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There Is Still Value in Emerging Fixed Income: These Are the Reasons

cruising-4057622_640 — Pixabay CC0 Public DomainTodavía hay valor en renta fija emergente . Mapa de Asia

Local currency and hard currency emerging market government bonds have partly recovered since the lows of the COVID-19 crisis, but Colchester Global Investors believes there is still value to be found in these emerging market fixed income asset classes.

Colchester has been holding a number of conferences on Emerging Market sovereign debt to give investors a better understanding of the key differences between the main asset classes within this space, namely hard currency and local currency denominated debt. The response from investors has been heartening and we share with you some of the key questions investors have been deliberating over, and the thoughts of Colchester’s investment team below:

Yields are rising in the US, what does this mean for Emerging Markets?

Emerging market assets have weakened since the turn of the year with rising yields in the US weighing on local and hard currency bond prices and some depreciation of EM currencies against the US dollar. Rising yields do equate to a tightening of global financial conditions all else being equal, and a strengthening US dollar is often associated with a reversal of capital flows to EM as we observed with the “taper tantrum” in 2013. Nonetheless, we at Colchester believe the current period is not comparable to 2013, for a few reasons:

The rise in US yields can largely be attributed to the more positive outlook for the US and global economies, and an associated rise in inflation expectations;
Real yields in the US remain close to historical lows, and remain a “push factor” for capital to seek out the more attractive real yields of the Emerging Markets;
There is no indication of monetary policy being tightened in the US; and
The external balance sheets of emerging economies are generally stronger than in 2013, for example more robust current account positions in many cases and a lower reliance on portfolio inflows.

Real exchange rate valuations of many of the major Emerging Markets have improved relative to those prevailing in 2013, as exchange rates have weakened materially in nominal and real terms since then. With external vulnerabilities having significantly reduced since 2013, this puts many of the Emerging Markets in a much stronger position today to withstand tighter global financial conditions. We see opportunities to take advantage of undervalued currencies, combined with robust external balance sheets and credible policy frameworks.

EM currencies have weakened for many years, why don’t you think they will continue to depreciate?

The consistent undervaluation of EM currencies in recent years is indeed striking, but does not in itself shift our opinion that such undervaluation will eventually be corrected. In the short term, exchange rates can be volatile and deviate from fundamental “fair value” for significant periods of time. Emerging Markets have certainly been negatively impacted by a series of negative shocks in recent years also, which have contributed to their relative underperformance. We continue to believe however that the undervaluation of EM exchange rates, combined with a credible policy framework in most instances, will act as “pull factors” for global capital. Furthermore, the US dollar has been relatively strong for some time, even considering the declines seen in the second half of 2020. This overvaluation may ultimately lead to the beginning of a significant depreciation. Such an eventuality has historically been a good backdrop for Emerging Market assets, both local and hard currency denominated.

What is the impact of Covid-19 on Emerging Market currencies and bond markets?

Vulnerability to crises was previously a feature of many Emerging Market economies, but today that vulnerability is lower, at least for the major issuers of local currency emerging market government bonds. According to Colchester’s analysis, the market turmoil and economic contraction associated with the COVID-19 pandemic was met with a strong policy response from central banks in many major Emerging Markets.

Do you see a dollar weakening trend as being more beneficial to hard currency due to reduced interest payments or local through currency effect?

As shown in the chart below, historically there has been a relationship between movements in the US dollar and the relative performance of hard versus local currency EM government debt. Typically, although not always the case, we see local currency outperforming in an environment of US dollar weakness and vice versa.

Source: JP Morgan and Colchester Global Investors. Data is calendar year returns from Dec 2003 to Dec 2020. Hard Currency is the JP Morgan EMBI Global Diversified Index (EMBI GD index), and Local Currency is the JP Morgan GBI-EM Global Diversified Index in USD Unhedged terms.

The outperformance of the Local asset class from a weaker USD tends to be driven by an appreciation of EM currencies. When we look at USD hedged returns of EM Local bonds versus Hard Currency bonds, we see a general trend of Hard Currency outperforming EM Local bonds.

With regards to a weaker USD improving debt servicing for a sovereign’s Hard Currency debt, certainly an appreciating local currency will tend to make the conversion of domestic revenues into USD less costly, and thus somewhat ‘cheaper’. This is one reason why when assessing Hard Currency debt we incorporate the valuation of the country’s Real Exchange Rate. Colchester looks at several factors when assessing Hard Currency debt serviceability which focus on a country’s external liquidity, including the ratio of a country’s foreign currency uses relative to its foreign currency resources, and the Terms of Trade.

This article should not be relied on as investment advice. Colchester Global Investors Limited is regulated by the UK Financial Conduct Authority, and only deals with professional clients. https://www.colchesterglobal.com for more information and disclaimers.

Pictet Asset Management: A Little Less Growth, a Little More Inflation

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Inflation has become investors’ chief concern. Price pressures are clearly building – US core CPI in April hit 3.0 per cent year-on-year, its highest level since 1995. But what is less clear is whether the rise is transitory or points to a more fundamental change in economic conditions as the world recovers from the pandemic.

Our analysis paints a positive picture over the short term. Strip out Covid-sensitive items from price gauges and inflation looks modest, having barely picked up at all in April. (We remove prices for air fares, lodging, used cars, car rentals, tvs, toys and personal computers). Look ahead, however, and the potential for a build-up in price pressures is considerable. Even if there is little evidence of a rise in wages, US consumers have plenty of disposable income, having accumulated some USD 2 trillion in savings. Should as little as a third of that be spent on services – a bigger component of CPI than goods – it is possible to see core inflation hovering between 3.5 and 4 per cent in a years’ time.

While such a prospect is, in itself, a cause for some concern, what worries us more is the possibility of high inflation coinciding with a slowdown in economic and corporate profit growth. Our leading indicators point in that direction. Growth is already moderating appreciably in China and also easing a little in the US; the global three-month rate of expansion has recently halved to 7 per cent.

So with financial markets facing the possibility of persistent price pressures and weaker growth (see Fig. 2), we retain our neutral stance on stocks and shift to more defensive areas of the equity market.

Although economic conditions remain buoyant, our business cycle gauges suggest GDP growth will slow over the second half of the year; inflationary pressures, meanwhile, will linger. Signs of deceleration have multiplied in China, where recent data show that both industrial production and construction activity were below their normal levels for the month of April. Industrial profits for the month grew at a year-on-year rate of 57 per cent, down from 92 per cent the previous month. Elsewhere in emerging markets, price pressures have been building, with CPI having risen from below 2 per cent at the end of last year to above 3 per cent on average.

Japan is another weak spot. Our leading indicators point to a sharp decline in economic activity as Japanese authorities struggle to speed up vaccinations while trying to contain a fourth wave of the virus outbreak. Economic conditions in the US, meanwhile, are strong yet prospects remain hostage to potentially inflationary imbalances in demand and supply. While retail sales are booming – currently 18 per cent above pre-pandemic levels – industrial production is a lacklustre 3 per cent below normal.

Compared to the US, Europe is at the very early stages of a post-pandemic recovery. But with around 30 per cent of the population having received a first Covid vaccination and 10 per cent fully vaccinated, economic growth should begin to pick up rapidly over the summer.

The provision of monetary stimulus from central banks remains just about sufficient to underpin riskier asset classes, our liquidity indicators show. The volume of liquidity flowing into the financial system is growing at a much slower pace, currently only one standard deviation above the long-term trend rate, down from four standard deviations a few months ago. Nevertheless, that aggregate reading masks the growing prospect of a sharp drop in short term US interest rates, the possible result of commercial banks parking ever increasing amounts of surplus cash at the US Federal Reserve’s reverse repurchase facility.

Looking ahead, it is unclear how long markets will be able to count on support from central banks. The Peoples Bank of China has already tightened the monetary reins while the Fed, contending with a flood of fiscal stimulus, excess cash in the financial system and pent up consumer demand, will soon face a choice between withdrawing support early but modestly, or later this year/early 2022 but more aggressively. As things stand, it would seem policymakers prefer the latter.

Valuations indicate equities are expensive relative to bonds. The gap between equities’ earnings yield and bond yields is at its lowest level since 2008 while our ‘equity bubble’ index has now reached levels last seen in 1999 and 2007.

Our technical indicators paint a mixed picture. Seasonal trends favour bonds over equities. Nevertheless, the scope for a decline in stock markets remains limited as investor surveys show investors scaled back on their holdings of stocks.

Opinion written by Luca Paolini, Pictet Asset Management’s Chief Strategist.

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China’s Bond Market Comes of Age for Global Investment Funds

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beijing-3675835_640 — Pixabay CC0 Public DomainPekín. Pekín

The trajectory of the onshore Chinese bond market has been positive over recent years with increasing inflows. Eight percent of the market is already owned by offshore investors, which includes about 3% foreign ownership, and this is up from virtually 0% just 5 years ago. The IMF SDR (’15), the JPM GBI-EM (Feb ’20) and the FTSE WGBI (Oct ’21) have all created demand for local Chinese bonds and Bond Connect has helped create a path to satisfy that demand, with average daily trading volume in April at RMB24.7 billion.

However, as with most things, it takes time – time for funds to recognize that the benefits outweigh the costs (operational, execution, setup) and time to get approval to trade in the onshore market as an offshore participant.

If Bond Connect were easier to deploy, more funds in the US, Europe and Japan would have pre-positioned in the lead-up to China bonds being included in the FTSE Russell WGBI. Once funds are greenlit, it will be a steep trajectory for inflows. With that, investors will see more strategies oriented towards offshore investors and a huge push for green bond issuance (already 13% of the market and the 2^nd largest green bond market in the world) which is a major topic for investors in the west.

Given China’s ambitious net-zero carbon target by 2060, the country will require trillions of yuan in new investments to revamp its carbon-intensive economy and energy system over the coming four decades. This will pique the interest of many funds given the average yield of Chinese green bonds was 3.44% as of March 31st, compared to 0.58% for the Barclays MSCI Global Green Bond Index.

Source: Goldman Sachs

China debt inclusion in the Russell flagship benchmark (FTSE Russell WGBI) will be a gamechanger in terms of foreign investors’ strategic allocations.The inclusion can’t be ignored, as an estimated $2-4 trillion in assets follow this index. It will make China the sixth largest market by weight and will have the second highest country group yield in the FTSE World Government Bond Index (WGBI) behind only Mexico, but with a much larger weight (5.25% vs .6%) thereby pushing the overall index yield up 15bps. It may not sound significant, but it is, considering the whole index only yields 32bps today. Monthly passive inflows will likely total US$5-7.5bn a month (3x today’s pace) from October 2021.

There will likely be a 36-month phase in after that (in-line with previous inclusions). We should expect an acceleration of inflows (2x today’s pace) which could lead to a market driven compression of yields which was the case when Malaysia and Mexico were added to the index in 2007 and 2010, respectively.

The inclusion also provides a stamp of approval around liquidity, policy transparency and currency management that have kept many offshore managers at bay for years. For many funds, navigating the local landscape was a daunting prospect. With this inclusion, the prospect is far less scary.

Source: Goldman Sachs

The Chinese government’s management of Covid-19 along with recent policy changes have made its bond market more attractive to institutional investors. While policy makers elsewhere were cutting funding rates, expanding balance sheets and increasing fiscal spend, Chinese counterparts were more austere, and in some cases, they even tightened policy. The goods and digital economy in China far outweigh the service economy so less structural support was needed.

Why does this matter? Chinese rates were stable and even higher in absolute terms while bond yields were plummeting elsewhere with some credit fundamentals deteriorating. The Covid-19 pandemic has really been a goldilocks situation for Chinese bonds. After the initial shock of the pandemic, investors started to realize China offered a unique opportunity and we saw flows into Chinese local bonds ramp up in the second half of 2020.

Default risk in China has always been more about refinancing risk than leverage. Seventy-six companies have roughly $50bn of repayment pressure over the coming months. Moody’s forecasts the trailing 12-month default rate for these firms will fall to 3.5% at year-end from 7.4% at the end of 2020. Continued supportive fiscal and monetary policies and better pandemic containment with vaccination rollouts also play a role in the improvement.

Still, weaker firms’ funding channels “could be restricted” following guidance last month from China’s supervisor of state-owned assets regarding bonds’ proportion of total debt at riskier firms.

In the private credit sector, there can be too much gearing, forex risk, and/or secular headwinds. This risk is far easier for international investors to tolerate, understand and navigate than the SOE risk. If a company has 8x debt to EBITDA and a majority of that is in FX despite most income being in local currency, there is potential solvency risk. It’s high yield for a reason.

Regulators have stepped in to limit home price growth and home development. That means the property names that grew unchecked for years by accessing cheap financing in USD and using it to amass disproportionately large land banks, now find themselves on the wrong side of regulation. These corporations have a lot of assets that they cannot offload or develop along with acute debt service costs.

Regarding SOEs, bank regulators are doing what they can to limit future default risk by guiding the so-called zombie corporations towards insolvency. By doing so, they are pruning fundamentally impaired institutions before they become a systemic issue and cause contagion. We applaud these measures. Coal names come to mind most readily with the default of Yongcheng in late 2020 just weeks after they issued bonds. Fortunately, it was only RMB 1 billion, so it wasn’t a systemic issue. SOEs have some 5.4 trillion yuan of bonds maturing this year. Net bond financing has been negative for more than a dozen provinces since Yongcheng Coal’s default in November.

Ayman Ahmed is a Senior Fixed Income Analyst at Thornburg Investment Management.

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US Strong Recovery and a Focus on Infrastructure

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bridge-1081782_640 — Pixabay CC0 Public DomainLa Administración Biden contempla una fuerte inversión en infraestructuras. Golden Gate

The U.S. stock market rose to a record closing high at the end of April, scoring its best monthly gain since November. The spring rally was powered by a strong stimulus fuelled economic recovery and corporate earnings reports that by month end had topped analysts estimates by a wide margin. Berkshire Chairman Buffett commented at the annual meeting on May first that U.S. fiscal and monetary stimulus ‘did the job,” and 85% of economy is running in ‘super high gear’. However, the U.S. economy remains about eight million jobs below its pre-pandemic level in February 2020. Continued gains at March’s pace of 916,000 new jobs and a six percent unemployment rate would take a while to catch up and may bump into the time frame when the Fed is expected to start tapping on the monetary brakes. Fed chairman Powell addressed this market concern at the April FOMC meeting when he said, “We don’t have to get all the way to our goals to taper asset purchases, we just need to make substantial further progress.”

As we look for new investment opportunities, our equity research continues to focus on infrastructure. President Biden’s American Jobs Plan (AJP) has spending proposals targeting transportation, including roads, bridges, train service, and the transition to electric vehicles. Plus, upgrading public water systems and improving broadband access and connectivity to rural Americans.

Mr Buffett commented on the current backdrop for deals from Berkshire’s perspective. Here are some of the dots. Berkshire has not made a major acquisition since 2016 and has $70 billion to $80 billion of its $145.4 billion cash hoard it would “love to put to work.” But the ‘casino’ effect from SPACS has made it difficult to compete for deals. Despite environmental concerns, Mr. Buffett said he would ‘not feel uncomfortable’ owning ‘the entire business’ of Chevron, but did not say that was his intention. Berkshire held Chevron shares at year-end 2020. Chevron’s market capitalization is about $200 billion compared to about $630 billion for Berkshire. An upbeat Mr. Buffett said he is looking forward to seeing everyone at next year’s annual meeting in Omaha.

M&A activity remained vibrant in April with nearly $500 billion in newly announced transactions, providing merger arbitrageurs with an expanded menu of investment opportunities. Performance in April was bolstered by deals that made continued progress towards closing, improved deal terms, and deals that were completed in April. Notably, Alexion’s acquisition by AstraZeneca received antitrust approval in the U.S. without an extended review, in what was viewed as an early test of the Biden Administration’s approach to pharmaceutical mergers. Kansas City Southern received an overbid from Canadian National Railway, and Suez reached an agreement in principle to be acquired by Veolia under improved terms. We believe these dynamics highlight a desire and urgency to acquire strategic assets, and believe it bodes well for a healthy M&A environment.

After a record first quarter, April’s global convertible market issuance returned to a more normal cadence and continued on more attractive terms than previously occurred at the beginning of the year. The market moved higher as underlying equities advanced, but many new issues traded lower. There were two reasons for these moves. First, the convertible valuations were a bit stretched. It was reasonable for companies to take advantage of the market to improve their capital structures, but convertibles with zero coupons and 60 or 70% premiums very rarely make attractive investments. Second, many of these convertibles came from growth companies where high valuations were somewhat dependent on low interest rates. As investors include higher interest rates in their valuations, weakness has developed in growth equity and in turn weakness in their aggressively priced convertibles. This has left the convertible market in a compelling place. We anticipate that issuance will continue this year, as the convertible market is one of the most attractive ways for companies to raise capital while allowing investors to participate in equity performance in a risk adjusted way. There are also many existing converts that are now more attractively priced and offer asymmetrical profiles that should participate in more equity upside than downside.

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Disclaimer:
The information and any opinions have been obtained from or are based on sources believed to be reliable but accuracy cannot be guaranteed. No responsibility can be accepted for any consequential loss arising from the use of this information. The information is expressed at its date and is issued only to and directed only at those individuals who are permitted to receive such information in accordance with the applicable statutes. In some countries the distribution of this publication may be restricted. It is your responsibility to ﬁnd out what those restrictions are and observe them.

Some of the statements in this presentation may contain or be based on forward looking statements, forecasts, estimates, projections, targets, or prognosis (“forward looking statements”), which reﬂect the manager’s current view of future events, economic developments and ﬁnancial performance. Such forward looking statements are typically indicated by the use of words which express an estimate, expectation, belief, target or forecast. Such forward looking statements are based on an assessment of historical economic data, on the experience and current plans of the investment manager and/or certain advisors of the manager, and on the indicated sources. These forward looking statements contain no representation or warranty of whatever kind that such future events will occur or that they will occur as described herein, or that such results will be achieved by the fund or the investments of the fund, as the occurrence of these events and the results of the fund are subject to various risks and uncertainties. The actual portfolio, and thus results, of the fund may differ substantially from those assumed in the forward looking statements. The manager and its affiliates will not undertake to update or review the forward looking statements contained in this presentation, whether as result of new information or any future event or otherwise.

Listed Infrastructure’s Crucial Role in the Clean Energy Transition

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It is in one area in particular where listed infrastructure is emerging as a viable alternative to its private counterpart: clean energy.

It’s abundantly clear that renewables and sustainability-related sectors will be a magnet for infrastructure investment in the coming years. Both governments and an increasing number of large multinational corporations have committed to ambitious carbon reduction targets in the post-Covid era.

This will require trillions of dollars of capital to be re-directed to clean energy assets. The shift was already gathering momentum prior to the public health crisis.

In the year before the pandemic, the renewables sector had accounted for the largest share of private-sector infrastructure investment. It drew in more than USD40 billion in new capital in 2019 alone – or over 40 per cent of the total amount invested in infrastructure that year. This is up from 20 per cent at the start of the decade (1).

That looks modest compared with what could unfold. According to the International Renewable Energy Agency, cumulative investments in the energy system will need to increase 16 per cent to USD110 trillion between 2016 and 2050 from what’s currently planned to meet climate targets.

If that happens, investment opportunities in the electrification and infrastructure segment – which includes power grids, EV charging networks and hydrogen or synthetic gas production facilities – could expand to as much as USD26 trillion by 2050. It is a similar picture in renewables.

Public infrastructure: gaining depth

And there are reasons to believe that the public market could attract a significant share of this capital.

The rise of blank-check financiers, popularly known as SPACs (special purpose acquisition companies), is a crucial development in this regard.

SPACs start off with no assets and go public to pool capital with the intention of merging or acquiring targets. They provide a quicker and more efficient alternative for firms to raise capital than through a traditional public listing.

According to US law firm Vinson & Elkins, the number of announced “de-SPAC” transactions by clean energy companies – or the post-IPO process of the SPAC and the target business combining into a publicly traded operating company – set a record in 2021 while IPOs of energy transition SPACs have been equally robust.

Among the most popular industries targeted by SPACs are electric/alternative fuel vehicles, vehicle autonomy and grid-level battery storage (2).

The V&E report adds: “with projected capital requirements to meet carbon goals and deep investor appetite for these investments, activity to date may be but a prelude to even more robust activity over the next decade.”

The average clean-energy SPAC is estimated to have an anticipated enterprise value – a measure of a company’s potential takeover value – of USD1.8 billion (3).

Traditional IPOs in the clean energy industry are also strong in some regions. In Spain, partly in response to the EU’s green recovery investment plan, at least four companies, including Repsol, are working on possible IPOs of renewable assets this year.

Green infrastructure for impact

As the world accelerates efforts to decarbonise and become more resource efficient, listed infrastructure firms specialising in clean energy and sustainable solutions are both a complement and alternative to private assets.

Listed infrastructure stocks, especially in clean energy and sustainable sectors, also allow investors to align their investment return objectives with their environmental and social goals.

Pictet Clean Energy strategy: investing in energy transition

Pictet AM’s Clean Energy strategy is ideally placed as a complement for institutional investors looking for exposure in sustainable infrastructure.
The strategy invests in companies supporting and benefiting from the energy transition. It aims to deliver long-term capital growth with a scope to outperform major global equity indices over a business cycle.
The strategy invests in broad and diversified clean energy segments, not only in renewable energy but also technologies, innovations and infrastructure supporting smart mobility, energy efficient buildings and efficient manufacturing.
Utilities and industrials make up at least 40 per cent of the portfolio.
About a third of the portfolio is directly exposed to infrastructure assets and investments, while the remaining has indirect exposure which should also benefit from growing inflows into green infrastructure.
The portfolio is nearly 100 per cent exposed to US President Joe Biden’s USD2 trillion stimulus.
Launched in 2007, Clean Energy strategy has a track record that is one of the longest in the industry. The experienced team that manage the Clean Energy strategy sit within our pioneering Thematic Equities team that manages around USD53 billion across a range of strategies.
Data as of 31/03/2021.

Opinion written by Xavier Chollet, Senior Investment Manager in the Thematic Equities Team co-managing the Clean Energy Strategy at Pictet Asset Management

Click here for more insights on clean and sustainable infrastructure

Notes:

(1) Source: Global Infrastructure Hub. Investments combining debt (75%) and equity (25%) flows.

(2) Source: Vinsons and Elkins, 13.01.2021

(3) Shayle Kann, a San Francisco-based managing director at Energy Impact Partners, in an InterChange podcast entitled “The Cleantech SPAC Attack.”

Información importante:

Este material va dirigido exclusivamente a inversores profesionales. Sin embargo, no deberá ser distribuido a ninguna persona o entidad que sea ciudadano o residente de cualquier lugar, estado, país o jurisdicción en el que dicha distribución, publicación o uso sea contrario a sus leyes o normativas. La información utilizada para la elaboración del presente documento se basa en fuentes que consideramos fiables, pero no se hace ninguna manifestación ni se da ninguna garantía en cuanto a la exactitud o integridad de dichas fuentes. Cualquier opinión, estimación o previsión puede modificarse en cualquier momento sin previo aviso. Los inversores deben leer el folleto o el memorándum de oferta antes de invertir en cualquier fondo gestionado por Pictet. El tratamiento fiscal depende de las circunstancias individuales de cada inversor y puede cambiar en el futuro. Las rentabilidades pasadas no son indicativas de rentabilidades futuras. El valor de las inversiones, así como la renta que generen, puede disminuir o aumentar y no está garantizado. Es posible que usted no recupere el importe inicialmente invertido.

Este documento ha sido publicado en Suiza por Pictet Asset Management SA y en el resto del mundo por Pictet Asset Management Limited, sociedad autorizada y regulada por la Financial Conduct Authority, y no podrá reproducirse ni distribuirse, ni parcialmente ni en su totalidad, sin su autorización previa.

Para los inversores estadounidenses, la venta de acciones en los Estados Unidos o a Personas de los Estados Unidos solo se puede realizar mediante colocaciones privadas a inversores acreditados según las exenciones de registro en la SEC en virtud de las exenciones a colocaciones privadas de la Sección 4(2) y el Reglamento D conforme a la Ley de 1933 y a clientes cualificados según lo definido en la Ley de 1940. Las acciones de los fondos de Pictet no se han registrado según la Ley de 1933 y, salvo en operaciones que no violen las leyes de valores de los Estados Unidos, no pueden ser ofrecidas ni vendidas ni directa ni indirectamente en los Estados Unidos ni a Personas de los Estados Unidos. Las Sociedades de Gestión de Fondos del Grupo Pictet no se registrarán según la Ley de 1940.

Pictet Asset Management: It’s in the Price

| For Meritxell Sedo | 0 Comentarios

Just four months into 2021, global equity markets have already hit our targets for the year (returns of 10 per cent). That and tentative signs that economic and corporate earnings growth may be peaking has led us to take some profits. We therefore downgrade equities to neutral, and trim our exposure to cyclical stocks.

Our business cycle indicators suggest the global economy is recovering well from the pandemic, but growth momentum has slowed slightly. That’s particularly true in China, where weaker-than-expected first quarter data has prompted us to trim our 2021 GDP growth forecast there to 10.0 per cent from 10.5 per cent. This slowdown is partly due to a cooling in credit growth. China’s credit impulse, our own measure of credit flowing through the economy, has dropped off sharply since October is now broadly in-line with its long-term average of 6.5 per cent of GDP.⁽¹⁾ This is in keeping with the view that China will stick to its promise of maintaining continuity and stability in economic policies.

In the euro zone, the recovery is not self-sustaining yet and is fully conditional on successful control of the pandemic, the vaccination campaign and on the persistence of accommodative monetary and fiscal policies. Economic activity in the US, meanwhile, continues to beat expectations – for now. We expect growth to peak in the current quarter, before slowing into the year-end as the fiscal boost starts to fade. Reinforcing our view, a New York Fed survey shows US households plan to spend just 25 per cent of the their stimulus cheques; 34 per cent of the cash will be used to pay down debt and the balance saved.

Our liquidity indicators show that private credit conditions – credit flowing to household and corporations – have normalised globally. Overall liquidity, however, remains marginally supportive for riskier assets thanks to continued central bank stimulus. However, this support is likely to ease over the coming months. We think that the US Federal Reserve may move faster than expected on tapering QE; it could flag the shift in policy as soon as its June rate-setting meeting.

That, in turn, adds to the case for dialling down exposure to equities – particularly in light of extremely stretched valuations. The total return ratio of US equities versus bonds is now at a historic high, and a staggering 47 per cent above its long-term trend (see Fig. 2). The gap between stocks’ earnings yields and government bond yields, meanwhile, is at its lowest since the 2008 financial crisis.

Globally, stocks’ earnings multiples should come under further pressure in the coming months as monetary stimulus fades. Any further upside for equities will thus have to come from corporate earnings growth. This could indeed continue to surprise on the upside for a while longer, but with investor positioning in – and sentiment towards – stocks already at very bullish levels, any positive market reaction to news of stronger profits is likely to be muted, while weaker-than-expected results could be severely punished.

Technical indicators suggest we are about to enter a three-month long period of negative seasonality for equities (the period running from May to July tends to be associated with weak stock market performance). While investment flows into equities remain strong, the momentum is slowing even if our indicators do not yet suggest stocks are ‘overbought’. For bonds, the overall technical signal remains negative.

Opinion written by Luca Paolini, Pictet Asset Management’s Chief Strategist.

Discover Pictet Asset Management’s macro and asset allocation views.

Notes:

(1) China’s credit impulse is a broad measure of credit and liquidity to the real economy, which we calculate as year-on-year change in total social financing quarterly flow (ex-equity).

Important notes

AUM’s Growth for the Afores Will Fuel Local and Global PE Investments

| For Gabriela Huerta | 0 Comentarios

mexico-4879142_1280 — Pixabay CC0 Public DomainPhoto: Dezalb . Foto:

In 12 years, the Mexican institutional investor has increased its investments in private equity through public vehicles registered on the local stock market (CKDs and CERPIs). Today these investments reflect a market value of 16.186 billion dollars of which 13.544 billion dollars come from the Afores (84% of the total), with the remaining 16% coming from other institutional investors such as insurance companies and such.

The total represents 1.4% of Mexican GDP and this figure doubles if one considers committed capital, which amounts to 32.824 billion dollars. This figure highlights the importance that the CKDs and CERPIs are gradually acquiring, as well as their great potential.

According to Santander’s area of analysis in the document: How Should Mexico’s Pension Reform Benefit Its Financial System? prepared by Alan Alanís, Claudia Benavente, Héctor Maya and Jorge Henderson (February 2021), it is estimated that Afores’ AUM could more than double from 237 billion dollars at the end of 2020 to 537 billion dollars by 2027, via employee contributions, investment returns, and benefits from the pension reform. This growth means that assets under management will go from 20% of Mexican GDP in 2020 to 32% in 2027.

The same document comments that in the last decade, assets under management increased at a compound annual growth rate (CAGR) of 13%, with 7% originating from returns and 6% from employee contributions.

Additionally, if the assets under management double in six-year periods, the potential investments in bonds, equities and private equity, among others, will also experience a boom.

Of the 12 years that institutional investors have been investing in private equity, in the first 6 years (2009-2015) investments were focused on local investments (CKDs) reaching a market value of 7.835 billion dollars. By 2021, this has almost doubled reaching 12.944 billion dollars (+ 65%).

In 2018, the year in which the Afores began investing globally, the market value of available CERPIs was of 1.827 billion. By March 2021, it had already reached a market value of 3.243 billion dollars (+ 78%), which represents 1.4% of the assets under management of the Afores while the investments in local private equity (CKDs) is 4.3% to reach a combined total of 5.7%.

If this 5.7% of total assets under management is simply maintained, does not grow at all, if it were applied to the 537 billion dollars projected in total AUM by Santander for 2027 it would represent 30.6 billion dollars.

In the past 12 years that the CKDs have been in place there have been 121 funds, while in the three years since the creation of CERPIs there are already 51. The explosive growth in the issuance of CERPIs with respect to the CKDs is due to the fact that they have primarily focused on fund of funds (43) while the others have been more sectorial focused as can be seen in the table.

This fund of funds CERPIs’ trend has led to their creation according to the risk profile of the investor or by the age of the workers affiliated (years of retirement of the worker to get their pension and / or money saved), or “Target Date Funds”. Blackrock, for example, issued 7 series of its CERPI in 2019, while Lock Capital and Spruceview México released 7 and 8 series respectively in 2020. These three issuers alone represent 22 of the 51 CERPIs.

With this projected dynamism, investments in local and global private capital through CKDs and CERPIs will continue to grow.

Column by Arturo Hanono

Why Investors Seeking Returns and Impact Should Consider Water

| For Beatriz Zúñiga | 0 Comentarios

water-4429191_1920 — Pixabay CC0 Public Domain. Por qué los inversionistas que busquen rentabilidad e impacto deben tener en cuenta el agua

As sustainable investing grows in popularity, investors often ask us what they can do to position their portfolios to make a positive social and environmental impact without sacrificing potential returns. Our answer is always the same: Consider making a dedicated allocation to water as an investible theme.

The societal benefits of investing in water are clear. One-in-three people globally lack access to safe drinking water, a shortfall contributing to the avoidable deaths of nearly 1,000 children daily. Along with this human toll is a costly economic drag: The millions of lost hours spent seeking potable water could instead be used for education and other productive activities that could lift countless people out of poverty. Our water crisis is so severe that the United Nations lists “Ensuring access to water and sanitation for all” as one of its 17 Sustainable Development Goals. However, achieving that goal requires a massive buildout of infrastructure driven by a massive marshaling of investment capital.

The need for water-related investment is not limited to the developing world. Over the next decade, billions of dollars will be spent on water infrastructure in Europe and the US, where demand for water outpaces supply, driven by population growth, the expansion of agriculture and more water-intensive consumption as living standards continue to rise. Factors such as industrial growth, the increasing number of data centers or the electrification of transport will inevitably result in more water needed for power generation needs. Already in the US, power generation makes up 40% of total freshwater withdrawals, on par with water used for irrigation in farming.

As the world industrializes, electrifies and grows in population, water consumption has increased by more than 150% in the past five decades while supply—mainly from rainwater—remains static, and unevenly distributed, leaving locals with few choices to address water shortages.

The most obvious two choices are to proactively address this imbalance by protecting existing freshwater resources from misuse and wastage, or by making water use more efficient. Various technology and product solutions are available, but both approaches require initial capital outlays in addition to the billions of dollars that will be required simply to maintain existing water infrastructure in countries like the US, where much of the existing infrastructure is more than 100 years old. The environmental benefit to investing in water resources preservation is also obvious, given its essential nature and the fact that no substitute exists.

Our water challenges are exacerbated by climate change, which is resulting in more severe weather patterns including prolonged droughts, flooding and unseasonal temperatures. As a result, places that once had adequate water might now require significant infrastructure upgrades to weather storms and meet individual and industrial needs. The good news is that we can fix these problems if we apportion enough public and private capital to build out and improve water infrastructure globally. As such, investors can help meet this need for capital by investing in the long-term structural growth of the water sector while helping fix one of our most pressing environmental problems.

So, how can investors deploy capital? We see three areas where investors can become part of the solution while also benefitting from the upcoming investments to address water shortages:

Increasing access to water: Companies that distribute water to growing populations, improve water storage capacity or help to covert salt or wastewater into useable water
Improving water efficiency: Companies with products that allow customers to reduce their water footprint without loss in productivity, i.e. by reducing wastage or fixing leakages.
Enhancing water quality: Companies that help to manage wastewater, often by recovering some of the huge amount of water flushed down drains or toilets, or companies which help to ensure our drinking water is and stays safe for consumption.

By targeting these areas, investors can access a potential source of long-term growth at risk levels that have historically been lower than other types of growth stocks. Unlike many other growth areas such as tech innovators, companies in the water segment tend to offer already well-established and cash-generating business models with strong client relationships that are not easily disrupted, given that the reliance on sufficient and safe drinking water creates high barriers to entry.

Of course, like all investments, water-related companies carry their own asset-specific, idiosyncratic risks. For that reason, investors should stick to fundamentals and diversify their holdings across companies, regions and sectors. There are over one hundred companies globally across these categories, offering enough options to construct a diversified portfolio of pure play water holdings.

These characteristics make water-related companies an ideal target for investors looking to incorporate sustainability into their portfolios. However, investors looking to capitalize on this opportunity should move quickly. Infrastructure is at the center of the political agenda in the US, where the Biden administration is planning a $2 trillion infrastructure investment. Europe, China and other locations are increasing investment, too. This spending has the potential to trigger a flood of projects aimed at replacing old, hazardous lead pipes and upgrading water infrastructure from its current old economy brick-and-mortar state to a more automated, smart, digital, 21^st-century iteration.

There is an even more compelling reason for investors to act now. As a society, we are long overdue to address the problem of water access. We know how to solve it; all we need is the will and the capital. Investors can help with both. By stepping up now, investors can reap the potential financial rewards while also driving positive impact in an area where it is needed most.

A column by Andreas Fruschki, CFA, Head of Thematic Equity at Allianz Global Investors; and Alexandra Russo, member of the Thematic Equity team at AllianzGI, based in New York.

Hear more from Andreas and Alexandra at AllianzGI’s virtual Sustainability Day event on May 12.

Finding Opportunities in Today’s Credit Markets

| For Cecilia Prieto | 0 Comentarios

money-2724235_640 — Pixabay CC0 Public DomainOportunidades en renta fija. Oportunidades en renta fija

Fixed Income can still provide protection on the downside and some benefits on the upside, but it is notably harder of late. You have to be opportunistic. You have to be nimble and you have to be solutions oriented.

In our view as active managers, the benchmark is not a starting place for asset allocation, but a proxy for risk. It’s how much risk a manager should be taking in order to achieve whatever solution is mandated. Ultimately, the first thing is to give active management a range around that benchmark. The aim doesn’t always have to be perfectly neutral. In times like COVID, you want your fixed income managers to be taking on a little bit more risk, and in periods perhaps like today or in a period where the manager doesn’t believe the risk is well-compensated, you want less.

The risk/reward isn’t skewed in an investor’s favor today. Becoming more defensive in building a portfolio that has a lower potential volatility and looking forward to areas of the market that may not sell off is important to protect against downside potential.

Risk and Reward: How to Play Defense

1) Be cautious on duration

Our advice is to remain cautious on duration. We continue to look for opportunities to take down credit duration given the move in spreads over the last 12 months. The investment grade spreads are now tighter than early 2020 (pre-COVID sell off) despite corporate leverage having increased over 2020 from already high levels. Fiscal and monetary stimulus should continue to support the economy and ultimately corporate earnings and cash flows. Therefore, we aren’t concerned about the exposure; however, prices do seem to already reflect a lot of the economic healing. As always, we search for interesting opportunities no matter what the market environment. Recently these have been higher quality in the 2- to 5-year maturity range.

2) Move up the capital stack to securitized assets where possible

The reality is that sometimes markets are mispriced across silos, and one of those mispricings was actually global airlines pre-COVID where the corporate unsecured debt and a secured position in that exact same corporate airline were priced on top of each other. Going through COVID they diverged rather significantly. One of them went down 70 percent, and another went down around 40 percent, so 30 cents on the dollar versus 60 cents on the dollar. Today, it’s actually relatively easy to make those gift trades when you give up 1, 2, 3, 4 or 5 basis points of yield, but you take on a lot of protection by moving back up the capital stack spectrum and to securitized assets.

Secured credit is another area where we can do that, by just taking out credit duration, through both defensive posturing within individual assets, but also pulling back and being more defensive across the board.

Some agency mortgage-backed securities (MBS) continue to look reasonably attractive, especially relative to high-quality corporates. There are specific stories such as low coupon and low loan balance mortgages that have reasonably stable payment profiles such that we believe we are getting paid to take on the convexity risk (i.e., prepayment/extension).

3) The consumer story still resonates and has more runway

We still believe in the consumer story given the long-term improving job market and stimulus payments. Consumers entered the COVID recession in good financial shape, and while the immediate impact of the recession was quite harsh, direct stimulus payment and the overall economic rebound have allowed them to regain/maintain a good financial profile.

The places where investors should be looking today are where central banks have intervened notably less, and that is the world of securitized products.

While spreads in senior tranches of Asset-Backed Securities (ABS) and non-agency Residential Mortgage-Backed Securities (RMBS) have tightened along with corporates, we continue to think some asset types and programs remain interesting. Senior ABS are particularly interesting because spreads are relatively attractive, and the durations are short. Additionally, most of those bonds are amortizing so we get cash flow each month.

The non-agency RMBS market remains attractive because of the consumer financials as well as the strong housing market which provide collateral for these bonds (underwriting remains quite good with income/asset documentation requirements, low Loan-to-Values (LTVs), no low rate promo periods where there could be payment shocks, etc).

Structuring Portfolios for Economic Shifts, Volatility and New Opportunities

In some of our portfolios, we are moving toward a more conservative position. Spread compensation has decreased notably over last 12 months. Fiscal and monetary stimulus provide good economic support for credit (much already reflected in prices), but it also provides a basis for potential inflationary and policy rate move scares which could create volatility along the yield curve and in credit spreads. We want to be positioned to take advantage of those opportunities. Thus, we continue to preserve liquidity in the form of cash, Treasuries, agency mortgages, monthly amortizing ABS and short, high quality corporates.

Coming out of the global financial crisis a decade ago, there were structural shifts as to how the global economy was going to work. Central banks around the world shifted the regulatory environment. They became almost commoditized utilities, and to be fair, that’s being tested now with the winddown of a hedge fund in Asia that we all read about recently.

Coming out of the COVID crisis, we are seeing structural shifts again. There has been a shakeout of some of the levered players. To move up in quality as measured by rating agency grades, investors need to look across silos for relative value.

In sum, as active fixed income managers, we take risks when it makes sense to take risks, and we focus on downside protection when our view is that the markets aren’t well suited to reward risk-taking. In fixed income we are playing defense roughly 80 percent of the time, and that’s certainly true today.

Important Information

Unless otherwise noted, source of all data, charts, tables and graphs is Thornburg Investment Management, Inc.

High yield bonds may offer higher yields in return for more risk exposure.

Any securities, sectors, or countries mentioned are for illustration purposes only. Holdings are subject to change. Under no circumstances does the information contained within represent a recommendation to buy or sell any security.

Investments carry risks, including possible loss of principal.

Outside the United States

For more information, please visit www.thornburg.com

Navigating Market Uncertainty with a Focus on Both Income and Growth

| For IreneValiente | 0 Comentarios

weather-vane-1209398_1920 — Pixabay CC0 Public DomainFree-Photos. Los gestores europeos confían en el rally de la bolsa pese a que decae el optimismo global sobre la macro

The US economy appears to be on a path to recovery after the massive dislocation caused by the onset of the Covid-19 pandemic in early 2020. Large scale vaccinations, a new $1.9 trillion stimulus package, and declining overall levels of infection have triggered renewed optimism among investors about the future of growth and financial markets.

But the path to normalization is not without risks, and investors should be mindful of potential asset-price volatility in the near future. Fears of higher inflation resulting from a re-ignited economy, for example, sparked a strong sell-off in Treasury bonds in March, boosting the yield on the 10-year note above 1.7% from about 1% in early February. Concurrently, belief in the so-called “re-opening trade” prompted many investors to rotate from high-growth stocks—which showed strong performance during the pandemic—to more cyclically oriented ones.

So, the question now is: What’s an investor to do?

We believe that a multi-asset approach combining equities and nontraditional fixed income has, historically, offered smoother returns in periods of volatility such as the one we see today. Based on more than 14 years of experience managing such strategies, we have found that a mix of US convertible securities, US high-yield debt, and US equities can offer a powerful solution for those seeking equity-like returns with less volatility than stocks while keeping a meaningful income stream.

Let’s contextualize this in our current environment. While it’s understandable that some investors are jittery about the rapid rise in US 10-year Treasury rates, it’s worth placing that in historical context: For the past decade, 10-year rates have moved between 1.5% and 3%. So, while the magnitude of the 10-year move (and its speed) is noteworthy, we view current rate levels as reverting to historically normal levels. Indeed, current rates are perhaps what investors should expect from a market that is starting to reflect an economy edging back to more normalized activity.

Investors that combine US convertible securities, US high-yield debt and US equities are seeking to generate upside participation and diminished downside relative to a pure equity allocation. So, how are market conditions in these three asset classes?

Two key themes dominate convertibles. First, convertibles had a strong 2020—returns topped 40%, its second-best year ever as measured by the ICE BofA US Convertible Index, only behind 2009, when the US was recovering from the Global Financial Crisis. In addition, new issuance was strong. The convertible universe was valued at less than $215 billion at the start of 2020, but with new issuance of over $100 billion and strong returns, it finished the year worth above $350 billion. The market also diversified beyond its concentration in technology and healthcare with new issuance coming from consumer discretionary and financial firms.

As new issuance continues, the asset class should continue to enjoy an asymmetric risk-return profile, typically capturing roughly 60% to 80% of the upside of the underlying equity and 50% or less of the downside. The first quarter of 2021 has already seen roughly $30 billion of new issuance and while we expect that pace to moderate, we still expect 2021 to be another strong year for new issues as companies take advantage of low financing costs and higher stock prices and opportunistically diversify their balance sheets.

High yield prospects also look positive for 2021 because of expectations of improved corporate earnings and stronger economic growth. Improving economies tend to lead to tighter credit spreads, benefiting high yield. Historically, when interest rates rise, high yield tends to outperform investment-grade credit and Treasurys because of its higher coupon and spread cushion.

The equities market has been dominated recently by some investors rotating from growth to value stocks and sectors that might do best in a re-opening. While we see some merit in that rotation, we believe that investors’ long-term focus should be on identifying firms with improving earnings expectations because, in the end, earnings are critical to generating outperformance. Firms that continue to meet or exceed expectations, should continue to outperform.

Investors should also be cautious about judging valuations based merely on price-earnings ratios, because for many companies, such as cruise lines and lodging/hospitality firms, earnings might not revert to trend until 2023. At the same time, investors should also take account of the interest-rate environment when considering valuations as well as the fact that the latest $1.9 trillion stimulus package is yet to hit the real economy. Until we get through this recovery phase, investors are unlikely to get clarity on the true earnings power of the US economy.

That said, companies’ cash positions are, on average, very healthy, especially those which used extremely low rates to issue fresh debt to shore up their balance sheets. In this light, we believe that conditions are in place for markets to see another wave of acquisitions in 2021 as companies utilize both their stock prices and debt to finance deals.

Overall, the outlook is positive with the tailwinds of improving earnings, massive stimulus and increasing M&A activity. Possible headwinds from inflation and higher interest rates are a risk, but on balance, we expect that investors should be rewarded for taking risk because tailwinds, at least for now, more than offset potential headwinds.

A column by Justin Kass, portfolio manager and managing director at Allianz Global Investors, responsible for the firm’s Income & Growth team