ALTERNATIVE ASSET OPPORTUNITIES PCC LIMITED
ANNOUNCEMENT OF RESULTS
For the year ended 30 June 2006
CHAIRMAN'S STATEMENT
for the year ended 30 June 2006
Since the last review, the Company's portfolio has been completed. If the early
months of the Company's existence were marked by considerable activity in the
review and acquisition of policies, a new, quieter phase has begun. As we have
purchased life policies mainly on the basis of medically assessed life
expectancies of over 5 years, it is likely that the next few months will see
little portfolio activity.
The portfolio as at 30 September consisted of 156 policies with exposure to 130
separate lives. The face value of these policies is US$247 million. No further
bids are being made on behalf of the Fund. Roughly two thirds of the lives
assured are male, with an overall average life expectancy at purchase of 7.55
years. The Investment Manager's review and the accounts give further details of
the portfolio, which is very much as envisaged in the Company's prospectus.
There have to date been a total of four maturities, with a face value of
US$4.975 million.
In the investment update released to the Stock Exchange on 19 July, 2006 it was
reported that projections for the Fund were now being based on actual policies
acquired and on the published NAV of the Company, allowing for agreed premium
payments and current interest and foreign exchange rates. As at the end of
August, and based on the NAV at that date of 105.6 pence per share, the
projected returns were:
Illustrative redemption yields (% per annum)
Exit
Mortality Proportion Price
Assumption Surviving
Note 1 Note 2 Note 3 -10c -5c 0c +5c +10c
+ 18
months 45.00% 41.51c 9.40% 10.50% 11.60% 12.60% 13.50%
+ 6 months 49.00% 41.63c 7.60% 8.90% 10.10% 11.20% 12.30%
0 52.10% 41.73c 6.00% 7.50% 8.80% 10.10% 11.30%
- 6 months 55.50% 41.83c 4.10% 5.80% 7.30% 8.80% 10.10%
- 18
months 61.30% 41.99c 0.10% 2.30% 4.30% 6.10% 7.80%
Notes
1. This assumes that deaths occur as predicted by the medical assessors
2. This shows the percentage of policy lives insured assumed to survive
throughout the life of the Fund.
3. This shows the assumed average realisation value per US$1 of TLI policy
face value in respect of the policies of the surviving policy lives insured at
the end of life of the Fund. The base case (Realisation Value = 41.73 cents per
$1 of face value) corresponds to the market value assumptions used in arriving
at the end-August NAV, assuming medically adjusted life expectancies as at that
date.
Principal Assumptions
1. The illustrative returns have been prepared by reference to the actual
investments made by the Fund as at 31 August.
2. The Fund will in all other respects be managed in accordance with its
existing investment objective and investment policy.
Source: Surrenda-link Limited
Valuation
The published NAV is based on a market related policy valuation method, as
previously reported. Since my last review, the market for TLIs has been steady,
with little change in the yield basis for typical policies of the expected
duration acquired for the portfolio. The basis of valuation is believed to be
conservative and one of the results of our methodology is that the emergence of
value in the portfolio of policies will be slow in the early stages of the
Fund's life.
A key factor in valuing the portfolio is the rate at which policies mature. To
the extent that maturities happen more slowly than our actuarial projections,
this will have a negative effect on the value. Mortality experience to date has
been allowed for in the calculation of NAVs and the projected yields shown
above.
Gearing
The Manager's review makes a reference to gearing. Since 30 June, the full
amount of the US$20 million facility has been drawn but not yet fully utilised;
gearing remains well within the facility covenants. At present the average
level of monthly premiums payable is around US$750,000; the future level of
gearing will depend on the rate at which policies mature, the speed of payment
of policy proceeds and any corresponding reductions in premiums payable. The
Manager has been authorised to approach the Company's bankers in so far as the
present facility of US$20 million may require an increase.
Foreign Exchange
As previously reported, the current value of the US$ portfolio is hedged, with
contracts maturing in 2009 and 2012. This produces fluctuations in net asset
value as these positions are marked to market each month, even though the
contracts are expected to be held to maturity. The Board has also considered
whether and to what extent it might be prudent to hedge future gains in
portfolio value. The difficulty in doing this is that the timing of the
emergence of these gains and the exact scale of any gains is uncertain; it
would thus be impossible to arrive at an exact hedge, and there is a risk that
losses might be generated on forward contracts if they did not match predicted
cash flows. The Board will keep this policy under review, but at present it
intends to maintain current policy. As the value of the US$ portfolio increases
over time, further forward currency transactions (or spot currency sales) will
be entered into to keep the portfolio value hedged.
Administration
At this stage, while work on portfolio acquisition has ceased, considerable
work is still required to administer the portfolio. I am pleased to report that
the transfer of sub-custody of the portfolio is complete, and that the new
arrangements are working well. One benefit to the Company from this change is
that custody costs have fallen; this will become apparent in future sets of
accounts. The new sub-custodian arrangements allow premium payments to be
better controlled - a key aspect of ongoing administration. The Investment
Manager is also responsible for monitoring the lives assured, and for making
timely claims on policies which have matured.
Outlook
The Fund remains on target to deliver shareholders with an attractive rate of
return from an asset class largely uncorrelated to the performance of the
broader equity and bond markets.
The reviews of the Manager and Investment Manager follow. The growing maturity
of the TLI market is commented on, and this remains important for the Company
in view of the projected requirement for the disposal of remaining policies
when the Fund is eventually wound up.
Charles Tracy
Chairman
25 October 2006
INVESTMENT MANAGER'S REVIEW
for the year ended 30 June 2006
Market Overview
Over the past year the U.S. life settlement (TLI) market has continued to
evolve in terms of size, efficiency and regulation which have led to increased
awareness and acceptance by the international financial industry.
Substantial year-on-year market growth continues to be the headline that
attracts attention from policyholders and their advisors as well as
institutional investors. From June 05 to June 06, the level of policy
submissions to Surrenda-link has more than trebled and currently average more
than 250 per week representing between $500m and $600m of face value. The main
driver of supply during this period was increasing awareness amongst
policyholders of the option to sell rather than surrender. Given the size of
the U.S. financial industry, many believe that the level of awareness is still
relatively low with significant room for further gains which should support the
growth trend for the foreseeable future. Also likely to play a role is the
proliferation of premium finance programmes that incubate policies prior to
sale. It is estimated that between $10b and $20b worth of face value has been
issued under these programmes in the last two years alone. These policies are
likely have a major impact on policy supply in the coming years. Over the
longer term, U.S. population demographics suggest expansion will strengthen as
the "baby boomers" reach an age which makes their policies attractive in the
secondary market.
On the efficiency front, the squeeze continues on middleman fees that erode
value for both seller and investor. An increasing number of sophisticated
advisors and their policyholder clients are liaising directly with investors
resulting in improved values for sellers and higher projected returns for
buyers. Further to this, a number of electronic exchanges have commenced
operations and offer an efficient platform for both sides of the trade.
Despite these improvements, it is likely efficiency gains will be constrained
due to the nature of the asset.
The regulation of U.S. life insurance sales in the secondary market remains
under debate. Life insurance is regulated at the state level and increasingly
state insurance commissions are of the belief that transactions should be
controlled through legislation. The National Association of Insurance
Commissioners (NAIC) continues to revise its 'model act' as the debate carries
on over how the market should be regulated. Some states have adopted a version
of the act though many make alterations based on specific requirements. As of
May 06, approximately 39 states have implemented some form of regulation.
Portfolio Overview
In July 06 the Fund completed its final policy purchase taking the total number
of TLIs acquired to 160 representing 134 unique lives and a total face value of
$252m costing on average approximately 30 cents per dollar of face value at
acquisition. The Fund has since experienced 4 maturities (3 Females/1 Male)
totalling $4.975m of face value leaving the current portfolio with 156 policies
and 130 unique lives. Each of these 4 policies matured well before their
estimated maturity date and therefore resulted in substantial cash windfalls
for the Fund. Summary statistics on the remaining portfolio are as follows:
AAO Portfolio Summary Statistics: October 2006
Face Value: $247m
Male/Female Ratio: 66%/34%
Average Age at Purchase: 82.6 years
Average Life Expectancy at Purchase: 7.55 years
Total Number of Life Companies: 44
Life Group Distribution (Top 5):
Face Value Weighted Group Holding A.M. Best
AIG Life 15% A++
Manulife 13% A++
AEGON USA 11% A+
Jefferson Pilot 9% A+
MassMutual 9% A++
Credit Quality Distribution:
Face Weighted A.M. Best Holding
A++ 47.64%
A+ 42.95%
A 2.10%
A- 1.14%
Au* 6.18%
*u means A.M. Best is reviewing the rating of certain life insurance companies.
Premium Payments
Each policy within the portfolio has its own unique premium payment schedule
that has been produced by Surrenda-link to maximise the policy's financial
return by minimising the amount required to maintain the policy in force.
Surrenda-link reviews all policy statements (annual or otherwise) with a view
to further optimisation should circumstances allow. Wells Fargo (as
sub-custodian) pays premiums on behalf of the Fund and ensures the life
insurance company receives the premium and applies it to the correct policy.
Ongoing premium requirements represent the single largest draw on the Fund's
liquidity and are constantly monitored. Over the next 12 months the Fund's
premium requirement (assuming no exits from the portfolio) amounts to
approximately $9.4m or 3.5% of face value. As the insureds age, the premium
required for each policy generally rises - although as policies mature and exit
the portfolio the premium requirement as a percentage of the Fund's total
assets will decline.
Outlook
With portfolio construction complete the principal ongoing management tasks
involve monitoring for possible maturity events and subsequent claim processing
along with ensuring premiums are paid according to schedule and further
optimised if possible. Tracking is undertaken by a U.S.-based agents and
complemented by Surrenda-link electronic tracking. To date, the time lapse
between the actual maturity event and tracking identification has averaged less
than 7 days. The Fund's cashflow model, which incorporates an actuarial
assessment of the likely frequency of maturity events, suggests claim
experience should average approximately 2 to 3 per month after portfolio
completion. However, it is often more useful to research the actual experience
of other, older portfolios. Through Surrenda-link's various contacts in the
market it's understood that claim experience is usually light in the first few
years then begins to increase significantly. Given that 80% of the portfolio's
constituents were acquired less than one and a half years ago, it's likely that
the Fund's claim experience will remain infrequent over the near term.
Surrenda-link Limited
25 October 2006
MANAGER'S REVIEW
for the year ended 30 June 2006
Cash management and borrowings
By 30th June the Fund had largely completed its programme of purchasing
policies. To that end the US dollar borrowing facility provided to the Fund by
its bankers, Allied Irish Banks, was raised to $20,000,000 in January. Of
this, $19,500,000 had been drawn down by 30th June.
On the basis of these figures, the envisaged gearing level of 20% has been
exceeded. It must be cautioned that level of gearing depends upon the balance
between receipts arising from the death of the original policy-holders and
outgoing premium payments for ongoing policies. So far, as discussed
elsewhere, there have been only a modest number of policy maturities and it is
possible that gearing may rise further, depending on the exact pattern of
maturities in the next few months. The Fund's bankers are aware of this
position which remains comfortably within the terms of the facility.
Currency hedging
The Fund's US dollar exposure, that is the net value of those assets that are
denominated in US dollars, is hedged back into sterling. As explained
previously, this has been implemented by means of forward sales of US dollars
into sterling partly for 31st March 2009 and partly for 30th March 2012, the
latter being the winding-up date for the Fund.
However, it does not mean that there is necessarily a perfect hedge for
intermediate periods. The difference between the currency spot rate and the
forward rate reflects the difference between the applicable interest rates
(strictly swap rates) for US dollars and sterling. As the forward contracts
move towards expiry, the spot rate and the forward rate will gradually
converge. However, they will not do so in a smooth progression, and since the
Fund marks its forward positions to market, there will almost certainly be an
additional profit or loss on the contracts during intermediate periods.
This additional or excess profit or loss will be reflected in the ongoing
calculations of the Fund's net asset value and in its financial reporting.
From time to time this balance may be material (as at 30th June there was an
excess profit of �583,110: by 31st August this had fallen to �330,882),
however over the life of the Fund it should largely disappear, such that the
end result will be that the Fund's US dollar exposure will have been
substantially hedged.
RCM (UK) Limited
25 October 2006
STATEMENT OF TOTAL RETURN
For the year ended 30 June 2006
Year ended 30 June 2006 27 February 2004 to 30 June 2005
Revenue Capital Total Revenue Capital Total
� � � � � �
Net gains on investments - 1,274,437 1,274,437 - 436,086 436,086
Other capital gains
on currency movements - 2,767,288 2,767,288 - 45,337 45,337
Income 292,381 - 292,381 1,704,186 - 1,704,186
Management fee (293,410) - (293,410) (449,877) - (449,877)
Investment manager's fee (213,081) - (213,081) (249,315) - (249,315)
Custodian fee (19,423) - (19,423) (27,651) - (27,651)
Other expenses (343,787) - (343,787) (407,042) - (407,042)
Net return on ordinary activities
before finance costs (577,320) 4,041,725 3,464,405 570,301 481,423 1,051,724
Interest payable (178,775) - (178,775) (1,601) - (1,601)
Total return on ordinary
activities for the financial period (756,095) 4,041,725 3,285,630 568,700 481,423 1,050,123
Balance brought forward 568,700 481,423 1,050,123 - - -
Balance carried forward (187,395) 4,523,148 4,335,753 568,700 481,423 1,050,123
Return per redeemable share (1.89p) 10.10p 8.21p 1.42p 1.20p 2.62p
The revenue column of this statement is the revenue account of the Company.
All revenue and capital items in the above statement derive from continuing
operations.
BALANCE SHEET
At 30 June 2006
30 June 2006 30 June 2005
� � � �
Assets
Investments 49,439,126 16,541,068
Debtors 461,567 72,247
Cash on fixed deposit 1,619,232 17,520,230
Cash at bank 758,358 6,582,934
Unrealised gain on forward foreign
exchange
contracts 1,984,764 -
54,263,047 40,716,479
Current liabilities
Creditors 209,393 338,795
Unrealised loss on forward foreign - 159,325
exchange contracts
Loan account 10,549,665 -
10,759,058 498,120
Capital and reserves
Share premium account 39,168,236 39,168,236
Capital reserve 4,523,148 481,423
Revenue reserve (187,395) 568,700
Equity Shareholders funds 43,503,989 40,218,359
54,263,047 40,716,479
Net asset value per share 108.8p 100.5p
CASH FLOW STATEMENT
For the year ended 30 June 2006
Year ended 27 February 2004 to
30 June 2006 30 June 2005
� � � �
Operating activities
Net (deficit)/revenue (756,095) 568,700
Increase in debtors (389,320) (72,247)
(Decrease)/Increase in creditors (62,121) 271,514
Net cash (outflow)/inflow from operating
activities (1,207,536) 767,967
Financing activities
Issue of shares - 40,000,000
Issue costs paid - (831,764)
Loan received 10,549,665 -
Exchange movements 623,199 204,662
Net cash inflow from financing activities 11,172,864 39,372,898
Investing activities
Purchases of investments (32,691,297) (17,323,053)
Proceeds from sales/disposals of
investments 1,000,395 1,285,352
Net cash outflow from investing activities (31,690,902) (16,037,701)
Net cash (outflow)/ inflow before use of
liquid resources (21,725,574) 24,103,164
Management of liquid resources
Net cash matured from/(placed on) short
term deposit 15,900,998 (17,520,230)
(Decrease)/Increase in cash in the period (5,824,576) 6,582,934
Reconciliation of net cash flow to movement in
net funds
(Decrease)/Increase in cash in the period (5,824,576) 6,582,934
Net cash (inflow)/outflow from management of
liquid resources (15,900,998) 17,520,230
(Decrease)/Increase in net funds in the period (21,725,574) 24,103,164
Opening net funds 24,103,164 -
Closing net funds 2,377,590 24,103,164
END
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