Other Financial Assets Allowed the Afores to Minimize Mark to Market Loses

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La inclusión de otros activos financieros ayudó a las Afores a minimizar las minusvalías
Pixabay CC0 Public DomainPhoto: PS Photography / Pexels. Other Financial Assets Allowed the Afores to Minimize Mark to Market Loses

After the triumph of Donald Trump, financial markets show in the last 30 days: an upward shift in the US Treasury bond yield curve that reflects increases of up to 50 basis points (bp) along the curve. In the case of the Mexican bond curve, there is an increase that is between 50 and 107 bp between November 8th and December 8th. For example the Mexican bond that matures in 2024 (m24), that is in eight years, its effect is equivalent to a reduction in its price of 6%. The m24 raised 106 bp in that period.

In contrast, in the same period, there has been a rise in the international stock markets not only because of the movement in the exchange rate (Mexican peso/dollar), which moved in the last month 11%, but also driven by the expectations generated for Trump’s triumph. The Dow Jones industrial average rose 18% in pesos (11% explained by the movement in the exchange rate and 7% by the movement of the stock index). Other indices such as the Russell bring a 27% direct yield in pesos in the last month; while the ETF of financials in the United States (XLF) registers a 31% increase in pesos.

When reviewing the yields of the Siefore Basic 2 that are the Siefores that concentrates the largest number of resources (36%) of the 5 Siefore, you can see how different the results have been. Sb2 assets are worth $49 billion USD and in the last 30 days they had a mark to market loses of 1.7%, that means $ 826 million USD: 4 Siefores perform above average (Inbursa, Profuturo, Coppel and Azteca); two are in the average (Principal and MetLife); while 5 Siefores bring a performance below (XXI-Banorte, Banamex, Invercap, Sura and PensiónISSSTE), where the benefit or impact is different in each case.

Given these results we can see that the Afores that were diversified not only between fixed income, equities and other assets; had less investments (duration) in long bonds and had a diversification between local and foreign securities.

If 100% of the portfolio had been invested in the m24 bond, the result for the month would have been -6.3% in pesos; If 100% had been in the Mexican Stock Exchange index, the result would have been -4.4% in pesos; If 100% had been in dollars the yield would have been 11% in pesos; If it had been in the Dow Jones industrial index the yield would have been 18.4 in pesos and if it had been invested with foreign exchange coverage would have been only 7% in pesos.

These examples considered non-diversified investments where everything is invested in one asset class. This exercise is complicated by incorporating the regulatory limits where in the case of SB2 it is allowed to invest 25% in equity, where only 20% may be foreign securities; only 30% is allowed in foreign currency and the most important thing is that all investments can not exceed a Value at Risk (VaR) of 1.1%.

Due to the characteristics of the portfolios and the investment regime it seems that it is difficult to avoid negative returns without incurring the concentration in an asset class in periods such as that experienced in November, where there is a negative perception of the market and investments in Mexico.

When looking at these results, what emerges is the need to increase the percentage of equity, increase the limit of foreign securities and it is necessary to raise the limit of Value at Risk (VaR), because any increase in these

Column by Arturo Hanono

Asia’s Coming Healthcare Boom

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El auge del sector salud en Asia está llegando
CC-BY-SA-2.0, FlickrPhoto: Phalinn Ooi. Asia’s Coming Healthcare Boom

We take a bullish long-term stance on few sectors around the world — healthcare in Asia ex Japan is one. A combination of key regional factors—including demographics, urbanization and existing infrastructure gaps—all point to sustainable growth. Additionally, the competitive position of the region’s domestic healthcare providers, including local barriers and a low cost base enable future growth in export and service outsourcing.

We believe that the long-term potential of Asia ex Japan’s healthcare sector and the competitive advantages that Asian firms enjoy over global peers portend a key long-term opportunity for investors.

Why Healthcare in Asia is primed for expansion

Asia ex Japan’s ageing population, rising urbanization and lack of medical infrastructure coupled with nascent health insurance systems provide powerful impetus for long term growth. Asia already represents 60 percent of the world population. In fact, some of the region’s countries—such as Korea, Thailand and China—have rapidly ageing demographics, which will lead to a population comprising almost 1 billion aged 65 and older in Asia by the year 2050, according to the United Nations (World Population Prospects: The 2015 Revision). We believe the demand for medicine and healthcare services in Asia ex Japan can only increase.

Rising urbanization and better living standards will also amplify healthcare demands in Asia. As countries in Asia urbanize, their GDP per capita will improve, leading to an increase in healthcare spending relative to GDP. By means of comparison, healthcare spending in relation to GDP in the US, Germany and Japan in 2014 was 17%, 11% and 10%, respectively. Asia ex Japan on the other hand, was only spending 4 – 7% of GDP on healthcare in 2014, according to the World Health Organization. As these countries converge towards the same level of economic development as the US, Germany and Japan, their healthcare spending in relation to GDP will undoubtedly advance.

Finally, existing infrastructure gaps in Asia ex Japan presents a need for investment in medical infrastructure, such as hospitals, beds, healthcare professionals and medical equipment to meet rising demand, that will spur spending in other healthcare segments. In addition, healthcare insurance is still at an early development stage in Asia ex Japan. The region is at a crucial juncture in how it provides healthcare to its citizenry and the imminent shift from out-of-pocket to public/private insurance funding will further accelerate healthcare spending.

Asian healthcare firms have a competitive advantage

We believe that Asian healthcare firms can fully capture the growth in their home market, and that some firms may even gain market share outside Asia ex Japan.

Healthcare is largely influenced by local culture, distribution and regulation. For example, understanding traditional medical treatment in countries like China is critical and not easy for non-local players. Distribution is also extremely complicated throughout the region with no one-model-fits-all solution due to the area’s geography, size, culture and languages. Also, regulations—such as the drug approval process— differ in each country and frequently change, which makes it difficult for foreign players to keep up.

In most Asia ex Japan countries, affordability remains a key issue in healthcare. The strongest and best positioned healthcare companies can leverage their lower cost structure, such as for labor, to gain an advantage over their international peers.

The Opportunity in Asia ex Japan Healthcare

Asia’s healthcare sector has retreated in 2016, largely due to a combination of temporary, cyclical factors (such as sector rotation from healthcare to energy/material) and temporary price corrections (in particular, in the India generic pharma sector). Our view is that the recent market adjustment does not undermine the fundamental long-term growth story for Asia healthcare and that the mid-to-long-term investment thesis of the sector remains intact.

As a result, we consider the drawdown in Asia ex Japan’s healthcare sector as an investment opportunity for long term investors like ourselves.

Peter heads the Asian ex-Japan equity team at Nikko AM Asia.

The Ageing World – Global Equity Opportunities

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The changing demographics and the ageing populations in many regions have led to top heavy societies. In the developed world the issue of changing demographic profile needs no explanation and whilst the changes happen at glacial pace they really matter.

We found some statistics about the changing global demographics eye opening:

  • Currently there are 20 countries with declining populations; by 2050 this is expected to be 80 countries.
  • In the not too distant future it is expected that all of the main economic forces in the world will see a decline in their working population apart from the US.
  • Germany needs 650k net migration every year for the next 20 years just to keep the workforce flat.

The changing demographics and ageing population profile of different regions has originated some new investment ideas. For global equity investing, it is important that we identify companies where there is a positive change in their business or operating environment, but the stock market valuations and forecasts are not fully reflecting the implications of such change.

Some companies are set to benefit from the changing demographics and aging populations, such as those with a core business on accommodation for the older generations and healthcare.

In the UK, it is forecast that the number of over 55’s is growing at twice the rate of the UK population average, implying that in 15 years’ time there will be approximately one third more over 55’s than there is today.

One of the companies looking to benefit from this changing demographic is McCarthy & Stone, a leading UK retirement home builder. According to McCarthy & Stone, it accounted for 70% of this niche privately-owned retirement accommodation in the UK, focusing on selling homes to over 55’s. The McCarthy & Stone products are priced to attract older residents wishing to downsize and release equity. The facilities are custom built for the demographic they serve and include common spaces and house managers although the accommodation still provides separate living.

When looking for opportunities in the global equity universe, it is important that we constantly meet with companies and discuss industry trends with their peers, suppliers, and other companies who serve the same end market so as to build a view on the strength of different companies’ potential customers, test our investment thesis and challenge our non-consensus angle.

From our analysis, McCarthy & Stone’s internal transformation programs are expected to lead to greater margins than the market expects. Their land bank acquisitions have been executed at better gross margins than the market believes, which is driven by higher hurdle rates set by management.  It is believed that they are capable of accelerating completions above the targeted 3,000 pa.

Another interesting example is Orpea, a French listed operator of high end nursing homes with majority of the business in France currently. However, due to limited licences being granted in France, this company has focused the growth overseas, primarily in Europe but also with one early stage venture in China.

By understanding the company’s on-the-ground approach to M&A and their international greenfield expansion plans which are already in motion, we believed that sustainability of 5% M&A growth and acceleration of organic growth to above 5% from 2018 is not in consensus numbers.

Regulation around licences and the inability to do a deal to buy scale makes it hard for competition to present a large threat in their markets. There are no new licences being granted in France and besides Orpea and Korian there are no large competitors. In addition, there is a hugely inadequate stock of specialised care beds for the last stages in life. Growth opportunities therefore exist for a top end operation like this where the focus is on providing very high quality care home for the older generation.

The changing demographic profile in different regions bring challenges but also investment opportunities. Market very often is not fully appreciating the positive implications of some of those positive changes companies are undergoing – investors should focus on identifying such opportunities.

Column by SLI written by Mikhail Zverev, Head of Global Equities, Standard Life Investments
 

Riding the S Curve of Creative Disruption

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¿Cómo encontrar empresas al principio de la curva de crecimiento?
Pixabay CC0 Public Domain. Riding the S Curve of Creative Disruption

The S-curve, which shows the growth trajectory of a company creating a new product or even a new industry can be an ally or enemy for investors. Find such a company toward the front end of the S curve and you could potentially own the stock through its explosive growth period. Invest at the top of the S curve, and you’ve missed much of the growth.  It’s at that point – when most of their growth is behind them – that many companies graduate to the larger stock indexes. Skilled active managers try to find these companies much earlier on in the curve, with an eye toward tapping greater growth potential.

Consider the adoption of the personal computer in the 1980s and 1990s, which started slowly when they were cumbersome and expensive. But once PCs became easier to use in the early 1990s and allowed multi-tasking, prices fell sharply and soon they were on virtually every desktop within major corporations. Retail prices fell further, bringing the PC within reach of the home user. The introduction of the web browser in the mid-90s suddenly unleashed a wave of demand for computers, software and related products that culminated in the dotcom bubble which burst so memorably in the spring of 2000. Eventually the market for personal computers matured and became saturated. They became a low-margin, commodity product with little to differentiate one from another.

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Personal computers spawned an industry which has had unprecedented impacts on many aspects of society, including the way we work, learn and consume content. The ripple effects of the PC revolution continue to be felt, even as the devices themselves evolve.

Under such creative disruption scenarios, the investment opportunity for skilled active managers comes from: 1) understanding where a company is in its growth trajectory along with key drivers of growth in a given industry and 2) an ability to reassess as the market matures. Are we in the early adoption or infancy phase, where there is great potential but the need for patience? Are we in the expansion phase where growth accelerates almost vertically? Or the maturity phase, where competitors flood the market, the product becomes commoditized and margins compress? 

As history has shown, these cycles repeat. In recent years the smart phone has displaced the personal computer. Instead of storing data on floppy disks, we now store it in the cloud. Instead of consuming entertainment content at home on a television, increasingly we consume more of it on the go on a mobile device. Creative disruption is a never-ending process, creating opportunity and risk at every turn. Having an integrated research platform helps a skilled manager identify the opportunities and the risks and make decisions accordingly.

The market is a discounting mechanism of all available information. What we do as managers is to try and determine what the market has discounted and whether it’s correct. Our goal is to recognize a trend or an undervalued asset and risk-weight that asset appropriately. Having diverse points of view across the organization — in terms of exploring opportunities from both a fundamental and quantitative perspective, across geographies and from analysts in different sectors—can all play a role in creating better investment decisions, and hopefully better outcomes. 

A collaborative culture and an integrated research platform can help skilled managers understand the ripple-effects created by disruptive new technologies. Teams of talented managers and analysts are better positioned to think-through the ramifications on a global scale than those focused strictly on the technology or product itself.  For instance, would a new technology, such as electronic payment methods be adopted more rapidly in developed markets owing to an infrastructure advantage, creating opportunities for incumbent technologies to gain market share in less developed markets? This is the type of issue where a skilled active manager who cross-pollinates ideas across disciplines and stress-tests assumptions among investment team members would hope to stay ahead of the curve.

Robert M. Almeida, Jr. is MFS Institutional Portfolio Manager.

Time Is a Terrible Thing to Waste

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Lo peor que puede hacer es malgastar su tiempo
Pixabay CC0 Public Domain. Time Is a Terrible Thing to Waste

Investors’ misperceptions about what impacts their outcomes often make them spend too much time measuring what doesn’t matter and not enough time on what does. It’s time to start looking at what really counts when choosing an investment manager.

Investors have a tougher job today than ever before. They’re taking more risk than in decades past in order to achieve similar returns. And they’re doing so against a backdrop of geopolitical and market uncertainty — things they cannot control, but still must take into consideration. Understandably, that sense of uncertainty, coupled with the need to take more risk, is driving investors to focus on what is tangible and easy to measure — in an effort to gain some sense of control.

We see investors spending a lot of time anchored to short-term past performance — three year returns dominate decision-making for example — as well as tracking traditional, price-momentum benchmarks that point more to changes in prices than true, long-term value. But these metrics don’t matter as much to investment outcomes.

So it’s time to have a disruptive conversation. We want to help investors get back to spending time on what they know has always counted more — people, process and philosophy, but also a healthy dose of honesty around time horizons.

However, in a world that has become so short-term focused, that is a significant hurdle. Lack of clarity around time horizons appears to be a growing convention, and it’s tough to break with popular sentiment, especially at a time of greater angst. Markets are more complex and finding returns is more challenging. But here is an important truth. Looking at what is easy to measure (e.g., endless data comparisons) only creates the illusion of control, and feeds into ambiguity aversion — a known behavioral bias that kicks in because we don’t like uncertainty.

Also, short-term micro-measurement doesn’t help forecast the future, generate returns or meet investors’ long-term goals. Rather, it causes pro-cyclical (herding) behavior among investors, which, as noted by the International Monetary Fund in a paper on countercyclical investing, takes them away from their inherent “edge as long-horizon investors.“

While investors do spend considerable time evaluating the harder to measure key attributes of investment managers during their search process, they tend to brush those metrics aside in post-hiring evaluations, especially in times of short-term underperformance. It may be common practice to revert back to performance measurement, but there is a danger in relying too heavily on what doesn’t persist.

As you can see in the exhibits below, even the top-performing managers don’t stay on that pedestal from period to period. For example, of the managers who performed in the top quartile from October 1990 to September 1995, only 25% remained in the top quartile in the subsequent period from October 1995 to September 2000, while the rest dropped down to lower quartiles. On the other hand, looking at the second exhibit, which shows what happened to bottom quartile managers over the same time periods, 27% of these managers went from the lowest performance ranking to the top performance ranking in the subsequent period.

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An investment manager’s people, process and philosophy — which reflect the strength of its collective intelligence, culture and the management of its talent and business, tend to be far more persistent. Why does that matter so much to investors? Because these qualities may reflect a manager’s ability to go against the grain when necessary, applying its insight toward finding opportunities other managers may be missing and potentially recognizing risks that others may not. In short, investors want to see signs of a manager’s power to be countercyclical.

The harder-to-measure manager attributes are also highly relevant to the environmental, social and governance (ESG) conversation. We believe ESG is often misconstrued as more of a social/responsible investment decision. That has driven some investment managers to respond with a relevant product set. In reality, ESG is much more about trying to invest in good businesses rather than bad — finding those with true long-term value by understanding what factors (e.g., good management, effective capital allocation and superior products and services) are material to a company’s sustainability and competitive advantage. Integrating those considerations into the investment process — whether you’re an investment manager selecting securities or an asset owner selecting an investment manager — could reduce risk and potentially improve returns over time. But it takes patience and robust research to understand what is material over the long term.

Passive management typically does not integrate ESG factors, and yet we believe these considerations are more important than ever to “getting it right” for the investors we serve. But getting it right depends as much on the investor as it does on the investment manager. Investors’ time tolerance has to align with how their investment managers make decisions within their portfolios, or the resulting misalignment could damage both expectations and outcomes. For example, portfolio turnover is an important consideration in aligning investor horizons and manager decision making. When investors see an active manager with low portfolio turnover (i.e., a longer-term focus), they can better understand why that manager would need a full market cycle to generate alpha. 

The work we do as an industry to improve the misalignment between investor time horizons and investment manager decision making is really about improving trust. Because ultimately investors need to trust a manager’s skill long enough to allow it to work.  

Carol W. Geremia is President of MFS Institutional Advisors, Inc. Co-Head of Global Distribution.

 

Japan’s “Show Me the Money” Corporate Governance: 3Q update

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Los beneficios empresariales de Japón van a seguir creciendo (III)
Pixabay CC0 Public Domain. Japan’s “Show Me the Money” Corporate Governance: 3Q update

Overall corporate pre-tax profit margins in Japan decelerated in the recent quarter, but before one panics and says that margins are about to plummet, one should realize that there are long-term structural corporate-governance reasons for the overall upward trend and that the 2005-2007 period showed that profit margins can plateau at a high level for an extended period of time.

Indeed, while the overall four-quarter average fell from its record level, this is due to the impacts of a fairly mild global economy and the strong Yen, while the non-manufacturing sector, which is nearly entirely domestically focused, soared to a record high.

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The fact remains that, partially due to the encouragement of the Abe administration, Japanese corporations are continuing their structural shift towards higher profitability. Abenomics is “icing on the cake” of the “Show Me the Money” corporate governance improvement that we have long-highlighted in our thought leadership effort on Japan.

Indeed, while increasing the number of independent directors and other recent governance issues are very important in the intermediate term for Japan, it is crucial for investors to understand that the profitability message has actually been understood by most Japanese corporates for over a decade. This is shown by the divergence in the profit margins from the trend in GDP growth in the charts above, showing that even though GDP growth has remained subdued, profit margins have surged.

Since the Koizumi era, Japan has embarked on major rationalizations in most industries, with the number of players usually reduced from seven down to three. The fruits of this restructuring were slower to ripen than in Western world examples, and they were hidden by a series of crises (the Lehman shock, the turbulence in China, the strong Yen and of course, the Tohoku tsunami), but since Abenomics began, the global backdrop for Japan has been stable and there have been no domestic crises, thus allowing the fruits to ripen.

Conclusion

We expect that the overall four-quarter average pre-tax profit margin will rise in coming quarters due to the weaker Yen, and that non-manufacturing margins should remain at a high level.

Furthermore, many sectors are continuing their rationalizations and cost-cutting that will help support their profit margins. Of course, if the Yen were to weaken to 120:USD, then even the manufacturing sector’s profit margin will likely move back to, or above, its prior high.

One should also note that these Ministry of Finance statistics do not cover post-tax income, and due to recent corporate tax cuts, the overall net profit margin (excluding extraordinary write-offs) is likely expanding even more sharply than the pre-tax data shown above.

John Vail is Chief Global Strategist at Nikko AM.

 

Taking Stock of the U.S.

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Stronger GDP growth is the key to sustaining U.S. equity momentum.

As we enter December, the market continues to chew over the implications of a Donald Trump presidency. Last week, my colleague, Erik Knutzen, CIO of Multi-Asset Class, examined the outlook for emerging markets debt and equities. This week, we take a look at the prospects for U.S. equities.

There’s been a lot of noise and excitement about the so-called “Trump Bounce” in equities, but I want to dig a little deeper and look at some of the factors that are likely to sustain it. The most important element in equities’ continued recovery is a pickup in expectations for stronger GDP growth. Indeed, this may already be in the works.

The most recent figures, for example, show an upwards revision in Q3 GDP—up from 2.4% to 2.9%1, largely driven by consumer spending. This was better than anticipated, and although estimates tend to fluctuate throughout a quarter, the Atlanta Fed is projecting Q4 GDP to be over 3%. So, if this plays out, it represents a 2.25% increase in GDP for the whole year. That’s a pretty decent tick up from the 1.5% the U.S. economy experienced throughout 2015 and much of 2016.

Fiscal Boost?

Next, you need to factor in the new administration’s plans for meaningful fiscal stimulus. Indeed, Steven Mnuchin, the Treasury secretary designate, made a case for greater fiscal policy intervention only last week. This included much talk about tax cuts, both corporate and personal, together with the long-heralded increase in infrastructure spend. Taken together, and if implemented, these initiatives should provide the tailwind that will drive U.S. GDP growth above the levels we’ve seen in recent years.

With a stronger level of growth, earnings should improve. Back in the spring, this was an area of concern for us. Accelerating earnings growth would be the strong foundation for further improvement in U.S. equity markets and support the higher P/E multiples that, for the first half of 2016, were driven by lower bond yields.

Industry Sectors a Mixed Bag

So, which areas of the U.S. stock market are most likely to benefit under this new environment and which ones will be left out in the cold? On the positive side of the ledger, financials should do well because of the expectation of interest rate increases and less rigorous bank regulation. Domestic cyclicals and energy companies should also be among the beneficiaries of faster domestic growth.

The small-cap space is also enjoying a strong rally. Since its November 3 low point, the Russell 2000 Index is up nearly 15% through the end of November. In contrast, the S&P 500 has posted a return of around 6%.

Health care, however, is a mixed bag. Tom Price, the proposed Secretary of Health and Human Services, is a vocal critic of the Affordable Care Act. In fact, he’s likely to try to do away with “Obamacare” altogether and replace it with a more market-based system. As a result, investors are struggling to figure out who’ll be the winners and losers if the current system begins to unravel.
Risks?

Trade and the Dollar

So what are the risks to this more optimistic scenario? One is that trade becomes an issue. There was a lot of anti-trade rhetoric during the recent U.S. election, although things have quieted down a bit since then. But tensions could reignite next year when Trump takes office. A trade “war” of sorts could be a meaningful drag on global GDP growth. Trade has in fact already been slowing over the past three years due, in part, to protectionist measures implemented in many countries.

The stronger U.S. dollar is making life increasingly uncomfortable for many large-cap exporters. Growing dollar strength has major implications for large international companies and, by association, their earnings growth. Since the U.S. election, the greenback has already risen by 4% and looks set to rise higher. And there’s near-universal agreement that the Fed will increase rates later this month, which will put additional upward pressure on the currency and, therefore, on big global exporters.

Net-Net, We have a Positive Outlook

But despite these concerns, the prospects for U.S. equities look far healthier than they did a month ago. So the decision of our Asset Allocation Committee just over a week ago to raise our 12-month outlook for U.S. equities to slightly above normal has, so far, proved to be the right one. Stay tuned to see whether this remains the case.

Neuberger Berman’s CIO insight by Joseph V. Amato

Gauging Europe’s Political Risks

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Gauging Europe’s Political Risks
Wikimedia CommonsFoto: Niccolò Caranti. Evaluación de los riesgos políticos en Europa

Key European political events are now in focus as investors look for another potential populist backlash. The Italian constitutional referendum on Dec. 4 comes as the conservative candidate in France’s presidential election next year is being finalized. This week’s chart helps explain the market backdrop.

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Deeper structural problems are the backdrop to Europe’s political challenges. As the chart shows, investors have shunned eurozone banks relative to global counterparts. Italian bond yields have risen versus German yields before the referendum, yet the narrow spread also highlights the European Central Bank’s (ECB’s) efforts to calm the 2010-12 debt crisis and revive growth.

Stagnation fuels populism

Italy’s referendum as well as presidential elections in Austria and France should show whether populist parties are gaining greater sway. Election polls have wrong-footed investors this year, yet we see a limited risk of populist governments arising.

Polls currently suggest the Italian referendum, supported by Prime Minister Matteo Renzi, is likely to be voted down. Any Renzi resignation afterwards should result in a caretaker government that is likely to focus on reforming Italy’s electoral law. A yes vote could spark a brief relief rally in regional bonds and bank shares, in our view. We see a strong “no” vote delaying any fixes to the country’s sick banking system and emboldening populist parties. In France, polls show the successful conservative candidate for president as the favorite in any contest with far-right populist Marine Le Pen in the final round next May.

Even if populists don’t win now, the economic stagnation and political frustrations driving their rise are still at play. Europe’s leaders face other big challenges: managing Brexit, the anti-trade backlash and the migration crisis.

We expect investors to remain pessimistic on Europe relative to upbeat U.S. reflation prospects. We are neutral on European government bonds and favor investment-grade debt due to the ECB’s ongoing purchases. We are underweight European equities on concerns about the growth outlook. Read more market insights in my Weekly Commentary.

Build on Insight, by BlackRock, written by Richard Turnill

What Should Investors Make of a Trump Victory?

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¿Qué deben hacer los inversores tras la victoria de Trump?
CC-BY-SA-2.0, FlickrPhoto: Gage Skidmore. What Should Investors Make of a Trump Victory?

After a turbulent, historic election, Republican Donald Trump was elected to the US presidency and will take office in January. Republicans also swept the Senate and House of Representatives. What does it all mean for investors?

One of Trump’s biggest campaign issues was protecting US industry, which raises the potential for import tariffs. The president, whether a Democrat or a Republican, has enormous powers regarding the regulation of international trade, including the power to unilaterally impose tariffs and duties. Given that there was downward pricing pressure in the global economy prior to the election, the addition of tariffs or countervailing duties is probably a negative for S&P 500 companies since roughly 40% of their revenues are generated outside the United States. Lower revenues and profits should be expected if deglobalization becomes a centerpiece of the Trump agenda, and I think it will.

Trump has proposed very large tax cuts, and he is likely to have the support of a Republican-led legislative branch in enacting those proposals. Lower taxes could mean many things, including larger fiscal deficits if revenues fall and government spending is not cut. At the moment, there appear to be no plans for massive spending cuts. If the deficit increases, the US Department of the Treasury will need to issue more bonds to finance it, and I believe there will be a bias toward higher interest rates in such an environment.

On the campaign trail and in the presidential debates, President-elect Trump voiced his opposition to the Federal Reserve’s low interest rate policy. While the Fed is an independent central bank, Trump may choose — when her term expires in 2018 — to replace Chair Janet Yellen with someone more hawkish, which could lead to higher short-term rates down the road. Expect the regulatory burden on banks to be less onerous under a Trump administration than it would have been under Clinton.

A few final thoughts. The risk of price controls on the pharmaceutical industry has fallen dramatically with Trump’s election. Businesses broadly will likely see a reduction in government red tape. The impact of large tax cuts remains an open question. Will they lead to a sustained boost in economic growth? History doesn’t offer much evidence of this since the biggest chunk of tax cuts falls to the top 10% of earners, who tend to be savers as opposed to spenders. A lot of the tax cuts could end up in the banks as savings rather than recirculated into the Main Street economy. It’s hard to say for sure, but the outlook from here suggests a more cautious approach is warranted for both bond and equity investors as they digest the potential for a combination of tariffs and somewhat higher interest rates in the future.

Column by MFS’ James Swanson

 

Luxembourg Secured Lending Funds: Attractive Alternative to Traditional Fixed Income for Wealth Managers

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Los fondos luxemburgueses de préstamos respaldados por bienes: ¿una alternativa a la renta fija tradicional?
Photo: JimmyReu, Flickr, Creative Commons. Luxembourg Secured Lending Funds: Attractive Alternative to Traditional Fixed Income for Wealth Managers

“It is remarkable…what a change of temper a fixed income will bring about”. Virginia Woolf, A Room of One´s Own.

Though few who practice our trade will admit it publically, the wealth management industry is immersed in an existential crisis. Quantitative easing by the world’s central banks has driven yields on high quality corporate bonds to near zero, and those of many sovereign nations to negative values. Traditional fixed income instruments are an essential tool of the wealth management industry and have been the mainstay of the classic “bonds/equities/hedge funds” asset allocation for decades. However, until yields rise from their current levels, government bonds and high quality corporate debt no longer add value to a portfolio. Rather, the fixed income allocation of a portfolio under current interest rate conditions adds credit and duration risk compensated by almost no return, or indeed a negative return. 

If questioned as to why they persist in recommending traditional fixed income to their clients, wealth managers and asset allocators typically will state that “there is no alternative” as a justification for continuing to invest in this grossly overpriced asset class. It does not require a guru to see that market price and intrinsic value are clearly out of equilibrium in the fixed income markets, due to massive bond purchases by central banks and the increasingly frenzied search for yield by pension funds and insurance companies desperate to cover their future obligations. Even high yield bonds (formally known as junk bonds) now offer scant returns, as the hunger for yield overrides caution. From my point of view after twenty-five years of practice in the wealth management industry, to invest in an asset class that adds risk to a portfolio without providing return is tantamount to professional malpractice. 

This being the case, where is a wealth manager to turn to secure attractive yields given the ongoing distortion of the traditional fixed income markets? Many wealth managers and family offices worldwide are turning to real estate as a substitute for fixed income, where rental yields replace bond yields. Investing in direct purchases of rent-generating properties as well as participations in real estate investment trusts and similar instruments is unarguably a reasonable move. However, I would suggest that many wealth managers are overlooking an alternative source of attractive yields that avoids the pitfalls of direct real estate purchase or participation in real estate funds, such as liquidity risk and exposure to real estate price cycles. This source is secured lendingfunds registered and regulated in the Grand Duchy of Luxembourg.

There is an astounding width and depth of credit expertise to be found among the management teams of many of the secured lending funds registered as Luxembourg SICAV-SIFs. Luxembourg is second only to the United States in terms of mutual fund assets, totaling over 3,500 billion euros as of July 2016 according to the highly respected CSSF, the Luxembourg financial regulatory authority. Although the majority of Luxembourg-registered assets are daily liquidity retail funds under the UCITS umbrella, there are over 1,000 Luxembourg-registered SICAV-SIFs. These vehicles are by their very nature a wealth management rather than a retail product, as they are intended for well-informed investors and are subject to the Luxembourg Act of 13 February 2007 on specialized investment funds, as amended. For this reason, they are subject to a minimum investment requirement of 125 000 euros. Liquidity varies, but redemptions and NAV declarations are typically on a monthly basis.

Since there is no equivalent of Morningstar to collectively track the performance of the SICAV-SIFs, a great deal of outstanding investment and credit analysis talent in this segment has not received the attention it deserves. For example, among the SICAV-SIF managers, there are secured lending funds specializing in each of the various segments of the asset-backed lending spectrum, including financing account receivables, specialized small business lending, aviation and machinery leasing, trade finance and real estate bridge financing. Though the particulars are different in each case, the common element among these successful secured lending funds is that they lend their investor’s capital to finance selected short term opportunities in the real economy, with a sufficient guarantee to secure the loan and protect the fund’s NAV in case of a default. These funds normally operate in creditor-friendly jurisdictions such as the United Kingdom or Germany where assets pledged to secure a loan can be quickly transferred to the creditor if a default does occur. In short, these funds operate in a terrain that once belonged to traditional merchant banks, but is increasingly abandonded by the banks as they restructure in the face of Basel III capital requirements.

Given this track-record and the ease of investment in Luxembourg SICAF-SIFs for wealth management clients through their securities accounts, I would encourage private bankers, family offices and wealth managers in general to begin to think outside the box of traditional fixed income and real estate to give serious consideration to Luxembourg-registered secured lending funds as a source of attractive, stable, non-market correlated returns.

Opinion column by James Levy, Director of Clearwater Private Investment.