Pixabay CC0 Public DomainPhoto: elenlackner. WisdomTree Buys ETF Securities’ European Exchange-Traded Commodity, Currency and Short-and-Leveraged Business
ETF Securities has agreed to sell its European exchange-traded commodity, currency and short-and-leveraged business to WisdomTree Investments the Nasdaq-listed (ticker: WETF) and New York headquartered global exchange-traded product provider.
The business being sold comprises all the European operations excluding the ETF platform. The business being sold to WisdomTree has $17.6 billion of AUM spread across 307 products, including the flagship gold products PHAU and GBS. The business has a comprehensive range of commodity, currency and short-and-leveraged products and more than 50 dedicated staff.
WisdomTree and ETF Securities will work to ensure that integration is seamless and expect no change to the current high standards of service and operations experienced by our customers and partners.
The sale is subject to regulatory approval and is currently anticipated to close in late Q1 2018.
Graham Tuckwell, Founder and Chairman of ETF Securities, comments: “We are pleased to be selling our European exchange-traded commodity, currency and short-and-leverage business to WisdomTree and to become the largest shareholder in the company. I believe this combination creates a uniquely positioned firm which will flourish in the years ahead, continuing to deliver huge value for customers and stakeholders. ETF Securities has a strong cultural fit with WisdomTree as both firms have been built from scratch by teams who have worked closely together for many years and who show an entrepreneurial spirit in seeking to deliver innovative and market leading products for their customers.”
Mark Weeks, the UK CEO of ETF Securities says: “This transaction creates a leading independent global ETP provider which is well positioned to compete in the rapidly growing European ETP market. We have complementary expertise, product ranges and customer networks. We both continue to challenge the status quo to provide customers with a range of differentiated products. In this industry customers want and value firms like ours, which provide broader choice.”
Yerlan Syzdykov, courtesy photo. Venezuela On the Edge of a Cliff: Lets Be Cautious
A full Venezuelan sovereign default scenario would be one of the most complex events of its type and would require a large-scale restructuring, according to Yerlan Syzdykov, Deputy Head of EM at Amundi AM who does not see anuy rapid solution to the restructuring process.
What is your analysis of recent events in Venezuela?
President Nicolas Maduro recently announced the Republic of Venezuela’s intention to restructure all foreign debt, thus recognising the country’s current debt load as unsustainable. The nation missed a coupon for about $200ml and failed to make the payment by the end of a 30-day grace period, triggering the rating agencies downgrade to default. A meeting of the International Swaps & Derivatives Association will follow shortly to discuss whether a week- long delay on bond payments from the state oil company will trigger default-insurance contracts on those securities. We think Maduro’s move is part of a political game to increase his chances of re-election in 2018, and it follows an attempt to consolidate power by the regime, including sweeping victory in recent gobernatorial elections – despite a 21% approval rating at the time. With this political capital in hand, pushing bond payments further out, Chavismo1 now turns to the debt issue. To further delay and complicate the negotiation process, the Republic invited bond holders to Caracas on 13 November to begin restructuring negotiations. The meeting was chaired by Venezuelan Vice President Tarek El Aissami. Among the attendees was the Economy Minister Simon Zerpa. who also serves as CFO of PDVSA, the state oil company. Both Mr El Aissami and Mr Zerpa have been sanctioned by the US, which inhibits US persons participating in the discussion. No specific proposals seemed to have emerged from the meeting but government officials insisted they plan to continue to service obligations.
What is the market expecting for the near future?
The restructuring announcement changes the prevalent consensus towards both Venezuela and its related quasi-sovereign bonds. The market was expecting Venezuela to service into 2018 and then seek to restructure the Republic only. Now the market has begun to debate the Republic’s specific timetable and the range of potential outcomes. With Maduro in power, the range of outcomes is narrow. The market’s assessment of the probability of a transition, and therefore Maduro’s future, will be important drivers of bond prices. Maduro’s recent comments confirm that the Republic plans to include PDVSA and other Venezuela quasi- sovereign issuers in the restructuring programme. PDVSA and the electricity company Elecar collectively have $750m in coupon arrears on $66bn of outstanding bonds. It appears that the government is proposing to address these arrears collectively or concurrently with the Republic. The Republic may be attempting to protect PDVSA by going for a restructuring. Considering the complexity of the government’s position, the decision to restructure may reflect a desire to negotiate a more favourable outcome, which is unlikely, in our view.
What happens if Venezuela should default? A full Venezuelan sovereign default scenario would be one of the most complex events of its type and would require a large-scale restructuring. Only the Republic knows Venezuela’s total debt level, which is estimated to be around $150bn. US investors hold some 70% of Venezuelan hard currency debt. This introduces further complication to an already complex situation, given the prevailing US sanctions. Creditors include recipients of promissory notes, as well as those with material trapped capital – such as airlines. This creates a potential burden on the state through unresolved claims. It also contributes to uncertainty around bond servicing, as the total size of these claims is not widely known.
Who could come to the rescue?
We see quite limited options. Venezuela does have some assets, even though foreign currency reserves have declined in the past years. The country has an equivalent of $1.2bn in SDR2 reserves with the IMF, and around $7.7bn in gold. Further external support from Russia is also a possibility. The government could also negotiate an extension to several Chinese loans due at the end of this year. Venezuela getting further loans from Russia or China remains a low probability event, in our view. China is unlikely to bail out the government, having previously declined to revise the terms of a loan. The IMF enters the process facing a number of challenges. It is said to regret its role in the recent Greek bailout. At that time, the Fund was pressured to take a 30% participation, a transaction it says it now regrets. This may influence the Fund’s path of engagement with the Republic. The Fund enters the discussion with incomplete and outdated information. Venezuela had reduced contact with the IMF in recent years. The fund’s first challenge will be to develop a precise understanding of the situation – a goal that may take time to be achieved. Holdouts present a real challenge to any attempted restructuring or re-profiling of maturities. Another wildcard: in the US, a creditor with a court judgement is entitled to attach receivables, which means creditors could seize oil payments. As a result, the Fund might alter its traditional approach and attempt a more direct resolution. For example, the Fund might move to engage the market earlier by going for an early debt haircut; should it go down this route, we expect considerable scepticism. Lastly, IMF’s decision to support the restructuring and commit any funds to the country has a complex political dimension given antagonistic relationship between Venezuelian government and the US. Overall, we believe that the Venezuela story will persist for several years.
Where does the state oil company PDVSA stand in all of this?
PDVSA enters restructuring talks with c. $42bn in outstanding bonds, of which $29bn are USD-denominated. 2016 EBITDA has been estimated at $15bn compared with $66bn in 2011. The company currently operates 44 rigs, down from 70 a few years ago. PDVSA’s oil production is likely to have fallen below 2.0 mm bpd (barrel per day), (-11% YoY), as sanctions complicate oilfield equipment purchasing. PDVSA ships around 1mm bpd to service borrowings from China and Russia, as well as to service other political commitments made by the regime. This limits the amount of production available for debt servicing. PDVSA is a different legal entity than the Republic, hence an event that impacts the Republic doesn’t automatically impact the company (so called cross-default). The Republic’s intention may be to protect PDVSA and oil flows ensuring access to petrodollars. Sovereign bondholders, however, will immediately seek to attach those flows through legal remedies based on the legal argument of ‘alter ego’. Furthermore, it is unlikely that the IMF would allow the Republic to default while PDVSA continued to service.
Would you expect any spillover from the Venezuela crisis?
Contagion among EM is mitigated by a number of factors. Firstly, the possible default of Venezuela has been well flagged. In fact many investors believed Venezuela should have defaulted long time ago. Secondly, fundamentals in EM are currently generally strong and the spreads reflect a healthy macro background. Most countries are not overleveraged, and we see current account surpluses in many EM economies. Where there is a potential contagion is around US refineries. Venezuela supplies crude to many US refineries, particularly those around the Gulf. These refineries produce gasoline and are configured to take Venezuela’s sour crude. A slowdown in Venezuelan output could reduce US gasoline production, which might alter inflation or growth characteristics. While that is theoretically possible, at this juncture it does not look likely.
In Russia, some petroleum companies are invested in PDVSA (mainly Rosneft, but also Gazpromneft and Bashneft). There is also a reported miss on a payment to ONGC, the Indian state oil company. Were Venezuela would service its debt or restructure, the result would be immaterial given the relative size of the exposure for those companies. In an unlikely scenario of a blockage of the Venezuelan oil exports, US majors and oil servicing companies will have a negative but limited impact.
Do you see opportunities emerging from the crisis?
The timing and tone of the government’s proposals may have a material impact on discussions, successful or otherwise. PDVSA, as the country’s main source of hard currency export earnings, could give exposure to Venezuelan yields from a possibly advantaged position if an event occurred. Given the overall uncertainty, the complexity of both PDVSA and the Republic’s capital structure, and the unknown size of overall liabilities, it is too early to make a meaningful assessment of potential recovery value. An additional consideration is about alternative investment opportunities – if Venezuela’s interest rate spread continues to widen, it might pull investment from other, higher-risk debt issuers: the composition of return from EM could shift in character. Overall, we remain very cautious on Venezuela, we don’t see any rapid solution to the restructuring process, and we continue to look for tactical opportunities as they emerge with risk control as a priority for our investors.
Pixabay CC0 Public DomainRodolfo Campos Villegas en su toma de protesta, foto PENSIONISSSTE. Afore Pensionissste Grants its First Investment Mandate to BlackRock
Short after a change in leadership in Afore Pensionissste, with Rodolfo Campos Villegas, as its new CEO and Ruben Omar Rincón Espinoza, as its new CIO, the Mexican pension fund is really shaking things up. An example of this is that they have granted their first investment mandate.
Sources close to the operation told Funds Society that Afore Penionissste has chosen BlackRockto invest part of their portfolio in european equities. Up until recently the afore had very small international allocation given it is one of the three ones that is not allowed to invest in derivatives and thus, properly hedge risks, but things are about to change.
One of the highlights of this pension fund is that it has the lowest fees of the Mexican system charging only 0.86%, while the system’s average is 1.03%.
Campos Villegas also plans to grow their allocation to the energy sector while reducing Mexican government debt.
Foto: Dennis Jarvis. BlackRock lanza un fondo con exposición al mercado chino de acciones clase-A
BlackRock has launched the BlackRock Global Funds (BGF) China A-Share Opportunities Fund. The Fund is designed for investors looking for growth, alpha and diversification from the China A-Share market.
The Fund is a liquid, long only, Systematic Active Equity (SAE) UCITS strategy targeting consistent alpha on an annual basis. The strategy uses a combination of both traditional quantitative signals and more innovative big data and machine learning insights. Together, these tools are used to identify around 300 companies for investment from a universe of 1,300 Chinese companies in the Shanghai, Shenzhen and Hong Kong Exchange Stock Connect programme.
The Fund will be managed by the SAE team in San Francisco, with trading executed in Hong Kong. The team comprises more than 80 investment professionals across research, portfolio management and investment strategy. Dr Jeff Shen, PhD, co-chief investment officer of active equity and co-head of investments within SAE, leads the portfolio management team. He is supported by Dr Rui Zhao, PhD, who is co-portfolio manager on the fund.
Jeff Shen comments: “We’ve been applying systematic investment methods to equity markets for over thirty years and more recently, we’ve been researching and applying new methods – big data, machine learning and artificial intelligence – to our models. We find these insights have extraordinary relevance in a market like China where data is quite often available and the market is large and complex. We have been managing this strategy for institutional investors for five years, and we are very excited to offer this strategy to retail investors in a vehicle that provides daily liquidity.”
Michael Gruener, Head of EMEA Retail at BlackRock, adds: “China is one of the largest stock markets in the world, but due to restrictions on ownership, foreign investors have had very little exposure to Chinese domestic equities. Now, with access to onshore Chinese companies through the recently opened Stock Connect programme, investors have the opportunity to invest in a previously untapped market.”
Foto cedidaSimon Fox, Senior Investment Specialist at Aberdeen Standard Investments, courtesy photo. Aberdeen: “Diversification Across Funds Should Mitigate Market Falls"
Investors have to deal with both short-term volatility and downfalls risks. For Simon Fox, Senior Investment Specialist at Aberdeen Standard Investments, the adequate way to deal with this is to better diversify your portfolio. As he explains in this interview with Funds Society, at a difficult time for traditional fixed and variable income, he finds the most compelling opportunities through a range of diversifying assets, such as emerging market debt in local currency, investment in infrastructure and asset backed securities.
What does provide an ‘alternative’ approach to markets? Is it about looking for new sources of alpha or is it about protecting against risks?
Multi asset investing has evolved considerably since the Global Financial Crisis. Today’s investors are looking for a more explicit focus on their own objectives – such as a cash or RPI+ return; or maybe a consistent level of income. In the past a simple blend of stocks and bonds may have delivered decent returns, but not without significant volatility. Looking forward, historically low bond yields and challenging equity markets mean that even the returns achieved in the past look unlikely to be delivered in the future.
To address these challenges, we believe that investors should further diversify their portfolios. In particular, there are, today, a broader array of asset classes available and accessible to investors via UCITS regulated investment structures. Our Diversified Asset team seeks out fundamentally attractive long-term investments across listed equities, private equity, property, infrastructure, high yield bonds, loans, emerging market debt, asset backed securities, alternative risk premia, insurance linked securities, litigation finance, peer-to-peer lending, aircraft leasing, healthcare royalties and other asset classes.
Combining these asset classes in a diversified portfolio results in the attractive returns coming through in a much more consistent fashion than any one asset class in isolation. This approach is very transparent and does not rely on complex derivatives trades or our ability to trade in and out of markets over short-term horizons. This makes the approach easy to understand and robust to differing market conditions.
What are the main risks that you currently appreciate and how could alternative strategies help to mitigate them?
Investors have to contend with both the risk of short-term volatility and also the risk of failing to generate the growth (or income) that they need over the longer-term.
We believe that the right foundation for dealing with both of these is to better diversify the portfolio. As we have seen over the last few years, equity markets can, and do, suffer large drawdowns over short time periods – notably in the summer of 2015 and the start of 2016. By being more diversified, our multi-asset funds have experienced much smaller drawdowns through these periods; as such, they have also been able to compound positively as the markets have recovered.
And talking on risk, we could mention the low rates risk… do you see a bubble in fixed income? And could this bubble burst in some markets? How do you manage this risk in the funds? – Central Banks: what do you expect from Fed? Which will be the next steps of ECB? How do you manage all this issues in your portfolios?
When building our portfolios we make use of sophisticated optimization techniques and other quantitative modelling; but we also believe that it is important to consider the possible future risk scenarios that risk models won’t capture. Most recently we have assessed the possible impact of a North Korea/US conflict, a global pandemic and secular stagnation – as well as a rout in bond markets. While we regard it as a very low probability, there is nonetheless a risk that the US Fed is forced to raise interest rates rapidly over the next 12 months to deal with inflationary pressures and the prospect of a substantial fiscal stimulus. This scenario would see Treasury yields spike higher and equity markets fall. While our multi-asset funds would likely be down in this scenario, we would expect them to provide significant protection relative to a more traditional balanced portfolio.
Often this exercise throws up a call for some portfolio protection (put options, gold, etc) as minds become overly focused on the worst-case scenarios. However we remain of the view that the diversification across the funds should mitigate market falls to a large degree and that portfolio protection strategies are typically not cost effective. The recent reduction in equities is an example of our more preferred route to risk reduction especially when stretched equity valuations make the risk-reward trade-off less attractive. We currently have no exposure to traditional fixed income – either government bonds or investment grade credit.
Brexit: Which risks do you appreciate related to this process? Do you place the portfolios at a specific way in the run-up of Brexit?
At the start of 2016 – ahead of the UK referendum – we modelled a Brexit impact in our scenario analysis. In practice, the diversified and global nature of our portfolios, as well as share class specific currency hedging, meant that Brexit had little impact on our portfolios.
About Multi-Asset spectrum: in which segment do you see more opportunities of returns: in risk assets or in those assets with lesser risk?
Our asset allocation is derived from a longer-term outlook than many multi-asset funds, with a 5 year view of risk and return the main driver of our positioning. The chart below shows our current outlook for various asset classes. It highlights that traditional bonds – investment grade credit and government bonds – offer limited return potential (and, in some scenarios, limited diversification benefit). Equities still offer a premium over risk free assets, but this has narrowed over the last 6 months, notably in the US where valuations looked stretched on a range of measures. As such, we find the most compelling opportunities across a range of diversifying assets. This includes local currency emerging market debt (benefitting from good yields and strong fundamentals); infrastructure investments (which we can access through REIT-like investment trust structures); and asset backed securities.
Taking into account the environment of markets: do you consider necessary to reduce the expectation of returns or is still possible to obtain good returns with an alternative and multi-asset approach?
As can be seen from the chart above, our 5-year view is that traditional assets will under-perform relative to history. However, by being able to diversify the portfolio across a broader array of asset classes, we continue to believe that we can meet our long-term return targets for our funds while maintaining a volatility well below that of equity. Since inception our growth strategy has outperformed its Cash+4.5%pa return target, net of institutional fees, with a volatility of c.4.5%pa. Our ability to access a range of compelling opportunities stems from our ability to identify and access a broad range of asset classes in a liquid form. This is driven by the breadth and depth of resources we have across a range of investment specialisms.
Could you give us some examples of investments you currently hold in the portfolio? I mean some bets on relative value, for instance.
Within social infrastructure we have taken a couple of new positions recent months – adding Bilfinger Berger Global Infrastructure (BBGI) and International Public Partnerships limited (INPP). Both INPP and BBGI provide exposure to a large portfolio of Public Private Partnerships/Private Finance Initiative projects across the UK, continental Europe, Canada, Australia and the USA. These provide attractive, government-backed and largely inflation-linked long-term cash flows.
Within our special opportunities sleeve we have also made a new allocation BioPharma Credit. This holding provides exposure to a diversified portfolio of debt backed by the assets or royalties of biotechnology firms. Benefitting from the premium associated with specialist lending, Pharmakon Advisors are targeting an 8-9%pa return from a portfolio offering significantly different return drivers to other exposures in our Funds.
Pixabay CC0 Public DomainCarlos Noriega and Agustín Carstens at AforeMX. Carstens Says Mexican Pension Funds Could Learn From Behavioral Economics
Celebrating the 20th anniversary of the Mexican Pension funds, the Afores, Mexican financial authorities, OECD and IDB representatives along with international experts, specialists, academics and investors met in Mexico City for the Second Afores National Convention and the 15th FIAP international seminar.
In the event, Carlos Ramírez Fuentes, president of the Mexican Pension system regulator, Consar, said that this year has been of significant capital gains and a good level of collection, but that the discussion on commissions for 2018 is expected to be “complicated”. The participants also recognized that the contribution rate of Mexican workers is one of the lowest in the OECD.
In his speech, the Bank of Mexico’s Governor, Agustín Carstens, commented on “the virtuous circle that is produced thanks to the synergies that have been generated by the reform of the pension system and the autonomy of the Bank of Mexico, with its consequent impact on the savings in our country,” but he noted that the system faces enormous challenges that must be addressed in a coordinated manner. “The current pension system has a low coverage, to the first quarter of 2016 the contributors to social security in Mexico represented only 27% of the population of working age, which places our country below countries like Chile ( 40%), Costa Rica (41), Panama (47) and Uruguay (65),” he said.
Robert Kapito, president of BlackRock, said that Latin America offers investment opportunities because it has a large percentage of workers compared to the general population, but stresses the need to improve its performance and savings capacity, following the example of emerging Asia. In his opinion, this can be achieved through an improvement in financial education, an increase in women in the workforce, adjustments to policies and regulations, as well as an evolution of investment solutions. “Definitely if people in Latin America know more about their finances and their future financial needs, that would help economic growth,” he said.
Meanwhile, Guillermo Arthur, president of FIAP, warned that short-term solutions should not be sought in Mexico, since doing so could lead the country to face a crisis like the one currently experienced in Chile. While the Undersecretary of finance SHCP, Vanessa Rubio, said that “we must think of an increase to mandatory contributions, in voluntary contributions, in the possibility of giving incentives for this, and in perhaps gradually increasing the retirement age. ” However, Carstens stressed that “while establishing an increase in mandatory contributions could be reasonable, (…) this measure alone could generate incentives that would favor informal employment”, proposing the use of schemes such as 2017 Nobel Prize winner, Richard Thaler’s nudges, to automatically enroll workers in voluntary savings schemes. The central banker concluded that although there are still important challenges, he is convinced that “with the will and commitment of the institutions, the authorities and the employer and union sector, the necessary measures will be implemented for the benefit of the workers and the country as a whole. “
CC-BY-SA-2.0, FlickrPhoto: Eric Golub
. Why We Are In The Silver Era For Hedge Fund Strategies
Three years ago K2 Advisors, part of Franklin Templeton Investments, launched its first UCITS Liquid Alternatives fund, the Franklin K2 Alternatives Strategies Fund. At the time, some would have argued that the macroeconomic conditions were not favorable for certain hedge-fund strategies. While they haven’t for a number of years, but now this may be changing.
Monetary policy looks to be shifting in some countries, currencies are becoming more volatile and geopolitical risks have intensified of late.
“We think these fundamental elements could drive alpha opportunities for skilled hedge fund managers to capture. Many think that hedge-fund strategies are super-charged and high-octane. We would argue hedge-fund strategies are actually meant to be dull, with low volatility. But hedge-fund strategies can also provide diversification and long-term capital growth potential.” Says Brooks Ritchey, Senior Managing Director, Head of Portfolio Construction, K2 Advisors.
His team believes that low interest rates are often an overlooked factor in regard to hedge-fund strategy performance. Now, as US interest rates are making slow but steady strides upward from historic lows, they think certain hedge-fund strategies may be finding new opportunities to show their mettle.
“If the US Federal Reserve (Fed) continues to raise interest rates this year and next, we think it could cultivate an environment for certain hedge-fund strategies’ to flourish. Rising interest rates have historically been associated with lower cross asset correlations, creating more alpha opportunities for hedge funds,” adds Ritchey.
Additionally, K2 Advisors reminds us that rising interest rates have typically led to future periods of above average alpha, as represented by the Hedge Fund Research Index Fund Weighted Composite Index (HFRIFWI).
The illustration below shows a positive correlation between alpha and interest rates. The average level of alpha rose to the highest level at 14.07% during the measured period, where the US 10-year Treasury yield stood at 7.05%. Based on what we’ve seen in the past, they think hedge-fund managers could have the opportunity to capture that alpha, or outperformance, as US interest rates continue to rise.
For Ritchey, global geopolitical risk is another element that should drive a change in the landscape for hedge-fund strategies. On the back of recent geopolitical tensions, major currency spreads have widened, and historically wider spreads have benefitted hedged strategies’ alpha. “This is particularly noticeable within the Group of Seven (G7) economies, since they coordinate and attempt to manage major exchange rates in a way that leaves their currencies closely linked. As a result, we might not yet be in the golden era for hedge-fund strategies—the most-ideal environment for managers to capture alpha—but we could be approaching the silver era, where favourable opportunities are starting to appear.” He notes.
Allocating Toward Market Themes
Not all hedge strategies will fair equally as conditions change. K2 Advisors expects that the event-driven hedge-fund space, for example, may face headwinds as central banks globally begin to normalize interest rates. Event-driven hedge funds often seek to profit from merger-and-acquisition (M&A) corporate activity, which, in their opinion, could be diminished as interest rates rise. Global macro strategies, however, may benefit from rising rates. The global- macro space has seen an increase in trading volume over the last two months, and the firm anticipates this trend will continue.
“We’ve seen evidence that the current market landscape could become a nurturing environment for certain hedge-fund strategies, but we’re only just at the beginning and believe more opportunities could crop up during this silver era.” He concludes.
Investors are at a crossroad. To be able to obtain the same level of returns as in the past and achieve their investment goals, they must take on roughly three times more risk than that of two decades ago. During the 2017 MFS European Investment Forum in London, Michael Roberge, CEO, President, and CIO of MFS Investments Management, emphasized the secular and cyclical difficulties facing investors and the importance of choosing active managers who are both committed to investing with a long-term time horizon and have conviction in their portfolios.
Secular challenges
Following the Global Financial Crisis, the prolonged approach of central banks around the world was to try to stabilize the economy by keeping rates low. This approach has resulted in extremely low interest rates persisting, with some countries even dipping into negative yields. These low interest rate levels have completely changed the investment environment, helping to push both bonds and stocks to maximum valuation records. Many investors, including MFS are asking what will this environment lead to? While asset prices are expensive today, the lower-for-longer rate environment is likely to dampen returns for both equity and stock investors in future business cycles. With that backdrop, investors will be challenged to achieve their investment goals and we can expect to see many investors taking on greater risk to achieve the same historical return they would expect to achieve in a more normal environment. To illustrate the case, Michael Roberge mentioned a study by investment services consulting firm Callan Associates. The report shows that in 1995, in order to obtain an average return of 7.5% — which is the average yield that most pension plans expect to obtain in the long run – an investor would need to allocate approximately 73% to bonds and 27% to cash. The volatility of the portfolio, measured by its standard deviation, was around 6%, so that the investor was not really exposed to excess risk. In the following decade, the deterioration of interest rates has meant that, to achieve the same return of 7.5%, new asset classes must be introduced. Investors have to expand the allocation beyond the fixed income and cash instruments, needing instead to add riskier exposure to equities and alternative assets, for example. The new portfolio would now need to invest 52% in fixed income, 40% in equities and 9% in alternative assets, including exposure to private equity and real estate. This results in a more complex portfolio which incurs greater risk, with a volatility of 8.9%, representing a 50% increase relative to the portfolio of the previous decade. Moving forward another 10 years, in 2015, following the Global Financial Crisis and a dramatic drop in interest rates, central banks significantly increased their balance sheets with quantitative easing measures. To achieve the same return of 7.5%, the portfolio now would need to invest 12% in fixed income, 63% in equities, and 25% in non-traditional assets. Given the complexity of this portfolio, the risk rises up to 17.2%, tripling the risk level of 20 years ago. “This explains the current stress of investors globally, because they can see the potential for lower future returns as compared to those currently and in the past. Of course, they still have to meet their investment goals. The problem now is that they have to take greater risks to achieve them,” said Roberge.
Cyclical challenges
While the United States is experiencing its second longest economic cycle since World War II, it is impossible to predict how much longer this cycle can last. Obviously, you can say that the end is approaching, and investors should be starting to think about preserving capital instead of increasing their risk. Global economies have performed relatively well. Inflation is still not a problem, and central banks remain relatively accommodative. This adds up to a favorable environment with low volatility. Investors have been forced to take greater risk, being compelled to participate in the equity market. This works “until it stops working.” Historically, when entering periods of low volatility, investors often show signs of market complacency, and according to Roberge, a surge in volatility and market pullback is probably not that far off. At present, investors are not discriminating between companies with positive results and companies with negative results, the cycle seems to have forgotten the possibility of the market incurring a correction.
The importance of the time horizon and conviction in the portfolios
MFS emphasizes the importance of understanding both time horizon and conviction, two factors which are often overlooked in this long business cycle. In a low volatility, low interest rate environment investors have been forced to take on greater risk across multiple asset classes, including less-liquid opportunities, like infrastructure and private equity to achieve returns.
First, the investment horizon must be determined within the market cycle, because that determines the managers’ evaluation criteria. The market cycle can be determined from either peak to peak or trough to trough. In order to correctly assess a manager’s performance within an asset class, the complete investment cycle must be taken into account. However, despite the fact that 57% of institutional investors define a complete market cycle between 7 and 10 years, managers’ performance is usually measured within a range of 1 to 3 years. This is clearly a disconnect in the evaluation process of investment managers.“Studies carried out in this respect show that failure to give managers time to complete a cycle results in lost performance. Specifically, between 1% and 2% per year, a figure which may seem not very high, but which, given the current level of low interest rates, can be a problem for investors, especially when compounded over time. Now, given where we are in the cycle, is the ideal time to identify ways to preserve capital. It is an environment in which active management tends to perform better. In a market at such an advanced stage in the cycle, investors continue to pursue the market’s beta, when in fact they should be doing precisely the opposite”.
Returning once more to the issue of the importance of long-term investment, Roberge referred to Warren Buffet, who is considered by many to be the world’s best investor: “If we compare Berkshire Hathaway’s returns over the past 30 years against the S & P 500 Index, it can be seen that the firm which Buffet leads surpasses the market index by 600 basis points. However, if you look at different three-year periods, approximately 37% of the time his company trailed the market. If it had been a mutual fund, Warren Buffet would have been fired as manager. But being Warren Buffet, he’s allowed time to make good, long-term decisions and let them slowly materialize. As a consequence, the returns obtained at various 10-year periods exceed the S&P 500 Index in 95% of the time. Quite simply, time matters. It’s necessary to allow an investment manager’s conviction to deliver the alpha clients need to achieve their long-term financial goals.”
Pixabay CC0 Public DomainJosé Antonio Llaneza, courtesy photo. Principal To Acquire MetLife’s Pension Fund Management Business in Mexico
Principal Financial Group has signed an agreement to acquire full ownership of MetLife Afore, MetLife’s pension fund management business in Mexico, subject to regulatory approval. After closing, Principal Afore will be the fifth largest pension provider in Mexico in terms of assets under management.
According to CONSAR, the Mexican regulator, the main differences in their portfolios are that Principal has a larger allocation to equities and structured instruments than Metlife, which favors fixed income.
“As the middle class in emerging markets continues to grow, there is increasing demand for long-term retirement and investing products that enable individuals to retire with the highest pension possible,” said Roberto Walker, president of Principal International in Latin America. “This acquisition strengthens our commitment to Mexico’s pension market.” Giving them “additional scale, a larger distribution network and the capacity to better support its customers in Mexico with innovative advice and customized tools that help them achieve their retirement goals.”
Jose Antonio Llaneza, country head for Principal Mexico, added: “This acquisition demonstrates our continued commitment to invest in Mexico. Our focus remains on providing superior performance and counsel, while helping to educate people on the importance of increasing their contribution rate to their pension accounts.”
The purchase agreement between Principal and MetLife will be reviewed by Mexican regulatory authorities before closing, which is anticipated during the first quarter of 2018.
“The divestiture of MetLife Afore will allow us to enhance our focus on growing our leading insurance business in Mexico, where we are the number one provider of life insurance,” said Oscar Schmidt, executive vice president and head of MetLife’s Latin America region. “We are confident that Principal will provide our Afore clients in Mexico with access to quality resources and capabilities to help them achieve their retirement goals.”
BNP Paribas Securities Corp. and Credit Suisse Securities (USA) LLC served as financial advisors on the transaction to Principal and MetLife, respectively. White & Case LLP served as legal counsel for Principal and Nader, Hayaux y Goebel, S.C. for MetLife.
During his presentation at the OMGI Global Markets Forum in Boston, and questioning conventional investment thinking, Ian Heslop, Head of Global Equities at Old Mutual Global Investors, explained the double difficulty of forecasting market behavior. It’s often quite easy to make a mistake when forecasting, but even when the outcome of an event has been forecasted successfully, guessing the market reaction is just as complex. “If someone had been able to foresee the Brexit result, they could have guessed the market’s behavior for about 7 days. If someone predicted that Donald Trump would be elected for president, they could have guessed market behavior for about 7 hours. As a team, we try not to forecast, especially as regards market reactions.”
Another important issue, according to Heslop, is that investors have lost confidence in active management. In the United States, only 27% of active managers are able to beat the S & P 500, the main reason is that many fund managers are not taking enough risks to beat the index: “Firstly, if investing in an active fund which is not taking sufficient active risk, but which charges active management fees, the return will be lower than the index. Secondly, the S & P500 index is also said to be a very efficient index, which it is, to a certain extent, but to attribute the lack of higher yields to the index’ efficiency is to greatly simplify the argument. The difficulty in consistently outperforming it is real enough, but I don’t think it’s based on the efficiency of the index itself. The third reason would be concentrating on a particular style. Active funds are often cyclical in nature. Sometimes it is the value style that gains the favor of the market, in others it is the growth style, or the quality, if the fund only takes into account a particular style of investment, it will not be letting compound interest act correctly, lagging behind the market at some stage.” As a result, investors have turned their backs on active investment by investing more than US$ 1.4 trillion in US equity ETFs since 2007. “The main problem with indexed products is that investors think they are buying diversified exposure to the US equity market, when in fact the portfolio’s performance comes from 10 shares of the S & P 500. Partly, because these companies represent a significant part of the economy, but to a larger extent it’s due to flows. “
Helsop cited as examples those ETFs that invest in the 100 less volatile stocks of the S & P 500 index, the valuations of which, in terms of price to book value rates, have increased substantially, increasing from 2.37 times in 2013 to 3.59 times in 2017. Another trend is the purchase of equity ETFs with high dividends. Investors often do not take into account their exposure in terms of risks, and are unaware that they are actually buying risk of size, momentum, market sensitivity or beta. “It should be noted that some of the dislocations in the US equity market are directly dependent on the extensive use of ETFs by investors, both from the point of view of market capitalization and from the point of view of exposure of styles in the portfolio. Investors find it very attractive that a particular investment environment can work all of the time, but this is not the case.”
How do we solve the problem?
The market sentiment and perceived level of risk in the market are two factors that determine which type of values are going to perform better than the index. At the end of the first quarter of 2016, the markets were going through a scenario of high volatility with a very negative sentiment. With a macroeconomic scenario very different to that in 2008, the market reflected an environment with little appetite for risk, behaving in the same way, but for very different reasons. Looking at the market’s behavior during the third quarter of 2017, the markets’ scenario is of low volatility and high optimism, where risk appetite has increased. “The approach that active management must take in both scenarios is different, so obtaining results above the index is extremely difficult, being especially complicated if it aims to forecast the outcome of an event and the market’s behavior towards it, something which depends on the sentiment. However, if we try to locate which moment the market is at by measuring its evolution against the change and then adjusting the portfolio accordingly, we will be somewhat behind the market, but we maximize the time in which we have a signal located, being able to discard noise. On the negative side, if we see a very abrupt change over a very short time, it will take a while for the portfolio to adjust. For each period of rapid adjustment to a new state in the market, there are multiple periods of time in which there is no direction in the market, minimizing the loss in those moments.”
The investment and stock selection process
Old Mutual Global Investors’ global equity team uses five variables or themes to identify which type of company will achieve a good result at each moment in the cycle: a dynamic valuation that allows them to be alert at every moment of the cycle and to buy a certain style of investment, sustainable growth, which looks for opportunities within the market, analyst sentiment, which allows them to assess what happened in the company, the company’s management team, whose communications are used to control whether they are acting in the best shareholder interest, market dynamics, with which they try to understand the demand and supply of each stock.
“Our way of managing strategy is not a ‘black box’, but rather a very transparent and rigorous ‘glass box’. We invest and create portfolios in a very rigorous way. The investment process uses the five themes to have or not to have assets in the portfolio. We look at metrics for valuation, quality, growth, revenue, information, momentum, and trends, but what really sets us apart is that we are trying to understand the motives that make a stock perform well. There are environments in which the market is willing to buy stocks of a certain style: value, growth or quality, and if at that time you maintain exposure to that particular style in the portfolios, it will most likely add return to the portfolio”
Helsop also commented that what really matters to the management team is to know the elements that are influencing the market’s direction, something that is the key to understanding how the investors will behave. “We try to respond to the requirement that clients have for a different type of alpha, without forecasting or minimizing the amount of forecasts we use. In our alpha generation process we don’t consider a top-down macroeconomic analysis or a fundamental bottom-up analysis, but we mix all the factors and the result is a different approach that provides the opportunity to diversify”.
Funds under the same approach
With nearly 18 billion in assets under management, Old Mutual Global Investors’ equity team manages a number of different strategies; all of them with a high active share. The Old Mutual North American Equity fund strategy, the Old Mutual Global Equity Fund and the Old Mutual Global Equity Income fund are long-only strategies. The first one has about 200 securities in the portfolio and has been managed by Ian Heslop’s team since 2013. The second one has approximately 450 securities and the third has 500 securities and doesn’t invest in those classic names that pay a high dividend and that the rest of funds have in their portfolios. Lastly, the Old Mutual Global Equity Absolute Return strategy with over 650 names in the portfolio is market neutral, being a clear example of how the five factors combine to generate alpha in a different way from the rest of the market. This fund manages about 11 billion dollars in assets.
