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BlackRock Expands Asian Equity Range with High Conviction China Fund

BlackRock has expanded its Asian equity fund range by launching the BlackRock Global Funds (BGF) China Flexible Equity Fund. The Fund is designed to enable a growing number of investors seeking to access opportunities in both onshore (A-shares) and offshore (H-shares, Red-chips, P-chips, American Depositary Receipts [ADRs], etc.) Chinese equity markets without having the need to allocate to two separate strategies.

Funds investing in China often focus solely on offshore equities, with onshore Chinese equities – namely China A-Shares – severely under-owned by global investors due to historic market restrictions on foreign investment.

The BGF China Flexible Equity Fund is managed under a flexible approach, and invests across A-Shares and Chinese offshore equities, market capitalisation, sectors and factors. It seeks to take advantage of the nuances in the Chinese equity markets, including valuation differences between markets, factors which work favourably in different market cycles, or sector specific opportunities. The Fund is a long-only, fundamentals-driven and concentrated portfolio, investing in between 20 and 50 companies from a universe of over 3,300 onshore and 1,000 offshore stocks.

The BGF China Flexible Equity Fund is managed by Helen Zhu, Head of Chinese Equities at BlackRock, and is supported by a team of 10 dedicated China-focused research analysts based in Hong Kong and Shanghai.

Zhu said: “Chinese equities have been demonstrating higher sector return dispersions, offering active stock pickers a rich investment universe. Dynamic, vibrant and now more accessible than ever before, we believe Chinese equities offer investors an attractive opportunity to invest in the transformation of this huge country. The Fund aims to blend the best opportunities, taking advantage of the nuances in the Chinese equity markets. Through flexible allocation, the Fund can invest across the full range of market capitalization and Chinese stocks listed globally, whether they are listed in mainland China, Hong Kong, the US or elsewhere.”

Michael Gruener, Head of EMEA Retail at BlackRock, added: “Backed by the world’s largest population, the second largest economy and an increasingly sustainable growth path, Chinese equity markets are a rich hunting ground for investors. Most funds investing in China still tend to focus solely on offshore equities, meaning investors are missing out on hundreds of potential investments. Through this fund, we are giving clients the opportunity to access both mainland and offshore Chinese equity markets with one flexible strategy.”

As Rules Regarding the Creation of Synthetic ETFs Become More Stringent, They Could Have an Impact on Growth

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"La regulación más estricta sobre ETFs sintéticos podría impactar en el crecimiento y la velocidad de convergencia entre el mercado de ETFs en Europa y EE.UU." — Agnieszka Gehringer and Kai Lehmann, courtesy photos. As Rules Regarding the Creation of Synthetic ETFs Become More Stringent, They Could Have an Impact on Growth

According to Agnieszka Gehringer and Kai Lehmann, members of the Research Institute of Flossbach von Storch, ETFs go beyond passive investment, due to their hyper trading activity and the latest innovations in the field of smart beta. In this interview with Funds Society, the experts also warn of the uncertain behavior of ETFs in turbulent periods, something not yet tested, and are confident of the industry’s potential for growth in Europe, although, they are aware the stricter rules on the creation of synthetic products could be a drag on its development.

What do you intend when you doubt that ETFs are passive?

The ETF are often put in the context of passive investment, based on the fact that they follow the performance of a certain index. This is exactly the idea staying behind the traditional index funds – an invention of Jack Bogle dating back to 1976. But Bogle aimed at providing an instrument for a long-term investment in stock market by simply following the index. To the contrary, ETF investors are very much short-term focused. They trade ETF shares very actively, indeed hyper-actively. This is what we find in our analysis based on the three biggest equity ETFs tracking respectively the German DAX, the US S&P 500 and the FTSE 100 in the UK. The volume of the ETF shares traded on average every day is four times higher than the traded stocks of the underlying indices. This hyper-activity brings the idea of passive investment ad absurdum.

Has the innovation propagated the creation of ETFs which can be called active? Isn’t it a contradiction? How does the passive and active investing complement one another in an ETF?

Besides the traditional ETF there is indeed a growing interest in the so called smart beta ETFs. Whereas the traditional ETF are supposed to reconstruct 1:1 the index performance based on the market caps of the index constituents, smart beta ETFs weight the basket of the underlying securities based on alternative criteria, called factors. In this way, they aim at performing better than the market and thus better than traditional ETFs. These factors may relate to some kind of assessment of accounting metrics of the index constituents, like book value, dividends, or cash flows, or to still other factors, such as low volatility, undervaluation or expected momentum. In this sense, smart beta ETFs add an active layer with respect to traditional ones: they are not only actively traded, but render the underlying investment choice active as well. Is it a contradiction? I wouldn’t say so – it is more an enhancement on the activity scale. But the important thing to note is that such “active” choices are not comparable with the investment decision made by an active asset manager who thoroughly analyse the entire business model of a company in order to assess its intrinsic value. Smart beta strategies are focused on fast-track, partial, rather than thorough, and more quantitative, rather than qualitative assessment of companies.

Due to this innovation, could ETFs push the active strategies aside?

Given the current popularity of ETFs, be it traditional or smart, it wouldn’t be surprising to see further rise in the relative share of ETF-managed funds. At the same time I would doubt whether it is in the interest of ETF investors to fully eliminate active investment strategy. In the end ETFs freeride on the contribution which active managers deliver to the efficient price building on capital markets. By the same token, we can’t exclude that upon the attainment of a certain critical mass on capital markets by ETFs, the price building process might get into difficulties.

It is often stated that both types of investment strategies would survive. What would be the role played by the one and the other?

It is plausible to expect that both ETFs and active management will coexist. On the side of ETFs, they have been surely attractive so far, given the positive past performance on capital markets and their warranty of obtaining the performance of the underlying index. They could be thus appropriate for investors willing to simply follow the market. At the same time, not much is known so far about ETFs’ performance under difficult weathering conditions on capital markets. Only when markets enter more turbulent waters will we be able to assess the true performance of ETFs. For now ETF investors should keep this uncertainty in mind. On the side of active managers, and especially of those following a consistent and well-founded investment strategy, they will continue to play a role in enhancing the price setting on markets, especially when we see some market turmoil.

In your opinion, which was the major innovation in the world of ETFs during the last years?

The original idea of following the market in order to enjoy the long-term positive return at a rock-bottom cost is quite revolutionary. Their invention may have helped to get in touch with capital markets. But today there is not much left out of this. To the contrary, the hyper-activity of ETF trading and allegedly “smart” investment choices of smart beta ETFs could pose more risks than benefits, should capital markets experience turmoil in the future.

In launching of novelties (smart beta, currency hedging (?), …), where could the next innovations go in the world of ETF?

Given the past creativity in the field of ETFs, the innovation could go anywhere. Just think of the different kinds of thematic or even esoteric ETFs, like for instance “biblically responsible” ETFs… If this trend continues, the question will be increasingly about the risk-reward balance of less diversification and less market liquidity versus chances to pick up an index performing better than the others. All in all, there seem to be less and less well-founded investment choices.

Is the use of ETFs changing – from tactic to strategic positioning? Does this generalization in the use regard all types of investors?

This seems to be particularly the case for institutional investors. In the past, they were using ETF for cash equalization and transition management. But now the growing use for core exposure can be observed.

Comparing the markets, the European with the US market, Europe is lagging behind, but could still catch up. How much could the European industry grow?

The size of the ETF market in Europe is indeed significantly smaller than in the US. Precisely, the total assets held by US-ETFs now add up to about 3.3 bn. USD whereas its European counterparts are currently approaching the roof of 1 bn. USD. There is surely catching up potential for Europe. At the same time, there are some important regulatory changes applying next year, which could decelerate the process. Precisely, rules regarding the creation of the so called synthetic ETFs become more stringent. Accordingly, given the current non-negligible share of synthetic ETFs in Europe, this could have an impact on growth and the speed of convergence between the European and US ETF market.

Could the regulation have an impact on the use of ETFs and why?

As mentioned above, the regulation is already having an impact on the use of – in this specific case synthetic – ETFs. But more generally, given that ETFs can still be considered as relatively new to the financial market reality, the regulators have to gather information and experience regarding the functioning of ETFs. This task is not easy and regulators could lack the necessary information to set up well-functioning rules. And the past teaches us that unfortunately sometimes it needs an external shock to discover the loopholes in the system. Hopefully this time is different.

Pictet AM: “Tech Stock Valuations Still Offer Room to Invest”

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The new disruptive technologies are experiencing exponential growth and should be measured in terms of the power of transformation of their technology. It is more than a revolution, something that has to do with the potential to completely change the way societies live and work; a turning point from everything else before it.
For investors who do not want to be left behind in this revolution Pictet offers three thematic strategies. The most recent, Pictet Robotics, was launched in 2015 and invests in companies that provide an automated solution and in all technologies that allow this type of solutions (such as artificial intelligence, sensors, and semiconductors). The strategy has been so successful that it is only available to current investors that are already invested in the fund.

Pictet Security and Pictet Digital strategies had been launched previously, the first strategy invests in companies that develop security solutions to protect the integrity of governments, companies, and individuals. Meanwhile, the second strategy invests in disruptive companies that offer interactive business models through web-based applications and software.

In an interview with Funds Society, Alexandre Mouthon, Senior Client Portfolio Manager at Pictet Asset Management, presented the multiple examples of disruptive technologies that can already among us, and those that are yet to come, such as autonomous vehicles, artificial intelligence, robotics or process automation, as well as the internet of things.

“In the future, all electronic devices will be connected through sensors, being able to be linked effectively through the internet of things. The IoT is a very broad concept in which everything can be interconnected. It will be possible to create and manage infrastructures, cities and smart homes. An example could be effective control over traffic signals or even the vehicles themselves will be connected.”

Is it still a good time to invest in technology?

In a market in which the main technology stocks have experienced a rise above 35%, many investors are asking if it is still a good time to enter this sector or if instead it has risen to stratospheric levels. In that regard, Mouthon explains that he does not believe that tecnology stocks are experiencing a bubble like the one that occurred in 2000, since the price/earnings ratio of the MSCI World Technology index have recently traded at levels close to 18.4 xs.

“The MSCI World Technology Index reached a price/earnings ratio of 44.2x during the course of the internet bubble in the year 2000, then it was deflated by the correction of the market, and since then a lateral evolution has been seen, therefore, based on history, we can say that there is still room in these valuation levels.”

According to Mouthon, since 2010, earnings in the technology sector have been very positive. About 90% of the movement in the index could be explained by a very positive momentum; while the remaining 10% could be explained by a lower expansion of the ratio. “There is a slight expansion in the ratio levels, but with a positive momentum. This means that most of the yield is due to positive returns with very strong fundamentals. “

Technology companies’ balance sheets are solid. Especially when comparing Amazon’s, Ebay’s and Priceline’s December 1999 ratios with those obtained in September of 2017.

“At the end of 1999, Amazon’s enterprise value-sales (EV/S) ratio was 9.8 xs. While it currently stands at about 2.2x times. These companies are now generating much greater earnings, with much more cash. They are much more profitable than 17 years ago. The vast majority have much stronger balance sheets than in the year 2000. This does not mean that if companies were examined on a one-by-one basis, we wouldn’t find that some of them are not properly valued.”

Pictet manages between 40 and 70 stocks in its strategies, having the opportunity to diversify and arbitrate between those companies with the highest valuation and those that still maintain attractive levels of valuation.”It can be managed very effectively. At present, ratios in the portfolio are in line with or below the global equity market. Although the valuations are attractive, it is possible that there is a correction in the market. It’s something that we’ve been expecting for months, but that has not happened yet. It’s possible that it will happen shortly, but it will not be a total reversion of the market”.

The investment universe

The strategies are agnostic with respect to the index. To determine the investment universe of each of the strategies, the management team determines the thematic purity of these companies. In this way, the team seeks that at least 20% of the sales of the companies in which it invests a certain strategy has its origin in the theme of the fund. For example, in the Pictet Digital strategy, at least 20% of the sales of the companies in which the fund invests come from the internet or from a web-based activity.

“In the Digital strategy we are investing fundamentally in internet or software companies. Of course, the FANG, Facebook, Amazon, Netflix and Google shares, or their oriental versions, BAT, Baidu, Alibaba or Tencent, are part of the universe in which it is invested, and so are many of the internet or software participants such as Medidata, Athenal Health, and Zendesk. We are global investors by definition, as long as we find companies that dedicate 20% of their sales to internet services and software, whether in the United States, Europe or Asia, they may potentially qualify to be included in the strategy. Naturally, there is a bias towards the United States, due to the natural leadership of its companies in the Internet sector “.
Likewise, in the Pictet Security strategy, 20% of sales come from activity in cyber security, security in transportation, security in food processing companies, and in the Pictet Robotics strategy, these come from companies dedicated to automation of processes and artificial intelligence.

The most disruptive tendencies

Every minute, 500 hours of YouTube videos are uploaded to the internet; 3.3 million comments are posted on Facebook; 29 million messages are exchanged through WhatsApp, and 3.8 million searches are made on Google. Access to the Internet from any device is, according to a study carried out by the McKinsey Global Institute, the most disruptive technology of the coming years. This report points out 12 technologies that will completely change the current way of living and working. Specifically, six of them are expected to have a strong economic impact: automation and the introduction of robotics, mobile internet, the cloud, the internet of things and autonomous vehicles. “What we have tried is to establish a map with our strategies, integrating these six important disruptive technologies, to which we have added Fintech, which is also expected to change the financial industry and how we currently know it. This mapping is helping investors to realize how our three-disruptive technology fund are complementary in covering these 7 trends among the technology space and the coverage, through the 3 strategies is almost perfect. These seven technologies should benefit from a high growth environment, so they should grow in excess of the global GDP growth, and above of global spending on information technologies. These technologies are tending to grow exponentially and they interact with each other. The artificial intelligence market can be very significant, from 5 to 6 billion at present, and could reach 120 billion in 2025. This will happen when software and hardware applications are combined. You can invest in artificial intelligence through software, investing in the digital strategy, while investing in artificial intelligence through the hardware side is an exposure to robotics. Therefore, artificial intelligence is present in the two strategies.”

The effect of technology on employment

Both artificial intelligence and robotics will have a strong impact on the economy. In general, we talk about the negative effect that technology will have on the labor market, but we underestimate how these new technologies will open the door to new types of jobs that are not yet known.

“As in the internet revolution in the year 2000, when nobody expected that companies like Google could employ so many people, nobody has expected the emergence of companies like Salesforce or Zendesk nowdays, or the large number of companies that are benefiting from the internet revolution. Very likely, the same will happen with the robot revolution or the artificial intelligence revolution, where new jobs will be created from the digital revolution. The main issue is that artificial intelligence and robotics not only affect one sector of the economy, but they are affecting all sectors of the economy at the same time. It is a revolution that moves at a great speed and its growth is exponential. At some point, we will begin to see certain regulations coming into force that will try to slow down the adoption pace of automatic or robotic solutions, giving more time to the workforce to adapt and probably to learn new jobs,” concludes Mouthon.

Robert Spector (MFS): “We Expect a Flattening US Yield Curve and a Steeper One in Europe”

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In an environment in which interest rates are historically low after eight years of expansive monetary policies, Robert Spector, who along with Pilar Gómez-Bravo and Richard Hawkins is one of the lead managers for MFS Investment Management’s MFS Meridian Funds Global Opportunistic Bond strategy, believes that there are still attractive, or relatively attractive opportunities, in which you can get good returns.

During a recent conference in Miami, the asset manager pointed out that the strategy seeks to provide consistent returns and transparency: “We want to provide investors with a fixed income experience, regardless of whether we buy high yield debt or emerging market bonds. When there is an event in the market in which investors lose appetite for risk, we don’t want this fund to behave as if it were an equity fund.”

According to Jed Koenigsberg, Institutional Portfolio Manager, who also participated in the event, some of the funds that compete in the same Morningstar category have a 30% or 40% correlation with the variable income universe. The search for predictability in returns is the differentiating characteristic of this strategy relative to competitors: “When stock prices fall, you don’t want your fixed income exposure to go down as well”.

Where are the fixed income opportunities?

The current macroeconomic environment indicates that many global regions are showing more broad-based, sustained growth, something that had not been seen since the global financial crisis. With this growth, it is very likely that rates will start to rise, albeit gradually, with very different responses depending on each of the regions.

A year ago, there was genuine concern in the markets that China, and potentially the United States, could fall into recession. Today, the risk of an impending recession is very low. While fundamentals remain strong enough to support exposure to riskier assets, MFS suggests a note of caution because of credit spread levels and higher valuations. With this scenario, MFS sees value in the higher-quality part of high-yield market and in some investment grade bonds, especially in those sectors that are increasing their leverage.

For six or nine months, the MFS Global Multi-Sector strategy managers have emphasized emerging market debt within its high-yield allocation, where they have found greater value. Investment in emerging market debt began to make sense with the noise created by President Trump when he signaled that he was going to pull the US out of certain international treaties, and with the improvement of global growth.

According to Robert Spector, although the market continues to price in the continuation of Fed rate hikes, the risks incurred in fixed income when entering a more restrictive cycle are not being correctly evaluated. By reducing its balance sheet and interest rates at the same time, the Fed is accelerating the rate at which the monetary cycle is being restricted. Although the US central bank has informed investors that it is a gradual and automatic withdrawal, Spector believes that the combination of both measures will have a material effect in the coming year.

“The balance sheet rose from US$ 7.15 billion to US$ 3 trillion, which significantly helped the economy and served as support for risk assets. A reduction in this balance sheet should have the opposite effect. In the first phases, in which the balance sheet decreases, there will be no significant changes, but later it will have a material effect. In its economic projections and ‘dot plot,’ the Fed places the rate hike for the coming years at 2.75%, but it is likely that, if the balance sheet reduction takes place, the Fed will end up at a significantly lower rate, not above 2%. Even if the Fed stops its rate hike sometime next year, it is very likely that the US yield curve will continue to flatten. At the same time, the European Central Bank has announced that it will withdraw its quantitative easing program, although it will keep interest rates in negative territory. This has already caused the yield curves in Europe to begin to steepen. We are positioning the portfolio accordingly, remaining with steep positions in Europe and with flat positions in the United States.”

For Spector and the MFS team, the sovereign debt of core European countries is widely overvalued. “Yields on German 10-year bonds are around 50 basis points. Bond yields in countries such as Austria, Finland, the Netherlands, Belgium and France keep their interest rate below 0.75%. In a world in which Europe is growing at a rate of about 2% and inflation is between 1% and 1.5%, we see a historical gap between returns and the economy. These are signs of a significant overvaluation, which is why we have eliminated most of our duration risk outside that European core, especially in the short end of the curve.”

Performance of the rest of the central banks, such as the Bank of Japan and the Bank of England, should also be considered. Put another way, global liquidity carries as much weight as the Fed’s performance in its unwinding. “This experiment has not been done before, so the final result of quantitative easing will most likely be different from the expectations that have been generated with the models of the main central banks.”

Other opportunities detected by the MFS Global Multi-Sector Fixed Income team are structured products, which represent an attractive valuation opportunity as an alternative to high-quality fixed income, where the spreads are really significant. “We have found opportunities in commercial mortgage-backed securities (CMBS) not issued by government agencies, select asset-backed securities (ABS) and collateralized loan obligations (CLOs), as well as Freddie Mac bonds, which can be a good alternative to treasury bonds. Through this type of exposure, we are able to find excellent liquidity which is roughly equivalent to that of more expensive high-quality corporate debt.

Investment philosophy and alpha sources

The MFS team emphasizes the need for a diversified approach in fixed income, especially in an environment like this one. The team’s approach is to incorporate multiple alpha sources across different categories within fixed income to find attractively valued securities, paired with active risk management. Investment opportunities vary with changes in market conditions, so they require an integrated analysis between the different fixed income disciplines at MFS: global credit, global high-yield debt, emerging market debt, collateralized securities and municipal securities and currency. Furthermore, where MFS differentiates itself is in the selection of securities. “At this point in the cycle, where spreads are so compressed, it is more important than ever to focus on debt securities that are truly appropriate for the portfolio. There are always inefficiencies along the entire cycle and throughout the cycle. And these inefficiencies are not only in the sectors, but they are in regions, in credit quality, in currencies, and in duration. Our job is to have a team that finds these inefficiencies and then integrates these multiple perspectives within the analyst team, which then leads us to finding good ideas to position within the portfolio.”

Finally, the MFS Meridian Funds Global Opportunistic Bond generates alpha from a number of sources within the portfolio: between 40% and 60% from asset allocation, between 15% and 25% from duration and country exposure, with security selection accounting for 15% to 20% and currency between 5% and 15%. “We expect to obtain returns from several sources. The most important item for us is the asset allocation, moving in and out of different sectors, but the duration, the country, and the yield curve are also very important contributors. The selection of securities is an important part of who we are, applying a bottom-up approach. We hope that this is a determining factor that drives performance,” concludes Spector.

Legg Mason: “There is a Greater Movement towards Global Diversification by Brazilian Investors”

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During the ninth edition of the Annual Forum of Local and International Specialists for the Discussion of Economic Challenges in Brazil, which was held at the Unique Hotel in Sao Paulo on the 1^stof December, Western Asset, a subsidiary of Legg Mason received professionals of the investment world, with the objective of discussing the challenges Brazil faces in the short term.

Joe Sullivan, Legg Mason’s President and CEO welcomed attendees to the event. After his speech, Ken Leech, Chief Investment Officer for Western Asset, explained how the global scenario has been extremely benign for emerging markets in general, and for Brazil in particular, and what the chances are that this scenario will continue in 2018 .

Then, in a first panel, the government’s microeconomic reform agenda was analyzed as a catalyst for growth. Moderated by Paulo Clini, CIO for Western Asset Brazil, the debate was attended by Joao Manoel Pinho de Mello, Special Secretary of Microeconomic Policies of the Ministry of Finance, Walter Mendes, President of the Petros Foundation, and Marcelo Marangon, Executive Vice President of Citibank , who evaluated which are the most advanced microeconomic reforms to resume economic growth.

During the second panel, they examined how presidential elections will influence the agenda of fiscal reforms, analyzing the possibilities of achieving a fiscal balance in a turbulent political situation. On this occasion, the moderator was Adauto Lima, Chief Economist at Western Asset Brazil, and the panel counted with the contributions of Bernard Appy, Director of the Fiscal Citizenship Center, Caio Megale, Finance Secretary for the municipality of Sao Paulo, and Christopher Garman, Eurasian political consultant.

Strongly committed to Brazil.

The Brazilian economy has recently recovered from one of its worst crises in decades, and is finally returning to positive terrain. Interest rates remain at low levels, but investors worldwide have a strong interest in the yields offered by Brazilian debt.

“Interestingly, investors in Brazil think that their interest rates are at low levels due to their history, but when you think about the performance of the 10-year US Treasury bond, which is somewhat above 2%, in the German bond rate, which stands at 0.4% and the Japanese rate that is close to 0%, and you compare them with the interest rates in Brazil and the possibility that the currency will appreciate as the economy improves , you can get a very attractive return,” said Ken Leech during the press conference with journalists.

Meanwhile, Joe Sullivan added that they had increased exposure to Brazilian debt in all those portfolios in which the portfolio’s mandate allows it: “We have positions in Brazilian sovereign local debt and in certain Brazilian corporate bonds, usually denominated in dollars.”

Although the situation has improved in the Latin American giant, it’s still of vital importance that there is a fiscal reform in Brazil. “Our expectation is that some kind of fiscal reform will be approved, if not this year, the next, but we believe it will be enough to maintain support in favor of Brazilian debt securities. The Brazilian policy has turned towards a government more favorable to the markets, although the elections always introduce an element of uncertainty. We hope that this type of policy will continue, but we are prepared for what may come.”

Regarding how the normalizing process by central banks may affect emerging markets, Leech said that they hope that this time it will not be a problem: “If you think about the last three years, from 2013 to 2016, when the central banks were decreasing their interest rates, unlike in other periods, the rates in emerging markets rose, with a divergence of direction between the rates of developed countries and that of emerging countries. Our vision is that if the central banks begin to raise interest rates it will be because growth has improved and if this is true, then interest rates in emerging markets would not go down. With inflation so low, our vision is that interest rates are going to rise very slowly, so there should be no great impediment for emerging markets.”

The local investor’s appetite for diversification increases

Brazilian investors first became interested in international equities with exposure to currency. Many investors did not hedge currency because they really needed high volatility to compensate for the high rates that Brazil had until just a few years ago. In the last year, there has been an enormous success in hedged strategies because investors no longer need to have exposure to currency risk to find international investment alternatives that provide competitive returns when compared to the local interest rate level.

In any case, the demand from institutional and retail clients is different. The institutional client seeks long-term returns and is interested in variable income products that invest in infrastructure and global fixed income products, because they are a very powerful diversifying element as compared to local debt.

“Brazilian investors have the great advantage of having one of the highest interest rates in the world. So it’s not easy to find Brazilian investors wanting to invest outside of Brazil, where interest rates are much lower. But for the first time, Brazilian interest rates are at their minimum in decades, with inflation close to 3%. Many of their assets are invested in Brazil, but we have seen a growing interest in buying global returns. We believe there will be a greater movement towards global diversification on the part of Brazilian investors,” concluded Joe Sullivan.

“Markets Can Remain Irrational and Solvent for a Long Time. It ‘s Classical of the Herd Mentality”

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“Los mercados pueden permanecer irracionales y solventes por un largo tiempo. Es un clásico de la mentalidad de rebaño” — Wikimedia CommonsPhoto: Tim Paulson, Fixed Income Strategist at Lord Abbett and Justin Wells, Global Equity Strategist at Old Mutual Global Investors, discussion panel moderated by Gustavo Cano, Director of Product and Strategy for UHNW LatAm clients at BBVA Compass. “Markets Can Remain Irrational and Solvent for a Long Time. It ‘s Classical of the Herd Mentality”

In Miami, Martin Hofstadter, Offshore Business Director at Lord Abbett and Andrés Munho, Sales Manager for Latin America, Florida and Texas at Old Mutual Global Investors, welcomed US Offshore industry professionals to a lively panel on global macroeconomics. Moderated by Gustavo Cano, Director of Product and Strategy for UHNW LatAm clients at BBVA Compass, the event was attended by Tim Paulson, Fixed Income Strategist at Lord Abbett and Justin Wells, Global Equity Strategist at Old Mutual Global Investors.

Once the panel was over, the event was attended by Dr. Roberto Canessa, a renowned cardiologist and one of the sixteen survivors of the plane which crashed in the Andes in 1972.

The debate on the macroeconomic environment began by evaluating the performance of central banks, which continue to keep interest rates at low levels for a longer period of time. According to Justin Wells, it’s very complicated for the Fed to diverge radically with the rest of the main central banks, because this could cause strong volatility with respect to the rest of the currencies. In his view, central banks will maintain very benign levels of volatility despite an increase in geopolitical risks that is much greater in developed markets.

While Tim Paulson pointed to the great correlation between asset prices and balance sheet volumes of central banks. “We hope that as the Fed begins to unwind its balance sheet, the impact of its actions in the equity shares market will be reduced. We expect to see risk premiums begin to recover, at present, it’s clear that the European Central Bank’s and the Bank of Japan’s actions are surpassing the Fed’s normalization attempts, which are still very small reductions.”

Lord Abbett’s strategist argued that as long as the tremendous search for returns on revenue continues in the world, which results from the demographics of developed economies, we will continue to see low interest rates for some time. “If you compare returns on German sovereign debt with those of US debt, the latter are higher, but if you take into account the cost of currency hedging, both are more or less at the same level. US rates are at current levels due to the influence of the rate levels in Europe and Japan. And, all rates are moving together, affecting currencies. In this model, if the currency’s hedging goes up, the Fed’s rate goes along with this increase. There is massive global arbitration.”

According to Paulson, the market is expecting less aggressive behavior from the European Central Bank. “Just because they cut down from buying 60 billion to buying 30 billion, does not mean that at some point the market is going to decrease its purchase speed. In Europe, they are still trying to remain behind the Fed, but they continue to buy more than the market is able to digest. Everyone competes against everyone for profitability,” says Paulson.
As for the possibility of overheating the market, in which more and more investors are looking for the first indications that a correction may be taking place, Justin Wells said that there is strong speculation about a potential correction and about why is it’s different this time. “The relationships of conventional metrics with the correlation of the market are breaking down. There is a huge level of disruption in the economy, which is very interesting.”

Meanwhile, Tim Paulson, joked with the idea of ensuring a recession in the future. “While a possible recession may come in 6 months or in10 years, none of the market participants can say when. Economic data show that the chances of a recession in the next 6 or 12 months are lower than average. A recession is possible, but unlikely in the near future. The risk is that there is always going to be something that cannot be predicted, something that causes a recession. While it is unlikely that a recession will occur with a risk of restructuring and real loss of assets as a result of the behavior of central banks, it cannot be ruled out, as it can happen. At no time in history has it been so easy to access the capital markets. A rise in interest rates may put some pressure on the markets and bring them down, but we are far from a horrible decision being made by the Fed.”

Another issue that was mentioned during the debate was the US tax reform. According to Paulson, it’s not an issue that they are implicitly considering in their strategies and he does not believe that anyone in the market is doing it. “You cannot bet on the possible final result of the tax reform. All that can be done is watch which assets will be affected by the fiscal reforms, and if everyone is taking into account the same type of tax reform or that it will happen with the same probability. It is not a question that can be easily solved, but it is how you usually play this type of events; looking for differences in probabilities.”

The absence of volatility and complacency in the markets

On the absence of volatility in the markets, Paulson commented that after the global financial crisis many investors did not leave behind a psychology of pessimistic tendency and continued to bet on quality and defensive styles. “This defensive mentality is what has allowed very low or very benign levels of volatility. We continue to see frequent rotations that can be very destructive, by sector and style, we feel that perhaps they reflect in a more accurate way the real level of volatility, which measured in terms of conventional metrics is simply not reflecting what is actually happening.”

For Wells, another factor that is reducing volatility is the use of quantitative models, since the existence of a reversion to the average calibrates the behavior of real activity, both in the depth of the market and on the surface. “Spreads compression, high price-to-earnings ratios, all these indicators are changes that affect risk premiums, this is really what the actions of central banks has killed. The dynamics of the markets have changed, more than 1.2 trillion dollars have abandoned large cap equity strategies since 2007, and at the same time 1.4 trillion dollars have gone into passive investment and smart beta, a huge change in terms of the underlying dynamics of the market. You need to have a process that is dynamic and that responds to it, against the change in the rules.”

According to Paulson, in a period of low volatility with incredibly cheap access to capital, businesses and consumers start making bad decisions and do not feel the weight of these decisions until after a while. They become more complacent, and eventually the pressure in the system also becomes complacent. Historically, the longer it stays in these periods of low volatility, the more violent the rupture. “In a period in which stocks and bonds have very high valuations, investors are beginning to look for opportunities in alternative investment by increasing the risk of their portfolios. Something similar to what has happened in Europe in the last six or seven years. Bond yields have turned negative and investors continue to invest because they still need more profitability, it is not logical; it ‘s only working because all investors are taking the same position at the same time. Markets can remain irrational and solvent for a long time. It’s classical of the herd mentality that investors exhibit when they are not clear in which direction to invest.”.

Lack of inflation

According to Paulson, inflation will be affected by the structural trend in the long term. The labor market in the United States is very tight, being one of the reasons why inflation has picked up a bit, but somehow deflation is being imported from Europe and Japan, something that may be reversing many of the trends that are happening. “As long as inflation remains at low levels, I am confident that risk assets will perform well or at least central banks will maintain their accommodative policies. The issue that may introduce some disruption is that inflation starts to grow faster than central banks expect and they then have to change their reaction.”

For Justin Wells, this is one of the areas in which they are seeing a greater disconnect between the convection that has worked so far and has stopped working, the classic Phillips curve. “The massive disruption that the real economy is suffering at this moment, with its winners and losers, has caused huge deflation, we are not seeing wage growth as a result of the introduction of new disruptive technologies. Some workers will be replaced by automation or other forms of disruptive technologies, at an incredible rate of disruption; something which, from the point of view of the active manager, will create a large number of opportunities.”
To conclude, the asset managers commented that for the following 12 months they still expect to be closely watching the levels of support that the Fed provides to the market, the pressures that are being created in the system and how to navigate them.

Dr. Canessa’s participation

During his presentation, once the debate ended, Dr. Canessa reminded the audience that it is not necessary to wait for a plane crash to enjoy life: “Don’t look at the mountain, it can be very steep, just look at the next step that has to be taken, and if you feel disappointed look at what you have achieved up to that moment, you cannot wait until the helicopters arrive to save you, you have to continue walking.”

BlackRock to Acquire Citi’s Asset Management Business in Mexico

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BlackRock comprará el negocio de asset management de Citi en México — Wikimedia CommonsPhoto: Rafael Guajardo/ Pexels CC0. BlackRock to Acquire Citi's Asset Management Business in Mexico

BlackRock and Citibanamex, a subsidiary of Citigroup have announced a definitive agreement for BlackRock to acquire the asset management business of Citibanamex, subject to regulatory approvals and customary closing conditions.

BlackRock and Citibanamex will also enter into a distribution agreement upon the closing of the transaction, to offer BlackRock asset management products to Citibanamex clients in Mexico. Through its network of 1,500 branches in Mexico, Citibanamex provides wealth management products and services to more than 20 million clients.

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The transaction involves approximately US$31 billion in assets under management of Citibanamex, across local fixed income, equity and multi-asset products, primarily for retail clients. The transaction is part of Citi’s emphasis on expanding access to best-in-class investments products, rather than on manufacturing proprietary asset management products. BlackRock’s business in Mexico currently focuses mostly on institutional clients, offering international investment and risk management products and services across asset classes, strategies and geographies.

The agreement builds upon the long-standing relationship between BlackRock and Citi and brings together two leading firms to offer a wider range of products, enhanced technology and investment capabilities for clients. It is expected to close during the second half of 2018. The financial impact of the transaction is not expected to be material to Citigroup or BlackRock earnings. Terms were not disclosed.

Armando Senra, Head of Latin America and Iberia for BlackRock, said: “BlackRock’s ambition is to become a full solutions provider in key markets around the world. This transaction is a big step forward in that direction in Mexico. The acquisition of Citibanamex’s asset management capabilities combined with our global investment platform and technology create a stronger franchise that can deliver a more compelling set of investment solutions across client segments in Mexico.”

Jane Fraser, CEO of Latin America for Citi, said: “Our goal is to create a state-of-the-art bank in Mexico focused on delivering a richer, smarter, more intuitive experience to everyone who does business with Citibanamex. The agreement with BlackRock delivers on our commitment, offering clients leading asset management services, and provides BlackRock with access to our extensive network in Mexico. We are excited by the opportunities this transaction offers and look forward to working with BlackRock.”

Mark McCombe, Head of the Americas region for BlackRock, said: “BlackRock believes in the long-term growth potential of Mexico and is committed to continue growing our presence here. Combining BlackRock’s capabilities in product and technology with the distribution network of Citibanamex creates a stronger franchise that can do more for clients.”

Ernesto Torres Cantu, CEO of Citibanamex, said: “Our commitment is to deliver the best client experience by offering the best of Mexico, and bringing to them the best of the world. Our association with BlackRock does exactly that”.

Citi Institutional Clients Group advised Citi on this transaction.

EMD Should Shift From Being Beta To Alpha Driven

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As liquidity is slowly drawn from the global economy, the recent wall of money beta- driven rally is likely to morph into a market with higher dispersion, in which BlackRock thinks alpha opportunities may take a stronger role as a source of excess returns in 2018.

According to Sergio Trigo Paz, Managing Director, Head of BlackRock’s Emerging Markets Fixed Income and Pablo Goldberg, Managing Director, Head of Emerging Markets Fixed Income Research and Portfolio Manager, EM high-yielding bonds will be delivering positive total returns in 2018 as developed market central banks gradually normalize monetary policy. As monetary policy normalization continues, a proper assessment of country-specific EM idiosyncratic risks and active differentiation is key to future returns and volatility of portfolios.

According to them, a ‘reflationary’ environment is supportive of further strengthening of emerging countries’ fundamentals, and in turn validates tighter spreads and stronger currencies in EMD. However, they are aware that EM countries find themselves at very different points in their business cycles, which should lead to divergent monetary policies.

Blackrock believes the best news are coming from Latin America, which has finally departed recession in 2017 and could grow 2.4% in 2018. They continue to like high yield oil exporting countries and stay short duration, and favor unconstrained strategies that allow dynamic duration management. Which is why they believe investors may want to consider switching from indexing to alpha strategies that may more efficiently capture the opportunities provided by a more volatile market that may likely gyrate between these alternative scenarios during 2018.

“We believe that a more flexible allocation to local debt, between IG and HY, and a dynamic duration management, to accommodate U.S. curve shifts, provides the potential to maximize excess returns for the rest of the year,” they conclude.

John Stopford (Investec): “The Market Does Not Believe the Fed, Thinking it’s The Boy Who Cried Wolf”

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Is it possible to find opportunities in a bond market that has remained bullish for 35 years? According to John Stopford, Head of Multi-Asset Income at Investec Asset Management, there are still possibilities to find value in fixed income markets, although they are increasingly difficult to locate.

During the Investec Global Insights 2017 celebration in Washington, the manager reminded attendees of the origin of the current context. It all began when, at the end of the 70s, after a period of high inflation, Paul Volker, Chairman of the Federal Reserve, decided to put an end to the growth of the money supply. Since then, and except for short periods in 1994 and 2008, fixed income has not stopped rising in price. If we add to this a much lower growth than in previous times, with secular stagnation, as argued by Larry Summers, former Vice-President of Development Economics and Chief Economist of the World Bank, the result is an environment in which rates of developed governments are excessively low and will most likely not increase significantly. The real growth of the US GDP has decreased, and inflation has also diminished, although the Fed can now manage a restrictive monetary policy, the change will be slow, incremental and will take a while to increase.

“If clients expect to see US Treasury bonds back to 5% returns, they are probably wrong. Since the financial crisis, central banks have injected billions of dollars into financial markets, but the costs of expansive monetary policies are now beginning to outweigh their benefits. Central banks have begun to eliminate their excess supply, which will surely trigger a rise in rates. The Fed estimate is a rise of 60 basis points, it’s not much, but we must get used to these figures. We should not expect increases of 200 basis points, potentially being able to reach 50 – 100 basis points at some point during this new cycle,” Stopford pointed out.

Another issue that should worry investors is the US package of fiscal easing measures. An increase in the country’s budget deficit could raise interest rates, and given the point at which the cycle is located, it may also push up inflation expectations. “If the US deficit increases materially, real bond yield rates could be pushed upwards. The question is whether Donald Trump will be able to get approval for a 3.5 trillion dollar budget, because he needs each of the Republican senators to vote in favor. Both the application of an expansive monetary policy and the withdrawal of central banks are actually risks. The Fed has already shown all its artillery. In one of her latest presentations, Janet Yellen basically mentioned that inflation is a mystery; an alarming statement coming from the person whose aim is to control inflation in the world’s largest economy.”

According to the Investec manager, the recent weakness in inflation is partially transitory and he expects it to reverse sometime next year. Inflation can also be driven by lower unemployment, a weaker dollar, and firmer commodity prices. And, if the fiscal expenditure package is finally approved, it would have an inflationary effect at this stage in the cycle.

Returning to the economic normalization program, the Investec manager said that the Fed wants to continue raising rates, he believes that now is the appropriate time to abandon the quantitative easing policy, reversing bond purchases in its balance sheet. “Rates will not rise to 5% levels; they will probably stay at 2.5% levels. Furthermore, the market does not believe the Fed, thinking it is the boy who cried wolf, even though the Fed has already narrowed the market down to a greater extent than was expected during the past year. But, perhaps now is the time when the market should probably converge with the median of the Open Market Committee’s projections.”
As regards the positioning of the portfolio, the Investec manager recommends being careful with a potential sovereign crisis in the short term; mentioning that the opportunities could be in countries such as Australia, the Czech Republic, and Canada.

Corporate debt

On the corporate credit side, there are two reasons why credit spreads are at levels as low as the current ones. The first issue is the risk of recession, if you compare the spreads of high-yield debt in the United States with the probability of entering a recession, you can see that there is a strong correlation in their behavior, especially when there is a sudden movement. A recession causes companies’ balance sheets to begin to suffer, and it’s then when they cannot pay the debt they borrowed. According to Stopford, the current risk of entering recession is low, at least for the next 6 to 12 months.
The second metric that must be taken into account is the absence of volatility. The VIX is the measure of the cost of insuring a portfolio, the implied volatility in equities, which is to a certain extent the equivalent of buying insurance. But at the moment investors are more focused on obtaining returns, and are willing to trade security for returns. “If the credit spread indicates how much uncertainty there is around companies in the future, the VIX is exactly the same issue for equities. You can see that they both move together, so it should not be surprising that credit spreads are so compressed. Can they remain at that point? Yes, for a while, because thereis still not much volatility in the short term and monetary policy is still not affecting enough.”

Although Stopford recommends lower exposure to corporate debt due to its limited risk premium, the fact that the environment remains favorable for growth, suggests that opportunities could be found in the diligent selection of credit.

Emerging market debt

Investors continue to worry about everything that did not work in emerging markets in 2012 and during the period 2015 -2016. But the main opportunities could probably be found within this asset class, real bond yields are above the US rate, which is negative, as in most developed markets. Some emerging markets continue to cut rates and some have begun to raise them gradually. In addition, there are numerous idiosyncratic risks, so it pays to be selective. “You should not invest all your money in emerging markets, you should have a diversified portfolio, but this asset class shows good performance between fundamentals and valuations.”
In emerging markets the debts of Israel, Hungary, Chile, Peru, and Mexico are at reasonably attractive levels.

Foreign currency positions

Currencies usually behave much like a roller coaster. The good news is that they don’t usually move together, so it’s usually a field of opportunities. In this regard, Investec recommends taking advantage of the relative optimism seen in Europe as compared to the United States, cautiously selling the euro against the dollar. At the same time it sees an opportunity to position itself long in the currencies of certain emerging markets, such as the Czech koruna, the Indian rupee, the Mexican peso, the Hungarian forint, the Indonesian rupee, the Chilean peso, the Peruvian nuevo sol, the Egyptian pound, the Thai baht, and the Turkish lira.

MFS: “The Market Forgets that When Credit Liquidity Dries Up, There Is No Turning Back”

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Pilar Gomez-Bravo was recently appointed Director of European fixed-income for MFS Investment Management. She also serves as Lead Portfolio Manager for MFS Meridian Funds Global Total Return and MFS Meridian Funds Global Opportunistic Bond. Pilar shared her views on the global debt markets during the 2017 MFS European Investment Forum in London.

Beginning with the disparity between what the US Federal Reserve is saying with regards to rate hikes and what the markets are anticipating, the Gomez-Bravo says the markets are probably right. “The Fed has been lowering its neutral rate, which indicates the extent to which they expect to raise rates, dropping now to 2.75%, whereas the 10 year yield is even lower at 2.3%. Every time there has been a difference between market expectations and those of the Fed, it’s the Fed that invariably moves towards the market. The Fed’s rate policy guides the short end of the yield curve and that is where its communication and guidance is focused. What Central Banks would really like is to be able to control the long-term slope of the curve because it determines the level of accommodation of monetary policy.”

Likewise, Pilar Gomez-Bravo doesn’t see rate hikes in Europe in the short term, although she does acknowledge that the European Central Bank will want to avoid any mistakes as it manages the exit of its public asset purchase program. They also want to assure the markets that they are not going to change the deposit rate, which is currently still negative. “At a time when the unemployment rate has fallen, and growth is on the rise, the European Central Bank will begin to consider that it makes sense to stop buying assets and injecting liquidity into the market. Another issue is that the ECB doesn’t have many more options, given the criteria established for the purchase of government assets. The time will come when it can no longer maintain the guidelines that were established in the buying process. The ECB will want to avoid creating panic -similar to what happened during the Taper Tantrum in 2013, which led to widespread selling of risky assets and a drastic rise in interest rates- largely due to poor communication from the Fed.”

At MFS they expect Draghi to continue to gradually reduce the ECB’sdebt balance due to the lack of alternatives. They will also try to create as much distance as possible between the decision to withdraw liquidity from the market and the commencement of the interest rate increases. “It‘s possible that the European economy will continue to strengthen and we could see rate increases well before the end of 2018, which is what is currently priced into the market.”

What is the expected inflation scenario?

It’s expected that there will be very little upward inflationary pressures, mainly due to the market structure. Globally, there is an immense amount of debt, which limits the extent to which rates can be rise without leading to a recession. In addition, there are certain demographic problems in the United States and other developed countries that prevent inflationary pressures on the labor side. “The generation of Baby Boomers who tend to have very high wages is beginning to retire, and the generations replacing them earn much less. Companies are not investing and there is no growth in productivity in the United States, indicating that inflation will be contained. In a world dominated by technology and demographic shifts, conventional wisdom stops working. We’ve seen unemployment fall, without a meaningful increase in inflation, particularly in the United States. In Europe, disruptive technology are not having the same impact that we’ve seen in the United States, where companies like Amazon or Airbnb suppress pricing pressures. That’s why we could see rising inflation in Europe before it takes hold in the United States. In both cases inflationary pressures will probably come from wages and commodity prices, and in particular from oil prices, if we see sustained upward pressures in either of these two variables, we will change our vision on long-term inflation.”

The importance of credit selection

In an idyllic period of low inflation and low growth, the business cycle is much further along in the United States than in Europe. Until now, MFS had had a preference for US companies, because it’s a large deep market, with a lot of diversification and credit capacity. “The United States offers relatively high rates compared to other countries, but the cycle is coming to an end; while in Europe it still has further to go. Eventhough we have to account for European and US credit valuations, we do think that Europe may offer somewhat more value because the technical valuation is supported by the European Central Bank which continues to buy bonds.”

At present, credit selection, of a specific bond or issuer, through analyzing its parameters and fundamentals, that leads to investing in bonds on which there is a high conviction, has much more potential to deliver alpha than directional positions, since the latter have their performance limited to that of a market that is trading at high valuations. “Investing in higher-conviction securities makes sense for two reasons: you can avoid potential losses of some market issuers and concentrate the portfolio in those names where we see greater potential for outperformance. We have also been reducing systemic credit risk in our portfolios, while looking to generate more opportunities by investing in specific credits, which we believe will lead to a longer lasting source of alpha.”

The emerging credit market

In emerging markets, after the 2017 super rally, we see value in certain countries whose fundamentals have significantly improved, such as in Indonesia, India, Brazil and Argentina. We continue to see value in emerging market debt, both in hard currency and in local currency.

Is now the time to add more risk to the portfolios?

The current bull market is approaching nine years. MFS is positioned somewhat defensively because they are expecting a market correction and current risk adjusted valuations are not as attractive. Still, Gomez-Bravo argues that there are still opportunities for investors and that the more flexibility one has the better: “If you manage funds that are more global, or if you have a multitude of factors to choose from, you diversify the portfolio while removing risks. But we are still waiting to see what happens with tax reform and fiscal policy in the US. The market forgets that when liquidity dries up there is no turning back. During the last crisis, many investors weren’t able to sell their short duration floating rate bonds, and they had to settle for 50 cents on the dollar. Taking on a lot more risk for an extra 30 basis points doesn’t make sense in this environment”