Photo: Robert Huffstutter. China's Next Gen Consumers
The “Post-90s” generation, comprising those born in the 1990s, has emerged as China’s newest generation of consumers. Representing 15% of the total population and now in their 20s or entering their 20s, this segment of China’s young are embarking on their first jobs and even starting families of their own. While they do not yet have the purchasing power of older generations, they have already influenced how brands approach product development and marketing.
This generation was born amid the restrictions of China’s one child policy, which in many cases means that they have had a fairly comfortable upbringing, and did not have to split family resources with siblings. They were also raised among a macroeconomic backdrop of rapid GDP growth and wage increase. As a result, compared to China’s older generations, the Post-90s children tend to feel more optimistic about their futures and less inclined to save. In fact, they have often been described as “happy and confident spenders.”
The Post-90s generation also grew up with the Internet. While this is not unique to China, what is different is that as Chinese consumers they simultaneously witnessed an explosion of new brands. This younger set embraced the opportunity to gather information online and thus, has also become a more sophisticated group of consumers; often, they can look beyond a brand to make a more holistic decision, using online resources and reviews, to inform their purchases, considering features, quality and prices.
Express individuality
Most interestingly, the Post-90s group seizes opportunity to express their individuality. They view each product as an extension of their personal identity and a chance for self-expression. They are interested in the personality of a brand and the story behind a product—and consider it even better if they can engage in a dialogue with the brand or collaborate in the development of the product.
Some brands are ahead of the curve in understanding and appealing to this generation. For example, the Coca-Cola Company went as far as implementing a successful campaign to replace its iconic brand logos on bottles with online nicknames popular among the Post-90s generation, status updates used in social media, or lyrics from popular songs.
In another notable example, private smartphone manufacturer, Xiaomi, chose a collaborative approach to product development, making a concerted effort to consider and implement user feedback. This philosophy has resonated well with the Post-90s generation of those becoming more engaged and loyal customers, and who feel a connection with a brand and product that is tailored for their needs.
Most firms, however, are still grappling to discover what will resonate with this new generation of consumers. As the Post-90 generation grows to become China’s main consumer base, it will be important for brands to innovate and evolve along the way in order to prosper over the long term.
Opinion column by Hayley Chan, financial Analyst at Matthews Asia.
The views and information discussed represent opinion and an assessment of market conditions at a specific point in time that are subject to change. It should not be relied upon as a recommendation to buy and sell particular securities or markets in general. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. In addition, single-country funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific geographic location. Investing in small- and mid-size companies is more risky than investing in large companies, as they may be more volatile and less liquid than large companies. This document has not been reviewed or approved by any regulatory body.
Photo: BTC Keychain. Bitcoin Users To Approach Five Million by 2019
A new report from Juniper Research has found that the number of active Bitcoin users worldwide will reach 4.7 million by the end of 2019, up from just over 1.3 million last year.
However, the report, ‘The Future of Cryptocurrency: Bitcoin & Altcoin Impact & Opportunities 2015-2019’ argues that usage will be continue to be dominated by exchange trading, with retail adoption largely restricted to relatively niche demographics.
Retail Activity “Extremely Low”
According to the report, while a number of high profile retailers are enabling Bitcoin payment, activity levels from both online and offline deployments are extremely low. As report author Dr Windsor Holden observed, “While average daily transaction volumes have increased by around 50% since March 2014, the indications are that much of this growth results from higher transaction levels by established users rather from any substantial uplift in consumer adoption.”
The report cited a number of factors which it claimed would continue to inhibit growth, most notably the difficulty in communicating the concept of cryptocurrency payments to end users. It also argued that Bitcoin’s historical association with – and continued use by – criminals for illegal purchases and money laundering was likely to act as a further deterrent to mass adoption.
Supply Side Challenge
Meanwhile, the report observed that with many Bitcoins being hoarded by early speculators, currency supply could be further restricted with Bitcoin mining profitability threatened by a combination of the cryptocurrency’s volatility, lower Bitcoin yields and rising electricity costs.
Other findings from the report include:
The introduction of licensed, regulated exchanges could lead to a stabilisation in currency values and with it an increase in retail transaction adoption
The protocols behind cryptocurrency could be deployed in areas such as real-time transactional settlement
The altcoin market continues to be plagued by “pump and dump” currencies created solely as short-term investment vehicles
Photo: Rubén Alexander. India FY 2016 Budget: It’s Not a Sprint, It’s A Marathon
The Union Budget for the fiscal year to March 2016 (FY16) has successfully managed to balance maintaining fiscal discipline and promoting growth by focusing on infrastructure investment and improving the ease of doing business. It confirms our view that policy actions will be incremental and tactical rather than tectonic, aiming to gradually put India’s economy back on track towards a sustainably higher growth rate.
Maintaining fiscal discipline, with some leeway to promote growth
First of all, the government maintained its fiscal deficit target of 4.1% of GDP for FY15, showing its commitment to enforcing fiscal targets. For FY16, the target was cut to 3.9% with an objective of 3% of GDP by FY18, one year later than previously planned.
By doing so, the government aims to balance the need to continue fiscal consolidation and to create leeway to promote growth. It is worth noting that these budget assumptions look better grounded than past assumptions, which makes us more confident that the government can avoid slippage on the targets.
Achieving a higher growth rate is critical for India to ensure its ‘demographic dividend’ – a young population and a low and falling dependency ratio – does not turn into a burden because of insufficient job creation.
A focus on infrastructure investment
To promote growth, the government is focusing on infrastructure investment, financed by the less stringent fiscal deficit target as well as the fall in crude oil prices which should help trim the subsidy burden by 50% to INR 300 billion (USD 4.9 billion).
In total, the government aims to allocate an additional INR 700 billion (USD 11.3 billion) to infrastructure investment in FY16 compared to FY15. It plans to set up a National Investment and Infrastructure Fund (NIIF) with an annual investment of INR 200 billion (USD 3.2 billion). Lastly, it wants to create tax-free infrastructure bonds to fund road, railways and irrigation projects.
Improving ease of doing business, empowering state governments
Also critical to reviving capital expenditure, the government is introducing a ‘plug-and-play’ model, which sets out clear rules for large projects, listing all applicable norms and laws ahead of the bidding process. Companies will not need to continuously ask for permits or clearance as long as they follow the guidance, which should speed up execution and increase the number of projects that get off the ground (and contribute to improving India’s infrastructure). In addition, companies should benefit from a cut in the corporate tax rate from 30% to 25% over the next four years.
Another important step was the decision to transfer more responsibilities to states by increasing their share in tax collections by 9%, in line with the recommendations of the Finance Commission. This marks a paradigm shift in the relationship between the central government and the states, which should promote efficient policy execution at the local level.
Towards a gradual growth recovery
This balanced budget confirms our view that policy actions will be incremental and tactical rather than tectonic. Most importantly, it provides a clear roadmap to build the foundations for a sustainable 7-8% growth in the coming years, which we believe is a positive for long-term investors.
Foto: José María Silveira Neto. Companies Will be Central to Global Growth
Global financial markets have yet to take the consequences of numerous events in 2014 fully on board. Geopolitical risk featured prominently, the rate increase everyone expected in 2014 failed to materialise; instead, rates remained at historic lows while commodity prices collapsed.
Currency movements were behind half of financial market performance in 2014 but there were in fact numerous disparities, notably valuation divergences between cyclicals and non-cyclicals due to investor risk aversion. Against this backdrop, international equities, and value strategies in particular, offer numerous opportunities. But it is vital to adopt a diversified, long term approach.
Accommodating monetary policies (which has ended in the US but is just starting in the Eurozone), are factors benefiting companies which should see marked improvements incompetitiveness. In the Eurozone, where valuations are also very reasonable, the euro depreciation also plays an accelerator effect. US companies should benefit from a recovery of investments, as their levels are still under historical average. Finally the recovery in loan demand suggests that growth isimproving while corporate restructuring efforts should translate into higher margins and cash flow generation.
In this context of a small but sustainable growth recovery, some investment themes should stand out. For example, the global car cycle offers some opportunities. European brands benefit from improved margins and a high creation dynamic while sales of American brands, already at high levels, are supported by an old average age of vehicles. The resumption of credit should greatly benefit banks which are, on the other hand, heavily discounted.
Among other, we currently find value in names like Faurecia, Corning or TUI AG. Faurecia is a French car parts company which is the global leader in seats and interiors. Corning is a US company that makes electronic components. It is the leader in glass substrates used in touch screens (50% market share). The company is also active in environmental materials. TUI AG is a German tour operator created from the merger of two branches that were spun off a few years ago.
Non-cyclical stocks have so far benefited from two positive effects between risk aversion and the investorsearch for returns. The resulting cyclicals stocks discount offer many opportunities to benefit from the growth return in both the United States and Europe.
Christophe Foliot, Lead Portfolio Manager, Head of International Equities and Adeline Salat-Baroux, Portfolio manager International Equity Manager in Edmond de Rothschild AM (France).
CC-BY-SA-2.0, FlickrPhoto: Dinesh Cyanam. Sucessfully Riding the Thematic Reversal
The Lyxor Hedge Fund Index was up +1.7% in February. 10 out of 12 Lyxor Indices ended the month in positive territory, led by the Lyxor Special Situation Index (+5.3%), the Lyxor CTA Short Term Index (+3.5%), the Lyxor Convertible Bond Arbitrage Index (+3.1%).
The gradual stabilization in oil prices, sparks of economic improvements in Eurozone and multiple evidences of central banks efforts all contributed to ease deflation fears. It triggered a broad and rapid rotation in most of the assets and sectors tied to the themes which dominated over the last few months. Recovering risk appetite supported strategies most exposed to risky assets, in particular the Event Driven and the L/S Equity Long Bias funds. Short term CTAs’ models also strongly benefitted from the market trends rapidly emerging. Conversely, L/S Equity Market Neutral and longer term macro funds endured temporary turbulences.
The Lyxor L/S Equity Variable and Long Bias funds were up +0.5 and +2.6% respectively. US funds outperformed and generated the greatest alpha, in particular through their exposure to the energy, financial and healthcare sectors. European focused funds remained cautious. Following a number of false dawns and real scares, they only gradually participated in the rally in Eurozone. Over the month they materially raised their allocation to industrials and mid caps, while taking profits on the consumer sectors and to some extent on financials. These changes were consistent with greater confidence toward the economic dynamic in the region, while taking profits on the oil and QE trades. EM focused funds produced returns in line with their underlying market, flat over the month. By month-end their aggregate exposures displayed a dominant allocation on Asian cyclical sectors.
The Lyxor L/S Equity Market Neutral index was down as much as – 0.9%. The reversal in themes which dominated these last months (the oil scare, the deflation fear and EU de-risking) resulted in a substantial and rapid sector rotation out of the defensive sectors into cyclical stocks. The ones without sector neutrality underperformed the most.
The recovery in Event Driven funds accelerated in February. The drivers that played so severely against the strategy in the second half of last year were powerful contributors to their recovery in February. Merger arbitrage funds were the first ones to rally, primary beneficiaries of resuming investors’ risk appetite. A meaningful deal spread tightening and completion of some operations contributed to the strong returns. An honorable load of new announcements allowed funds to refresh their portfolios.
The Lyxor L/S Credit Arbitrage index was up +1.4%. Most funds were supported by a recovery in global credit markets. Substantial inflows poured back into the space. Easing concerns on deflation and a stabilization in oil prices gave some air to both IG and HY markets – especially in the non-energy segments. Funds focusing on European markets outperformed. They benefitted from the ECB’s QE prospects being priced in periphery spreads. They also extracted alpha out of the Greek situation, though with volatility. The intensifying Fed debate ahead of the March FOMC weighted on EM credit in the early part of the month.
The drivers for the strong performance of the Convertible Arbitrage Strategy were similar. The easing pressure on liquidity, tightening spread and rallying equity markets provided strong tailwinds. The stabilization in oil prices had a strong impact on HY convertibles. Primary markets rebounded after several months of poor activity, positively contributing to the strategy’s return. Funds focusing on Europe also benefitted from the ECB reflation being priced in.
The Lyxor CTA Long Term Index was down -0.2% over the month. The thematic reversal in oil, inflation and growth stances resulted in substantial losses in their fixed income and commodity exposures. These were only partially offset by their long equity positions. A pause in the USD strength also detracted performance. The last week of February saw renewed weakness in oil and yields. This allowed LT models to recoup most of the lost ground.
In contrast, ST models quickly captured the trend reversals unfolding over the month and outperformed not only their long term peers, but all other hedge fund strategies.
Global Macro funds tend to be adversely impacted by turning macro themes. However, they were only marginally unsettled by that of February. A majority of them were adequately positioned for an inflection in yields. Their long equity positions balanced losses recorded in commodities (both in energy and precious metals).
“It’s now time to be selectively directional, in reflation zones especially. Global FX and rates , likely to be the most active playing fields, would also offer appealing trading opportunities.”, says Jean-Marc Stenger, Chief Investment Officer for Alternative Investments at Lyxor AM.
Photo: Evan Bench. Who Do the Markets Really Want to Win 2015 UK General Election?
One of the few certainties in financial life is that political uncertainty will unsettle the currency markets – and the 2015 UK General Election is looking like the toughest to call for decades. Investec foreign exchange trader Demitri Theodosiou offers his take on the potential scenarios for Sterling in the run-up to May 7.
2015 election – more uncertainty, more Sterling volatility?
Now we face, on May 7, the country’s most wide-open election in more than 40 years. If the past is anything to go by, the pound will respond poorly for as long as the outcome remains in doubt. The only way to stabilise Sterling would be for one party to emerge as a clear favourite. But, who do the markets really want to win?, asked Theodosiou.
“The key thing, as we’ve seen is that markets hate uncertainty and tend to sit out political skirmishing with as little exposure as possible. The less clear the view of the future, the antsier traders get”, said Investec foreign exchange trader.
But while the markets don’t really play favourites politically, some outcomes would clearly be more favourably received than other:
Outcome 1: Strong lead for the Conservatives. Big thumbs up from the markets. A likely Tory victory would be certain to have a nice stabilising effect on the pound.
Outcome 2:Strong lead for the Labour Party. Maybe just one thumb up. Markets might well view a future Labour government as rather less pro-business than a Tory one, and perhaps more likely to tax the foreign owners of Sterling assets. Whatever you think of that idea, you could hardly blame overseas investors for reducing their holdings of such assets.
Outcome 3: Polls show potential for Conservative/UKIP coalition. No thumbs. The possibility of the Tories getting into bed with Nigel Farage & Co would be a negative point for investors, at least in the short term, because it could potentially bring forward a referendum on EU membership. Whatever you think of the pros and cons of EU membership, it’d be bound to generate loads of uncertainty – currency market kryptonite.
Back to the future: lessons from 1974
Perhaps the best way to get a feel for what actually might happen this year is to take a quick time-machine trip back to the last election that was as uncertain as this one is promising to be – February 28 1974.
Labour won more seats than the incumbent Conservatives, but no overall majority.The Tories had more votes, however, and spent the weekend of March 2-3 trying to cut a coalition deal with the old Liberal Party. No deal emerged, so Labour took office as a minority administration on Monday March 4.
“And what happened to Sterling, you ask?” From $2.32 at the start of 1974, the pound had dropped to $2.27 by close of trading on March 1. Once the new government was appointed on the Monday, it rallied to $2.28.
“Bear in mind that this minority government was committed to widespread nationalisation and a wealth tax too. All of which just goes to show that, in the currency markets, the key election battleground is never left versus right – but instability versus certainty“, concluded Theodosiou.
Carmignac has announced several promotions within the European Equities, Cross Asset and Fixed Income teams.
Huseyin Yasar has been appointed co-manager of the €420m Carmignac Portfolio Grande Europe fund, alongside Muhammed Yesilhark with whom he has worked since 2011. Yasar joined Carmignac in 2014 as an analyst.
In addition, Malte Heininger has been promoted to co-manager of the €565m Carmignac Euro-Patrimoine and Carmignac Portfolio Euro-Patrimoine funds, equally alongside Muhammed Yesilhark. Heininger has also recently been appointed as manager of the €440m Carmignac Euro-Entrepreneurs and Carmignac Portfolio Euro-Entrepreneurs funds.
Carmignac also confirmed the re-organization of its Cross Asset and Fixed Income teams, with Julien Chéron being appointed co-manager of the €1bn Carmignac Investissement Latitude and Carmignac Portfolio Investissement Latitude funds, which he will manage together with Frédéric Leroux.
For the fixed income team, which is headed by Rose Ouahba, Pierre Verlé has been appointed head of Credit, a position previously held by Keith Ney. Ney will now focus on the management of the €6.5bn Carmignac Sécurité fund which he managed since 2013.
CC-BY-SA-2.0, FlickrPhoto: C.K.Tse
. One Cheer for India: Hip, Hip but no Hooray?
It seems that America, and American investors, are embracing India like never before. President Barack Obama was the chief guest at India’s recent republic day celebrations. The trip was the first such visit by a U.S. president, and an honor that India has typically bestowed on traditional allies. There was a sense of optimism over India’s place in the world, with Indian media headlines optimistic about the seemingly good chemistry between President Obama and Prime Minister Narendra Modi.
Obama’s visit to India capped several good months for India’s new government. The Modi government came to power on a platform of development economics, reflecting the desire of a poor nation to see rapid economic growth rather than a redistribution of wealth. Along the way there were some unanticipated good fortunes; weakening oil prices moderated inflation and provided some leeway to pursue reforms. And India’s stock market seems to have indicated its wholehearted approval.
Optimism regarding India is becoming the norm—look at the International Monetary Fund growth forecasts, for example. The IMF now expects India’s growth rates to begin to exceed those of China sometime between 2017 and 2018. And it is not as if India’s population is particularly old—on the contrary, 29% of its people are under 15 years of age, and a mere 5% is over 65. For China, the comparable percentages are 18% and 9%, respectively.
There is much that India can do to improve just by copying China’s growth, such as building infrastructure. And India can do so with a more entrenched sense of corporate governance and capital markets. China had to destroy a communist system and try to rebuild free markets. India’s task is presumably easier. So, one cheer for India!
But investors would do well just to cool their heels a bit here. Challenges remain. Structural reforms are difficult to push through given well-entrenched existing interests. These roadblocks get magnified in a democracy, particularly in such a large populous country. India’s parliamentary democracy has two bodies—Upper House and Lower House—any legislation needs to be passed by both these houses. In the Upper House, the ruling party is in a minority and hence has been unable to pass through any significant legislation.
And, moreover, it is not as if the market is trading at cheap valuations. The BSE 500 Index’s price-to-earnings ratio* (using the last 12 month’s earnings per share) is at 21x. While this might look only marginally higher than the long-term valuation of 17x, companies in sectors, such as property have underperformed. Several sectors are much more expensive than that reflected by the aggregate market valuation.
Using forecast earnings, the valuations appear much cheaper at 17x. But this is the point. At the moment, India is trading on expectations—expectations of accelerating earnings, expectations of better governance and expectations of faster economic growth. Given heightened expectations, even minor missteps can translate to pain in the stock market.
So, it is not that we don’t see the value of Modi’s proposed reforms or the promise of a young India, freed from the encumbrances of bureaucracy; it is just that these goals have yet to be achieved. One should invest in India only after a sober look at the long term. Beware of chasing price momentum.
Sudarshan Murthy, is research analyst at Matthews Asia.
The views and information discussed represent opinion and an assessment of market conditions at a specific point in time that are subject to change. It should not be relied upon as a recommendation to buy and sell particular securities or markets in general. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. In addition, single-country funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific geographic location. Investing in small- and mid-size companies is more risky than investing in large companies, as they may be more volatile and less liquid than large companies. This document has not been reviewed or approved by any regulatory body.
Photo: John James, Managing Director-Vanguard Australia. Vanguard Names New Managing Director for UK and Europe
John James, Managing Director-Vanguard Australia, and Colin Kelton, principal of Vanguard’s Retail Marketing & Communications group in the United States, have been named to new roles on the leadership team of Vanguard’s International group, reporting directly to James M. Norris, Managing Director, Vanguard International.
James will transition from his current position as Managing Director-Vanguard Australia, assuming responsibility for management, distribution, and operations of Vanguard’s UK and European businesses.
He replaces Thomas M. Rampulla, who after seven years of leading Vanguard’s operations in the United Kingdom and Europe, will return to the US to head Vanguard’s $1trn (€930m) Financial Advisor Services division by mid-year. Rampulla will join Vanguard’s senior executive team and report directly to Vanguard CEO Bill McNabb.
Mr. James joined Vanguard at its US headquarters in 2008 as head of Broker-Dealer Sales and Distribution, and then moved to the International division and was the global business lead for the group’s strategic review of The Vanguard Group’s non US business and distribution efforts. In 2010, Mr. James returned to Australia to lead Vanguard’s Australian operation.
Prior to joining Vanguard, James was the CEO of Australian Football League team Port Adelaide for four years. In addition, he brings more than 15 years of executive leadership experience with prominent Australian financial services companies.
In Australia, Colin Kelton will assume the position of Managing Director-Vanguard Australia, with responsibility for all aspects of management, distribution, and operations of Vanguard’s Australian business.
Kelton started with Vanguard in 1990 as a service associate and has held various positions of increasing responsibility in Vanguard’s Retirement Resource Center, Retail Operations, and Retail Services.
James Norris, Managing Director, Vanguard International, comments: “We are very pleased to retain John on Vanguard’s international leadership team. He is a tenured professional in the investment management industry who will bring his experiences from the US and Australia to benefit our European business and our clients.”
Photo: Damian Gadal. Drilling Into the Oil Price Impact
Over the last six months the oil price has fallen sharply. This has been attributed variously to fracking in the US causing a rise in the supply of hydrocarbon energy, concerns about a slowdown in the Chinese economy leading to weaker demand, high oil prices prompting a structural shift in energy efficiency and resistance by Saudi Arabia within OPEC to cut production to support prices. Whatever the underlying cause, the low oil price has implications for the high yield market, especially in the US where around 18% of high yield issuance in 2014 originated from the energy sector.
Energy positioning within the strategy
In late 2014, we reviewed our positioning in high yield Energy and stress tested our holdings based on a long-term WTI Oil price of $60/bbl. As a result, we exited four energy positions – Sandridge Energy, Energy XXI, Tervita and California Resources Corp (Calres). For the first three we projected potential default scenarios at the end of 2015/early 2016 and, therefore, further downside risk. We decided to exit Calres despite its low cost structure and liquidity because the company is unhedged and results are likely to be volatile in the medium term.
However, it is important not to write off the energy sector entirely. There will be plenty of companies that are able to tolerate the volatility in oil and gas prices and the risk premium that is reflected in their yields can offer an attractive opportunity. That is why we reviewed several higher quality names that were better positioned to withstand a low oil price environment due to a low cost profile, solid balance sheet, significant liquidity and an equity cushion. As a result we have added Chesapeake Energy and Hilcorp Energy as names that have sold off, but also offer downside protection. At 20 February 2015, the yield to worst on these two bonds was respectively 5.0% and 5.8%, with the yields declining (prices rising) since we made the purchases. The table below shows the HY energy weight in the fund.
The plight of oil services
Having lots of debt may stop some capacity exiting as producers operate to earn every dollar of cash they can, hoping for an upturn, but in the process they will try to force down costs. Just as supermarkets squeeze their suppliers, we anticipate oil margins at oil services companies being squeezed by oil explorers and producers that are seeking to cut costs. Daily prices for rigs are already tumbling and many producers are announcing big cuts to capex budgets as they seek to preserve free cash. In anticipation of a difficult near term for this sub-sector, we now hold no oil field equipment and services debt.
Similarities with 1986
Lower oil prices are contributing to lower inflation, which in turn is contributing to lower yields. Some commentators are interpreting this as a signal that the global economy is weak. It is not uncommon for a sharp drop in the oil price to occur without presaging a recession, however, as happened in 1986. This view is shared by Morgan Stanley, the investment bank, which has pointed out that 1986 offers many similarities to today: US credit spreads initially widened, Treasury bond yields fell and the yield curve flattened – the following years would see the economy do reasonably well. The chart below shows the direction of the oil price in 1986 overlaid with today’s oil price movement. If the oil price follows a similar pattern, then it may level out at current levels. Equity markets rose for several more years following 1986 and a strong equity market is usually helpful for the high yield bond market in general in terms of investor sentiment, capacity for M&A activity and IPO activity.
The oil price decline is good news for global growth as it should act as a tax cut for consumers, leading to a shift in wealth from oil-exporting countries to countries with a high propensity to consume. The US and Europe, in particular, should be net beneficiaries. Oil is an important primary input for many products, which together with tumbling transport and energy costs means the positive ripple-through effects on the broader economy are substantial. Spreads on high yield, however, have been dragged wider in response to worries about the energy sector and we believe this has created better value within the high yield market.
Improving flow picture
Higher spreads on high yield bonds come at a time when yields on core government bonds appear to be anchoring at lower levels, a consequence of lower inflation levels together with deliberate policy action by the European Central Bank (ECB) to purchase sovereign bonds. Unlike investment grade markets, the high yield market may not benefit as directly from the “crowding out” effect of the ECB’s quantitative easing program, but the second order effect could be just as large. The first beneficiary will be BB-rated (which is easier for institutions to move down into) but ultimately this will have a knock-on impact on B/CCC pricing. With fund flows starting to pick up, the yield and spread enhancement offered by high yield looks increasingly attractive in a world of negative or low government bond yields. Already, in recent weeks, there has been a shift towards positive flows within both the European and US high yield sectors.
Petrobras event risk
Petrobras, the Brazilian oil and gas giant, has been the subject of an ongoingcorruption investigation, which together with the collapse in the oil price, has led to negative sentiment towards the company and concern about its accounting practices. The company was downgraded to just one notch above investment grade by Moody’s and Fitch, the credit rating agencies, in early February 2015. A company’s credit rating for index purposes reflects the majority view of the big three ratings agencies. With around $50bn of outstanding debt a downgrade to sub-investment grade status could lead to a flood of high yield energy paper onto the market as investors who are restricted from owning non-investment grade bonds are forced to sell. This is all the more reason for our preference for higher quality high yield within the energy sector.
Kevin Loome is Head of US Credit and portfolio manager of the Henderson Horizon Global High Yield Bond Fund.
