Janus Henderson, Thornburg, Vontobel, GAM, RWC, AXA IM, Schroders, Columbia Threadneedle and MFS: are the asset management companies that took part in the fifth edition of the Investment & Golf Summit 2018, organized by Funds Society and held in Miami on the 12th and 13th of April at the Blue Monster golf course, at the Trump National Doral. While golf was the main feature on the second day, throughout the first day the management companies captured all the attention of around 80 fund selectors, financial advisers, private bankers, and professionals involved in making investment decisions for non US resident clients who attended the conferences.
On Thursday, the management companies presented their best ideas for a more volatile environment in which all eyes are on US inflation and the pace of rate hikes by the Fed; a context in which profitability can be obtained with strategies, in equities (global, European, emerging…), in fixed income (dynamic high yield, convertible bonds, MBS, emerging debt…) and in multi-assets. In equities, the ideas came from Janus Henderson, Columbia Threadneedle Investments, and Thornburg, with their respective strategies in Chinese stock market, small caps, and global stock market.
In emerging equities, Charlie Awdry, manager of Janus Henderson, reviewed what investors can expect in 2018 and where he believes the best opportunities in Chinese equities are. The manager was critical of the elimination of the two term presidential limit -which reduces the distinction between the Communist Party and the State-, but stressed that, in politics, not everything is negative in that country, pointing to President Xi’s focus in reducing inequality and financial risks, and mainly, reforms (both socially and economically, which will lead to greater consolidation in some of the country’s heavy industries). And above all, he explained that the reforms in the SOEs (the companies in which the State has a participation greater than 50%) will be positive for shareholders: “The reforms in the SOEs will begin to stimulate better decisions of capital allocation, including greater dividends.”
The asset manager also pointed out how the country has gone from having a focus on growth, to shifting its focus to reforms, fighting corruption (improving business efficiency) and, since last year, deleveraging, so that debt will be lower than in the past. And growth also: Awdry talked about shorter economic cycles and a current peak, predicting a somewhat lower growth after the summer, but without reaching a hard landing, which will begin to recover by the end of the year. As a positive factor, he pointed to a better relationship between the dollar and the renmimbi, more favorable than in the past, and spoke of three additional risks: trade wars (there will be more friction and competition, which will force greater negotiations with the US), North Korea, and Taiwan.
But, beyond the economic and political context, he pointed out the opportunities offered by some Chinese companies: “Many think that companies are not good, because of their state-owned nature or because of their low quality, but there are very interesting spaces in which to invest,” he said, pointing out the Internet segment, where the country is very innovative. In its fund, its main position is Alibaba, listed in New York, with a high percentage of market share in e-commerce, and the second Tencent, listed in Hong Kong (with data that invites investment, as is the fact that a third of its users spend more than 4 hours a day in the app.). The problem of some securities which represent the new China (technology, health, or consumption) is its price, so that its portfolio is currently divided equally between these segments and the most characteristic of old China (energy, materials, industries , banks or utilities), which are currently cheaper. In fact, the asset manager argued for the great opportunity in the H shares of the country’s banks (and also in some companies held by the state), which he bought in Q2 last year for the improvement in their fundamentals, for their attractive valuations and, tactically, for the annual dividends of 5% -6% which they offer.
Its Chinese equity fund seeks to find the best opportunities in three markets: Hong Kong (where it sees attractive valuations and which occupies two thirds of its portfolio), A-shares (which still offer a discount and represent slightly less than 20% of the portfolio) and Chinese stocks listed in the US. (Now, with less attractive valuations and a peak in the market, which suggests that it is time to sell and is the reason why they have reduced their positions). On the A-shares, the asset manager pointed out the attractiveness of the liberalization of Chinese markets and the potential that MSCI expects to include these shares in emerging stock market indexes soon. As an opportunity, also the fact that investors’ positions are below the 2013 levels. “China is a very interesting bet at the moment, it is a volatile market but there are opportunities. Our strategy is to leave behind the beta and to think more and more about the selection of values and the generation of alpha “, concluded the manager.
Smallcaps Opportunities
Continuing with opportunities in equities, a presentation by Mark Heslop, Small- caps Manager for the European equity team at Columbia Threadneedle Investments and of the Global Smaller Companies strategy -launched four years ago-, focused on the potential of small capitalization companies. History shows that these firms can provide higher returns and faster growth than large-cap companies and the reasons are several: First, the proportion of businesses in which the managers are also the owners of the company is greater in the small-caps segment, which means that, when making investment decisions, they do so with a longer-term horizon. “Many large-caps are managed with a view to the results of the next quarter and do not focus so much on creating value in the medium and long term.” In addition, smaller firms have the “humility and flexibility” to change business if they see opportunities, compared to large ones. “These are the reasons that justify the faster growth of small-caps and I hope this trend continues,” said the manager. As additional reasons for their attractiveness, a greater investment universe, and with higher levels of inefficiency, or lower hedging of these securities, are the factors that represent great opportunities to generate alpha within this segment.
And they also offer attractiveness from a quantitative point of view, risk adjusted profitability: “Some say that small-caps are a high-risk asset, but they are not, and it can be the same as when investing in large-caps. For a little more volatility, you can get double returns,” said the manager, who pointed out that if the returns of large companies at 20 years have been 4.1% with 15.2% volatility, those of small-caps have been 7.7% with a volatility of 17.6%.
The management company’s strategy in this segment is bottom-up and is focused on the quality of the companies, but also on growth (provided that this growth creates value for the shareholder). Due to its investment philosophy, the portfolio has structural underweights and overweights, depending on where they find high quality firms and good growth dynamics: They are overweight in industrials, a good area to find these firms, while on the other hand, it’s difficult to find names with these characteristics in financial or utilities, and in general, in highly regulated segments. By regions, the overweight is for Europe without the United Kingdom.
Beyond the small companies, in the global stock market, Josh Yafa, Director of Client Portfolio Management at Thornburg Investment Management, spoke of the opportunities in the asset, in his case also focusing the investment from a totally bottom-up perspective, although without losing sight of the macroeconomic situation, the analysis on the economic cycle and the valuations. In fact, the manager spoke of a positive economic context, with global PMIs expanding in the Q1 of the year, unemployment rates below the 1990-2017 average and other indicators that show that we are in a period of economic expansion.
On equity valuations, he pointed out that they are slightly below those of the end of 2006 (although above those at the end of 2008), and he stressed one positive factor: the net debt / EBITDA ratio, which, both at the end of 2008 and of 2006 was around 4.7 times, is now 1.8 times, a positive factor. The manager also spoke of a world in which, after the withdrawal of stimuli from the central banks, there will be more differentiation in the markets, which will benefit active managers, and also pointed out the fact that, according to the flows towards funds and ETFs, investors continue to show preference for bonds rather than for shares.
In this environment, Thournburg seeks to differentiate itself from other companies: Based in Santa Fe (New Mexico), it builds high conviction portfolios (its global equity portfolio has 30-40 names). “At Thornburg, we adopted a disciplined approach to the construction of portfolios, guided more by convictions than by conventions. Instead of using reference points as a starting point, we apply flexible and active management to find the best results for our clients,” added Yafa.
With a view focused on income, the entity also presented its global equity strategy that not only seeks capital appreciation but which also invests in firms willing to pay dividends, as well as a third multi-asset strategy, composed of equities – with about 50 names with a dividend yield of 3% – and fixed income (Investment Income Builder), and that it invests globally. “Companies that provide a higher payout ratio also tend to end up offering greater profit growth,” said the expert. The strategy, flexible in terms of geographical exposure and sectors, is positioned above all in segments such as financial and telecommunications companies and has low exposure in highly regulated firms such as utilities.
There are Still Opportunities in Fixed Income
There are still opportunities in fixed income, despite the dynamics of monetary normalization complicating this environment. Management companies such as Vontobel, GAM, AXA IM and Shroders, offered their ideas focused on obtaining income with a global focus, on the value that still exists in US high-yield, in emerging debt, or in the opportunity in the MBS.
Focused on obtaining income, and with its Strategic Income strategy -which aims to provide an attractive income level with capital growth as a second objective-, Mark Holman, CEO and manager of TwentyFour, a boutique of Vontobel AM, presented its strategy, which combines the best sources of income in the global debt segment in an unconstrained and unlevered portfolio, managed independently of the indices, with active management of interest rate and credit risks and focused in relative value and in liquidity. “2018 will be a tough year for fixed income: There is 85% of the market that I do not like but there’s still 15% that I do like,” he said.
If I had to buy a bond today, it would be in credit (not in the public debt area) and, given that the cycle and valuations are mature, it would have to be high-quality and well analyzed, to avoid the risks of default. In addition, it would have a short duration to avoid the risk of interest rates, but not too low, to be able to obtain “roll down” gains. And it would be in the currency of the country of origin, because currently said risk is too high. Such a bond would survive complicated market conditions, summarized the expert. Because this year is a year for caution, and their fund is better positioned to face it (it has a shorter duration than the index, 2.72 compared to almost 7, and a much higher yield, 5.24% as compared to 2.11%).
Within that 15% of the market where the asset manager sees value, by geographies he points out that there are more opportunities outside the US. – “an economy which is close to the end of the cycle” – that within the US, and has strong positions in Europe (29%) and especially in the United Kingdom (more than 30%), where it takes advantage of the Brexit premium. North America occupies 21% of the portfolio and the remaining 18% is mainly in Australian public bonds, “secure, because the country is not in a dynamic of rate increases”. By rating, it’s willing to take credit risk but avoiding the CCC segment, where many defaults are concentrated, and the B, while it’s positioned in the BBB and BB areas, more secure and with good returns. By sectors, it mainly focuses on banks… as the manager sees opportunities mainly in three segments: European CLOs, subordinated bank debt and emerging corporate debt in strong currency (the latter benefited from the coordinated global recovery that began last year). “The banking sector has never been as healthy as it is now, it has more capital than ever before,” he says.
As to what to avoid in 2018, he points out the interest rate risk, the sectors where the ECB focused its purchasing program, European public debt (especially the German Bunds), the British Gilts, the long-term investment grade credit and the CCC segment while it is willing to take credit risk, to take advantage of the “roll down” gains (favoring securities in the part of the curve from 3 to 4 years), stories with rating upside potential and the Brexit premium. In general, his watchword is that it’s a year to face credit risk (the end of the cycle is far away, and 2017 showed a scenario of global financial recovery), but taking care of the valuations (the markets are expensive, although the situation is justified by the fundamental forts, economic recovery and technical support). That is why its strategy is to gradually reduce this risk as the cycle progresses and focus on finding relative value by geographies, sectors and companies.
MBS & ABS Strategy
GAM’s idea in order to take advantage of this environment focuses on mortgage and asset-backed securities (MBS and ABS). Tom Mansley, Investment Director of GAM Investments and specialist in the analysis and management of these securities, argued for how these vehicles can offer a differentiated fixed income proposal for investors. A strategy that arises from the need to respond to two recent problems: One is correlation, because although in recent years the markets have been highly correlated in a positive way, the situation could change: “We are looking for something that provides diversification in the fixed income portfolios “. And the second is the lack of income and liquid income when investing in the asset. In response to these concerns, the entity has built a portfolio that invests in bonds backed by US mortgages, a market that has been growing in emissions in recent years, although with different dynamics depending on whether it is agencies’ MBS – with a majority of issues and considered lower risk -, CMBS or RMBS issued by other entities.
With the strategy which, thanks to their attractive valuations, has been increasing the positions in these latter securities that have no government guarantee, the idea is to offer returns in the mid single-digits, with very low volatility: “It is not an overly exciting market, but in a context in which many financial assets are expensive, we can offer those returns with very low volatility – below the index and also high-yield and correlation,” and always with the idea of making money (in 2013 within the context of the Taper Tantrum, with a downward bonds market, their strategy rose). This low volatility is helped by the fact that investors aren’t retailers, but institutional: According to the expert, pension funds and insurers are very comfortable with the asset, because the credit is “very solid”.
And it’s solid because the real estate market in the US is going through a sweet moment: The ratio of empty houses is already at historically normal levels, around 1.5%; the offer of existing homes for sale is below the average levels (so that in three months all would be sold); the number of houses under construction is also below normal levels (around 500,000); the home ownership ratio is lower than that of the levels prior to the crisis and around the average of the last decades which was 64%… these factors, together with the greater capacity to pay for a home, serve as a basis for an appreciation in the price of it. “The index that compares the average income with the average mortgage payment, and that, taking that income into account, measures ease of payment, shows that current generations can buy a house cheaper than their parents”- by measuring the relationship between price and income-, both because the price is lower and because of the income growth, characteristics which are totally the opposite to those of a few years ago.
Dynamic High-yield
Although some prefer fixed income alternatives, some others continue committed to more classic segments, such as AXA IM, which highlighted the opportunities for investing in high-yield debt from a dynamic perspective. Robert Schumacher, Chief US Strategist and Client Portfolio Manager of Fixed Income at AXA Investment Managers, explained why it’s still a good time to bet on high-yield, dismantling stereotypes that keep some investors out of the assets. “If the argument for not investing in US high yield is that the cycle is coming to an end, you can lose a great opportunity to obtain income,” he said. In the first place, because nobody can know when a cycle is going to last – and it is not clear that it will end soon -, and also because, even if it were true, the work of the managers is, as in other assets, such as variable income, to look for inefficiencies in those environments. “The argument for not investing cannot be that,” he said. Also, in his opinion, “cycles do not die of old age, but due to political errors.”
According to the entity, the moment is still good for the asset, and it can be an attractive alternative for those reluctant to invest in equities but looking for correlated returns with stocks with lower volatility.
The management company’s US high- yield strategy has positions concentrated on names of great conviction, with the selection of credit as the main source of alpha, a volatility in line with the market (but with higher returns) and the possibility of using leverage derived from the use of CDS (up to 150%) -with the objective of improving returns in neutral and bull markets-. However, entity sources explain, it’s not a distressed strategy or a neutral market or negative exposures. Last year, it beat the market thanks to the selection of securities in debt and also to positions in CDS -which are not the main catalysts of returns, but are also a source for achieving them-; it also did so in 2016, despite being underweight in energy and with limited exposure to very cheap commodity issuers whose prices rebounded strongly. Since its launch, it has managed to limit the falls in difficult markets and offer alpha in periods of positive returns.
Also in fixed income, Schroders‘ bet focuses on emerging debt. John Mensack, Senior Investment Manager Emerging Markets for the management company, was very constructive with the asset: “Emerging debt is a main asset class and one in which investors are underinvested,” and which already represents 18% of the market of negotiated bonds. In addition, considering the growth of public debt issues in local currency and corporate bonds in hard currency, traditional indices become obsolete, so that investment in assets “deserves a more sophisticated approach; It’s time to be more sophisticated.” In addition, in seven of the last 10 years, the difference between the returns of the most and least profitable debt segments has been greater than 7%: Hence the importance of looking for a professional who only invests where the value is and moves away from areas that are expensive.
And that is precisely Schroders’ perspective, which combines in its strategy sovereign debt in strong currency, sovereign debt in local currency, and credit in hard currency; the latter is a sector in which it sees great opportunities while being less exposed, for example, than the second one: “Debt in local currency usually offers 100 basis points more profitability than that in hard currency, but now there is only 30 points difference -6.1% against 5.8% -, so it makes no sense to overweight the currency now. There are good stories like South Africa or Indonesia, but when we look at these cases of relative value we tend to underweight the areas that we see more expensive, as is now the case with local currencies.” In fact, less than a third of its portfolio is exposed to sovereign debt in local currency (27%), while the rest is debt in hard currency – corporate debt weighs 28% and public debt in hard currency, 40% -. In any case, the idea is to have around one third of the portfolio in local currency, which works better than the 50/50 strategies.
The opposite occurs with corporate debt in hard currency, where it sees opportunities, with more than double the returns for the same level of risk in duration as US credit, and focusing on “great national champions,” that can achieve rating increases and that are mainly in the investment grade segment. In general, Schroders’ fund positions are low in interest rate risk, it’s overweight in credit risk -because countries are doing well and credit is improving- and underweight in currency risk due to low differentials (and high valuations) of the debt in local currency).
All in a strategy that offers greater diversification (thanks to lower volatility and a greater set of opportunities), a better opportunity to obtain income globally with good credit quality and low correlation with US Treasury bonds, which reduces the interest rate risk (specifically, 24% correlation, so that the Fed rate hikes will not condition the portfolio). On the dollar, the expert argued that, at the current level or lower – something that could happen, in his opinion, due to the deterioration of some US data, which will cause investors to look for opportunities in other markets, such as emerging markets-, would be positive for their strategy. “During the period of Taper Tantrum the dollar rose a lot but that reality has already been left behind and we believe in its moderate weakening,” Mensack added.
The Opportunity in Convertibles
Halfway between fixed and variable income, convertibles are also a good idea in this environment, according to RWC. Davide Basile, Head of the Convertible Bond Strategy team and Manager of RWC Partners, explained the benefits of the asset, capable of capturing a large part of the increases in equities (with between half and a third of its volatility) and offering bearish protection at the same time. “At present, a strange world is combined with global growth, and convertibles offer the best of both worlds: An appreciation when there are increases in the markets with the security of a bond”, commented sources from the management company, with a focus on understanding both the credit part and the equity of the asset, “understanding each name, the different components, how they move…”
“The asset has an additional ally in this environment: The increase in volatility. Thus, since the end of 2016 and during 2017, and due to the low volatility, convertibles have participated less in the rise of equities, but that could change. “When the volatility is higher, they also participate more in equity returns thanks to the exposure to optionality, so in these scenarios they tend to do better, as compared to shares”, explained the experts. And a more volatile environment also favors the issue of convertibles.
Due to their characteristics, experts recommend this asset, rather than as a substitute for shares, as an alternative to a debt market with already tight spreads – and with less potential for narrowing – and the risk of raising interest rates. In this segment, they would be a “good place for diversification, since they tend to have shorter durations” and protect them from these increases. “A few years ago convertibles offered lower returns than corporate debt, which can be explained by the cost of the option, but now the level of income they offer is comparable, so if you are comfortable with the characteristics of the convertibles, they could serve as substitutes for fixed income, in order to obtain a similar income level”. Even in a multi-active portfolio, its introduction does not usually involve surprises in terms of volatility, and provides diversification benefits.
Multi-asset: The Necessary Diversification
What all the experts agree on is that the environment makes portfolio diversification necessary, something that multi-asset strategies undoubtedly achieve. During this event, MFS was the management company that presented a strategy of this type to achieve diversification and a better performance adjusted to risk, in an environment of lower rates and in which, in order to achieve the same results as 20 years ago, greater diversification and taking more risk is required. The management company’s strategy has a historical allocation of approximately 60% in shares and 40% in fixed income, which facilitates the work of the managers, explained Gary C. Hampton, CFA, Product Specialist of MFS Investment Management. “The combination of stocks and bonds in a multi-asset portfolio offers investors diversification and the opportunity to achieve better risk-adjusted performance,” he explained.
Thus, the equity part focuses on investing in global companies and large businesses, selected from a value perspective (they must be global businesses, sustainable for years, generating cash flows, with strong balance sheets and that are well managed by good equipment, also with attractive valuations). Thus, their perspective of looking for high quality firms with attractive valuations is clearly differentiated from the so-called “deep value” managers, which look for highly undervalued firms, but which could belong to industries in difficult situations or have problems that justify those low prices.
In fixed income, the fund uses a top-down approach in the process of selecting countries and currencies, generally investing in investment-grade debt. “The correlation between high- yield and shares in bear markets is very high, so we think that the mix of equities with investment grade debt is a better mix for times of correction,” explained Hampton, recalling that in 2008, when the market fell by 40%, the fund only fell 15%. This perspective tends to cause overweight positions in the variable income sector and in sectors such as basic consumption, and underweight in technology, while in fixed income corporate credit is overweight and, for example, US public debt is underweight.
The management company also presented its MFS Meridian Funds-Prudent Capital Fund, with an exposure to global equities of between 50% and 90%, global credit of between 10% and 30% and up to 40% in liquidity, a concentrated portfolio in which preserving capital is key.
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