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If The Economic Scenario Were To Be Stagflation?

If deflation occurs in Europe, there is no evidence to suggest it would persist, as most countries are flooding their economies with additional money backed by public debt. Furthermore, inflation is on the rise, albeit slowly in some countries. I would like to share a perception that first occurred to me in 2010. What if the European economy faced a scenario of stagflation, that is to say a combination of economic stagnation compounded by persistent unemployment and moderate inflation? This is a matter I would like to discuss.

What are the attributes of this footprint stagflation? Besides the aspects of state solvency, they are the same as the symptoms as witnessed during the 1970s: a low rate of economic growth combined with a marginal decrease in productivity, structural and high unemployment (structural dislocations characteristic of economy), underutilization of production capacities, low expectations of earnings (at least in the medium-term), low capital investment to moderate a scarcity of bank credit for private investment, balance of trade deficits and widespread deindustrialization.

The effects of stagnation can essentially be detected by structural unemployment, which is already well established in some areas. Beyond the visible effects the retirement of a significant portion of baby boomers have, (which merely postpones the problem of their replacement income to future governments) unemployment is related to different phenomena: industrialization, inadequate education, exhaustion of the growth model by debt, lack of flexibility in the labor market, entrepreneurship and especially weak ancillary mindsets that have not yet integrated into growth areas. There are also issues surrounding immigration; for example, will it be redesigned to ensure new continued growth in employment?

Inflation meanwhile is not a desirable solution, since it poses a risk of self-power and only nominal increases in state spending. It would appear that as a consequence, this unavoidably leads to the monetary rediscounting of public debt. Of course, inflation depletes returns, especially since the savings are invested in fixed income securities. But as Keynes advanced (1883-1946), “it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier.

“Some economists even argue an iconoclastic theory that the banking, state and economic crises are the result of a period characterized by excessive disinflation. This period, known as “the great moderation” apparent between 1985 and 2005, would benefit from the expansion of trade areas (through globalization) and a low-cost accessibility to employment pockets, to mask the reality of the repayment of private and public debt. The expansion of demand did not lead to an inflation crisis because western governments absorbed this by their trade deficits.

Why does the perception of inflation raise the specter of secular deflation with many economists (which constitutes a strong collective preference for liquidity and is often confused with disinflation)? Because money created ex-nihilo with coupons which become claims on other coupons, and recalling the words of the economist Jean-Baptiste Say (1767-1832) “the currency is just a veil”, as implemented by the central banks, is a treatise on the future, meaning reimbursement will become uncertain. It is indisputable that the States and also the central banks are currently conducting a monetization of the debt with its corollary of liquidity creation and possible delayed inflation. The recent measures therefore create money without creating a capital.

Finally, we must ask ourselves how European monetary authorities dared to simultaneous impose an extremely low annual inflation target of 2%, whilst authorizing Member States to increase their public debt in such proportions that the most intuitive way to reduce its weight or to reduce its relative value is through inflation as the ECB now intends to stimulate.

Bruno Colmant – Bank Degroof Petercam

Mexican REITS (Fibras): Some Stand Out For Their Capital Gains, Others For Their Dividends

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Fibras: algunas sobresalen por sus ganancias de capital y otras por sus dividendos — Photo: HorseBadorties/Pixabay. Mexican REITS (Fibras): Some Stand Out For Their Capital Gains, Others For Their Dividends

With the emergence of Fibra Uno (FUNO) in March 2011, the Mexican REITS (Fibras) celebrate six years since they first appeared on the Mexican Stock Exchange. In these six years, we have seen 10 issues of Fibras which, according to the firm Vector, at the end of the first quarter have nearly 1,400 properties in total, of which roughly 500 belong to FUNO. Amongst the FIBRAS, one might find not only diversified ones but also specialized ones in sectors such as commercial, industrial, offices and hotels.

A Fibra is an investment vehicle dedicated to the acquisition and development of real estate in Mexico with the intention to lease (or potentially sell) such properties. A Fibra is similar to an investment trust real estate (“REIT” for its acronym in English) in the United States.

The Fibras have given liquidity to an illiquid market. During these six years, they have continued to increase their assets (through follow ons / subscriptions) and issuing debt, to also increase its investment portfolio, leverage their expertise and gain economies of scale.

Other investment vehicles that are considered Fibras but are really a different vehicle include VESTA, GICSA or Fideicomiso Hipotecario, FHIPO, among others. The case of FHIPO is perhaps the clearest example because although the company is considered as Fibra, some analysts place it in the financial sector.

The 10 Fibras manage assets worth just over 15.7 billion dollars, as of end of April. FUNO (with 48% of this) represents almost half the market value. The second largest Fibra is DANHOS with 20% of the market; and Fibra Macquarie (FIBRAMQ) and TERRA (7% respectively), are in the third and fourth place.

While this market does not represent even 2% of the Afores, or Mexican Public Pension’s AUM, between March 2014 and March 2016 Fibras holdings by the Afores increased 1.6 times. Afores now own the equivalent of 2.9 billion dollars in Fibras, or roughly 20% of all Fibra issuings. Considering that the investment regime allows the Afores to have 92% of the total outstanding issue of Fibras, which at today’s levels barely reach 10% of their assets, there is still some ways to go.

Fibras have two components that give investor returns: The first is the equity gains and the other the dividend.
The major change in the share price (in pesos) since the IPO untill April, has come from FUNO (2011) Fibra which has gained 110%, followed by DANHOS (2013 ) 48%; TERRA (2013) with 13% and Fibra Monterrey (FMTY in 2014) with +7%. Fibras which price today is below their IPO are Fibra Inn (FINN in 2013) with -23%; Fibra Hotel (FIHO in 2012) with -15%; Fibra Macquarie (FIBRAMQ in 2012) and Fibra Shop (SHOP in 2013,) both with -5%. Fibra Prologis (FIBRAPL in 2014) and FIBRAHD (2015) are at IPO price.

Volatility in the equity price, shows risk vs returns. The Fibras with the highest volatility in the last 12 months were: FUNO, FIHO and FIBRAMQ.

The other component is the dividend. So far, the Fibras have generally adopted a quarterly distribution (although it could be annual). This year FIBRAHD adopted a policy of paying monthly. For a fiscal issue, the dividend is at least 95% of taxable income for the corresponding period.

The first quarter of 2016 the average Fibras dividend is at 6.55%. Fibras with higher dividends are FIBRAHD with 9.65%; FIBRAMQ with 7.47% and 7.10% FMTY.

The perspective of this industry is promising, so surely, we will see the Fibras growing in assets as well as new participants.

Column by Arturo Hanono

Is Gold More Productive Than Cash?!

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Is gold, often scoffed at as being an unproductive asset, more productive than cash? If so, what does it mean for asset allocation?

There are investors that stay away from investing in gold because it is an ‘unproductive’ asset: the argument points out gold doesn’t have an intrinsic return, it doesn’t pay a dividend. Some go as far as arguing investing in gold isn’t patriotic because it suggests an investor prefers to buy something unproductive rather than investing into a real business. In many ways, it is intriguing that a shiny piece of precious metal raises emotions; today, we explore why that is the case.

Investing is about returns…
Each investor has their own preference in determining asset and sector allocations. Some investors prefer to stay away from the tobacco, defense or fossil fuel industry. During times of war, countries have issued bonds calling upon the patriotism of citizens to support the cause. At its core, however, investing, in our assessment, boils down to returns; more specifically, risk-adjusted returns. The “best” company in the world may not be worth investing in if its price is too high. Similarly, there may be lots of value in a beaten down company leading to statements suggesting profitable investments may be found “when there’s blood on the street.”

Gold is not only unproductive, but has a storage cost and is expensive to insure. So what could possibly be attractive about gold?

Investors like nothing…
We wonder where all these patriotic investors are hiding. That’s because if we look at long-term yields, they are near historic lows throughout the developed world, with many countries showing near zero or even negative yields on governments bonds. Differently said, many investors rather get a negative yield on the safest investments available to local investors (disclaimer: U.S. regulatory point of view, foreign government bonds aren’t considered “safe”) than invest in so-called productive assets: a corporate bond may qualify as a ‘productive asset’ if a company uses the proceeds to invest in future ventures; yet, in today’s environment, corporations frequently issue bonds to buy back shares. Why do investors prefer “nothing” – as in no or negative returns – over investing in productive assets? And if investors really like negative returns, is gold – that doesn’t have an intrinsic return, suddenly attractive?

Productivity is king
On April 7, Fed Chair Yellen joined an “International House” panel with all living former Fed Chairs: Bernanke, Greenspan and Volcker. When Bernanke was asked whether we need more fiscal stimulus as monetary policy may have reached its limits, we interpreted Bernanke’s long-winded answer as agreeing to the basic notion that it would be helpful to ramp up fiscal spending. Little coverage was given to Greenspan’s response: “No!” Focusing on the U.S., he said unemployment is close to what’s historically considered full employment: if fiscal spending were to be ramped up, we might get a short-term bump in growth due to the induced government spending, but we would foremost get wage inflation and increased deficits that will come back to haunt us. Instead, he argued, we need policies that increase productivity: when you are near full employment, the way you grow an economy is to increase the output per worker. He suggested the best way to increase productivity is to encourage investments.

While we acknowledge that not everyone agrees with Greenspan’s policies over the years, we believe he is dead right on this one. So why the heck aren’t investors investing? Why are they buying bonds yielding just about nothing?

Investment is dead…
There may be many reasons why investors are on strike. Current low inflation, in our view, is a symptom, not a cause of that. At its core, we believe investors don’t think they get rewarded for their risky investments. Our analysis shows that investors in recent decades have – on average – focused on ever more short-term projects. That is, projects that require massive investments with an expected return in twenty years rarely happen these days.

In his book “Civilization: The West and the Rest,” economic historian Niall Ferguson makes the point that what differentiates the West from ‘the Rest’ is the rule of law. When there’s certainty over the future rules and regulations, i.e. when the rules of the game are clear, investors are more likely to invest. We believe that rule of law has been deteriorating, but not necessarily in the most apparent way:

Regulatory risks. We allege regulatory burdens have substantially increased in many industries. This increases the barriers to entry (stifling innovation), as only large players can afford to comply with the rules. If we take the U.S., gridlock in Congress, has caused regulatory agencies to increasingly change the path of regulations without legislative process. The cost of doing business has gone up in many industries, from finance to pharmaceuticals to energy, to name a few.
Government debt. We allege investments are at risk when governments have too much debt. That’s because the interests of a government in debt is not aligned with the interests of savers. A government in debt may be tempted to induce inflation, increase taxation or outright expropriate wealth. In our assessment, investors need to be convinced government deficits are sustainable for them to have an incentive to invest.

Neither government deficits nor regulations are new phenomena, of course. But we believe it’s concerns over trends like these that are key to holding back investments. It’s often argued that the U.S. can print its own money and, as a result, will never default. Possibly, but that doesn’t mean the U.S. won’t induce inflation or find other ways to tax investors. And while there are solutions to any problem, investors must be convinced that those that benefit risk takers will be embraced. Eurogroup chief Dijsselbloem, at the peak of the Eurozone debt crisis phrased it well, arguing that we cannot expect long-term investments if we don’t tell people where we want to be in ten years from now. While a crisis is apparent when Greek government bonds rattle global financial markets, the global strike by investors to invest in productive assets may be just as alarming.

Demographics
But aren’t demographics at least partially to blame for the low rates? It cannot be entirely a view about fiscal deficits and regulations? Sure enough, we agree that demographics put downward pressure on real rates of return. Yet, we see this as part of the same issue: we could introduce policies that encourage workers to be productive longer rather than retire at age 65. Instead, we have policies in place that have enabled many to go into early retirement by claiming disability benefits. With increased life expectancies throughout the world, we feel retirement at age 65 has become a major fiscal burden.

Is gold now good or bad?
As we have pointed out many times in the past, it’s not gold that’s good or bad. Gold doesn’t change – it’s the world around it that does. We believe an investment in gold should be looked at in the context of an overall portfolio construction. There, one should look at the expected risk and expected return of any asset one considers including in a portfolio. Please read our Gold Reports for more in-depth analysis of gold’s low correlation to other assets that might make it a valuable diversifier; you may also want to read our recent analysis Gold Now as to why we think gold might be good value for investors. For purposes of this discussion, however, we like to put gold in the context of productive assets. Our interpretation of the bond market suggests investors are shunning productive assets these days. Part of that may be concerns by investors that they will not be rewarded, with part of that due to what may be excessive government debt and regulations; another attribute may well be valuations, as we believe monetary policy has pushed many so-called productive assets into what may be bubble territory. Following this line of reasoning, reasons to hold gold in a portfolio may include:

We may be pushing the can down the road. A belief that policies in place have not put us on a sustainable fiscal path. Concerns of ballooning entitlement obligations come to mind. Namely, we are pushing the can down the road. Importantly, we don’t see a change in that trend for some time, if at all.
Regulatory uncertainty is only increasing. Regulations are strangling businesses, discouraging investments.

In contrast, reasons to reduce gold holdings in a portfolio may include, with respect to the above bullet points:

Recent government deficits have been improving; folks have always complained about the long-term outlook, but when push comes to shove, politicians will find solutions.
Both small and big business have always complained about regulation, there’s little new here.

Phrasing it this way, it’s not a surprise that an investment in gold often has a political dimension. We caution, however, that gold is anything but political. As such, it may be hazardous to one’s wealth to make investment decisions based one’s political conviction. Instead, investors may want to take a step back and acknowledge that investors in the aggregate give a thumbs down to investments as evidenced by the low to negative long-term yields in the U.S. and other countries.

Gold: cash or credit?
Before we settle the discussion on gold being ‘unproductive,’ let’s clarify that cash isn’t productive either: the twenty-dollar bill in your pocket won’t earn you any interest either. To make cash productive, you need to put it at risk, if only to deposit it at a bank. With FDIC insurance or similar, such risk might be mitigated for smaller deposits. Gold is no different in that regard: to earn interest on gold, one needs to lend it to someone. Many jewelers are only leasing the gold until they find a buyer for the finished product; to make this happen, someone else is earning interest providing a loan in gold. Many of today’s investors don’t like to loan their gold, concerned about the counter-party risk it creates. The price such investors pay is that they don’t earn interest on their gold, a price those investors think is well worth paying.

Gold more productive than cash?
The reason we started this discussion wondering whether gold may be more productive than cash also relates to the fact that real rates of return on cash, i.e. those net of inflation, may be negative in parts of the world. There are many measures of inflation and some argue that government statistics under-represent actual inflation. As such, each investor might have his or her own assessment where inflation may be. However, when real rates of return on cash are negative, it may be appropriate to say gold is more productive than cash.

In summary, anyone who thinks that we are heading back to what might be considered a ‘normal’ economy, might be less inclined to hold gold, except if such a person believes that the transition to such a normal economy might be a bumpy ride for investors (due to the low correlation of the price of gold to equities and other assets, it may still be a good diversifier in such a scenario).

However, anyone who thinks history repeats itself in the sense that governments over time spend too much money or over-regulate, might want to have a closer look at gold. There may well be a reason why gold is the constant while governments come and go.

For more information you can join Axel Merk’s webminar ‘What’s next for the dollar, currencies & gold?‘ on May 24th.

FOMC Statement: A More Positive Tone

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As expected, and in keeping with the minutes from its March meeting, the Federal Open Market Committee (FOMC) decided to keep rates on hold. Importantly, the Federal Reserve Board cited several aspects of the US economy and global conditions that leaves the door ajar for another June or July rate hike.

The Federal Reserve indicated that it would maintain the current level of the target Fed Funds rate at 0.25% to 0.50%, in line with the minutes of the March FOMC meeting.The statement focused on US growth, rather than global conditions.
The statement underscored factors underlying a strong consumer – improved labor market conditions, rising household real income, continued strength in the housing market, and strong consumer sentiment – while acknowledging slower GDP growth, moderating household spending, soft business fixed investment and net exports.
The FOMC took the important step of excluding their prior observation that appeared in the lead-in sentence that “global economic and financial development continued to pose risks,” implying that this risk has abated. Instead, they indicated that they will continue to monitor global conditions and moved this statement to the end of the second paragraph. The outlook for global growth has improved, in the wake of more supportive global central bank policy, increased fiscal stimulus in China, recovering commodity and energy prices and increased inflation.
The statement continued to take a guarded view of inflation; the FOMC eliminated the comment that inflation had “picked up in recent months”; they maintained inflation would “remain low in the near term.” We would cite the recent uptick in core CPI and core PCE as indications of increasing inflation. Apparently, the Fed hasn’t completely bought into this upward trend.
We believe the statement confirms the Fed’s assessment that the futures market still reflects too shallow a trajectory for rate increases. The Fed does not want be forced to implement sharp rate moves that could jolt markets and have a negative impact on still relatively low GDP growth.
We believe this assessment opens the door for a June or July rate increase. We do not think any increase will occur, however, without continued strong employment data, coupled with improved household spending and stabilization in the manufacturing sector.

Column by Ken Taubes of Pioneer Investments

Japan’s “Spring Offensive”

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Japón, a punto de cerrar ‘la ofensiva de primavera’ — CC-BY-SA-2.0, FlickrPhoto: PV9007. Japan's "Spring Offensive"

The annual “spring offensive” or in Japanese “Shunto” is currently underway in Japan. The terms refer to the annual wage negotiations that occur in March and April between labor unions and employers. In an effort to revitalize the economy, Prime Minister Shinzo Abe has been pushing the private sector to raise worker pay and try to boost consumer spending. However, media headlines have expressed much disappointment over a slowdown in wage growth and the so-called “failure of Abenomics.” But to get a true picture of Japan’s wage situation, it is important to look at growth in both base wages and bonus payments. Though base wage increases may be slowing from last year, the outlook for bonus payments is more positive.

Overall, base wage increases in Japan will likely be lower than last year, reflecting economic uncertainty surrounding the recent strength in the yen and a slowdown in its largest trading partners, namely China. On the other hand, bonus payments may be larger thanks to record corporate profits. Media attention seems to be fixated on the base wage hike at Japan’s leading manufacturers, particularly in the automotive and electronics sectors, as they set the trend for wage negotiations in the broad manufacturing sectors. So far, base wage increases have been lower than last year, so the media has been on its “Abenomics failure” frenzy. However, they ignore the fact that workers at some of those companies are getting large bonus checks that will increase their total compensation more than last year when base wage gains were higher.

Additionally, wage pressures are now stronger at small and medium-sized enterprises (SMEs) rather than larger corporations. The Japan Council of Metalworkers’ Union (JCM), which includes automotive and electronics sectors, reports that base wage gains were higher for companies with less than 300 employees than for larger corporations. This is important as SMEs provide the bulk of employment in Japan.

Even more importantly for Japan, however, is what happens at the lower end of the wage curve where we believe, wages are too low. The national average minimum wage was increased by 2.3% as of October 2015 (previous year was 2.1%). Abe is working to boost wages at the lower end, including plans to raise the minimum wage by 3% per year until it reaches 1,000 yen per hour (it will take eight years from the current 798 yen per hour) and an “equal work equal pay” rule where employers cannot discriminate pay between full-time and temporary and part-time workers if they are doing the same work. More than 30% of Japan’s workers are temporary or part-time, and are paid much less than full-time workers. Lower-income workers have a higher propensity to spend; therefore, wage increases at the lower end will have a more significant impact on consumption and hence the economy overall.

The other glaring reality is that labor is in short supply in Japan as the population declines. In 2015, Japan created more full-time than temporary or part-time jobs for the first time in 21 years. Almost 90% of those full-time positions were filled by women. Japan’s unemployment rate is 3.3%, while the job offers-to-applicant ratio is 1.28, the highest level since 1992. Regardless of what the government may or may not do, we believe there is a structural upward bias on wages in Japan.

What does this mean for consumption and the Japanese economy as a whole? This is the tricky part. As Japan’s population is declining, there is a structural downward bias on consumption and GDP. Higher female labor participation and rising wages may offset the population decline but to what degree is uncertain. For now, we remain cautious on consumption in Japan as inflation in daily goods prices has made consumer spending habits more defensive. I hope Abe will cancel the planned consumption tax increase planned for April 2017. Nobel Laureates Joseph Stiglitz and Paul Krugman were both recently in Japan where they argued that raising the consumption tax would be detrimental for the economy. We believe Abe has his mind set on postponing the tax hike and this is just a ritual to convince the Ministry of Finance. Of course, cancelling the tax hike alone won’t lift the economy. Further wage increases are needed in Japan to convince the perennially conservative Japanese household to spend. Hopefully, younger Japanese will wake up to the fact that they are increasingly becoming a “rare” resource and actually have the upper hand in terms of wages.

Kenichi Amaki is portfolio manager at Matthews Asia.

Re-Emerging Markets?

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The emerging markets comeback is still young, but encouraging.

Last Wednesday, I was fielding questions from a couple of CNBC reporters on the trading floor of the New York Stock Exchange. One thing they asked me about was emerging markets, which was great as it allowed me to talk about our Multi-Asset Class (MAC) team’s views on these important regions. It also reminded me of how little space we’ve given the subject in CIO Perspectives so far.

Now is a good time to put that right. Emerging markets equities have outperformed the developed world by around four percentage points since mid-February. On the bond side, hard currency sovereigns returned more than 5% in the first quarter, while local currency was up more than 11%.

Moreover, while news out of the developed world was light last week (the European Central Bank struggled to match the excitement it generated in March), news out of the emerging world bordered on the historic.

Recent News Underlines Political Change in Latin America

It started on Sunday night, with the lower house of Congress in Brazil voting to impeach President Dilma Rousseff. This was the high watermark to-date of a wide-ranging scandal that is testing the country’s political and judicial institutions.

A few days later, Argentina returned to the international bond markets after 15 years. And what a return it was. The government sold $16.5 billion worth of bonds and could have put out four times that. Buyers got a 7.5% yield on the 10-year issue and on Friday the “holdouts” in Argentina’s defaulted debt were paid, ending one of the longest-running sovereign-debt disputes.

Both events underline the theme of electorates turning toward more market-friendly leadership in the region, but also two of our longstanding emerging markets themes: at the company level, businesses that benefit from the rise of the domestic consumer; and at country level, economies that benefit from structural reforms. Orthodox economics tend to see the two things as intimately linked, and that may explain why Brazilian assets have rebounded so strongly despite such political turmoil.

It is also worth recalling earlier discussions in CIO Perspectives on the stabilization of the U.S. dollar and oil, both of which have been positive for emerging markets.
Our Take on Emerging Markets Remains Optimistic—but Cautious.

And yet, while we on the MAC team generally have been in favor of increasing emerging markets exposures after the precipitous drop early in the year, our preference has been for shifts that are both cautious and tactical, seeking to exploit short-term moves that may or may not consolidate into something more fundamentally driven.

And we don’t think the fundamentals are there quite yet, which is why more broadly we favor emerging markets debt over equity, and hard currency bonds over those issued in local currency. As long as investors are being well compensated for taking credit and duration risk, our overall caution would weigh against adding high-volatility local currency risk at this stage. We also expect the Federal Reserve to raise rates one or two more times this year, which could give the dollar short-term support and take the wind out of emerging market sails, especially in local currencies.

That means we missed some of the upside despite timing our recent increase in exposure well. But it fits with our overall view that these past two months have seen a “relief rally” in riskier assets rather than a genuine return of confidence, and that the fundamentals have not changed much since the start of the year.

Relative Value Still Favors U.S. High Yield—for Now

For the moment, we feel that the marginal dollar of risk should still go to U.S. high yield bonds before it goes to emerging markets. Moreover, when I spoke at a conference with one of my emerging markets debt colleagues recently, he agreed that, while he saw many discrete opportunities in his own asset class, high yield was a more attractive risk-adjusted prospect. High yield spreads have since narrowed, but in my view that is still true.

The fundamentals can change, of course. Our colleagues in emerging markets debt are certainly excited about Latin America, in particular, and while I’m not 100% persuaded yet, there’s no denying that part of the world bears watching closely.

The new administration in Buenos Aires is still very young. Likewise, the process in Brazil may take a long time to play out and the story can quickly turn upside down from the way markets currently read it—as emblematic of some of the headwinds that emerging markets still face. Nonetheless, once it’s clear that the political scene really is changing in this region, turning those headwinds into tailwinds, the yields on offer could present some very interesting opportunities.

Neuberger Berman’s CIO insight

Mexico’s Mutual Fund Industry Grew 9% in Dollars the Last Five Years

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La industria de fondos en México crece un 9% en dólares en 5 años — CC-BY-SA-2.0, FlickrPhoto: Antonin. Mexico's Mutual Fund Industry Grew 9% in Dollars the Last Five Years

In the last 5 years, the Mexican mutual fund industry’s Assets Under Management grew 9% in dollar terms, while the Afores (Public Pension Funds) grew 31% in the same period. It is noteworthy that in the period the peso lost 40% versus the dollar, which was one of the main reasons there was only a single digit growth.

According to the regulator (CNBV) as well as industry information (AMIB), the mutual funds companies manage US$ 112 billion through 567 mutual funds. There are little more than 2 million contracts divided between 29 intermediaries. The three largest participants account for 56% of the market and the 10 largest participants have a combined 90% market share. The three largest are bank related entities, with more than 10% market share each. These three are: Banamex with 25% of all AUM, BBVA Bancomer with 19% and Santander with 12% as of the end of 2015. In the last 5 years Banamex increased its market share 0.5%; while BBVA’s decreased by 4% and Santander also saw outflows equivalent to 1% of its AUM.

While there is still a strong interest, from both locals and foreigners, to enter and increase their presence in the mutual fund industry in Mexico, reviewing the figures for the last five years, the most important changes come from GBM which added an extra 2% market share to their AUM, to settle with 4% market share and in ninth place; and the case, already mentioned, of BBVA Bancomer whose market share fell from 23 to 19%. The rest have small variations of plus or minus one percent.

In addition to the above, the entities that stand out are Banorte IXE (on 4th place with a 7% market share) with an increase in market share of 1.2%; Actinver (5th place with 6% market share), Finaccess with 0.8% (15th place with 1% of the market); and Principal (13th place and 1% of the market) with an increase of 0.6% over five years.

Although the number of debt and equity funds offered is very similar (280 debt funds vs 287 equity funds for a total of 567 funds at December); the distribution by assets class is not the same: 73% of assets are in debt funds while only 27% are in equity funds.

Reviewing the composition of the assets between debt and equity funds of each intermediary we observe some specialization. Managers with more than 90% of its assets invested in debt funds are: Nafinsa (98%); CI Fondos (98%); Intercam (96%); Monex (95%); HSBC (93%); Mifel (92%); Vector (91%); Invex (90%); and Multiva (90%). Those with more than 60% of its assets in equity funds are: Valmex (70%); GBM (65%); Inbursa (59%) and Finaccess (59%).

It is estimated that management fees average 1.12% in Mexico with debt funds fees are around 1%, while funds fees ranges between 1.5 and 2%, on average.

Reviewing the five years figures, one concludes that the fund business in Mexico is a long term one and where participation slowly grows.

Be on the Right Side of Change

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AB: “Adaptarse correctamente a los cambios tecnológicos marcará la diferencia en la rentabilidad de las empresas” — CC-BY-SA-2.0, FlickrPhoto: Mark Strozier. Be on the Right Side of Change

Companies are having a much harder time producing earnings growth. Those that are positioned on the right side of change should be better placed to increase profits—and deliver investment returns—in a growth-constrained world.

Corporate profit margins today are much higher than their average since the early 1950s (Display). These profitability levels are very high, even when taking into account that the mix of US economic activity has shifted toward more capital-light business models (e.g., services and technology), which inherently generate higher margins.

Ampliar

But not every company or industry is facing the same squeeze on earnings growth. In particular, changes triggered by technology, regulation or structural shifts in specific markets are excellent sources of growth potential—even in an earnings-constrained world. Finding companies that are on the right side of changes like these is one of several ways that active investors can capture excess returns over long time horizons.

Using Technology Right

Technological change isn’t only about the Internet or social networks. Consider the retail sector, where new technology and information systems allow companies to take advantage of massive amounts of available data on customer behavior. Companies that recognize this potential and invest accordingly are using these tools to deepen relationships with customers—and are capable of doing better than rivals who haven’t.

Manufacturing is another case in point. Companies that are at the vanguard of manufacturing innovation have greater flexibility in managing their businesses, which provides a powerful way to boost profitability.

For example, when we researched Nike in 2015, we discovered innovations that looked likely to significantly improve the company’s earnings growth potential. Nike may be adding sophisticated chips to some of its sneakers; this will allow it to deepen its relationship with customers by offering personalized deals that bypass retail outlets, bringing more profit to the shoemaker. It’s also using a new automated manufacturing technology called Flyknit that lets customers customize their orders with minimal labor, allowing Nike to shift its production closer to consumers—in the US and around the world—and save costs on shipping, duties and tariffs. Our research suggests that innovations like these are transforming Nike’s business model and could potentially trigger a leap in its profitability.

Why the wide gap between our view and the street’s? It’s because most analysts aren’t evaluating how new technologies and processes will filter down to the bottom line over several years; the potential payoff is a couple of years beyond their horizon. In a short-term world, building thoughtful, independent models like these can make the difference in choosing stocks that stand out from the crowd.

The Innovation Factor

It’s not only giants like Nike that turn innovation into investment opportunities. It’s becoming easier every year for people to change the world because traditional barriers to innovation—such as capital and time—are falling dramatically.

Today, new ideas can be transformed into businesses for only a fraction of the prior cost thanks to continued exponential declines in the cost of computing. For example, the required costs of a typical tech start-up have fallen by roughly 95% since the dot-com era of the 1990s (Display, left). And the disruptive potential is enormous, as seen in the shift in advertising from print newspapers toward the digital world, which has had a profound impact on profits for both traditional media companies like the New York Times and new media leaders like Google (Display, right). For investors, the challenge is to get an early grasp on how unfolding changes will transform the profitability outlook for a wide range of companies.

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Transcending Traditional Industries

This often requires an understanding of broad themes that transcend traditional industries and sectors. For example, increasing environmental awareness is spurring global efforts to address challenges that include carbon emissions, clean water, food availability and sanitation. Policy support and technological progress are making the shift to decarbonized energy inevitable, in our view. And the costs of renewable energy such as solar or lithium-ion batteries for electric cars are falling dramatically (Display). We believe that many investors have underestimated the disruptive potential of exponential cost improvements to drive faster and broader adoption.

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Changes like these are opening up big investing opportunities. Over the next 15 years, we estimate that $4 trillion will be invested in new solar and wind capacity. Industries like these are highly fragmented, and offer strong growth opportunities for winners.

But identifying investment targets requires a substantial research effort in order to understand the technological and business dynamics of many public companies operating in nascent industries. By searching for businesses that are on the right side of changes like these, we believe investors can find companies that should be well positioned to grow their earnings—even when broader business conditions are stagnant.

Frank Caruso is CIO US Growth Equities at AB and Daniel C. Roarty is CIO Global Growth.

Be on the Right Side of Change

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Corporate profit margins today are much higher than their average since the early 1950s (Display). These profitability levels are very high, even when taking into account that the mix of US economic activity has shifted toward more capital-light business models (e.g., services and technology), which inherently generate higher margins.

But not every company or industry is facing the same squeeze on earnings growth. In particular, changes triggered by technology, regulation or structural shifts in specific markets are excellent sources of growth potential—even in an earnings-constrained world. Finding companies that are on the right side of changes like these is one of several ways that active investors can capture excess returns over long time horizons.

Using Technology Right

For example, when we researched Nike in 2015, we discovered innovations that looked likely to significantly improve the company’s earnings growth potential. Nike may be adding sophisticated chips to some of its sneakers; this will allow it to deepen its relationship with customers by offering personalized deals that bypass retail outlets, bringing more profit to the shoemaker. It’s also using a new automated manufacturing technology called Flyknit that lets customers customize their orders with minimal labor, allowing Nike to shift its production closer to consumers—in the US and around the world—and save costs on shipping, duties and tariffs. Our research suggests that innovations like these are transforming Nike’s business model and could potentially trigger a leap in its profitability.

The Innovation Factor

Today, new ideas can be transformed into businesses for only a fraction of the prior cost thanks to continued exponential declines in the cost of computing. For example, the required costs of a typical tech start-up have fallen by roughly 95% since the dot-com era of the 1990s (Display, left). And the disruptive potential is enormous, as seen in the shift in advertising from print newspapers toward the digital world, which has had a profound impact on profits for both traditional media companies like the New York Times and new media leaders like Google (Display, right). For investors, the challenge is to get an early grasp on how unfolding changes will transform the profitability outlook for a wide range of companies.

Transcending Traditional Industries

Changes like these are opening up big investing opportunities. Over the next 15 years, we estimate that $4 trillion will be invested in new solar and wind capacity. Industries like these are highly fragmented, and offer strong growth opportunities for winners.

But identifying investment targets requires a substantial research effort in order to understand the technological and business dynamics of many public companies operating in nascent industries. By searching for businesses that are on the right side of changes like these, we believe investors can find companies that should be well positioned to grow their earnings—even when broader business conditions are stagnant.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

A Glimpse into North Korea

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Un vistazo a Corea del Norte — CC-BY-SA-2.0, FlickrPhoto: (stephan) . A Glimpse into North Korea

During a recent visit to Asia, I took the opportunity to join a tour to the notorious demilitarized zone that separates North and South Korea. The “DMZ” as it is more commonly referred to, is 4 kilometers wide and has served as a buffer zone between the two states since the Korean War Armistice Agreement of 1953.

Lacking a peace treaty to bring the Korean War to an official conclusion, the countries remain technically at war, which makes the plight of the Kaesong Industrial Complex—a jointly run industrial park—all the more intriguing for visitors.

The complex, located just north of the DMZ, has manufactured goods for export into the South since 2004. According to global news agencies, there are 124 South Korean companies operating within this area and our tour guide informed us that some 50,000+ workers from the North can expect to earn approximately US$100 per month for their services.

If these figures are accurate, these employees earn only 6% of the average household disposable income in the South. However, upon closer inspection, this facility is less about profit margins than it is a step toward re-unification; a concept that was repeatedly referred to throughout our tour.

Despite this positivity, my visit unfortunately coincided with an indefinite closure of the Kaesong Industrial Complex—a response by the South to the launching of a North Korean long-range rocket. While this is not the first time the complex has had to close, it should be noted that past shut-downs had been initiated by the North. Whether we will see future reconciliation on this front remains open to debate.

While we don’t know if the lights are out for good or not at Kaesong, my experience was that commerce is not completely absent from the region. As just one of 42 paying visitors on my tour, I saw several other bus-loads of sightseers at multiple stops. Furthermore, whether it was in the Joint Security Area, the Third Infiltration Tunnel or the Dora Observatory, we found gift shops were never all that far away. This offered me the opportunity to buy key rings, figurines and even soju—a distilled rice liquor—that reputedly came from the North.

From my various vantage points (and despite technically setting foot inside the secretive state), it is impossible to tell what life is truly like in North Korea, north of the DMZ. Whether North Korea will ever see projects such as Kaesong as a pathway to economic development remains to be seen. But I would like to think that one day I’ll be able to return to this fascinating region in an investment capacity.

Colin Dishington, CA, CFA, is Research Analyst at Matthews Asia.