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Drilling Into the Oil Price Impact

Ahondando en el impacto del precio del crudo — Photo: Damian Gadal. Drilling Into the Oil Price Impact

Over the last six months the oil price has fallen sharply. This has been attributed variously to fracking in the US causing a rise in the supply of hydrocarbon energy, concerns about a slowdown in the Chinese economy leading to weaker demand, high oil prices prompting a structural shift in energy efficiency and resistance by Saudi Arabia within OPEC to cut production to support prices. Whatever the underlying cause, the low oil price has implications for the high yield market, especially in the US where around 18% of high yield issuance in 2014 originated from the energy sector.

Energy positioning within the strategy

In late 2014, we reviewed our positioning in high yield Energy and stress tested our holdings based on a long-term WTI Oil price of $60/bbl. As a result, we exited four energy positions – Sandridge Energy, Energy XXI, Tervita and California Resources Corp (Calres). For the first three we projected potential default scenarios at the end of 2015/early 2016 and, therefore, further downside risk. We decided to exit Calres despite its low cost structure and liquidity because the company is unhedged and results are likely to be volatile in the medium term.

However, it is important not to write off the energy sector entirely. There will be plenty of companies that are able to tolerate the volatility in oil and gas prices and the risk premium that is reflected in their yields can offer an attractive opportunity. That is why we reviewed several higher quality names that were better positioned to withstand a low oil price environment due to a low cost profile, solid balance sheet, significant liquidity and an equity cushion. As a result we have added Chesapeake Energy and Hilcorp Energy as names that have sold off, but also offer downside protection. At 20 February 2015, the yield to worst on these two bonds was respectively 5.0% and 5.8%, with the yields declining (prices rising) since we made the purchases. The table below shows the HY energy weight in the fund.

The plight of oil services

Having lots of debt may stop some capacity exiting as producers operate to earn every dollar of cash they can, hoping for an upturn, but in the process they will try to force down costs. Just as supermarkets squeeze their suppliers, we anticipate oil margins at oil services companies being squeezed by oil explorers and producers that are seeking to cut costs. Daily prices for rigs are already tumbling and many producers are announcing big cuts to capex budgets as they seek to preserve free cash. In anticipation of a difficult near term for this sub-sector, we now hold no oil field equipment and services debt.

Similarities with 1986

Lower oil prices are contributing to lower inflation, which in turn is contributing to lower yields. Some commentators are interpreting this as a signal that the global economy is weak. It is not uncommon for a sharp drop in the oil price to occur without presaging a recession, however, as happened in 1986. This view is shared by Morgan Stanley, the investment bank, which has pointed out that 1986 offers many similarities to today: US credit spreads initially widened, Treasury bond yields fell and the yield curve flattened – the following years would see the economy do reasonably well. The chart below shows the direction of the oil price in 1986 overlaid with today’s oil price movement. If the oil price follows a similar pattern, then it may level out at current levels. Equity markets rose for several more years following 1986 and a strong equity market is usually helpful for the high yield bond market in general in terms of investor sentiment, capacity for M&A activity and IPO activity.

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Impact for rest of the portfolio

The oil price decline is good news for global growth as it should act as a tax cut for consumers, leading to a shift in wealth from oil-exporting countries to countries with a high propensity to consume. The US and Europe, in particular, should be net beneficiaries. Oil is an important primary input for many products, which together with tumbling transport and energy costs means the positive ripple-through effects on the broader economy are substantial. Spreads on high yield, however, have been dragged wider in response to worries about the energy sector and we believe this has created better value within the high yield market.

Improving flow picture

Higher spreads on high yield bonds come at a time when yields on core government bonds appear to be anchoring at lower levels, a consequence of lower inflation levels together with deliberate policy action by the European Central Bank (ECB) to purchase sovereign bonds. Unlike investment grade markets, the high yield market may not benefit as directly from the “crowding out” effect of the ECB’s quantitative easing program, but the second order effect could be just as large. The first beneficiary will be BB-rated (which is easier for institutions to move down into) but ultimately this will have a knock-on impact on B/CCC pricing. With fund flows starting to pick up, the yield and spread enhancement offered by high yield looks increasingly attractive in a world of negative or low government bond yields. Already, in recent weeks, there has been a shift towards positive flows within both the European and US high yield sectors.

Petrobras event risk

Petrobras, the Brazilian oil and gas giant, has been the subject of an ongoing corruption investigation, which together with the collapse in the oil price, has led to negative sentiment towards the company and concern about its accounting practices. The company was downgraded to just one notch above investment grade by Moody’s and Fitch, the credit rating agencies, in early February 2015. A company’s credit rating for index purposes reflects the majority view of the big three ratings agencies. With around $50bn of outstanding debt a downgrade to sub-investment grade status could lead to a flood of high yield energy paper onto the market as investors who are restricted from owning non-investment grade bonds are forced to sell. This is all the more reason for our preference for higher quality high yield within the energy sector.

Kevin Loome is Head of US Credit and portfolio manager of the Henderson Horizon Global High Yield Bond Fund.

Why China’s A-Shares Matter Now?

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¿Es interesante el mercado chino de acciones de clase A para los inversores a largo plazo? — Photo: Jacob Ehnmark. Why China's A-Shares Matter Now?

Although we often receive questions on mainland China’s A-share equities, which trade on the Shanghai and Shenzhen Stock Exchanges, we currently invest in Chinese equities primarily via Hong Kong-listed companies and also by way of U.S.-listed Chinese firms. China’s domestic A-share market remains largely closed to foreign institutional investors. The only way for foreigners to participate in this market is to enroll in China’s Qualified Foreign Institutional Investor (QFII) program or invest via a manager who has a quota in this program. Even still, relatively few QFII licenses have been granted.

China’s A-share market performance has been lackluster over the long term. Ten years ago, the Shanghai Composite Index traded at approximately 1,800 and had a stellar run to 6,000 in late 2007. But the index has since erased most of its gains and is now trading back around 2,000. This may leave you to wonder: do the A-share markets reward long term investors?

There are a couple of unique characteristics of China’s A-share markets that have, either directly or indirectly, contributed to the country’s stock market performance. First, a key issue has been China’s “non-tradable shares,” which were awarded to the management teams and employees of listed state-owned companies. As their name implies, these shares have been disallowed from trading in the open market. But after a long reform process of the non-tradable shares in from 2005 to 2007, individuals could gradually sell their shares. Over the next few years, batches of non-tradable shares continued to become available for trading and created a situation of excess liquidity, weighing down stock market performance.

Unlike in most markets, another characteristic unique to the A-share market is its trading volatility. This results from the dominance of the A-share market by retail investors, who make up 80% of the market and tend to be short-term market-timers.

All of that said, many of these comments are backward-looking. The non-tradable shares issue peaked around 2009 and provokes less discussion today. High volatility continues to be challenging, but steps have been taken to introduce more institutional and QFII participants to the market, encouraging a longer term investment mentality.

As these markets evolve, they may present more attractive opportunities for investors. For starters, valuations are currently enticing, trading at price-to-earnings (P/E) multiples currently estimated by Bloomberg at 8x for 2014 and 7x for 2015. These valuations are approaching 10-year historical lows. The A-share markets also broaden the pool of stocks from which investors may choose. For example, in certain fast-growing Chinese sectors as health care, consumer and technology, there are many more selections on the A-share market, compared to the relatively few numbers of firms listed in Hong Kong or the U.S. We may also be able to research the A-share competitors of businesses we currently study.

Matthews Asia currently holds no exposure to A-share equity markets, and we are not commenting on the domestic markets as a whole. Careful stock picking is particularly important here since this market does have its fair share of poorer quality companies, including a large representation of state-owned businesses. However, such a large opportunity set does have the potential for investors to choose from a larger menu of quality companies.

Winnie Chwang, portfolio manager at Matthews Asia, is set to present her views on Chinese companies when she takes part in the Fund Selector Summit Miami 2015, at the Ritz-Carlton Key Biscayne on 7-8 May.

The views and information discussed represent opinion and an assessment of market conditions at a specific point in time that are subject to change. It should not be relied upon as a recommendation to buy and sell particular securities or markets in general. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. In addition, single-country funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific geographic location. Investing in small- and mid-size companies is more risky than investing in large companies, as they may be more volatile and less liquid than large companies. This document has not been reviewed or approved by any regulatory body.

China’s New Generation of Entrepreneurs

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Una ola de innovación recorre China — CC-BY-SA-2.0, FlickrPhoto: Jon Russell. China’s New Generation of Entrepreneurs

In 2000, I was in the U.S., sitting in my college auditorium, listening to a panel of speakers discuss the whirlwind changes around the development of the Internet. That was shortly before the Internet bubble burst. One of the speakers was a Chinese school teacher-turned-entrepreneur, Jack Ma, who had just started an obscure e-commerce business. Even as charismatic and dynamic as he was, probably no one at the time could anticipate the later success he would find as one of China’s prominent Internet titans. Fast forward about a dozen years and China has managed to surpass the U.S. in online retail sales. In fact, its online sales grew another whopping 50% from 2013 to 2014, to reach about US$450 billion. By comparison, U.S. consumers pur- chased about US$300 billion in online goods last year.

China is often perceived to be a breeding ground for business copycats and has struggled with rampant intellectual piracy. Many businesses have indeed been founded in China based on business models that originated in the U.S. or Europe. But what’s been overlooked in recent years is China’s rising “innovation machine,” particularly in the technology sector. China’s new generation of entrepreneurs, represented by Jack Ma, is making waves and increasingly competitive against Western counterparts. They also continue to leapfrog their Western peers in creating innovative business models.

A good example is one of China’s most dominant smartphone players, Xiaomi. Its latest round of financ- ing has valued the private company at over US$45 billion. Xiaomi has become the world’s most valuable private technology start-up, surpassing all private firms in Silicon Valley whose valuations themselves reach up to the tens of billions of dollars. This is even more remarkable if you consider that Xiaomi was founded only four years ago. Although it uses Google’s Android system for its underlying operating system, this start-up has been an innovation engine. It provides a customized user interface, on top of the Android, that is appealing to end consumers. It has also successfully leveraged social networks to solicit user feedback in a way that has not been seen in the U.S. Probably most innovative of all, it has managed to sell a vast majority of its smartphones online directly to consumers, bypassing traditional telecommunications carriers.

Wave of Innovation

The current wave of innovation among small companies in China has been underpinned by further spending on research and development (R&D). The Chinese government’s favorable policies toward R&D have certainly helped. R&D spending in the country has been rising at double-digit rates in recent years, far outpacing most other countries. Entrepreneurs in China fully understand that, as labor costs continue to rise, and China’s ability to play labor arbitrage relative to neighboring countries continues to be eroded, it’s imperative for them to climb up the value chain.

So, whereas past generations of entrepreneurs set up manufacturing shops, churning out cheap shoes and apparel, the new generation of entrepreneurs is setting up shop in areas such as health care, electronics or online services. I used to be able to consider business models in China by comparing them against U.S. or European counterparts as reference points. But these days when I speak with some Chinese entrepreneurs, I am frequently struck by how often no equivalent business model exists yet in the West. For example, companies are developing e-commerce business models based on such things as residential communities or the selling and distributing of semiconductor chips online.

Even traditional hardware manufacturing businesses, which Chinese firms have long dominated, have moved on to new frontiers over the past two decades. Dozens of small independent and community-operated, techrelated workspaces known as hackerspaces, have popped up across the country in recent years. These collabora- tion spaces allow entrepreneurs who are interested in design and technology to tinker and create everything from drones to robots. What’s different from prior gen- erations of entrepreneurs that exported apparel (given massive government subsidies) is that entrepreneurs are now equipped with open-source software, emerging 3D printing technology and Silicon Valley-style venture funding—or even peer-to-peer lending.

The current wave of innovation among small companies has not gone unnoticed. Increasingly in recent years, we’ve seen multinational companies acquiring small China-based firms. This has happened across many busi- ness segments, including industrials, the medical device industry and consumer staples. They are not merely taking a minority stake as a passive shareholder, but often taking a controlling stake or even acquiring entire companies outright, with the approval of local regulators.

Having talked to many multinational companies as well as Asian companies over the years, I think there are a few reasons why multinational companies are interested in buying small companies in China. The obvious one is gaining access to the local Asian market. Also, the process of setting up an extensive distribution network across many Asian countries—where infrastructure is poor—tends to be very lengthy and costly. Many mul- tinational companies, thus, try to take a shortcut by acquiring a smaller, local firm that already has a distribu- tion network in the region.

Market Competitive Dynamics

The second factor is much less obvious. Multinational companies want to access local technology and R&D resources. This might seem very counter-intuitive. In most industries, multinational companies own the most advanced technology, while local small companies in Asia remain in the catch-up stage. Market-competitive dynamics in Asia are often such that multinational companies occupy the high end of the market while locals are at the low end. Over the years, however, having realized that they’re missing a big chunk of the market at the mid-to-low end of emerging Asian countries, they’ve been thinking of ways to move down the market. At the same time, local small companies, not content to reside at the low end, have been moving up the market.

To attack the mid-to-low end of the market, some multinationals have attempted to simply dumb down the higher-end products they offer in the U.S. or Europe. This approach has largely failed because they don’t have the right cost structure—you can’t support a much lower price point in Asia with U.S. or European-based R&D and manufacturing. Another reason is that a product development approach from the ground up is needed, rather than tweaking edges or eliminating features from an existing higher-end product. Therefore, in recent years multinationals have begun to acquire local small companies in China outright—often a more cost-effective approach than taking time to organically develop their Asian business.

But there is more. Technology gained through these acquisitions isn’t just used for local markets, but also exported to other emerging markets. Furthermore, with reverse innovation, technologies and products developed by entrepreneurs in China are increasingly brought back to the value segment of the market in the U.S. and Europe. In this way, small Chinese companies are no longer copycats; their impact is increasingly felt worldwide.

At the recent World Economic Forum in Davos, Switzerland, Chinese Premier Li Keqiang delivered a speech in which he remarked, “Mass entrepreneurship and innovation, in our eyes, is a gold mine that provides a constant source of creativity and wealth.” After decades of running the economy by central command and control, China’s leaders are now eager to promote grassroots-level entrepreneurship. If the current trend continues, foreign investors in China will not lack inter- esting opportunities that could possibly lead to the next Amazon or Google of China.

Beini Zhou, is portfolio manager at Matthews Asia.

The Upside Of Seeing The Downside

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Las ventajas de conocer las desventajas — Photo: Jeff Belmonte. The Upside Of Seeing The Downside

With the bull market running well past five and a half years now, the standard three- and five-year performance screens for mutual funds now look really great. Once the calendar turned from February to March 2014, the major losses sustained during the global financial crisis all but dropped out of funds’ trailing five-year return figures (the market hit its low in March 2009).

But those numbers forget that the average economic expansion has been roughly five years in the post-World War II era, and it’s hard to tell right now how your clients’ assets might fare once the bears begin to growl. True, we’re in uncharted territory: The current bull market has extended well past the 4.9-year average we’ve seen since 1950. And with the S&P 500 headed mostly upward since it bottomed out at 676.53 on March 9, 2009, it’s no wonder investors have such a tough time taking alonger-term view. That’s especially true given the amount of noise in the markets and the number of behavioral biases toward shorter-term investment decisions.

Furthermore, if you look back only five years, you’re judging active managers on only half their skill. It’s just as important to see how they performed on the downside, through a bear market, to evaluate their ability to add long-term value. Yes, past performance is no guarantee of future results, and certainly every market disruption is different. But advisors should judge managers’ performance in both the good times and bad times to better understand their investment process and see how they manage risk.

That’s why, if you’re using hypotheticals with your clients, make sure to emphasize the 10-year returns (if available) just as much as the three- and five-year figures. Or maybe look at how fund managers do over periods with significant intra-year volatility — at 2011, for example, when the S&P 500 slipped 20% from late April to October but still managed to close up just over 2% for the year. You can also look at measures of risk and volatility like standard deviation, beta and downside capture. Still, those may not resonate as well with your clients. Instead, show them how the values of their accounts have changed on their monthly statements. Look back at those values over several years, perhaps using rolling 30-day periods, to help your clients see what market volatility really means to their bottom lines.

What’s important is getting past complacency and unrealistic expectations of what the capital markets can actually deliver. We’ve seen a lot of that lately, as well as investors’ misperceptions about what their funds are designed to do. In a recent MFS survey of defined contribution plan participants, 65% of those surveyed believed that index funds were safer than the overall stock market, and nearly half (49%) thought index funds delivered better returns than the stock market. And while strong stock market performance may have helped keep such misperceptions intact, these investors could be in for a rude awakening when the market eventually pulls back.

As investment professionals, it’s our job to dispel myths, set the right expectations and help investors get a realistic picture of how capital markets perform over time. At times, that’s a matter of questioning the answers. Are certain performance figures enough or do advisors need more context to give their clients a full picture? If active managers are to demonstrate value through full market cycles, clearly there is an upside to showing your downside.

Jim Jessee is co-head of Global Distribution for MFS Investment Management (MFS). He is also a member of the firm’s management committee.

Opportunities in Asia’s Economies

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Oportunidades en las economías asiáticas — Photo: Vinoth Chandar. Opportunities in Asia’s Economies

Unfortunately, in recent times, developed markets have been veering on a downwards trajectory as global growth concerns come to the fore once again. In contrast, we believe the Asia-Pacific region is different: there’s a powerful ‘reform’ agenda creating specific catalysts that may drive markets there.

With changes of leadership in China, Thailand, India and Indonesia, a region-wide clampdown on corruption and a drive to improve efficiency, investor perceptions are beginning to shift for the better, along with share prices. The improving backdrop warrants a closer look.

Chinese SOEs – the lumbering giants are getting fit
State-owned enterprises (SOEs) have been instrumental in the Chinese economic growth story. Recently, however, there has been a drive to reshape these bloated structures into companies focused on shareholders rather than market share or job creation.

The hope is those SOEs with improving operating efficiency should contribute to China’s economic growth, reinvigorate private sector investment and help revitalise the economy by creating a more competitive business environment. Coupled with President Xi Jinping’s well-publicised anti-corruption measures, we believe this may improve investor returns in the medium term.

The SOE, PetroChina, is one of our favoured picks. The new management, installed in 2013, is more focused on the returns from invested capital, which should resonate well with external shareholders.

India – powering forward
Across the Bay of Bengal, newly-elected Prime Minister, Narendra Modi, is beginning to drive real change in political and economic attitudes. Expectations are high, and there is already evidence of the new administration beginning to address legacy stalled projects, by simplifying project approval and land-acquisition processes.Coal shortages are a major issue for the power sector and economy as a whole. With the newly-formed government committed to ‘24/7’ power supply across India, augmentation of national coal output is of vital importance.

Coal India is one beneficiary. With a virtual monopoly in domestic coal production, a lot of cash on its balance sheet, an undemanding valuation and increasing commitment to return cash to shareholders (as highlighted by the recent special dividend), we currently view this as an attractive investment proposition.

Korea – tapping reserves
The newly-installed Finance Minister, Choi Kyoung-hwan, announced a raft of tax measures aimed at unlocking billions of dollars in corporate cash reserves. The government plans to discourage companies from hoarding cash by imposing tax penalties on excess reserves after wages, capital expenditure and dividends have been taken into account. Investors hope this will boost the historically low dividend yields of Korean companies, and hence raise share prices.

We exercise some caution however. While there are changes being made at the government level these have not necessarily trickled down to the corporate level yet.

Indonesia – bringing the islands together
The people of Indonesia, and the third largest democracy in the world, chose Jowoki Widodo last July last year as their president following the failure of Susilo Bambang Yudhoyono to push through necessary reforms.

Undeniably a long list – first in line is energy, where fuel subsidies have led to an over-reliance on oil and a 20% strain on the total government purse. It’s not an easy task as, even though the knock-on effect frees money for other reforms (around $30bn), it risks social unrest with the impact felt by many companies and individuals alike.

Other reforms include education and agriculture, and infrastructure investment, where a focus on ports, railways, toll roads, and dams (for farming), should serve to decentralise manufacturing and release pressure from crowded urban areas. In this respect, Telekomunikasi Indonesia, the country’s largest telecommunications provider, is one that may benefit from such renewed investment.

Opinion column by Mike Kerley, manager of the Henderson Horizon Asian Dividend Income Fund.

Sustaining the Final Frontier through Investment

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While Africa continues to be an increasingly attractive investment destination, this has not resulted in comparative increases in foreign direct investment, with India for example receiving more foreign direct investment over the last four years than the whole of Africa combined. As the largest private investor in Africa, Old Mutual Investment Group is well positioned to capitalise on its unique advantage as a market leader on the continent and will continue to implement strategies in line with the projected future impact of Africa’s growing economies on investment returns.

Against this backdrop, we continue to see that improving perceptions of Africa as an investment destination are being underpinned by strong GDP growth, favourable demographics through a rapidly urbanising population and rising middle class, reduced political risk and improved corporate governance.

As such, the world is finally awakening to the emergence of Africa and its exciting GDP as the next big regional growth story.

China continues to expand its investment on the continent, while figures show there is also an increasing appetite for investment from the Middle Eastern economies, Asia, Latin America, the rest of Europe and the UK.

This growing interest is being driven by significantly positive prospects for the continent over the next decade. It’s not merely a matter of resources, but also about providing the structures and systems required by the burgeoning growth in the middle class, which is now larger than that of India.

The real story remains that of the developing consumer market across the continent, driving the growth of the retail sector. These consumers are increasingly accessing services in banking, insurance and mobile telecoms. Housing and infrastructure development also remains a key theme as well as the substantial opportunities in agriculture.

Figures show that 10 years ago, there were 116 million people constituting the middle class in Africa. Currently, this figure stands at over 326 million people, about a third of the continent. This compares to about 54 percent of the population in Asia and 77 percent of the population in Latin America.

The corporate, governance and political landscape has also transformed significantly for the better over the last decade.

From a global viewpoint, Africa continues to offer high growth opportunities, while risk diminishes and fundamentals remain solid.

Our investment focus is largely directed at sustainable projects around key development themes, which also go beyond listed equity. These include alternative investment and fixed interest arenas such as low carbon energy, education, affordable housing, infrastructure real estate, agriculture, and unlisted debt, diversified across countries, asset types, managers, and economic/inflation cycles.

By investing in schools, housing and infrastructure, we are not only supporting the development of the continent and making a lasting, positive impact on the social landscape, but also ensuring sustainable returns for investors. While private equity investments on the continent remain long term and illiquid, they are giving us net real returns of 2% to 3% above listed assets.

Hywel George, Director of Investments, Old Mutual Investment Group

Liberalizing Brazil Like the Free Spirit of Carnival

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For nearly three centuries, Brazilians have been flocking to the streets adorned in colorful costumes for their annual Carnival. There’s no shortage of whimsy here, and it’s a time-tested tradition that attracts visitors from across the globe.

But there’s more to Brazil than just a big party. While its economy may not be prime for celebration right now, it did take years for Carnival to get internationally noticed. Why shouldn’t an emerging country also receive adequate time to build itself?

Last year, Brazil was slighted by investors as one of the “Fragile Five” emerging market economies because it was deemed as being over-dependent on foreign investment. Brazil was also one of the market economies hit hardest by capital flight after the US Federal Reserve announced plans to reduce stimulus policies that initially encouraged international investors to allocate money to so-called riskier assets.

We believe the lackluster image that has been given to Brazil may be unwarranted. Brazil maintains a strong fundamental growth story. The country has an ample supply of quality companies. Many of our holdings are market leaders in their respective industries and have strong businesses that are well-equipped to weather any economic or political swings.

The country has now grown to become the world’s seventh largest economy with a population of more than 200 million people. It is also South America’s largest country and abundant in natural resources.

Of course, these strengths do not mean Brazil is without obstacles. Corruption concerns and excessive government intervention in its economy are also driving up costs that make the country among the harder countries to conduct business in.

Brazil’s historical emphasis on supporting domestic industries also created a slew of taxes and tariffs that limited imports. With such a protected domestic market, companies had little reason to become efficient, and the prices of goods rose to an unfavorably higher price.

The country’s stock market is also hitting a bump on recent news of President Dilma Rousseff’s re-election in October 2014. Investors worried that her continued leadership would prevent policy changes. But we believe Brazil is learning from past outcomes, and we foresee Rousseff being more open to alliances with political counterparts who are more market-focused and business-friendly. We’re already seeing some shifts in motion.

Joaquim Levy was recently named finance minister, which signals that more market-friendly policies are likely to be adopted. His announced plan is to bring the primary surplus before interest payments down to 1.2% of gross domestic product (GDP) this year. He then plans to raise it back up to 2% moving forward after that. The whole point of doing this is to restore credibility, in hopes that greater certainty will boost private investment.

Former Treasury Secretary Nelson Barbosa is transitioning to planning minister, in charge of major infrastructure projects. This is vital to the development of Brazil’s rich natural resources industry. Often, the issue with having abundant resources is having the proper infrastructure upgrades (which require substantial funding) in place to keep up with growing demand.

The Brazilian government’s declining popularity under Rousseff is adding pressure on the country to address all the economic problems it’s facing, and we expect to see more discipline in the fiscal and economic policies that it rolls out. For Brazil to continuing growing on the world stage, it needs to focus on exports, which currently account for only 10% of the nation’s GDP.

Over the long-term, increased exports would support the Brazilian currency and help reduce imported inflation. In turn, this would lower domestic interest rates and debt servicing costs, potentially supporting consumer demand.

We expect that Brazil’s growing young population will also help foster demand by driving urbanization, industrialization and domestic consumption. As purchasing power rises, there will be potentially many new investment categories that service this population, including shopping mall developers, retailers, financial services providers and consumer goods companies. This will foster a stronger economy.

In short, what Brazil needs more of right now is liberalization – the freedom to change, adapt and grow – much in the unobstructed way that Carnival has been able to evolve these past centuries. Because Brazil cannot afford another restrained economy or “lost decade” like the one it experienced in the 1980s. That is one party we wouldn’t want to attend.

By Nick Robinson, Director – Head of Brazilian Equities at Aberdeen Asset Management

Miami, the Next Singapore: Making the Case

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There is a lot to Miami ‒ and more broadly speaking, to South Florida ‒ than tourism and real estate.

Art Basel has given us bragging rights as a cultural crossroads. eMerge has given us the confidence to envision an emerging technology nexus. And more than 1,000 multinational company offices, together with Miami’s bustling international trade, unquestionably make South Florida an international business gateway.

But lately, we have also begun to tout our credentials as a hotbed for financial services, a Singapore of the Americas.

So, it is only fair to ask: Does Miami, a.k.a. South Florida, really have the chops to be taken seriously as a financial services hub? Or is it just a lot of wannabe chatter? Until now, the case for Miami as a budding financial polestar has rested largely on anecdotal evidence. Sure, new firms have been setting up shop. Scout Ventures, a New York-based venture capital firm, recently opened an office in Miami, and hedge fund Universa Investments moved its headquarters from Southern California to Coconut Grove. But at the same time, other financial firms ‒ such as Canada’s RBC Wealth Management and Britain’s Lloyds TSB Bank ‒ have left town.

So, anecdotally, it’s a tie.

For a change, let’s forget the anecdotes and allow the numbers to do the talking, starting with the most basic one of all: How many financial services firms do we have in South Miami? The answer to that question, simple as it sounds, turns out to be rather complex.

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For starters, financial services firms come in a variety of species, most of them kissing cousins. There are commercial banks, investment banks, hedge funds, mutual funds, asset managers, private equity firms, broker dealers, real estate investment funds, wealth management firms, private banks and family offices.

Databases, such as IPREO, Pitchbook, Thomson ONE, are a good point of departure for analyzing this maze, but often the databases don’t agree on how to categorize the firms. Compounding the confusion, firms sometimes categorize themselves differently than do the databases. Unsure of one firm’s lineage, we asked its CEO “So are you a private equity firm or a family office?” The answer: “We’re hedge fund.” Aha!

Beyond the often murky boundaries between venture capital and private equity, between multi-family offices and wealth management firms, are two distorting characteristics of the money business: mystery and bravado.

On the one hand, South Florida, from Miami to the Palm Beaches, has long been a magnet for wealthy global citizens, many of whom would prefer not to appear on anyone’s radar. On the other hand, there are plenty of investment advisors, who are more than happy to embellish their investment banking credentials, or wealth managers eager to exaggerate their importance.

So, first, we had to acknowledge that some pools of investment money being managed in South Florida will defy detection. And second, we had to weed out marginal players by applying minimum standards for inclusion in the hedge fund count, the investment bank club, the list of international banks, etc.

Even so, coming up with accurate numbers for the different segments of the South Florida financial services industry was a cumbersome process. But once we felt comfortable with our figures, we asked experts in each of the industry segments to validate them.

The results are presented in the accompanying infographic. South Florida is home to 50 community banks, 59 international banks, 60 hedge funds, 63 wealth management firms, 19 private equity firms, 13 investment banks, and more than 200 family offices, not to mention a few upstart venture capital firms, a $7 billion mutual fund and more real estate investment funds than we even dared to count.

Is that a lot? Does that make Miami a financial services hub? By all indications, it does. That’s not to say Miami is in the same league as New York. But it does deserve to be in the conversation. But this begs another question: How do South Florida’s numbers stack up against those of Chicago, San Francisco, L.A., Houston?

That is the next challenge. Stay tuned.

You can check the Miami Finance Infographic PDF in the attachment above

The Author: Ian McCluskey is Vice President of Newlink Financial Communications.

The Inevitable Levy Let-Down

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Since Joaquim Levy took over as Brazil’s finance minister, Brazilian markets have been surprisingly resilient. On the back of Levy’s commitment to produce a primary surplus of 1.2% of GDP, expectations that Brazil will avoid losing its investment grade status had increased sharply prior to the Petrobras downgrade last week. As a consequence the real gained 4.8% against the dollar, and 10-year sovereign bond yields were down since Levy’s appointment (see Chart 10).

Although gross public debt and the fiscal deficit have deteriorated sharply since 2011, many view Levy’s presence as enough to prevent a sovereign downgrade. Such confidence that Brazil will evade a downgrade indicates a belief that Levy can and will do whatever it takes to solve Brazil’s fiscal problems. This assumes that he will be given autonomy by President Dilma Rousseff to implement fiscal reforms and that Congress will pass a budget with sufficient cuts to achieve the targeted primary surplus. Given the scope of the recently announced deficit, we are not confident that Brazil will be able to achieve its fiscal target and are sceptical that Brazil will avoid a downgrade.

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The 2014 Brazilian deficit, the largest since 1999, increased sharply from last year. The Brazilian central bank announced a primary budget deficit of 32 billion Real ($13.76 billion) for 2014, equal to 0.63% of gross domestic product. This was the first primary deficit in over a decade and a sharp fall from the 91.3 billion Real surplus of 2013 (see Chart 11). The country’s overall budget gap, which takes into account debt servicing costs, doubled in 2014 to 6.7% of GDP, one of the highest among the major economies according to the IMF. Additionally, the steady decline of public sector finances is leading to a wider current account deficit, despite weaker growth and low investment.

Levy appears committed to repairing the severely unbalanced macro conditions through deep fiscal adjustment. However the true extent of the fiscal gap is unclear and it is doubtful Levy will have support from Rousseff and Congress to implement the necessary reforms. Due to Rousseff’s lack of fiscal transparency in her first term, additional outlays exist which make the deficit even larger; an investigation by the Federal Audit Court may conclude that 40 billion Real ($15.6 billion) in expenditures were improperly accounted for since 2012 and must now be fully recognized in the government’s budget; and as much as 8 billion Real ($3.1 billion) of an estimated 30 billion Real ($11.7 billion) in public investment subsidies that have been deferred since 2012 will need to be registered in 2015. This off-balance-sheet spending will deepen the fiscal shortfall and complicate Levy’s efforts to produce a primary budget surplus. Levy recently announced plans to raise taxes on fuel, financial transactions and imports, which will boost revenues by 0.4%of GDP. However, the reforms represent the limits of his powers to improve fiscal conditions without additional congressional approval. As the unfolding Petrobras scandal increasingly occupies Rousseff’s attention and impairs her ability to govern, congressional gridlock is becoming more likely. Despite the optimism surrounding Levy’s efforts, once the true extent of his challenge comes to the fore, markets could be brought back to reality.

Opinion article by Alex Wolf, Emerging Markets Economist at Standard Life Investments

A Busy Year Already

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Un comienzo de año muy intenso — Photo: SuperCheeli. A Busy Year Already

It feels like 2015 has been a long year already! Clearly markets have had much to contend with, but the dominant feature has been the continued collapse in core bond yields. Global economic activity remains muted, and the deflationary forces lowering inflation and impacting nominal growth are many and varied. Politics and geopolitics continue to grab headlines, and in the case of the Greek election, have the potential to affect markets significantly due to Greece’s conflicting ambitions of retaining the euro whilst also seeking forgiveness on its debt.

The oil price remains weak, and whilst its impact on inflation is clear, the follow-through in terms of consumer spending is less clear cut. On the policy front, the ECB recently announced full-blown sovereign bond quantitative easing (QE), with an intention to purchase €60bn a month in bonds until its target level of 2% inflation is reached.

Against this backdrop, yielding assets have had a strong start to the year. Credit, particularly investment-grade credit, has performed well, and similarly equities have enjoyed positive returns in a number of markets. Our equity strategy has been to favour the US, which has enjoyed a relatively stronger economy, the UK, which has valuation support, and Japan, where corporate profits are being boosted by ‘Abenomics’. Although the UK equity market has been held back by its exposure to energy and materials, both Japanese and US equities have performed well since we moved to favour them in our asset allocation model.

However, the US equity market’s valuation now looks relatively stretched given both its outperformance and, more worryingly, the impact of a stronger dollar on US corporate profits. Europe, on the other hand, benefits from a number of decent tailwinds: a weaker euro, lower oil prices, and a boost from the ECB’s QE programme. It is quite possible that we will see upward revisions to European GDP growth this year, a first for many years. European corporate profits will be supported by improved competitiveness as a result of the weaker currency, and valuations are relatively attractive. Interestingly, European earnings revisions have just turned positive (albeit in a very small way).

Elsewhere, in Asia Pacific excluding Japan, and also following a long period of underperformance, valuations look increasingly attractive. Whilst there a number of obvious losers in the region as a result of the oil price fall, there are many winners, and we are finding a wider range of interesting investment opportunities. Consequently we have moved overweight the region for the first time in a while. Similarly, we have moved overweight in European equities, funding both of these moves by downgrading US equities to neutral from overweight. We have also used these recent asset allocation changes as an opportunity to reduce the magnitude of our overweight in equities, but we continue to prefer equities over bonds.