qualified and suitable investors only. Alternative investments are speculative and involve a high degree of risk. Alternative investments such as derivatives, hedge funds, private equity funds and funds of funds can result in higher return potential but also higher loss potential. Changes in economic conditions or other circumstances may adversely affect your investments. Before you invest in alternative investments, you should consider your overall financial situation, how much money you have to invest, your need for liquidity and your tolerance for risk.

International Investing International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards, and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.

For this issue’s Investment Spotlight, Capital Acumen talked with Charles I. “Chuck” Clough Jr., co-founder, chairman and chief executive officer of the Boston-based investment company Clough Capital Partners, LP. The firm manages several hedge funds and three closed-end funds. To learn more about the specific funds, including their suitability for your investment portfolio, contact your U.S. Trust advisor.

Chuck, tell us about your firm.

Chuck Clough: I co-founded the company in 2000, with James E. Canty and Eric A. Brock. We started with $100 million in assets under management and now have roughly $4.5 billion in the firm, with about half of that in a series of closed-end funds and $1.5 billion in our equity-based hedge funds managed with a global long-short strategy. We also have a number of other hedge funds and separately managed accounts.

What are some of the themes that

guide your investments?

Clough: We’re emphasizing a number of themes at the moment in our global long-short strategies. The four main ones are healthcare, China, supply shortages and financial companies.

What do you look for when considering

investing in a company?

Clough: Something we often look for is companies that have healthy cash positions, can generate excess free cash flow and have “moats to entry,” which lower the potential for competition. We think cash flow is a good measure of the health of a company and a good measure of the supply and demand it faces. When a company is generating a high free cash flow yield — that’s cash after all expenditures and capital spending — and that number is 7% or more a year, this is significant. If they invest that cash wisely, the power of compound interest can typically work to their favor. To put it simply, if the cash flow is 7%, the value of that corporate entity has the potential to rise at a 7% rate every year.

We like hospitals and think the Affordable Care Act has provided a strong tailwind for them.

What sort of business or industry is attracting your interest?

Clough: Lately we’ve been interested in a number of media companies, including a provider of phone, Internet and cable TV services. We’re following some transport-related companies that include a large used car retailer and a major manufacturer of truck transmissions, as well as some names in the hotel and hospitality industries. What’s important to us is that they’re all generating levels of free cash flow that we think are high and sustainable.

Why is healthcare a big theme for you?

Clough: This is an extraordinary time for healthcare. We’re seeing advances in areas such as oncology, generic drug approvals and healthcare insurer exchanges. With the Affordable Care Act, there are millions of new customers. We’re seeing many companies with big opportunities that appear positioned to sustain growth for the foreseeable future. Our methodology is to identify them, follow them closely and determine whether and when the investment risk-to-reward ratio is most attractive.

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Where do you see healthcare opportunities right now?

Clough: We like hospitals and think the Affordable Care Act has provided a strong tailwind for them. We estimate that the use of medical services is continuing to rise, now that millions of new Americans are insured, and hospitals’ debt loads appear to be in decline. Lately, we’ve been focused on identifying how hospitals might spend any additional cash flow. We believe it will lead to a capital-expenditure cycle, spurring investment in areas such as information technology, surgery performed by robots and equipment for radiation oncology. Let’s talk about China.

How do you keep abreast of events there?

Clough: We have a Hong Kong office and our team there provides us with substantial research and analysis. They give us a strong fundamental understanding of what’s going on — not only in the general economy but also within Chinese companies.

What are some factors that might contribute

to long-term growth in China?

Clough: Millions of Chinese are migrating from the countryside to the cities. They’re earning more, helping to expand the middle class and drive demand for cars, electronics, consumer durables and housing. For example, almost 19 million passenger cars were sold in China last year vs. 16.5 million in the United States.1,2 On top of that, several years ago China’s government enacted policies designed to redirect the economy to be more consumer-driven and less export-driven. Plus, the Chinese have traditionally had a culture of saving, with households socking away more than 50% of the country’s gross domestic product (GDP) annually over the past few years, according to World Bank estimates. And, at the same time, our experience suggests that interest in investing may be on the rise there.

WE’RE INTERESTED IN SOME CONSUMER-FOCUSED BANKS BECAUSE WE THINK THEY’RE UNDERVALUED.

What would you say to investors who are interested in China but also reticent to invest there?

Clough: If they’re concerned about the long-standing underperformance of Chinese equity markets, I would say that those markets have been faring much better of late. The Shanghai Stock Exchange Composite Index, for example, a widely used indicator of Chinese stock performance, showed significant relative strength last year, climbing from 2115 to 3234 from the end of 2013 to the end of 2014. The index widened opportunities for foreign investors last year and that probably contributed to the climb and could provide a long-term benefit for some of the composite’s companies.

What’s the appeal of shortages?

Clough: We always look for shortages, which are mismatches between supply and demand. More specifically, we look for industries where the manufacturing of a product has been depressed or the market demand for the product is ticking upward. That kind of supply-and-demand imbalance often pushes up prices and profitability.

What about financial companies?

Clough: We’re particularly interested in some consumer-focused banks because we think they’re undervalued in the market, possibly by as much as a third, and potentially very valuable enterprises. For example, major banks with strong credit card operations can have millions of accounts. They tend to dominate the payment system, and it’s that kind of large payment structure that is likely to become critical as Internet banking continues to grow in popularity. We think these large franchises, especially those with international footprints, could create a significant portion of profit in the banking sector, and pay significant dividends to shareholders, over the next few years.

What are some of the risks you foresee

over the next 12 to 18 months?

Clough: The U.S. dollar has been strong for some time now, and to the extent that it remains strong, it could continue to create a potential headwind for those U.S.-based international companies whose products may be too expensive for consumers abroad. We think there could be more market volatility ahead, in part because the Federal Reserve has been signaling that in mid-2015 it might raise its benchmark interest rate, a move that may unnerve some investors. At the same time, volatility can be a positive for long-short strategies and can point to the value of active investment management versus passive management.

 

1 China Passenger Car Association, 2015.

2 Automotive News, 2015.

IMPORTANT INFORMATION

Investing involves risk. There is always the potential of losing money when you invest in securities.

Some of the featured participants are not employees of U.S. Trust. The opinions and conclusions expressed are not necessarily those of U.S. Trust or its personnel. Any of their discussions concerning investments should not be considered a solicitation or recommendation by U.S. Trust and may not be profitable.

Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

OTHER IMPORTANT INFORMATION

Equities Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.

Alternative Investments Alternative investments are intended for qualified and suitable investors only. Alternative investments are speculative and involve a high degree of risk. Alternative investments such as derivatives, hedge funds, private equity funds and funds of funds can result in higher return potential but also higher loss potential. Changes in economic conditions or other circumstances may adversely affect your investments. Before you invest in alternative investments, you should consider your overall financial situation, how much money you have to invest, your need for liquidity and your tolerance for risk.

International Investing International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards, and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.