David Wise wins gold in halfpipe in Sochi. Photo: Sochi 2014. Carrying the Torch for Retirement Security
I love everything about the Olympics, in particular what it showcases – sportsmanship, patriotism, and uncompromising dedication.
I can’t help being inspired by the countless examples of focus, endurance and strength. To me, the Olympics stretch the boundaries of what is possible. There is real human emotion, with the margin of victory often measured in hundredths of a second. Many of the athletes prepare for the better part of their lifetime for events that last just minutes, or less.
In stark contrast to the preparation of these Olympians, most workers dedicate little if any time to planning for retirement – an event that could last 20, 30 even 40 years. According to the Employee Benefits Research Institute, less than 2 percent of U.S. workers identify retirement planning as their most pressing financial issue, and 43 percent of workers reported that neither they nor their spouse are currently saving for retirement.[1]
I’m not saying that building a secure retirement is easy. It too requires discipline. Some of that discipline must come from within, as individuals shift some of their passion for spending to a passion for saving. Fortunately, some of that discipline can be automated, through participation in an employer-sponsored retirement plan such as a 401(k) account, with savings made automatically though payroll deduction.
In many ways, the keys to a secure retirement parallel the keys to success for Olympic athletes. Like athletes, savers must set goals, develop a game plan, make a long-term commitment and take action.
One of the winter Olympic sports I find most fascinating is the ski jump, because of the courage, control and composure it must take to ski down a hill at speeds in excess of 50 miles per hour, not to mention the part about flying through the air the length of a football field, then landing.
2014 marks the first time women will compete in this event. Just before year end, Jessica Jerome, age 26, became the first to win the U.S. Olympic Trials in women’s ski jumping. She didn’t decide at age 25 she wanted to be an Olympic ski jumper, this is something she’s been doing since she was 7 years old. And I guarantee her first jump was not off a 70 meter hill.
Her Olympic berth is nearly 20 years in the making. Secure retirements can take twice that long, but don’t demand anything near the intensity of effort. In building a retirement nest egg, starting early is key, but slow and steady wins the race. Saving just $5 per day, 365 days a year, for 40 years, translates into more than $500,000 in savings; at $10 per day you enter retirement a millionaire[2].
Perhaps what I love the best about the Olympics is that for most athletes, the journey started as a far-off and seemingly unattainable dream. There’s an opportunity for workers around the world to take inspiration from this, spending just a little more time defining what their medal-winning retirement would look like, and putting a plan into action to turn those dreams into reality.
[1] 2013 Retirement Confidence Survey, Employee Benefits Research Institute, March 2013.
Wikimedia CommonsPhoto: CEAC_Uchile, Flickr, Creative Commons.. Pension-Fund Governance, Proxy Adviser Debate, and More
From the reemergence of pension-fund governance in Australia and the Canadian government’s launch of a public consultation on the Canada Business Corporations Act to a new reporting framework from the International Integrated Reporting Council and continuing proxy adviser debate in the U.S., it’s time to span the corporate governance globe to review important developments from the month of December.
Australia
The new Australian coalition government has announced plans to revisit pension-fund governance through a recently posted discussion paper. The consultation will revisit extensive reforms of Australia’s 2009–10 Superannuation System (or Cooper Review) that resulted in changes to superannuation obligating directors of trustee companies to properly manage a fund and ensure the trustee acts in the best interest of beneficiaries. Chief among the issues being revisited is the structure of pension-fund boards. Currently about half of pension-fund board members are employee representatives; the other half being employer representatives. The proposed reforms would allow for a more independent board structure. The closing date for comments is 12 February 2014.
Issues that have been identified for review as part of the consultation process include:
greater transparency of the ownership of corporations to help ensure that they are not used for tax evasion, money laundering, or terrorist financing
the adequacy of corporate governance legislation in preventing bribery and corruption
the diversity of corporate board members and management teams
rules for takeover bids
the use of the CBCA’s arrangement provisions to restructure insolvent businesses
the role of corporate social responsibility
Comments are due by 11 March 2014.
United Kingdom
The Collective Engagement Working Group, a group of asset managers and owners, recently announced the launch of an investor forum to facilitate collective engagement in U.K. companies. The group is scheduled to become operational in June 2014 and is intended to facilitate collaboration among a wider range of investors both from the U.K. and internationally. The idea for the forum grew out of the Kay Review, and the main objective of the forum is to build trust among institutional investors and promote a culture of long-term strategic vision and wealth creation over time. The forum will operate engagement action groups to address and resolve issues of concern where existing engagement has failed.
United States
It seems that proxy advisers were in the sights of regulators and issuers an awful lot in 2013.
Issuers have long complained about conflicts of interest that may arise when a proxy adviser provides services to both investors and corporate issuers on the same governance issues. Regulators and proxy advisers in a number of jurisdictions are looking into the issue, with increased transparency being the most likely short-term outcome.
In Canada, a review of proxy advisers by Canadian Securities administrators is likely to result in a voluntary set of best practices.
In Europe, that scenario has already played out following the European Securities and Markets Authority (ESMA) consultation regarding the proxy advisory industry in Europe. An industry group of international proxy advisers has been tasked with developing a set of Best Practice Principles for Governance Research Providers. The principles are designed to govern how signatories to the principles interact with other market participants on a comply-or-explain basis. You can also read the CFA Institute comment letter on the principles.
In the U.S., all sides in the proxy advisor debate were on display at an SEC-sponsored meeting on 5 December. You may not have the time to watch all four hours of the discussion, but the meeting is a good primer on where things stand in the proxy advisory issue in the U.S. Whether the result of all this talk is regulation (doubtful) or a universal adoption of a global code of best practice, like the code coming out of Europe (more likely), expect scrutiny of the industry in the year to come. If such increased attention results in more transparency and accountability of the proxy advisory industry, that’s not such a bad thing.
International
A three-month consultation ended in December with the release of a new reporting framework from the International Integrated Reporting Council. The newest version of the framework provides more information on governance than previous iterations. According to the current framework, “An integrated report should answer the question: How does the organization’s governance structure support its ability to create value in the short, medium, and long term?” See our recent interview with Paul Druckman, CEO of the International Integrated Reporting Council, on what integrated reporting means for investors.
Photo: Toby Oxborrow from Kowloon, Hong Kong. Watching One Tea Leaf: The Relative Price of Credit
The price of riskier corporate bonds such as high-yield and emerging market debt is measured in terms of extra yield. This is the price of credit, which is measured relative to the highest-quality bond issuers, like the US government. Credit-sensitive bonds are backed by companies with uncertain financial strength and accordingly have lower credit ratings. Because these bonds represent a category of risk higher than other markets, they often signal distress or economic deterioration before other markets decline. These markets can be good “tea leaf” indicators about the path ahead. Also, when these markets show strength (less excess yield), they often signal better times for stocks and other assets.
Credit markets can be good indicators of the broader market’s path ahead
But right now the biggest economy in the world is showing signs of stress. The economic numbers from the United States have noticeably weakened. This is a bit surprising because in late 2013, in November and December to be exact, US economic data were showing increasing speed and strength. Factories were humming, exports were rising and housing starts were improving. Now, two months into 2014, it almost seems as though the US economy has hit the brakes.
The reasons for this slowdown are hard to pinpoint. An easy explanation is weather. US weather patterns have been disruptive, marked by storms and way-below-average temperatures. This could explain fewer trips to the mall by consumers and fewer homes being started on frozen home sites. But the data are also slow in California, not just Wisconsin, and the weather in California has been fine. Further, factory orders and exports —factors of production not usually associated with weather fluctuations — have fallen.
The US is currently experiencing a mini-cycle slowing point within the longer economic cycle
So something else must be going on. My explanation is that in this, and in other cycles we have seen, there exist “cycles within cycles,” patterns of spending and growth that ebb and flow within the broader economic cycle. We saw this in a pronounced way in 2012 and again, on a smaller scale, in 2013. These cycles seem to occur naturally and are driven by consumer trends, news worries, inventory “overhangs” and other reasons, including weather.
What the investor needs to assess is the risk of recession. Recessions bring the biggest avalanches in stock prices, create government bond spikes, disrupt government spending and also trigger huge increases in company defaults. Recessions are not connected to weather or mini-cycles. Recessions have distinct causes. We know that they don’t occur because people feel like staying home or companies just feel like pulling back; they happen because of the appearance of real constraints on spending. The main culprits in recessions are interest rate increases on a scale that chokes off spending. The second cause of recessions is a notable deterioration in profits, companies making less and less money on sales. Profit erosion means less money to spend and sparks a loss of confidence. Usually these two causes are conflated: Higher interest rates often hurt spending but also cut into corporate profit statements by raising financing costs. Both usually occur simultaneously.
The clouds of recession are absent, and credit spreads reflect this lower stress over risk
Neither of these two negative conditions is happening now. Profits in privately held and publicly held companies are rising. Also, the Fed keeps telling everyone who will listen that short-term rates won’t rise for at least a year. In addition, consumers and most corporations have not taken on a lot of debt in this cycle, and both camps have better cash flow to pay principal and interest than they did in the last two business cycles. There is no credit cycle underscoring this business cycle, pushing growth above the speed limit.
My conclusion — no recession in 2014, because the clouds of recession are not present.
Now, back to the credit spreads of riskier company bonds. What is this measure telling us? Interestingly, this indicator of trouble is going in reverse: Spreads above the AAA bond yield are shrinking, not rising. Complacency, even confidence, exists in the hyper-vigilant world of corporate bonds. The stress of recession would show up there first, in the extra yields that companies pay to finance riskier corporate strategies. Instead, the cost of debt for companies now is falling. Further, when credit spreads reduce or tighten, history suggests that the stock market moves up, not down. High-yield bonds have been a rather good indicator of both future weakness and future strength. The economic news is troubling, but the credit markets suggest that investors can relax.
By James Swanson, CFA; MFS Chief Investment Strategist
CC-BY-SA-2.0, FlickrFoto: Jennicatpink. No todos los mercados emergentes son iguales: Palomas, halcones y búhos
It’s tough to keep your head at times when the financial markets are behaving like they are. It may be especially tough when you are the governor of the central bank of a country with a 4% current account deficit and 6% inflation. In emerging markets especially, this is exactly the kind of mix that speculators are targeting right now. And yet, amidst all the swings in sentiment and the “risk-on, risk-off” trading, Reserve Bank of India Governor Raghuram Rajan expressed concern over following “the flock,” saying: “We are neither hawks nor doves. We are actually owls.”
The most recent events to roil markets have been those in Turkey. With pressure on countries that rely on external funding, it was surely not going to be too long before Turkey attracted the attention of traders. After all, it runs a current account deficit of over 7% of GDP and its inflation rate is also above 7%. Its policymakers decided to try to head off currency speculation by dramatically hiking interest rates from 5% to 10% in an effort to make shorting the lira uncomfortably expensive. But such high interest rates do put a strain on the domestic economy. How long can they conceivably keep rates so high before they sacrifice domestic growth for the sake of protecting the currency?
Feathers have been flying in Latin America, too, where most major nations are in external deficit. Argentina—whose international credibility has never really recovered from the debt default at the end of 2001—is being treated as the canary in the coal mine for the whole of the emerging market universe, including Asia. One need not be a scavenger these days to find opportunities to short emerging markets. Traders have been casting around for other targets like Turkey and Argentina.
However, emerging markets are not a homogenous block, either culturally or economically, as many countries in Asia have proven by their ability to close the gap in living standards with the West over the past 30 years. Asian economies continue to enjoy high savings rates and robust productivity growth. Most of Asia remains unruffled as the region runs healthy current account surpluses. Only Australia, Thailand, Indonesia and the Indian subcontinent run external deficits and perhaps only the latter two are really prey to currency speculators. And even here, India has already been restraining credit growth for some time in an attempt to squeeze any short-term excesses out of the economy. In Indonesia, despite short-term migration of capital, the government has been taking steps to remove supply-side obstacles to more efficient growth; China too remains an interesting potential source of long-term foreign direct investment to keep the economy investing in new capacity.
Not that currency speculators are going to pay much attention to Governor Rajan—they love to “take on” central banks. However, whilst their options in other parts of the emerging market universe may keep the speculators circling, opportunities in Asia are less widespread. After all, in Asia, current account surpluses abound: Japan (1.0% of GDP), China/Hong Kong (2.0%), Philippines (4.2%), Malaysia (4.5%), Vietnam (5.5%), South Korea (6%), Taiwan (11.5%) and Singapore (17.5%). Private U.S. dollar debt is manageable as a percentage of GDP and, unlike Latin America, bond issuers have increasingly relied on domestic lenders rather than the international markets. Outside of the Indian subcontinent, inflation rates remain manageable too—averaging about 2% in North Asia and a little above 3% in Southeast Asia, excluding Indonesia. In addition, Asia’s largest economy, China, is also in a relatively strong position. Its nearly US$4 trillion foreign exchange reserves and closed capital account make an externally forced currency crisis extremely unlikely.
So, the current market sentiment is something of an albatross around Asian economic and market performance. Whilst it is never safe to assume the currency speculators have “gone away,” the region’s economies have put in enough hard work over the previous decades, it seems, to earn some goodwill. Not all emerging markets are created equal. We don’t want to count any chickens, but the fact that Indonesia (+4.6%) has outperformed the U.S. (-1.6%) thus far this year* does suggest that a bit of owlishness is creeping back into the markets.
*Year-to-date performance in local currency terms, as of February 11, 2014.
Opinion Column by Robert Horrocks, PhD, Chief Investment Officer – 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.
Wikimedia CommonsPhoto: WorldIsland, Flickr, Creative Commons.. Creating Real Value: Strategy and Entrepreneurship
For decades, businesses have been involved in creating value; and many think of value as maximizing profits and minimizing costs. There are all sorts of models and matrices to help organizations create this sort of value. But, there is a limit to which a business can maximize profit and minimize cost, and that leads to the question: what do we do next?
Focusing just on profits and costs is unsustainable value creation, purely because of its limitations. It’s not enough to create long-term value. Let’s take pharmaceutical companies as an example. These companies spend months in closed rooms working on probabilities that mostly come down to, based on estimates of future sales, which projects to continue, which to shelve, and so on. These discussions are usually also surrounded by the notion of building a patent that creates maximum value in terms of profit.
What’s missing?
In all the talk about profits and costs, only rarely does the idea surface that the foundation of any pharmaceutical company and its products is curing people. If pharmaceutical companies urged their managers to closet themselves and talk about which kinds of new drugs could cure a dangerous disease, the whole idea of value creation would change. Developing a new, effective medicine for a pressing health problem would lead to new vistas for the company as demand for that innovative drug would obviously be very high — which in turn would lead to higher profits.
Too many managers have a myopic and self-centred view of value, and this is where the problem of sustainability arises. Creating only shareholder value is not sustainable. Shareholder value is not real value; it’s only a part of real value.
Real value is about going beyond trade-offs, it’s about creating shared value. Shared value is comprised of a set of different values bundled together, and inarguably shareholder value is one of them. Shared value, in my opinion, has four arms.
Employee value
Most of us know this as human resources. Instead, I like to call it human assets because I think employees are not resources; they are assets. Some company leaders care about this arm because they understand its importance; others do not because they either do not understand its value or discount it so heavily that the human factor in their business becomes marginal (at least, in their minds). In yet other cases, there is an inattentional blindness; but human assets are central to any business model within any industry or sector, anywhere. While technology has changed a lot of things, there is still a tremendous need for human assets.
Achieving employee value requires that companies create value for their employees in material terms — competitive salaries, bonuses, perks and the like. While material value is a key value in this sense, it is important to bear in mind the gaps between these salaries and bonuses. In other words, the structure for compensation should not have a large variation in an organisation. And, beyond material compensation, employee value also includes intangible factors: the corporate culture as well as such things as work/ life balance, promotion, recognition, career development and so on.
And, when it comes to establishing employee value, I would urge you to add one more important ingredient: reason. How many companies do we know today that give reasons to their people about why they are doing what they are doing? Companies must tell their employees why they are in the business they are in and what sort of value that creates for the other three arms of shared value. Shared value must be established, but it must also be explained to everyone. Very often, when I go into companies, I ask random people what they are doing. When their answers are entirely numbers-based, I know immediately that the growth of the company has a built-in limitation.
Consumer value
This arm is concerned with creating value for consumers through the products and services they buy. From a management viewpoint, there is more to it than just manufacturing products and offering services. Look around: there are millions of products and services available that create no real tangible value whatsoever, and yet they exist.
Let’s take an example of a fresh juice-producing company. The real value that company offers to the consumer lies in producing a beverage that isn’t full of unnatural stuff, that contains all the healthful ingredients so marked on the box, that doesn’t make the consumer fall ill and is reasonably priced. If, in this case, the juice product does not have one of those qualities, it doesn’t create real consumer value. Thus, while companies may sell products that help others increase their material wealth (say, computers that enable people to write business plans or novels), any product or service that has a positive impact on the lives of those paying for it should be considered as demonstrating that the company is committed to consumer value.
Shareholder value
While I have said that maximising profits and minimising cost is not all that is required to sustain and grow a company, it is a part of the story that cannot be left out. No matter how you want to define shareholder value, it entirely links to the material side of an organisation and is largely dependent on a good set of top-line and bottom-line numbers. Such numerical performance, being highly dependent on market and economic conditions, naturally becomes highly uncertain and less sustainable.
Consider, for example, the recent ups and downs of Amazon.com. When the company reported its numbers early in 2012, its profits missed expectations, causing the stock — despite enormous sales numbers — to drop 10 per cent or more. Profits and costs, surely, are topics of daily discussion at Amazon, which realises that it must improve those numbers if it is to prevail in its desire to be considered a company that delivers reliable shareholder value. There is a huge body of literature and research available on this particular arm of value. Every business school teaches this, and quite well; yet, as noted, there is so much more that must be taken into account for a company to thrive year after year. Which leads us to the arm that deals with contributing to society.
Social value
Though many talk about this value and discuss it at the highest levels of the company, the real implementation of this arm is still absent from the majority of companies. Why? Because businesses are supposed to create shareholder value, and social value is too often deemed an unnecessary cost, top managers pay the concept lip service while keeping the corporate wallet tightly shut.
Let me emphasise: thinking about social value as a cost is a mistake. It is, rather, a critical arm of shared value as it includes, among other things, whether a company is living up to its Corporate Social Responsibility (CSR). This is an enormous field of study, but Wikipedia’s definition that ties CSR to the adherence to a ‘corporate conscience’ and to the demonstration of ‘corporate citizenship’ carries, to my mind, a great deal of what it means to provide social value.
Yet, social value goes beyond CSR. It is also about creating value for society through good products and services; being ethical; creating jobs and opportunities; making lives better; cooperating, sharing, and uplifting society — and caring about all the elements of society that are required to sustain any business. For example, those still easy-to-find news stories about companies dumping toxic wastes into rivers are sad not only because of the inherent dangers involved when a company wrecks the environment in which its customers must live. It’s also sad because it reveals a corporate leadership so nearsighted (in terms of social value) that it seems all too willing to undercut the likelihood that it will be able to be profitable in the years ahead. A company with low social value has, in every case I can think of, low strategic value as well.
Think of shared value and its four parts as a diagram. The organisation is in the centre, with employee value to the north, consumer value to the east, social value to the south and shareholder value to the west. All the values are interconnected and share value among each other as well.
The enemy is…
The current global economic climate is evidence that there has been too much focus on one single arm of value, shareholder value; and this has led us into the dark economic times that we face today. Over the recent decades, too many of us in the business world have become self-centred and materialistic.
We, as individuals, should shoulder the bulk of any blame for the current state of the economic world because we run those organisations that do not create real value. We have created many high value creators but few shared value creators. If we build our tomorrow on all four arms of value, we will move away from dark economic times and build a sustainable world. It may sound naïve, but creating shared value is the best way to ensure shareholder value while also prudently managing the other elements of the business value chain that have an impact on the profitability and sustainability of your organisation.
Photo: Surajhaveri. Brazil: Coping With The Challenges of Wealth Transfer
Complex planning challenges require sophisticated wealth transfer strategies.
Despite a recent economic slowdown, Brazil remains firmly entrenched as an economic superpower thanks in large part to its vast natural resource wealth. The country’s enviable growth during the last decade led to the creation of great fortunes as entrepreneurs seized on the China-led global commodity boom to mint, according to Credit Suisse, nearly 230,000 millionaires. With a GDP of $2.2 trillion, Brazil’s economy is larger than India’s and is nearly twice the size of Mexico. Brazil is positioned to remain a critical market for wealth managers and other service providers focusing on the high net worth segment.
According to Wealth-X, Brazil is home to more than 4,000 ultra-high net worth individuals, holding $770 billion of wealth – the highest in Latin America. Unlike many other markets, especially those of developed economies, Brazil’s high net worth population has some unique characteristics that create interesting dynamics, challenges and opportunities. According to Forbes, only 6% of Brazil’s ultra-high net worth individuals have inherited their wealth, which indicates the overwhelming majority amassed their own fortunes or have shrewdly invested their nominal inheritances.
Being a continent-sized country, Brazil’s high net worth population has distinct regional differences that demand customized approaches. On the one hand, a significant amount of Brazil’s millionaires remain concentrated in the country’s two main cities – São Paulo and Rio de Janeiro. High net worth individuals in these cosmopolitan urban centers often operate globally-connected conglomerates that require highly-sophisticated financial and legal strategies to manage both domestic and international operations.
However, because the country’s natural resource driven wealth creation has largely occurred in the more rural areas, the industrious entrepreneurs emerging from these parts tend to be more nationalistic in their business, travel and outlook. These individuals typically operate businesses only in Brazil, and by and large maintain a strictly local business structure. In fact, many of these individuals fuel Brazil’s luxury market, as they are less inclined to travel overseas to make purchases and prefer to shop within Brazil’s notoriously high-priced borders, making the country a top performer for fashion powerhouses like Gucci and Louis Vuitton.
Regardless of where in the country they reside, wealthy Brazil residents are exposed to the legal and regulatory limitations of a country that only three decades ago was emerging from a military dictatorship. Brazil has generally not had the time to create sophisticated frameworks capable of properly addressing the complexities involved in managing and transferring large fortunes. Having succeeded in building their wealth, many of these individuals now face their greatest challenge – preserving that wealth, and ensuring its smooth and efficient transfer to the next generation.
The challenges of wealth transfer in Brazil
While the proper transfer of significant wealth in Brazil certainly requires the execution of well prepared legal documents, this also requires a patriarch or matriarch develop a clear vision for their financial legacy, which entails the careful management of emotions, personalities and complex family dynamics.
As most wealthy Brazilians attribute the majority of their wealth to the value of a closely held business, business-related planning challenges abound. Wealthy Brazilians have to determine if and how their business will suffer upon their death, perhaps because they hold key customer, vendor or governmental relationships. They also must determine how business equity should be transferred to heirs, especially in cases where some heirs are actively involved in management and others are not. Further, they must determine if their heirs have the necessary skills and desire to partner with existing shareholders, and whether doing so would add new challenges to the business. Finally, business owners need to evaluate whether the value of their business relative to their overall portfolio creates a significant diversification risk.
Further, as the miracle of wealth creation dictates many members of the next generation will not have the same level of success as their ascendants, patriarchs and matriarchs should consider how to preserve their wealth over time. This means they need to determine if wealth should earmarked not just for their spouse and children, but also their grandchildren and great-grandchildren. Decisions need to be made about whether wealth should be transferred to both bloodline and non-bloodline family members, and if estate funds should be used to repay outstanding debt obligations, meet philanthropic giving desires and/or fund education or retirement plans for their heirs. It also requires the patriarch or matriarch assess the various currency, sovereign and liquidity risks associated with their asset profile.
These are not often easy issues to tackle when the discussion of wealth transfer commonly surrounds the uncomfortable subject of death and the accompanying concerns about privacy and confidentiality. According to Barclays Wealth Insights, 34% of global high net worth individuals do not trust their children to protect their inheritance, 20% believe assets should be allocated differently between children and 40% have experienced wealth as a source of conflict within the family.
These challenges create an unprecedented need for high net worth Brazil residents to plan for their wealth transfer. Solutions that create liquidity, provide flexibility and offer peace of mind should be sought.
Fostering a planning culture
As Brazil’s current wealth is a recent phenomenon, the process of recognizing and addressing these challenges have not been practiced by multiple generations and a culture of planning has only recently begun to develop.
Wealth management advisors to high net worth Brazil residents typically focus on helping clients grow their assets. However, aiding them to preserve, structure and transfer their wealth is important to providing complete wealth management services.
Advisors who fail to address these issues not only impact their clients, but also jeopardize their own businesses in the long term. The Institute for Preparing Heirs suggests 90% of inheritors will change advisors upon receiving their inheritance, generally because the heirs have limited relationships with their parent’s advisors and have not been engaged in the wealth transfer planning process.
Alternatively, properly initiated and managed wealth transfer discussions help advisors solidify relationships with heirs and build new relationships with business partners and extended family members, while aiding them in identifying new assets and complementary business opportunities.
Life insurance as a solution
While Brazil residents have a variety of solutions available to aid them in meeting their wealth transfer needs, there is one highly attractive solution that can inject liquidity to an estate when needed most: life insurance.
Life insurance is often an ideal planning solution due to its ability to offer a death benefit that is a multiple of the premium, cash value in the event an early surrender is required, flexible premium schedules, attractive policy provisions and guarantees from highly rated entities.
As the domestic Brazil life insurance market is not highly developed and offers coverage amounts that are often insufficient to meet the needs of the growing high net worth population, more sophisticated strategies need to be considered in order to bridge the liquidity gap faced by affluent Brazilian families.
The taxation of life insurance in Brazil
Due to the social and economic benefits of life insurance, the tax laws of many countries have evolved to exempt life insurance death benefits proceeds from income taxation.
Eduardo Avila de Castro, partner of Machado, Meyer, Sendacz e Opice Advogados in São Paulo says, “Brazil tax law generally exempts death benefits proceeds of life insurance from income tax. Any life insurance based planning solutions should be evaluated and implemented with careful consideration for the relevant laws and planning objectives. Due to the changing international tax landscape, I suspect an increasingly growing number of advisors will consider the use of life insurance based solutions to meet the changing needs of their clients.”
The result
The widespread planning and liquidity needs of Brazil residents, combined with the attractiveness of available life insurance offerings, creates the most attractive opportunity in Latin America to serve high net worth clients. Practitioners who become educated on how to address and solve these complex needs, will surely reap the brand, monetary and associated benefits of highly satisfied clients.
By Diego Polenghi, Managing Director,International Planning Group
Photo: Toby Hudson. Sunshine Daydream? Wake Up – Now is The Time for Solar Energy in Latin America
Often, the most promising opportunities are those that become visible when the sun shines on a dark space. One such dark space is the wealth of untapped energy sources throughout Latin America; and of those energy alternatives, perhaps none looms as promising as the sunlight itself.
The rate of adoption for solar energy throughout Latin America is shockingly low when compared to the rest of the world. With up to 100 gigawatts of solar energy expected to be deployed globally each year, less than 500 megawatts — or about one half of one percent — is expected in Latin America.
While other regions have already deployed considerable resources in solar as part of larger sustainable energy programs, solar photovoltaic technology is largely non-existent in Latin America. The Inter-American Development Bank released a report last year indicating that Latin America and Caribbean countries could, in theory, meet 100 percent of their energy needs from renewables. For instance, the Chilean desert offers an economic potential for solar similar to Arizona or Nevada, two leaders in the U.S. Other regions – like South Africa – are making rapid headway; the time for solar power in Latin America is now.
First, let’s dispel some of the myths about the viability of solar energy.
There is a big distinction to be made between making solar panels and producing solar power. For instance, the U.S. solar panel manufacturer, Solyndra, a favorite target of critics of solar power, was in fact not a producer of solar power, but a maker of solar panels. Its demise was the consequence of a Darwinian shift in market forces: panel prices, driven down sharply by cheaper alternatives from China, made the business model of Solyndra – and many other manufacturers globally – untenable. That these companies were unable to compete in a burgeoning market is not evidence that the market does not exist, or that others won’t succeed in it. Solyndra is gone, but the demand for solar panels is growing rapidly. Supplying that demand today are fewer but stronger manufacturers, who have a brighter future ahead.
Where government assistance and intervention was once required for solar power plants to work economically, subsidies are no longer a requirement for solvency in the space. In the past five years, the cost of solar panels and other balance of plant components have fallen so dramatically that solar is reaching parity with conventional power sources – like coal and natural gas. The solar power model now stands on its own—a sustainable energy source supporting a viable business.
Latin America, as a potential market, has a competitive advantage in not being first. With new technologies, much can be learned from the mistakes of others. The average cost of an installed watt of solar energy has dropped nearly 25 percent in the past couple of years, and most projections indicate that the improvement will continue. More dramatically, consider that a watt of solar energy cost $1,785 to produce in 1953. Today, it costs about one dollar. The underlying costs associated with deployed solar photovoltaic power are expected to continue to decline.
For all the criticism it’s faced, solar energy has the biggest upside of all renewables. This is equally true when viewed through the lens of an investment opportunity. The time required to build a solar power project is less than or comparable to wind, significantly less than for hydroelectric or biomass, and a fraction of what’s required for coal or geothermal. Financing is readily available from both commercial and development banks, even without the need for a long-term power purchase agreement. Operators can start to produce power on a merchant basis, providing flexibility – and higher short-term profitability – in the more expensive power markets in Latin America. In addition, environmental impacts are often far less than other renewable alternatives. Residential and commercial rooftop installations require even lower investment and power can be turned on very quickly.
Solar energy is fast becoming the most productive natural resource in the world. Over the next 20 years, cumulative investment in solar power is expected to be close to $3 trillion – as much as $100 billion per year globally looking for investments. With some of the best solar resources in the world, Latin America is a vastly untapped potential source. It doesn’t take a flashlight the size of the sun to see the opportunity.
Ben Moody is President and CEO of Miami-based Pan American Finance, a specialized investment banking advisory firm providing advisory services on renewable energy in Latin America, the Caribbean and the U.S. markets.
Kevin Loome, cogestor del Henderson Horizon Global High Yield Bond Fund. Perspectivas favorables para la deuda high yield
High yield bonds have had a reasonably strong start to the year, particularly considering the fallout within the equity markets. For example, in January, the S&P 500, the index of leading shares in the US was down 3.5% over the month. In contrast, US high yield bonds, as represented by the BofA Merrill Lynch US High Yield Master II Total Return Index have returned 0.7% in US dollar terms.
A similar phenomenon exists in Europe where the MSCI Europe Total Return Index is down 1.8% in euro terms versus a rise of 1.0% in the BofA Merrill Lynch European Currency High Yield Total Return Index.
Driving the positive performance in high yield has been the decline in yields on core government bonds. Bond prices move inversely to directional moves in yields, so when yields fall, prices rise. The yield on the 5-year US Treasury fell more than 20 basis points in January whilst the yield on the 10-year US Treasury fell more than 30 basis points. This is important for the high yield markets because this is the maturity part of the yield curve around which high yield securities are priced.
The other major influence on bond prices is credit risk: this reflects individual corporate strengths together with broader macroeconomic forces on an issuer’s capacity to meet their repayment obligations to bondholders. There is a danger that investors may extrapolate the recent weakness in some of the economic data statistics such as the soft non-farm payrolls growth in the US as less an aberration (related to harsh winter weather) and more of a turning point signalling loss of economic momentum. Our view is that the temporary weakness in developed market economic data will abate.
More concerning has been the weakness in emerging markets where slower Chinese growth and volatility in emerging asset prices (partly due to liquidity draining from emerging markets in response to the US Federal Reserve tapering its asset purchases) has led to negative sentiment towards emerging market debt and equities.
So far, the emerging market fallout has not led to contagion to credit markets, although there have been outflows from Exchange Traded Funds (ETF). In the past, we have seen that during bouts of volatility, the ETF market has been a lot more closely correlated with equity markets than the cash bond high yield market.
This suits us because we are primarily invested in cash bonds from developed market issuers. In fact, fund flows support the notion that in volatile times, investor preference is for bonds over equities. The global mutual fund data flows from BoA Merrill Lynch for the first five weeks of 2014 show an outflow from equity funds and positive flows into bond funds, with government bonds, investment grade corporates and high yield all benefiting. The exception is emerging market debt, which remains in outflow.
Flows can be notoriously volatile, however, and our focus is on the cues that drive medium to long-term performance – valuations, fundamentals and liquidity. On all three factors, we believe the outlook for high yield bonds remains fair.
Valuations within high yield remain attractive. On a historical basis, metrics are marginally rich but only slightly above historical averages. On a relative basis, high yield bonds continue to look inexpensive when yield spreads are set against government bonds, investment grade bonds and expected default rates.
At the fundamental level, corporate earnings have been good. By 12 February 2014, almost 76% of S&P 500 companies that had announced earnings in the most recent reporting season had beaten expectations and the companies we talk to are generally upbeat. What we do not want to see, however, is optimism spilling over into shareholder-friendly/bondholder-unfriendly corporate behaviour. We have noticed, particularly in the US, which is at a more advanced stage in the economic cycle to Europe, a tick-up in more aggressive uses of high yield issuance proceeds, such as for acquisitions. However, as the chart shows more aggressive uses of proceeds (red shadings) are still far below the danger levels of 2005-7.
In terms of liquidity, the outlook remains encouraging. There is approximately US$25 billion of new US high yield issuance in February and that calendar is spread across bonds of different sizes, industries and credit ratings. Such breadth is usually a sign of a healthy market.
For now, our expectations are unchanged that global high yield can generate mid-single digit total returns in 2014, although the strength of that figure will depend on the quality of security selection. For our part, we continue to favour single B and CCC high yield bonds, and some of the smaller issuers where we believe fundamental research is able to identify value.
Kevin Loome, co-manager of the Henderson Horizon Global High Yield Bond Fund
During my last research trip in November, we visited mostly consumer-facing companies in Japan where we took the opportunity to pose two key questions to the management teams we met. The first was—“Are you planning to increase prices for products or services after Japan’s consumption tax hike (scheduled for April)?” And secondly: “Will you raise employee wages?”
To our surprise, many of the firms we met with said it would be difficult to increase prices for their products or services. While they seemed concerned about the rising costs of imports due to the weakening yen, they were also wary of meeting resistance from their customers, or possibly losing customers to competitors who may keep prices more stable. They also said they were quite reluctant to increase base salaries for their employees, noting that they would first need greater confidence that a more permanent, fundamental turnaround was occurring in Japan’s economy.
Opinion writer and Waseda University Professor Norihiro Kato has argued that Japan’s younger generations, those who came of age after the bursting of the country’s economic bubble, have never known what a booming economy feels like. They have not experienced inflation or rising wages. “They are accustomed to being frugal,” he wrote in The New York Times. “Today’s youths, living in a society older than any in the world, are the first since the late 19th century to feel so uneasy about the future.”
I suspect a similar trait has been embedded somewhat into parts of corporate Japan, especially in consumer-facing companies. Like Japan’s younger generations, many Japanese companies also have not experienced rising prices, regular wage increases and investments rather than savings over the last two decades; some firms may have experienced only the same sense of frugality and caution as the youth in its society.
Shaking this mentality of a deflationary environment may be key to what some parts of Japan Inc. need to help boost its economy. The central bank can overcome this obstacle by sticking to its guns on its monetary policy, creating expectations of higher nominal GDP. Fortunately, since the beginning of this year some larger Japanese companies have already announced wage or price increases. Also, some recent statistics in Japan, such as an increase in the consumer price index and the availability of jobs (measured as the ratio of job offers per job seeker), may pressure companies to raise wages. We hope to see more signs that Japan appears to be finding a virtuous cycle of economic recovery and growth.
Kara Yoon, Research Analyst 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.
Foto cedidaCaroline Maurer, Manager del fondo Henderson Horizon China Fund
. ¿Dónde vemos China en el Año del Caballo?
With further policy details provided by the central government in 2013, we see 2014 as the year for actual implementation. With the focus now shifted from politics to the economy, we believe that economic growth, forecast at a lower rate than 2013 at 7.5% for 2014, is likely to be more stable given better macro-economic management.
Given the more stable growth rate, we believe that there are reasons to continue staying positive on the China market.
The new government led by President Xi Jinping has set a positive groundwork for reform by communicating growth targets and reiterating the government’s commitment to change. Following the release of comprehensive reform plans after the 3rd Plenum meeting in November 2013, there has been a general uplift in overall sentiment. We feel that this level of transparency has done much to boost the confidence of people and better manage their expectations. We also have more confidence in the government’s execution capabilities to push for a wider scale of reforms as power is now more centralised. Not only is Xi Jinping the current president, but he is also Head of China’s Communist Party (CPC) and chairman of the country’s Central Military Commission.
The latest reported audited local government debt of 17.9tn RMB (end June 2013) is manageable, but has been an overhang for the market. Potential opening up of the municipal bond market will provide the local governments with a new source of long term financing outside of the traditional bank loans. This would help ease market concerns on duration mismatch of debt terms and infrastructure project cash flow generation cycles. Other measures to deleverage such as privatising government owned assets (eg: infrastructure, natural resources mining rights and state owned enterprises) are also positive to drive the improvement of operating efficiency. Lining up the interest of management and shareholders is likely to improve Returns on Equity (ROE) and benefit minority shareholders.
Apart from the traditional investment into roads, railways and ports, we are seeing incremental demand into the city mass transit system, drainage network, gas power plant, hospitals and other environmental protection areas. The process of local government deleveraging may put some pressure on project financing in the short term, however is expected to be mitigated in the longer term. We expect investment into infrastructure to remain stable in 2014.
The Chinese government is looking to aid income redistribution by increasing the number of regions that will have pilot programs privatising the residential land of farmers. Rural residences account for over half of the Chinese population and improving the wealth level of these residences may benefit domestic consumption.
As seen from the chart above, the dispersion between corporate earnings and PE has gone wider over the past three years. Market consensus is between 10-15% of corporate earnings growth in 2014 and we see further potential upside given the more positive business sentiment. The market has potential to rerate and we remain constructive, looking out for potential trading opportunities, as market valuation at below 10x 2014 estimated P/E still looks cheap. Valuation gaps between sector/names have been getting wider with “old economy” names such as China Communication Construction, Weichai Power and banks trading at 5-10x PE; and “new economy” names such as Tencent and Wantwant trading at 20-50x PE range.
The strategy for 2014 is to continue being focused on stock picks in quality growth sectors. The key sectors we favour are Consumer Discretionary, IT, New Energy, Selective industrials and Non-banking Financials. In the past year, we have seen the easing of overcapacity in the industrial sectors which occurred as a result of credit boom post financial crisis. We may start seeing supply cuts in industries such as cement, steel, paper due to a tightening of environmental standards and less capacity expansion in the past 12-18 months as companies had poor profitability. This will help improve the utilisation rate and profitability of cyclical industries especially for industry leaders.
Conclusion
There is likely to be some near term volatility as a result of tackling the accumulating debt risks of local governments and implementation of financial liberalisation amongst other reforms. Recently released PMI data slowed to 50.5 for the month of January 2014, but we feel that this is likely due to the Chinese New Year effect and is better to wait for February data before analysing this in depth.
With China’s reform plan taking shape, we believe that there is long term value to be found. The volatile market sentiment would allow us the opportunity to build up positions in stocks that we have identified as being attractive in the longer term.
Realistically due to the large scale nature of some reform projects, implementation will expectedly take some time. However this is to be expected and from an investment standpoint, we would much rather the government take time to lay the foundations right.
Caroline Maurer, Manager of the Henderson Horizon China Fund
