CC-BY-SA-2.0, FlickrPhoto: 401 K. Have Quality Companies Become Too Expensive?
We often stress the fact that our investment methodology leads us to focus on high-quality companies. We define these as companies with a very sound balance sheet and specific competitive advantages that enable them to stand out from the competition and generate a higher profitability. In turn, this higher profitability translates into the generation of substantial free cash flow and consequently a strong self-financing capacity and a low debt ratio.
Among such quality companies, those which operate in low-cyclical sectors have been particularly popular with investors in recent months, even years. The time has now come to question whether these quality defensive companies (Nestlé, Reckitt Benckiser, Unilever, for example) may have become too expensive.
First the comment. The level of interest rates plays a significant role in any valuation model. The answer to the question of whether quality defensives have become too expensive will depend to a large extent on the assumptions used, especially with regard to the rate used to discount future earnings/dividends and the cost of equity. Clearly, with a very low discount rate (on the basis that interest rates are very low), practically any price can be justified. This is why equity valuation models – like the one used by the Federal Reserve which compares the earnings yield of equities (through the earnings/price ratio, the inverse of the price/earnings ratio) to the yield on 10-year government bonds – always reach the conclusion that equities are undervalued compared to bonds. This is not surprising when the yield on the US 10-year Treasury note is around 1.5%. The comparison between equities and bonds is even more favourable for European equities, which offer a higher earnings yield (are trading at a lower price/earnings ratio) and face even less competition from bonds which have near-zero yields. But obviously, the lower the interest rate used in the valuation model, the smaller the margin of safety will be and the more the investment will be at risk in the event of interest rates rising.
Now the observations.
1.- Using a discount rate that would have been considered appropriate in the past, before the central banks started to manipulate interest rates, e.g. a rate of around 9%, you come to the conclusion that defensive companies are in fact relatively expensive, although their valuation cannot be described as exorbitant. But more importantly, compared to the rest of the market, they are not more expensive than in the past. The outperformance of their share price reflects the outperformance of their earnings, in other words much better earnings growth (note that this is the case for quality defensive stocks as a whole. Some of these stocks have certainly seen an increase in their premium over the market. For others, their earnings growth is largely due to buying back their own shares, purchases often financed through debt). The following graph shows the price/earnings ratio of these stocks in relation to the market. It can be seen that the premium these companies are enjoying (in terms of the P/E ratio) remains in a range similar to that of the past. And it could be argued that in the current context, dogged by numerous economic and financial uncertainties, these companies should trade at a higher premium given that they are the main beneficiaries of low interest rates.
2. However, let us suppose that an investor who holds these companies in the portfolio decides to sell them because they are expensive. Then comes the question of redeploying the newly released funds. Currently the return on fixed-income investments (cash and bonds) does not compensatethe risk incurred. The investor could obviously decide to stay in cash and wait for a sharp price correction in these quality names. However, experience shows that this is a very chancy approach. Alternatively, our investor could buy shares whose valuation seems more attractive. But where to find that kind of share? In recent years, equities have generally become more expensive (at least in the developed countries). Although quality stocks are more expensive than the market as a whole (and quite rightly so), we have already noted that their premium over the market has not increased. And companies whose valuation at first sight seems more attractive are often in sectors that are seriously at risk in the current context, examples being banking or highly cyclical stocks. To invest in these sectors you need to have a confidence in the global economic outlook and the financial system that wedo not currently have.
3. As already noted, the current valuation of quality defensive stocks is high but not yet exorbitant. The corollary of this is that their expected return is lower than in the past but still reasonable, especially in a low-interest-rate context. As the price paid determines the return, it would be naive to think that when you are paying more for these companies than in the past, you could get the same return as in the past. So we need to lower our return expectations on quality companies. If their valuation goes on rising, there will even come a moment when the expected return becomes so low that investing in them no longer makes sense. But that moment has not yet come.
Guy Wagner is Chief Economist and Managing Director at Banque de Luxembourg Investments.
Andrea Di Nisio, photo: LinkedIn. Andrea Di Nisio Joins Unigestion as Head of Southern Europe Intermediaries
Unigestion, the boutique asset manager with scale announces three senior hires to its newly formed intermediary team. The team will initially have five members and Unigestion plans to grow this further as the firm increases its presence in intermediary markets. Their initial focus will be making Unigestion’s institutional investment expertise available to intermediaries in the Southern Europe, UK, Nordics, Switzerland and the US.
Simone Gallo joins Unigestion as Head of Intermediary Distribution. Simone will have responsibility for building the global intermediary channels focusing on wealth managers, multi-managers and sub-advisory mandates. Simone joins from Pictet Asset Management where spent six years as Senior Vice President in the Global Clients Group. Before this he was Executive Director at Goldman Sachs Asset Management in charge of the sales relationships across global accounts in EMEA. He started his career with Schroders Investment Management in 2001.
Andrea Di Nisio joins as Head of Southern Europe Intermediaries. Andrea’s main focus will be to build Unigestion’s presence in intermediary channels in Spain, Italy and Portugal. Andrea joins Unigestion from Dalton Strategic Partnership where from 2009 to 2016 he was the Partner responsible for promoting the firm and its funds to intermediaries across Southern Europe. Andrea started his career in 1998 at Schroders Italia in Milan and in 2001 joined the international team of Schroder & Co in London. He then moved to Cazenove Capital Management as a Fund Director responsible for wealth management and fund distribution in Southern Europe.
Lloyd Reynolds joins Unigestion as Head of Nordic and UK Intermediaries. Lloyd will lead the expansion in these markets, leveraging Unigestion’s institutional presence. Lloyd brings over 20 years of experience in distribution across Europe and Asia. Most recently he was with North Hill Capital. Prior to this Lloyd has held various international leadership roles for Goldman Sachs Asset Management, JP Morgan, Schroders Private Bank and Flemings.
Tom Leavitt, Managing Director at Unigestion commented: “It is exciting to have Simone, Andrea and Lloyd on board bringing their collective knowledge of the international intermediary markets. They will help us extend access to our strategies through these markets, sharing the benefits of our institutional quality strategies to fund selectors looking to grow and protect the assets of their clients through multi assets, liquid alternative and equity solutions. We welcome them all very warmly to the team.”
CC-BY-SA-2.0, FlickrPhoto: Juan Antonio F. Segal
. JP Morgan Creates a New Wealth Management and Investment Solutions Unit
JP Morgan Chase has created a new unit that combines the firm’s wealth management business across Asset Management and Consumer & Community Banking. The Wealth Management & Investment Solutions unit will be lead by Barry Sommers and Brian Carlin, who will report to Asset Management CEO Mary Callahan Erdoes.
According to a memo by Erdoes, that Funds Society had access to, Sommers will become CEO of Wealth Management, responsible for JP Morgan’s client business: Chase Wealth Management, the Private Bank and J.P. Morgan Securities. While Carlin will become CEO of Investment and Banking Solutions, responsible for all wealth management products, services and platforms, including investments, lending, banking, technology and operations. In addition, he will oversee the Digital Wealth Management and Institutional Wealth Management Business.
“Barry and Brian bring a tremendous amount of experience and horsepower to our business and are ideal leaders to partner. They’ve worked together for years, and bring complementary experiences and backgrounds.” Erdoes wrote of the appointment.
Of Sommers she said: “Barry has worked in both Consumer & Community banking and Asset Management, and knows our investment business and branch network as well as any leader in the firm. As Consumer Bank CEO, Barry delivered record investments and outpaced the industry in deposit growth for four straight years.”
While for Carlin, she stated: “Brian has worked in Asset Management for 15 years, including the past three years as our Chief Financial Officer. Prior to that, he ran Products and Investments in the Private Bank, where he led the development of Private Bank and Chase Wealth Management investment solutions. He also built the Private Bank’s mortages, deposits & custody, and trusts & estates offerings.”
“Beyond their capabilities, Barry and Brian represent the best of our values and leadership. They think client first, are culture carriers and excel at running business end-to-end. We have complete confidence that they will continue our track record of success.” Erdoes concluded.
CC-BY-SA-2.0, FlickrPhoto: Michael Gil
. Luxembourg Launches First Green Exchange in the World
The Luxembourg Stock Exchange (LuxSE) becomes the first stock exchange globally to introduce a platform for green financial instruments: Branded Luxembourg Green Exchange (LGX). Access is limited to issuers who comply with stringent eligibility criteria. The platform aims to set a new benchmark for the rapidly evolving green securities market.
Commenting on the launch of LGX, Robert Scharfe, CEO of LuxSE, said: “New issuance of green securities has taken off since COP21. There is a real desire for change. The green market has enormous potential but this needs to be matched by interest from investors. By setting strict standards for green securities, LGX aims to create an environment where the market can prosper. The upcoming COP22 event will focus on preparations for the Paris Agreement to enter into force. With LGX, a dedicated platform for both issuers and investors, we are granting the solution for financing green projects.”
Only 100% green
LGX gathers issuers that dedicate 100% of the raised funding to green investments. It is home to the majority of the 114 green bonds listed on LuxSE, worth over $45 billion. LGX marks the first time that a stock exchange requires green securities to adhere to strict eligibility criteria, including:
Self-labelling as green or equivalent (e.g. climate-aligned). The issuer has to clearly state, during the application process, the intended green nature of the security.
Use of proceeds. Need of a clear disclosure that the proceeds are exclusively used for financing or refinancing projects that are 100% green, according to the GBP or CBI eligibility taxonomy.
Ex-ante review and ex-post reporting. Issuer’s commitment to provide both independent external review and ex-post reporting – a requirement unprecedented on the market.
“Ex-post reporting is far from being the market standard. The bold decision to introduce it as an entry requirement stems from our ambition to be able to guarantee that securities on LGX are genuinely green. Such reassurance is what investors seek as they increasingly expect issuers to be crystal clear about the use of proceeds,” the CEO added. Access to LGX is banned for securities on the excluded categories list comprising of, but not limited to: nuclear power production; trade in CITES; animal testing for cosmetics and other non-medical products; medical testing on endangered species; fossil fuels. The LGX concept has been developed in line with best practices set out by Climate Bonds Initiative, International Capital Market Association (ICMA) and World Wildlife Fund (WWF). LGX has its own logo – a colour variation of the standard LuxSE trademark. “An issuer who does not meet LGX eligibility criteria can still list on our markets, but the ‘bar is higher’ for entry to LGX. Having said that, we encourage issuers to go further than the minimum requirements and really leverage this platform to create new standards on the quality of communication with investors,” Robert Scharfe added.
Green market is our duty
With over $42 billion in new issuances globally, 2015 was another record year for labelled green bonds. As estimated by the Climate Bonds Initiative, in 2016, the green bonds issuance will reach $100 billion. The already thriving green bonds sector received an additional boost after the COP21 conference in Paris last year during which 195 countries agreed on keeping the rise of global temperature below 2 degrees Celsius. The International Energy Agency estimates that the world needs $1 trillion a year until 2050 to finance a low-emissions transition. The market for green finance is growing fast, and yet it represents an almost invisible fraction of overall capital market funding.
CC-BY-SA-2.0, FlickrPhoto: Jaime Silva. Amundi Creates Dedicated Platform for Real and Alternative Assets
Amundi is launching a single platform bringing together its capabilities in real and alternative assets (AI) in order to become one of the leading alternative asset managers in Europe.
Real estate, private debt, private equity, infrastructure and alternative multi-management are now all part of an integrated business, bringing together 200 investment professionals in origination, structuring and management, responsible for EUR 34bn in assets (as at 30th June 2016). Amundi aims to double its funds under management in real and alternative assets by 2020.
Amundi’s track record in alternative assets includes 40 years’ experience in real estate, a leading position in credit management and a pioneering approach in infrastructure, where it has partnered with EDF. The new business grouping will help Amundi develop these areas of expertise to serve investors’ needs for performance and diversification.
According to a press release, Amundi believes that with low correlation to traditional assets, AI strategies have an illiquidity premium which is attractive as we face long- term low interest rates and sustained equity volatility. 38% of institutional investors envisage reallocating part of their portfolio to private debt, 44% to infrastructure, and 51% to private equity.
Pedro Antonio Arias, Amundi’s Global Head of Real and Alternative Assets, said: “We have been meticulously building our capabilities over recent years by attracting skilled teams from diverse backgrounds. Our aim is to further develop our capabilities based on the EUR 34bn we already manage in this area, and to be a leading European player in real and alternative assets.”
Through this new platform, Amundi will offer institutional and individual investors the opportunity to invest directly in real assets with dedicated solutions or via collective solutions with co- investment or multi-management funds.
Eric Wohleber, Amundi’s Head of Real & Alternative Assets Sales, added: “Amundi’s power, infrastructure and financial strength are all major advantages allowing us to give European and Asian investors transparent, institutional-quality investment solutions in real and alternative assets.”
CC-BY-SA-2.0, FlickrPhoto: Thiago A.. A Matter of Time
Of all the arrows in an investor’s quiver, among the most powerful is time. Yet many asset managers and owners don’t fully grasp how powerful an impact time can have on investment decision-making and outcomes.
As a society, we’re moving at an ever faster pace – in business and in life – taking less time to do things that perhaps should take more. The need for immediacy can be all consuming. And technology certainly feeds that appetite, with its invaluable contribution to speed and efficiency. But technology can distort an investor’s sense of the time needed to allow skill and discipline to play out or manage risk when they have to take more of it. Many believe they are being efficient with their time by measuring numerous data points and reacting to them more quickly. But are they really? With so much information at their fingertips, investors and asset owners need to start distinguishing between check points and decision points.As an industry, we need to think carefully about why time matters to investors. We believe time allows skill, expertise and discipline to have the greatest impact on investment outcomes. It offers a meticulously researched investment thesis a chance to bear fruit. It favors thoughtful decision-making over reactive trading or chasing the latest fleeting trend. If investors are not taking the time to do good research – to identify value, good governance and a sustainable business, they are not investing responsibly.
Perhaps most importantly, time may allow investors to take risks more intentionally and manage them more effectively. In an environment such as we see today — in which investors must take three times the risk they did 20 years ago to earn the same returns — patience is essential. That’s true despite the angst investors might feel when taking on more risk. They need to curb the urge to micro-measure performance and make changes, which offers only a false sense of control at best.
It’s time to step back and help investors understand why, when used properly, time can be a valuable asset in getting to their desired outcome. Ultimately, the conversation isn’t about managing time. It’s about using time to manage wisely.
Carol W. Geremia is President of MFS Institutional Advisors, Inc. Co-Head of Global Distribution.
Photo: MIth, Flickr, Creative Commons. In Spain, A Third Election Could Result in a Fiscal Cliff
Spain has been without a government for almost a year. Moreover, given the current political impasse, there is a rising risk that it might not have one before the end of the year. So far, the economic performance has not been obviously affected, but, according to Fabio Balboni, european economist at HSBC, the fiscal performance has been.
Despite strong growth, the deficit has been broadly in line with the previous year, which at 5.1% of GDP was worryingly high.
“Low inflation and temporary job creation are all behind the disappointing revenue growth and difficulties cutting spending in real terms, but there have also been some tax giveaways. In total, we estimate the fiscal stimulus is adding about 1% to GDP growth this year.”
But the lack of a government might have more serious economic consequences from here. If the 2017 budget cannot be approved by the end of the year, all of the main spending items will be frozen at current levels, including wages and pensions. That would be equal to spending cuts of about 1% of GDP. This might help to reduce the deficit, but it would also have negative consequences for growth. This risk should also provide a strong incentive for the political parties to avoid a third election.
In October, Spain also faces a new round of negotiations with Brussels. The biggest risk is the suspension of the EU’s structural funds, worth about 1% of GDP. But given the anti-austerity mood prevailing in Europe at the moment, and the political situation, we don’t think the European Commission will be too tough. However, once a government is in place, Brussels will want to see more progress made on the deficit reduction.
CC-BY-SA-2.0, FlickrPhoto: 2Tales
. SS&C Acquires Wells Fargo's Global Fund Services Business
Wells Fargo Securities, the investment banking and capital markets business of Wells Fargo & Company, announced that SS&C Technologies Holdings, a global provider of financial services software and software-enabled services, has agreed to acquire its fund administration business, Wells Fargo Global Fund Services (GFS). Pending regulatory approvals, the transaction is expected to close in the fourth quarter. The terms of the transaction were not disclosed.
GFS administers more than $42 billion in alternative assets, covering a wide range of complex strategies traded by global portfolio managers including fixed income, credit, distressed, structured credit, macro, equity, commodities, CDO, CLO, private equity, private debt, real estate and hybrid structures. Wells Fargo’s fund administration business services its clients through its global network of offices in, Hong Kong, London, New York, Minneapolis and Singapore.
“We believe GFS clients will benefit from SS&C’s industry-leading position, proprietary technology and depth of expertise in fund administration,” said Dan Thomas, head of Institutional Investor Services at Wells Fargo Securities. “Wells Fargo Securities will continue to provide financial solutions to our alternative asset manager clients in core areas such as Prime Services, Futures and OTC Clearing and Futures Execution.”
As part of the acquisition, SS&C will acquire GFS’ operations and team members in New York, Minneapolis, Singapore, Hong Kong and the United Kingdom. Wells Fargo will work closely with SS&C to provide GFS clients a seamless experience and continuity of services. Additionally, Wells Fargo will continue to provide access to its suite of financial products and services to GFS clients after closing.
“Wells Fargo’s Global Fund Services is well known for its expertise in administering real estate equity and credit strategies. The acquisition of GFS will create a compelling advantage for our customers as they access and manage sophisticated asset classes,” said Bill Stone, Chairman and Chief Executive Officer, SS&C Technologies. “This transaction will expand our capabilities in the global fund market, reinforcing SS&C at the forefront among fund administration and extending our strong cloud-based platform for future growth.”
“Joining with SS&C will allow us to dramatically accelerate our global growth plans and pace of innovation,” said Chris Kundro, head of GFS. “SS&C’s innovations in cloud, mobility and fund technology are transforming investment management. This acquisition will create even more value for our customers and will benefit employees as they become part of one of the largest and most reputable fund administrators.”
CC-BY-SA-2.0, FlickrPhoto: Images Money
. Standard Life Investments to Reopen the Suspended UK Real Estate Fund
Standard Life Investments has announced its intention to reopen the suspended UK Real Estate Fund (and associated feeder funds) from 12.00 noon on Monday 17 October 2016.
The SLI UK Real Estate Fund was one of a number of funds to suspend trading on 4 July 2016. This decision was taken in order to protect the interests of all investors in the Fund following an unprecedented level of redemptions.
They subsequently implemented a controlled and structured asset disposal programme in order to raise sufficient liquidity to meet future redemptions and work is ongoing to ensure the Fund is well positioned for markets in the long-term. “We now believe the commercial real estate market has stabilised and that the adequate level of liquidity achieved will allow the suspension to be lifted.” Standard Life stated on a press release.
By lifting the suspension, dealing in the Fund and Feeder Funds, purchases and redemptions of shares, will return to normal on 17 October 2016, with the first valuation point being 12.00 noon on that date. Dealing instructions to purchase or redeem shares will be accepted from Wednesday 28 September 2016, in a written or faxed format only, ahead of the fund re-opening.
Providing advanced notice will enable investors in the fund to make any preparations required ahead of the re-opening.
David Paine, Head of Real Estate at Standard Life investments said: “In the immediate aftermath of the EU referendum result redemptions from retail investor property funds increased dramatically whilst property transactions reduced significantly. During the period of suspension the fund has been able to restore liquidity through an orderly disposal of assets. We are pleased with the progress made and the removal of the Market Value Adjustment, and able to announce the reopening of the fund next month. The Standard Life Investments UK Real Estate Fund invests in a diverse mix of prime commercial property. Its lower risk positioning should therefore be beneficial for performance at times of market stress and uncertainty and continues to offer a stable and secure income, with a distribution yield of 4.04%*. In our opinion, as the search for yield intensifies within a world of low interest rates and nominal growth, the outlook for UK commercial real estate returns and income remains attractive.”
With central banks across the world attempting to hit their inflation targets, the Bank of Japan (BoJ) has adopted a new policy framework named “QQE with yield curve control”.
There are two elements to the new policy. Firstly, instead of the traditional central bank model of setting the short-term rate, the Bank of Japan will now seek to set the rate on the longer-term 10-year part of the curve too (they will target a yield of around 0% at the front-end initially, close to current levels). Secondly, the central bank has committed to keeping the policy in place until inflation has overshot the inflation target of 2%. It has abandoned the explicit target of expanding the monetary base by ¥80 trillion each year, but instead says it will adopt a flexible approach.
The policy is designed to shift inflation expectations, keep banks profitable via a steeper yield curve and seek to address the issue of Japanese government bond scarcity. While Governor Haruhiko Kuroda has delivered a policy that helps banks, we doubt it is going to lead to a rapid adjustment in inflation expectations – it is more a case of adopting a policy that enables the BoJ to stay in the game for longer as it hopes the policy will require fewer bond purchases. The central bank itself admits that “a further rise in inflationary expectations is uncertain”.
The BoJ is trying to keep policy loose while mitigating the negative side effects of excessive asset purchases.
What does this mean?
This is tapering but with asset purchases no longer the independent variable in the policy mix. The global pool of liquidity is unlikely to keep on increasing at the current pace so the ‘hunt for yield’ trade looks less attractive. The BoJ announcement that it will target the 10-year should suppress local yield curve volatility, but could lead to volatility in other markets and asset classes.
The yen Japanese banks finished up over 7%, while the yen is 0.4% weaker vs. the US dollar (it had been 1% weaker)*. Moves in other bond markets have been muted.
Nicholas Wall is co-manager of Old Mutual Global Strategic Bond Fund.
