Foto: Philippe Put. How Can the Global Economy Adapt to Resource Scarcity?
The supply of resources is limited. Yet global demand for resources such as metals, fuel, water and minerals is increasing as the world’s population continues to grow. How can the global economy adapt to resource scarcity?
Resource scarcity prompts resourcefulness
According to the UN, the world’s population is expected to grow by another 3.7 billion, reaching a total of 10.9 billion by 2100. At the same time, changing consumer habits as a result of growing disposable incomes in the emerging markets and increasing industrial activity are putting additional pressure on natural resources essential to long-term economic prosperity.
The effects of rising demand are compounded by steepening costs of securing an adequate supply of resources. Most of the easily accessible resources have already been extracted. Geographical, political and environmental constraints mean that many supplies of critical resources such as oil or some metals are increasingly found in remote, difficult to reach places – such as deep sea areas or the arctic – making it difficult and expensive to extract them. In many cases, their extraction comes with added environmental, social and other indirect costs. All of this is contributing to price volatility and rising prices of production inputs. As a result, the global economy now sits at a crossroads. In order to prevent the depletion of natural resources critical to economic growth, we must transform industrial processes to become more resource efficient, develop substitutes for supply constrained resources and promote the reuse and recycling of limited resources.
But throughout history, human ingenuity and innovation have enabled us to adapt to resource scarcity by substituting away from supply-constrained resources and developing technological advances that have enabled productivity gains and the more efficient use of resources. Examples include energy-efficient LED lighting technology, or the aerospace industry, which has increasingly relied on lighter materials to reduce fuel consumption of their aircraft. These are the very mechanisms that have enabled humankind to cope with population and economic growth in a resource constrained world.
Companies that translate our resource challenges into opportunities by developing resource efficiency solutions that increase productivity or lower input costs will benefit from reduced risks associated with price fluctuations, environmental liabilities and regulation, and an enhanced reputation, boosting their competitiveness. And investors who identify these game- changers can benefit from superior risk-adjusted returns.
At RobecoSAM, we are convinced that companies that introduce innovative solutions to our resource challenges are more likely to enjoy a long term competitive advantage. Building on our in-depth understanding of long- term sustainability trends, we identify and invest in innovative game chang- ers that are leading the way in providing resource efficiency solutions. Our listed equity themes and private equity funds translate resource-related challenges into specialized investment portfolios containing future-oriented companies that are providing innovative solutions to resource scarcity in the areas of water, energy, climate, agribusiness and smart materials and infrastructure.
Ultimately, investing in the resource efficiency theme enables investors to mobilize capital to preserve resources critical to economic growth, generating a positive impact on the environment and society.
Emerging market debt is typically synonymous with increased risk. It is certainly true that emerging markets are more sensitive to global capital flows while the often more volatile economic and political backdrop means investors in emerging markets demand a higher risk premium.
However, this means that companies in emerging markets often take more effort to attract investors. At the basic level for a corporate bond issuer this means offering higher yields than developed market counterparts but it also means signalling to investors that there is little difference between an investment in an emerging market corporate bond and one issued by a similar company from a developed market. Over time, therefore, corporate governance standards have improved and are converging on developed market standards.
At an aggregate level, emerging market companies tend to be more financially conservative than their developed market counterparts. The chart below shows the lower leverage (debt to equity) ratio of emerging market companies compared with their US counterparts. Similarly, emerging market companies tend to hold more cash on their balance sheets than US companies.
In our view, this creates a valuable opportunity because investors can take advantage of the relatively high yields on emerging market corporate bonds while simultaneously investing in companies with stronger balance sheet and earnings fundamentals than some of their developed market peers.
I often hear about the connection between the bond-buying actions of the US Federal Reserve and the rise in stock prices. Indeed, the two do appear to have moved higher in tandem. The S&P 500 Index is up almost 200% since 2009, while the Fed has added trillions to its balance sheet to provide the US economy with extra liquidity to fuel growth and create jobs.
Something else has been happening during the same period, and I would like to draw attention to that. Not only have bond purchases and liquidity measures gone up on the Fed’s actions, but earnings have also risen — in the economy as a whole and by about 190% in particular for the companies traded on the major exchanges.
Over long periods of time, the observed behavior of stock markets has been directly linked to the amount of profits created by companies. That the market is up roughly in line with earnings over five years suggests to me that profitability has been much more of a driving force than Fed liquidity.
As I see it, there are five reasons why this is so important for investors to consider.
First, S&P 500 profits have continued to expand throughout this business cycle, well beyond the bounce that could be expected from recession-induced lows. Even in the third quarter, more than five years into the cycle, profits have risen at a rate of about 8.5% year over year as the US economy has regained momentum.
Second, the performance of companies in the major indices has been so robust that profits increased even when the US economy was shrinking. In the first quarter, the US government reported that economic activity contracted by an inflation-adjusted 2.1% — effectively a mini-recession. Earnings rarely, if ever, expand in the face of a shrinking economy, yet we saw that when first-quarter profits rose 4.5% year over year.
Third, the net profit margin —that is, the profit booked per dollar of sales— has continued to rise. To achieve profit margins that now exceed long-term averages by 100%, companies have limited their costs and improved their productivity to a dramatic degree — producing more goods and services per labor hour worked, turning assets more quickly, realizing lower natural gas costs, reaping the advantages of lower interest expense and so on.
Fourth, the gains in profits and profit margins are showing encouraging signs of breadth, occurring simultaneously in nearly all sectors and industries — including the much maligned health care and technology sectors.
Fifth, the US economy is expanding, almost alone among the major economies in the world. In fact, evidence is piling up that the US cycle is moving forward with solid support from consumer income, capital spending, pent-up demand, competitive improvements in global sales, wage gains and falling unemployment rates.
Won’t get fooled again
The investment world is on the lookout for bubbles, wary of asset categories filled with little but air, ready to be punctured by the slightest jab of interest rate increases or the withdrawal of government-injected liquidity. After all, only six years ago the collapse of credit pierced a genuine bubble in the housing market. No one who has sacrificed hard-earned savings to market breakdowns and defaults wants to be fooled again.
But today, there is no major flood of credit sweeping prices upward. Companies and consumers have demonstrated more responsibility with their borrowing. When the private sector borrows, incomes and cash flows are now supporting that debt.
So I agree, let’s not be fooled again. At the same time, let’s not suppose that the Fed is powerful enough to drive up profits in all categories when energy prices, labor costs and asset turnover are helping companies do well. In my view, the market cannot ignore the truly impressive results coming not from a world of liquidity, but from a world of real economy improvements.
The African continent offers huge growth potential for international investors. Coming from a low base, it is relatively easy for African economies to achieve high growth and companies’ valuations are still very reasonable.
The proportion of African equities in institutional investors’ portfolios is quite small however. The exposure they do have is usually to South Africa, as part of an allocation to emerging markets. The amount of listed equities in African frontier markets is still modest and only a few of them trade in big volumes every day. However, as investors’ interest in African frontier markets is growing, we expect this to change gradually.
Equity culture
This change will take place through two channels: the establishment of more stock exchanges and an increase in the number of companies going public. Algeria and Angola, for example, have concrete plans to introduce stock exchanges in the next three to five years. These are countries with large companies and local investors with a lot of money to invest. We see that the English-language countries, such as Kenya and Nigeria and, to a lesser extent, Ghana and Zambia, already have some sort of equity culture. This is less the case in countries with a French colonization history, such as Cameroon.
The investment case for Africa has many drivers African companies operate in a difficult environment in terms of productivity and corruption. We see this as an opportunity, as there is plenty of ‘low-hanging fruit’ that can be plucked to boost efficiency. We already see that the business climate is improving as governments in various countries are improving accountability. Environmental, social and governance (ESG) factors are therefore important to watch.
Another growth driver is the large amount of investments in infrastructure many African countries are making. Not only do these investments benefit, for example, cement companies and banks that finance these investments; they also reduce logistical problems by providing more ports, better roads and cheaper electricity. This should boost economic growth and earnings in other sectors as well. The emerging middle class in various African countries is growing and will drive strong growth in local consumer spending on both basic necessities and discretionary items.
Finally, as very few international investors are active in smaller markets like Botswana, Ghana and Zambia, we believe many stocks in these markets are undervalued. When frontier investors discover these markets, we expect significant share price increases.
Isn’t it risky?
Investing in Africa tends to be perceived as risky. Of course, we do not contend that it’s risk-free. However, we do want to put this notion into perspective. Research shows that over the last 12 years African equities were less volatile than equities in other emerging and frontier regions. This is explained by the fact that the various countries move quite independently from one another as local factors play an important role.
In addition, global cyclical downturns are felt to a lesser extent in some African countries because of their strong structural growth. Finally, as African stocks have a low correlation with stocks in the rest of the world, an investment in this continent offers diversification advantages in a portfolio context.
Ebola
Of course any article about Africa has to address Ebola. This big human tragedy has already affected the local economies of the three hardest hit countries: Guinea, Liberia and Sierra Leone. International flights to and from these countries have been canceled and domestic transport has also become very difficult. We do not hold stocks of any companies with significant exposure to the domestic economies of these countries. However, we do hold shares in some mining companies that are active there. Production could be disrupted as some foreign engineers will choose to stay out of these countries in the next few months. The share prices of these mining companies have been under pressure. They currently represent 0.5% of the portfolio.
In Nigeria, which takes up quite a big chunk of our portfolio, we were pleasantly surprised by the very effective way in which the Nigerian government tackled the issue. As per mid-October, Nigeria appears Ebola-free after eight patients died and twelve others fully recovered. Barring unforeseen developments, we expect the consequences for our portfolio to remain limited.
Opinion column by Cornelis Vlooswijk, Senior Portfolio Manager within the Robeco Emerging Markets Equities team.
This publication is intended to provide investors with general information on Robeco’s specific capabilities, but does not constitute a recommendation or an advice to buy or sell certain securities or investment products.
Foto: SP Duchamp. Un mundo en búsqueda de la recuperación
As the Federal Open Market Committee (FOMC) ends its fourth version of Quantitative Easing this month, whilst the European Central Bank (ECB) contemplates its first true version, Central Bankers are frustrated both by the lack of political restructuring to their national economies and also by the lack of economic growth, without which the huge Sovereign and private debts could not be afforded. Reinhart and Rogoff’s forecast that “using debt to solve a debt crisis” will simply result in slower economic growth than previously lives on. In the meantime, the World of Financial Repression is alive and kicking…unfortunately. Although the burden of debt is central to the recent financial crisis, there may be a confluence of events, globally, which is hampering a return to the old normal growth patterns of previous decades.
1. Demographics
Rapid aging can be experienced at first hand in many OECD (Organisation Economic Cooperation Development) countries, led by Japan and Italy with Germany and South Korea hot on their heels. In all these countries, we are seeing that as the number of hands to put to work diminishes, there are multiple challenges which inhibit economic growth. The fact is that the elderly spend significantly less on consumer and other goods whilst on the other hand they require increased healthcare treatment, services and assistance. Pensioners also tend to draw down on their savings which leads to a declining pool of investment capital. In addition, they have often become more risk averse in their latter years so that the pool of capital accessible to entrepreneurs and businesses also declines.
2. Youth education and youth unemployment
In the last few years, the USA has led the way with its youth assuming huge loans in pursuit of a college education which will lead to higher career earnings. However with over USD 1 trillion now lent and bad debt levels now rising to circa 20% of all loans, one must question if this “loan for education” is money well spent and indeed capable of generating a workforce with the changing skill-set which modern economies now require. Moreover, the UK is already heading in the same direction reflecting further misguided educational policy. This is of course juxtaposed with the travails in many European countries where between one third and one half of our youth under 25 is currently unemployed. Does it really matter, you may ask? Why is this so important for future growth? Well, with either heavily indebted youth or unemployed youth, we are circumventing our biorhythmic cycle of our youth moving into the workforce, forming relationships and families and moving onto the housing ownership ladder.
3. Falling productivity growth
Economic growth can be rationalised into the combinations of the availability of labour, the efficiency of labour and capital and, to a certain extent, a “frisson of leverage”, or debt. China’s urbanisation and industrialisation changed many sectors of the global economy including mining, manufacturing, steel and cement demand. Productivity (as I have noted already) is very important, but so too is the use, or productivity, of any debt which is incurred. At a global level this is because if this debt perpetuates or aggravates excess capacity, as in China, or excess welfare, as in Europe, or excess leverage, as in the global financial sector, then we are mis-allocating capital which will have to be written off eventually, at a cost to the growth prospects of the global economy. However, as this meteoric growth in China was being achieved, the global economy saw declining productivity, due to the impact of energy inputs rising consistently in price since the oil shocks of the 1970s and 1980s, together with the stalling in average wages for most blue and white collar workers. To the surprise of most economic commentators, the boom of IT and internet tools has not made that much difference to overall productivity levels.
4. Addicted to debt
The West has used more and more debt per unit of GDP since the mid 1970’s- a model which emerging markets are all copying today. We have currently solved the last Global Financial Crisis with yet more debt as Sovereigns have borrowed and borrowed to keep banks and their economies alive. This toxic combination of poor demographics, excess leverage and weak productivity suggests economic growth will remain anaemic in these financially repressive times. However, we are also seeing that it is not just Sovereigns and banks who are addicted to debt – but individual consumers too. With Zero Interest Rates, consumers are not being encouraged to save and invest and thus they are buying and borrowing to maintain and improve their lifestyles, bringing forward consumption from tomorrow, such that demand is likely to be lower in the future as we are shopped and borrowed out.
5. Global trade
Global trade has been slowing down despite many recent trade deals and hopes of greater World Trade Organisation initiatives. This is simply due to its scale and size inside the global economy. Since 1980, trade has grown from 14% of world GDP to 31.6% of world GDP. Interestingly, this means that trade has accounted for 50% of all the growth in activity in the last 25 years. Globalisation has indeed become a reality but the costs to many economies are now clear in terms of loss of manufacturing and some other office jobs such that off-shoring and on-shoring have become hotly debated political and social issues. With political and geopolitical tensions rising, trade is unlikely to carry the world higher from here and may indeed reverse for a while as trade sanctions in Russia and the EU are extended.
6. Energy
Over the last 40 years we have experienced two tremendous supply shocks to the price of oil, both emanating from the Middle East, which caused high levels of inflation and serious economic recessions in the West. Since 2000, the world has experienced more stable energy costs but this reflects a combination of strong and growing demand from Asia and the Middle East, where subsidies overstate demand and sharply rising costs of extracting oil and gas, as the “easy fields” have been developed and brought to market. Moreover, with productivity falling globally, energy is seeing nearly 35% of all capital expenditures, despite being less than 10% of economic activity, so that other sectors and industries are being squeezed out. Given the recent geo-political risks and rising Russian hostility plus possible American complacency over shale availabilities, a third oil shock remains a predictable “black swan”.
7. Structural reform and lack of political leadership
The Global Financial Crisis catalysed many of the apparent, if ignored, issues which had been brewing over the past decade; the proactive response from Central Bankers has held things together so far. However, around the world Central Bankers have been asking for, pleading for and even now begging for structural reforms from their national politicians which are a pre-condition for the economic “re-set” in many economies which urgently needs to occur. Whilst politicians have increased regulation on banks, for instance, there has been little recognition nor acceptance that policy also needs to change – hence Sovereign debt balloons, funded by Quantitative Easing Policies (QEP). With QEP now ending as the FOMC ends its latest program, the baton has been firmly handed to the politicians…
Conclusion
We continue to see a world enduring Financial Repression where growth remains fragile and dull. In this environment, it becomes essential for clients to “take on some risk in the search of some return”. With equities having been re-rated over the past few years with modest earnings upgrades, we do not expect a “rising tide of GDP growth” to bail-out the average corporate. Thus we conclude that clients need to become more selective in the future and look to companies offering superior growth opportunities through new products and geographies or through sustainably higher-yielding companies where mature and strong cash-flows provide an income well in excess of current Sovereign and credit yields.
If you’re worried about the recent spike in bond market volatility, we’ve got a bit of advice: Don’t be. There are plenty of other risks—chiefly credit quality and flatter yield curves—that are causing shakeups in some corners of the fixed-income world. Happily, there are things you can do about them.
There’s no denying the last few weeks have been volatile ones. But the recent price swings, amplified mainly by signs of weakening global growth, did not cause the two biggest dislocations in today’s bond market: sell-offs in the lowest-rated high-yield bonds and in short-maturity bonds in general.
Selling pressure in these areas has been building for months. As a result, many of these securities have underperformed higher-rated and longer-dated bonds. We think a closer look at the dynamics behind the selling can shed light on opportunities they have created and pitfalls investors should avoid.
Let’s start with the sell-off in short-maturity bonds. These securities are heavily exposed to the risk of rising interest rates, and as the third quarter wound down, it was beginning to look as if the US Federal Reserve could start hiking rates sooner than the market was anticipating. Investors tried to shield themselves by selling short-maturity bonds—investment-grade and high-yield corporates as well as US Treasuries.
This selling spree pushed up yields at the front end of most curves and shorter-dated bonds widely underperformed. We think the sellers may have jumped the gun. While the US economy has gained momentum, recent data from the euro area, China and elsewhere suggests the global economy may be slowing down. Consequently, the market is starting to think the Fed may play it safe and keep rates low for longer.
If so, this may prove a good opportunity to buy shorter-dated bonds at reduced prices. Through September, spreads on US high-yield bonds with maturities of one to five years have widened almost twice as much as those on bonds in the five-to-seven-year range. That could mean more potential upside for the short-maturity securities if interest rates don’t rise quickly
By the way, shorter-maturity paper tends to hold up better over a longer time period. Fund managers often refer to it as “cushion paper.” This is why we think the recent sell-off creates some nice buying opportunities for investors looking for short-duration securities with attractive yields.
The other notable disturbance in fixed income has been concentrated in the lowest-rated high-yield bonds. In this case, we view the sell-off as more warning siren than opportunity. Remember, CCC-rated bonds are issued by fragile companies with high leverage and weak balance sheets. It doesn’t take much for such companies to fail, and they often do so before the broader high-yield market starts to see rising default rates.
For most of the past year, investors have overlooked these risks and focused on the higher yields CCC-rated bonds offer. As a result, high demand has pushed yields down to the point where investors, in our view, are no longer being compensated for the risk they’re taking.
But the tide may be turning, with credit hedge funds leading the selling. The resulting rise in yields may tempt some investors to wade back in. But we think stretching for yield at this point in the cycle is risky. Doing so requires extensive credit research, and in most cases, we doubt the returns over the next 12 months will justify the risk.
To sum things up: We don’t think bond investors should fret about overall market volatility. But we do think they should pay attention to the bonds getting beat up the most. Understanding the cause of the selling can make it easier to view the bond market’s opportunities and dangers clearly.
Article by Ashish Shah, Head of GlobalCredit and Chief Diversity Officer, AllianceBernstein
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Earlier this fall, I attended the International Manufacturing Technology Show in Chicago, where companies from around the world came to showcase new products that utilize the latest in cutting edge manufacturing technologies, such as machine tools, robotics and various automation components. The biannual tradeshow is the largest of its kind in the world, a virtual theme park for manufacturing geeks. Despite the oft-mentioned talk of offshoring, manufacturing in America continues to grow at a healthy pace, driven by autos, aerospace and energy-related fields. Thanks to the expansion of these relatively higher value-added industries, productivity of manufacturing in the U.S. has seen impressive improvement in recent years. Capital spending has also been robust as companies seek to capitalize on business opportunities. However, such manufacturers are also keen to adopt more automation and robotics to help keep fixed costs in check.
“Collaborative robots” were among the new products I saw at this September’s show. The majority of today’s industrial robots are not made to work alongside humans as they are simply too powerful and not equipped with safety systems. On a production line, robots are typically housed inside metal cages to keep their human operators safe. This isn’t much of an issue if you have a large enough factory but as manufacturers seek to replace human processes with robots, they often find that the existing factory floor space is insufficient to make these metal cages. That’s where these collaborative robots come into play. These robots are equipped with sensors and other safety systems allowing them to operate in tight spaces alongside employees. They are also covered in a soft foam material and color coded to differentiate them from other non-collaborative robots. It will be interesting to see how this new type of robot is accepted in the market over the next few years.
Something else that caught my eye during the show was a project to build a car with a 3D printer. These 3D printing products, also known as additive manufacturing, had me feeling quite skeptical. Individual components were showcased as they were completed but ultimately, I wasn’t impressed. The parts looked like a lump of unfinished rubbery string, not aesthetically pleasing. I had been envisioning a ready-to-go product coming off the printer but the technology does not seem to be there yet. Don’t get me wrong. I think 3D printing is an exciting technology, but there are clearly areas where 3D printing will make sense and others where it won’t at all. Products like medical implants seem to be a good application, given the ability to customize the dimensions easily. However, slow production cycles and stringent quality requirements may limit adoption of 3D printing in areas like autos and aerospace. We will keep our eyes open for any technology breakthroughs that can speed up the adoption of such printing for manufacturing purposes.
Attending these tradeshows rarely leads to immediate investment decisions. However, they do help us better understand the industry and factors that may affect a sector’s future growth. And hey, where else can I play blackjack with a two-armed robot dealer.
Opinion column by Kenichi Amaki, portfolio manager at Matthews Asia.
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.
The 29 October statement from the Federal Open Market Committee (FOMC) doesn’t lend credence to the idea that the first rate increase is off the table for June 2015. Yields have dropped recently on broad-based disinflation, geopolitical concerns and fears of a slowdown in global growth. Yet these lower yields simply don’t reflect the US Federal Reserve’s current forecasts.
If you believe, as I do, that Fed policymakers will start to raise rates as early as next June, then they probably won’t begin to fully signal their intentions until the FOMC meets again in December. In the absence of a major deterioration in macro or financial conditions, the October statement primes the market for further “hawkish” guidance at the next meeting.
My view is that the Fed needs to start raising rates sooner rather than later. We’ve had negative real rates for a very long time, and that has almost certainly led to a misallocation of resources. Labor slack is being taken up; capacity utilization is rapidly normalizing. I think the Fed needs to slowly but assuredly take away the punch bowl, even though the party may just be getting started.
In the near term, as we assign a higher probability to the Fed’s first hike in mid-2015, rates will likely move modestly higher from here — especially at the front end of the yield curve. And as this environment of diverging central bank actions looks to be a multiyear trend, I believe the US dollar should continue to strengthen.
Opinion article by Erik Weisman, Ph.D., Fixed Income Portfolio Manager at MFS.
Foto: Verizon Wireless Arena front by ToddC4176. La transformación del sector de las telecomunicaciones y los medios: ¿riesgo u oportunidad?
The telecoms and media market is in a state of flux with convergence and consolidation reshaping the industry. Convergence comes as internet and voice traffic use the same channels, and the need to seamlessly transfer this data across networks in the most efficient way. Many wireless operators are discovering fibre in the ground is needed for this, while fibre operators are discovering the need for content to drive take up of data packages.
Consolidation comes from the need to reverse European Union (EU) policy that has created a fragmented European telecoms market. This landscape has left individual players with insufficient scale to invest in the new high speed data networks required for the latest generation of smartphones and their users. In media, the need for scale in international distribution has also driven a natural need for further geographical diversification.
The synergies generated in consolidation deals so far this year are typically positive for both shareholders and bondholders. Examples include Comcast’s $45bn purchase of Time Warner Cable, Liberty Global’s $14bn purchase of Ziggo and AT&T’s $67.1bn takeover of DirecTV.
Sometimes, anaggressively structured deal can offer bondholders mixed fortunes. Early in 2013, the bonds of Virgin Media fell sharply after Liberty Global announced it was purchasing the UK cable company. In this instance, holders of Virgin Media debt were adversely impacted as the combined entity had substantially higher leverage and the bonds were downgraded from investment grade to high yield status.
Conversely, new debt funding for merger and acquisition (M&A) activity has offered attractive entry points for strong credits with a clear deleveraging profile. Verizon’s record $49bn bond issuance in Q3 2013, to fund the $130bn purchase of Vodafone’s 45% stake in Verizon Wireless, is such an example.
Recent M&A activity has generally been driven by corporates, with most deals to date having clear economic logic that drives achievable synergies. Funding usually comes from a mix of high cash balances and cheap debt, often with an element of equity issuance to maintain a reasonable capital structure for the new entity.
In contrast to recent history, private equity are the clear M&A outsiders so far in this cycle. They have been unable to transact despite the low cost of credit to fund deals, given the high valuations of the firms under consideration and the struggle to achieve the same mutual benefits that the newly combined entities see in terms of lowering margins. That said, many private equity funds are cash rich and looking to deploy funds. Could a bout of aggressive behaviour from these funds stoke the M&A fire?
As a result of this shifting backdrop in the sector it is important to be mindful that not all consolidation is beneficial. Adequate fundamental research is required into the companies’ expected structures following the merger. However, opportunities do exist, and we are monitoring them with interest.
Article by Stephen Thariyan, Global Head of Credit, Henderson Global Investors
These are fund manager views at the time of writing and may differ from those of other Henderson fund managers. The information should not be construed as investment advice. Before entering into an investment agreement please consult a professional investment adviser
Foto: Bolsa de Shanghái, por Heurik en de.wikipedia. Hong Kong y Shanghai: Oportunidades a la vista
The mutual market access program that is due to launch in October between the Hong Kong and Shanghai stock exchanges is another step towards capital market liberalization. It will allow much easier access for foreign investors to the onshore Chinese Shanghai A-shares market as well as reciprocal investment by mainland Chinese investors in the Hong Kong market.
With the program due to kick off this month, foreign investors are busy doing their homework on Shanghai A-shares and trying to figure out what stocks mainland investors will choose to buy in the Hong Kong stock market.
Many overseas investors will be looking to buy dual-listed shares that are cheaper in the A-share market than in Hong Kong. However, we feel this arbitrage focus misses the more interesting development for foreign investors, which is to buy unique exposures, such as thermal coal railway owner Daqin Railway, traditional Chinese medicine producers, such as Tasly Pharmaceutical, and large capitalisation stocks that are unfashionable with local mainland investors and, therefore, very cheap, such as SAIC Motor, a joint venture partner with VW and GM.
Back in the Hong Kong market, while it is possible that mainlanders will buy well-known companies that were previously unavailable to them — like Tencent, which runs the ubiquitous QQ and Weixin internet and smartphone communication platforms (and is the largest holding of the Henderson China Opportunities Fund) — we think a more likely outcome is a dramatic increase in the volatility of small-cap stocks in Hong Kong. The Shanghai market is dominated by retail investors and they prefer to be active traders of smaller capitalization companies. If they transfer this characteristic to Hong Kong, then already volatile small-caps may well experience even more dramatic swings in performance and valuation as the stocks fall in and out of fashion with mainland investors.
The Henderson China Opportunities Fund’s portfolio has benefited from holding stocks that we believe will be positively impacted by the program. For example, Hong Kong Exchanges & Clearing’s share price rose dramatically on the news and we have since sold the shares, taking advantage of the price movement. CITIC Securities, still held in the portfolio, is another beneficiary. The company is a leading broker in China and last year acquired CLSA, a leading Hong Kong brokerage firm. It is thus well-positioned for flows in both directions.
Opinion column by Charlie Awdry, Portfolio Manager of the China Opportunities strategy, at Henderson Global Investors
