The Fed Insists on Higher Rates for Longer and Aims for Only One Cut In 2024

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Yesterday’s meeting of the U.S. Federal Reserve (Fed) went as expected, with no changes to interest rates yet, but it did convey some clear messages. One of the most relevant was that the Fed sees less need and urgency to ease its monetary policy but still leaves the door open for cuts this year. The key point is that, in the short term, it expects inflation figures higher than anticipated at the beginning of the year, although its long-term projections still show inflation returning to 2%.

“Central bankers delivered a seemingly aggressive surprise at the June FOMC meeting. The updated median projection for the federal funds rate, or dot plot, now indicates a single rate cut by the end of the year, compared to three expected in March. This change of opinion was likely due to a slight improvement in inflation expectations for this year and next,” says Christian Scherrmann, U.S. economist at DWS, regarding his overall view of yesterday’s meeting.

Regarding this change of opinion, Jean Boivin, head of the BlackRock Investment Institute, points out that the Fed has done this several times before, so they don’t give much weight to its new set of projections. “Powell himself said he doesn’t consider it with high confidence, emphasizing the Fed’s data-dependent approach. Regardless of the Fed’s forward guidance, incoming inflation surprises, in any direction, will likely continue to lead to significant revisions in policy expectations,” he explains. Boivin believes that given the lack of clarity from central banks on the path forward, markets have become prone to reacting strongly to individual data points, as we saw again today with the post-CPI jump in the S&P 500 and the sharp drop in 10-year Treasury yields.

For Raphael Olszyna-Marzys, international economist at J. Safra Sarasin Sustainable AM, Powell’s message was very balanced. “Although the dot plot shifted upwards, and most officials do not expect any cuts or only one this year, they are also very aware that maintaining a restrictive policy for too long could unduly harm the labor market and the economy. So far, the labor market is much more balanced, which should allow for a downward trend in inflation,” he argues.

What does this mean?

In the opinion of David Kohl, chief economist at Julius Baer, the updated summary of economic projections suggests that only one rate cut in 2024 and higher rates in the long term are appropriate. “The increase in inflation forecasts and the maintenance of growth expectations confirm the view that the FOMC wants to keep interest rates high for longer. The latest U.S. inflation figures, which were surprisingly low, were well received and increase our confidence that the Fed will cut its benchmark rate at its September meeting. We expect the Fed to pause from then and cut rates once more in December in response to a cooling labor market and easing inflation.”

For Kohl, the appropriate path for the federal funds rate has changed significantly for 2024: “Four FOMC participants do not see the need for rate cuts in 2024, seven advocate for one rate cut, and eight for two rate cuts.” This means, as he explains, that the median projection for 2024 has moved towards one rate cut and a preference for cuts in 2025. “The longer-term rate projection has increased, confirming the view that the FOMC wants to keep interest rates high for longer. The adjustment of the long-term rate path is an important acknowledgment that the U.S. economy is withstanding higher interest rates much better than feared,” says the chief economist at Julius Baer.

This view is also shared by James McCann, deputy chief economist at abrdn. “In reality, the median FOMC member now expects only one rate cut in 2024, compared to the three expected in March. This change in stance is likely due to higher-than-expected price growth in early 2024, which forced FOMC members to revise their inflation forecasts upwards once again. However, yesterday’s lower-than-expected CPI inflation surprise was much more encouraging, and with most members divided between one or two cuts, we wouldn’t be surprised to see the market continue to flirt with the option of multiple rate cuts this year,” adds McCann.

Alman Ahmed, global head of macro and strategic asset allocation at Fidelity International, emphasizes that during the press conference, Chairman Powell stressed the importance of incoming data flow, especially on the inflation front. “We have seen the Fed completely abandon any dependence on forecasts to set its policy, so we continue to expect it to maintain its current data-dependent approach,” he notes.

Forecast on rate cuts

In Ahmed’s opinion, his base case is that there will be no cuts this year, but “if inflation progress continues during the summer months or labor markets begin to show some signs of strain, the likelihood of one increases,” he explains. That said, he adds: “The U.S. economy continues to hold up, and yesterday’s release was affected by vehicle insurance components and airfares, meaning the bar for starting cuts remains high.”

Conversely, from Julius Baer, Kohl points to September, followed by another cut in December, and gradually reducing the official interest rate in 2025 with three more cuts. “The latest U.S. inflation data, which surprised to the downside in May, increase our confidence in a rate cut at the September FOMC meeting, while further cooling of the labor market in the second half of the year should motivate another round of policy easing at the December meeting,” he argues.

According to Scherrmann, more time will be needed for the term “progress” to move from the press conference to the post-meeting statement, where it would serve as a definitive signal for a first rate cut. Meanwhile, he believes the Fed must avoid scenarios like those in the fourth quarter of 2023, when financial conditions experienced unnecessary easing due to rising rate cut expectations. “Given the inconsistencies observed during the June meeting, we conclude that this goal has been successfully achieved for now: markets have discounted slightly less than two cuts in 2024, a slight decrease from pre-meeting expectations. As we connect the dots, we are likely to agree with this assessment,” defends the DWS economist.

Fed vs. ECB

In the opinion of Wolfgang Bauer, manager of the fixed income team at M&G Investments, these days we are witnessing a strange “mirror world” between central banks. “After the ECB cut interest rates and revised up its inflation forecasts last week, the Federal Reserve did exactly the opposite. Just hours after the release of surprisingly low inflation data, the Federal Reserve decided to keep interest rates at current levels and, more importantly, revised up its dot plot, indicating that it would only cut rates once this year. The Federal Reserve’s caution is likely to help the ECB hawks delay further rate cuts for now. Although the economic situation in Europe is different from that in the U.S., it seems unlikely that the ECB will proceed with monetary policy easing while the Federal Reserve remains on hold,” comments Bauer.

From eToro, they believe that this latest update also underscores that the Fed does not feel pressured to lower rates, as other G7 central banks (such as the BoC and ECB) have recently done.

While Europe Changes Course, the Markets Focus on the Key Event of the Week: the Fed Meeting

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The European Parliament elections have yielded three clear conclusions: far-right parties with an anti-establishment nuance have gained influence; a centrist majority persists; and the results have significantly impacted local politics in France and Belgium. The market’s immediate concern, however, remains on the upcoming decisions by the U.S. Federal Reserve.

According to the initial official results published by the European Parliament, far-right political groups have increased their presence. Nevertheless, the European People’s Party (EPP) emerged victorious with 191 seats, followed by the Socialists and Democrats (S&D) with 135 seats, and the Liberals (Renew) with 83 seats. These results have prompted a snap election in France, as President Emmanuel Macron dissolved the National Assembly and called for legislative elections later this month, and the resignation of Belgian Prime Minister Alexander de Croo, both due to their parties’ losses and the rise of more extreme right-wing parties.

According to Gilles Moëc, chief economist at AXA Investment Managers, the results of the European elections were not expected to trigger a significant shift in the EU’s stance. “Although the overall political space of the major parties is shrinking, the European Parliament has a long tradition of cooperation among the main groups – center-right, liberals, and social democrats – which, based on the national results seen so far, will likely maintain a comfortable majority of the seats together. It may be more difficult to reach the necessary compromises, and changes in public opinion will need to be considered, but a radical change of course is not to be expected. However, the decision of the French president to dissolve the National Assembly, the lower house of the French Parliament, in response to the European vote, changes the perspective,” he says.

Regarding Macron’s decision, Lizzy Galbraith, a political economist at abrdn, explained that “while these elections won’t affect Macron’s presidency, they might force him to work with opposition parties in Parliament, complicating his legislative agenda”. Axel Botte of Ostrum AM highlighted the uncertainty in France, questioning whether the far-right RN could secure a majority government, potentially leaving Macron’s centrist party as the viable option.”In any case, these elections are extremely important with a view to the upcoming presidential elections in 2027.”

According to Mabrouk Chetouane, head of global strategy at Natixis IM Solutions, “the economic and financial consequences of this political thunder are already palpable” in France, where the main stock index, the CAC 40, opened with sharp declines, reflecting market operators’ concerns about the visibility of the French economy’s trajectory. “Reform plans could be abruptly halted by the likely formation of a coalition, which would result in a coalition government in a context where the state of public finances leaves no room for maneuver for the future government. France, a pillar of the eurozone, could find itself in a possible deadlock. This would reduce investor visibility, increase national stock market volatility, and raise the cost of debt… A deleterious trio that would temporarily deter foreign investors from French markets,” Chetouane points out.

Where is the Market Looking?

Against this new political backdrop, the markets are currently calm and focused on what they consider to be the key event of the week: the monetary policy meeting of the U.S. Federal Reserve. The crucial question is whether the Fed will announce its first rate cut of the year this Thursday, following the ECB’s rate cut last week.

To understand what the Fed might do, it’s essential to look at the data. “The latest U.S. employment data gave mixed signals. The ratio of job openings to unemployed workers fell to 2019 levels, suggesting a relaxation in labor market tension. However, the strong growth in non-farm payrolls and the 0.5% increase in average hourly earnings for production and non-supervisory workers could indicate wage inflation pressures. This week’s CPI could help clarify whether the U.S. is enjoying a Goldilocks moment of slowing inflation combined with resilient employment or if inflationary pressures persist,” says Ron Temple, head of market strategy at Lazard.

According to Javier Molina, senior market analyst at eToro, following the latest data on the state of the U.S. economy, the Fed faces significant challenges in achieving its 2% inflation target, given the solid performance of the economy and labor market. “At the next Federal Open Market Committee (FOMC) meeting on June 12, it is unlikely that the Fed will change its guidance on future rate cuts given the lack of confidence in the sustainability of the current disinflationary trajectory,” Molina notes.

Meanwhile, Paolo Zanghieri, senior economist at Generali AM, part of the Generali Investments ecosystem, recalls that in recent weeks, members of the Federal Open Market Committee (FOMC) have called for more patience in easing policy, which will likely result in an upward revision of the median appropriate level for the federal funds rate by year-end. “Our baseline scenario remains two rate cuts (in September and December), with a single cut as the second most likely scenario. More important for long-term rates, the FOMC is likely to continue raising its estimate of the long-term neutral interest rate, an indicator of the level at which the easing cycle will stop. The current median of 2.6%, which corresponds to a real rate of 0.6%, is well below what most analysts think: market-based estimates are consistent with a rate above 3%.”

Implications for Investors

According to Reto Cueni, economist at Vontobel, the election results show a strengthening of far-right “anti-system” parties in Europe, but they have not exceeded expectations. This means the centrist majority remains intact in the European Parliament, likely securing more than 55% of the total votes, while green parties across Europe have lost parliamentary seats.

In his view, this has three implications for investors. Firstly, Cueni notes that this centrist majority provides stability in a Europe facing high geopolitical uncertainty. “For now, this is positive news for investors. However, in the coming weeks, it will be seen if the centrist parties can work together and elect a centrist president of the European Commission for the new five-year term,” he asserts.

Secondly, Cueni believes that the shift towards right-wing “anti-system” parties, which politically oppose the “Green New Deal” and prioritize national security and border control, demonstrates a change in Europe’s political focus. “Investors need to pay attention to the presentation of the programs of the candidates for the next EU presidency, scheduled for mid-July, to understand the parties’ agendas and the political momentum in Europe,” he advises.

Lastly, Cueni adds that the early parliamentary elections in France will increase uncertainty about the political course of Europe’s second-largest economy. Given that the country’s political system makes foreign and defense policy largely a presidential prerogative, “the uncertainty about France’s future cooperation in Europe and geopolitically remains controlled, at least until the spring of 2027, when the next French presidential elections are scheduled.”

Views on the European Elections

Experts from investment firms had already warned that there could be a greater presence of the far right, as some polls had predicted. Nicolas Wylenzek, a macroeconomic strategist at Wellington Management, noted before the elections that these could accelerate a shift in the EU’s political priorities, which could have potentially significant implications for European equities. However, he clarified that this adjustment would depend on several factors, such as the composition of the European Commission, changes in the political landscape of member states, and international events like the war in Ukraine and the U.S. elections.

“While a reduction in administrative burden could be clearly positive for EU companies, I consider the overall shift to be marginally negative. Reforms that promote greater integration, such as banking union and capital markets union, would strengthen the resilience of the EU economy and facilitate growth, while allowing and encouraging the immigration of skilled labor could be important to help limit inflation and improve trend growth,” he explained.

Similarly, John Polinski, vice president and fixed income portfolio manager at Federated Hermes, recently pointed out how the 2024 European Parliament elections could result in the first center-right coalition in the EU, with the European People’s Party joining forces with the European Conservatives and Reformists and Identity and Democracy. According to Polinski, this change could moderate environmental and migration policies and alter spending and debt dynamics within the EU. “We believe a political shift to the right will have a moderate effect on European fixed income markets in the short term. But in the longer term, a change could significantly affect the markets, especially concerning cross-border mergers and acquisitions, and industrial, ESG, and fiscal policies,” he asserted.

Lastly, Felipe Villarroel, a manager at TwentyFour AM (a Vontobel boutique), offered a clear reflection on not being swayed by today’s headlines: “In our opinion, the macroeconomic consequences are unlikely to be as significant as some of the headlines following the elections might suggest. While it is very likely that the average MEP will shift to the right, that does not mean that macropolitics will change drastically. Without a doubt, there will be microeconomic consequences for sectors heavily affected by climate policy, for example, if some policies are reversed. But we tend to think that most macroeconomic variables and aggregate company data, such as leverage or default rates, will not change too much as a result of the elections. The most disruptive theoretical macroeconomic impact would be a scenario in which European integration is questioned. Even if the far right achieves a massive victory next week, they will not have nearly enough seats to seriously threaten this. There may be incendiary headlines after the elections, but we believe that from a macro perspective and fixed income portfolio management point of view, the headlines will not translate into facts.”

Securitization of Digital Assets: Exploring the World of Cryptocurrency ETPs

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Cryptocurrency exchange-traded products (ETPs) have recently garnered significant attention and popularity as investors seek exposure to the growing world of digital assets. These innovative investment vehicles provide a more efficient way for retail and institutional investors to gain exposure to cryptocurrencies without the complexities of directly owning and managing digital wallets, highlights an analysis by the fund manager FlexFunds.

What is Cryptocurrency ETP? 

Cryptocurrency ETPs are investment products that track the performance of one or more digital currencies. There are several types of cryptocurrencies ETPs available in the market:

  1. Exchange-Traded Funds (ETFs)
  2. Exchange-Traded Notes (ETNs)
  3. Exchange-Traded Certificates (ETCs)

Each type has its unique structure and characteristics, offering different levels of exposure to the underlying digital assets.

According to the specialized consultancy firm, ETFGI, assets invested in the global ETF industry reached a record $12.71 trillion at the end of the first quarter of 2024, up 9.2% from the end of 2023, when the figure was $11.63 trillion, as shown in the following graph:

Furthermore, when examining exchange-traded products (ETPs) with digital assets as underlying collateral, Fineqia International revealed that assets under management (AUM) at the end of March 2024 reached $94.4 billion, reflecting a cumulative increase of 91% in 2024 compared to the beginning of the year when AUM was $49.5 billion.

From this, it can be inferred that cryptocurrency ETPs show an upward trend as an alternative form of participation in the digital assets market. Asset managers or investors interested in exploring the cryptocurrency market have three main ways to gain market exposure, summarized in the following table:

Cryptocurrency ETPs allow portfolio managers and investors to access the volatility and growth potential of cryptocurrencies without having to subscribe directly to one or more specific currency. One possible way to structure such digital asset ETPs is by the means of asset securitization programs like those offered by FlexFunds. As a leading company in designing investment vehicles, FlexFunds allows for the securitization of any underlying exchange-traded fund in less than half the time and cost of any other alternative in the market, facilitating distribution to global private banking channels and access to international investors.

Here are the advantages and risks that asset managers should consider when opting for a cryptocurrency ETP:

Main Advantages:

  1. Diversification: Cryptocurrency ETPs allow portfolio diversification by gaining exposure to a wide range of digital assets, reducing the concentration risk associated with investing in a single cryptocurrency.
  2. Accessibility: ETPs provide a nimble and effective investment vehicle that can be easily listed on secondary markets.
  3. Liquidity: Unlike direct ownership of digital currencies, ETPs offer liquidity through their listing on regulated exchanges, allowing for buying or selling holdings at market prices during trading hours.
  4. Exposure to different investment strategies: ETPs can replicate the performance of specific cryptocurrencies, while others may focus on specific sectors or themes within the cryptocurrency market. This allows asset managers to tailor their portfolios based on their preferences and market outlook.
  5. Regulatory oversight: Cryptocurrency ETPs are subject to regulatory oversight, which raises compliance standards, offering investors a higher level of protection and transparency compared to other existing alternatives for participating in this type of asset.

Risks and Considerations:

  1. Volatility: The cryptocurrency market is known for its high volatility, and ETPs tracking digital assets are not immune to this, as they reflect the value of the underlying assets.
  2. Regulatory uncertainty: The regulatory landscape surrounding cryptocurrencies is evolving, and changes in regulations can affect the viability and availability of cryptocurrency ETPs.
  3. Tracking error: ETPs aim to replicate the performance of their underlying digital assets, but tracking errors can occur due to various factors such as fees, market conditions, and rebalancing.
  4. Lack of investor protection: Unlike traditional financial markets, cryptocurrency ETPs may not offer the same level of investor protection.
  5. Technological risks: Cryptocurrencies depend on blockchain technology, which is still relatively new and evolving.
  6. Tax implications: The tax treatment of cryptocurrency ETPs can vary depending on the jurisdiction.

The emergence of cryptocurrencies and the subsequent development of exchange-traded products (ETPs) for digital assets have opened a new realm of possibilities for asset managers, investors, companies, and the global financial landscape as a whole. An increasing number of investors are eager to delve into these types of digital assets, especially during bullish periods. This implies that asset and portfolio managers must find ways to offer their clients a means of participating in this market with minimal exposure to inherent risks and volatilities.

An example of utilizing a vehicle that securitizes digital asset ETFs is the recent issuance by FlexFunds for Compass Group, one of the leading independent investment advisors in Latin America. FlexFunds structured its first investment vehicle backed by cryptocurrency ETFs, securitizing assets with a nominal value of $10 million, making it easier and less risky for Compass Group clients to participate in such assets.

If you wish to explore the advantages of digital asset securitization, feel free to contact the experts at FlexFunds at info@flexfunds.com

How can a structured note shape portfolio outcomes

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The outcome of a portfolio is the result of many different aspects, such as commissions, time horizon, asset classes held, among others, and how they align to increase the value of an investment. One of the main determinants of the performance is the strategy that composes the holdings, which is molded by each portfolio manager’s risk appetite, that depending on the capital, goals, and approach, will range from conservative to aggressive, highlights an analysis by the fund manager FlexFunds.

Tracking a portfolio’s performance is a critical and reassuring component of the investment process, enabling investors and asset managers to gauge the efficacy of their strategies.

Typically, conservative portfolio approaches use a 60/40 strategy, which consists of assigning 60% of the value of the total allocations in equities and the remaining 40% in fixed income; the 60/40 model aims to harness the long-term growth potential of stocks while seeking stability via debt instruments.  As reported by the 1st Annual Report of the Asset Securitization  Sector, gathering the input of 80+ asset management companies from more than 15 countries, more than half of the professionals interviewed believe that the 60/40 model will remain relevant. To implement this strategy, investors must buy many different securities (distributed in stocks and bonds) to have a diversified holding base. Nowadays, there is a comprehensive inventory of available securities that are integrated by different asset classes within a single instrument. An example of such securities can be a structured note.

What is a structured note? It is a hybrid financial product that combines features of different vehicles in the form of a debt obligation, and its performance is tied to the returns of these underlying.

Using flexible products that repackage different assets in a single security offers a significant advantage by accomplishing the desired weighting distribution without the need for multiple subscriptions, which ends up decreasing the total account value due to fees and commissions. For instance, FlexFunds’ FlexPortfolio allows structuring actively managed notes with no limitations on rebalancing or allocation. Since the securities that compose this product are not fixed or embedded, its composition can be adjusted by the manager depending on the prevailing market conditions and clients’ (investors) best interests, all these while being able to supervise the portfolio performance given that the notes have a NAV that is frequently distributed.

Despite the objective and weighting that each underlying (whether equity or debt) may have in a portfolio, there are a variety of ways in which a note can be designed, meaning that any financial goal can be pursued; it is up to the investor to decide what focus aligns the most with its desired outcome. The most common arrangements are the following:

  • Offer upside and growth potential.
  • Offer downside protection (hedging).
  • Offer an illiquid asset in the form of a marketable vehicle.
  • Offer periodic payments/disbursements in the form of coupons.

Structured investment targets and how they can make a portfolio more conservative/aggressive:

The preceding graph visually demonstrates how the constitution of a structured security can influence the overall risk-return relationship of an investment allocation, given the nature of its underlying. Equity-like instruments tend to augment portfolio volatility while potentially offering superior returns. Conversely, instruments exhibiting bond-like characteristics can introduce an element of price stability to the allocation.

Every investment process has an expected return for a certain level of risk; considering that we are assessing some of the structured notes’ pros and cons and the impact these may have on a portfolio’s outcome, let’s delve into some of the potential structured notes’ risks.

  1. Limited Liquidity

They may have limited liquidity, making it challenging for investors to sell their notes before the maturity date due to a lack of a secondary market. There may or may not be buyers for the note, and investors may be forced to sell the securities at a discount on what they are worth.

  1. Market Risk

While some offer protection against losses, this safety net has its limits. When the underlying experiences high volatility due to market fluctuations, investors can still experience losses. Linking the note to more speculative positions increase the market risk significantly.

  1. Default

Structured notes can possess a heightened credit exposure compared to alternative options. If the issuer of the note files for bankruptcy, the entire investment could be rendered worthless, regardless of the returns produced by the underlying asset.

Although achieving complete mitigation of all potential structured notes risks, or any other risks associated with individual positions or financial instruments, may be challenging, mitigating at least one may  provide an  edge in the market.

FlexFunds asset securitization program is carried out utilizing Special Purpose Vehicles (SPV), which makes each issuance bankruptcy remote. This SPV framework ensures that the resources contained within the structure are isolated from the originator’s balance sheet, providing financial protection in the case of bankruptcy or default.

Empower your distribution and reach with innovative yet proven solutions. FlexFunds, a recognized fintech leader in the securitization industry, offers a program of global notes that can help you expand your client base while issuing a flexible investment strategy. Explore which of FlexFunds’ tailored solutions better adapt to your specific needs. Contact us today to schedule a meeting at info@flexfunds.com

 

US Deal Activity is Providing Investors with New Opportunities to Deploy Capital

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Pixabay CC0 Public DomainAuthor: Alessandro D'Andrea from Pixabay

U.S. equities maintained their upward trajectory in February as the S&P 500 breached 5,000 for the first time. Building upon January’s momentum, the S&P 500 delivered its best two-month performance to start a year since 2019.

Playing a pivotal role in this sustained performance were several of the mega-cap tech companies often referred to as the “Magnificent 7”, notably Nvidia (NVDA), Amazon (AMZN), and Meta (META). Their earnings were bolstered by tailwinds in artificial intelligence, accelerated growth trajectories, and strategic initiatives aimed at enhancing shareholder value.

While the Federal Reserve is unlikely to raise rates further, the timing and pace of potential rate cuts remain uncertain. Federal Reserve Governor Christopher Waller stated that he would require “at least another couple of months” of data to determine if inflation has sufficiently moderated to justify interest rate reductions. The Fed will persist in monitoring incoming data and progress towards achieving their 2% inflation target. Despite investor eagerness for imminent interest rate cuts, initiating them prematurely could potentially lead to a resurgence of inflation.

The Russell 2000 outperformed the S&P 500 in February, but remains below its all-time high set in November 2021. We anticipate a favorable environment for smaller companies in 2024 as post-peak rates and necessary consolidation in certain industries like media, energy and banking should lead to a more robust year. M&A activity began the year strong, setting the stage for catalysts to emerge within our portfolio of companies.

Merger arbitrage performance in February was bolstered by deals that made significant progress towards completion. Immunogen, a biotechnology company developing targeted therapies to treat cancer, was acquired by Abbvie in February for $31.26 cash per share, or about $9 billion. Shares of Immunogen traded at a 6% discount to deal terms days before the deal closed, reflecting the uncertainty over whether the US FTC would launch a phase 2 antitrust investigation, but the FTC approved the deal and it subsequently closed on February 13.

Deal activity was vibrant in February, giving investors many new opportunities to deploy capital including: Masonite’s $4 billion deal to be acquired by Owens Corning, Catalent’s $16 billion deal to be acquired by Novo Holdings, Cymabay Therapeutics’ $4 billion deal to be acquired by Gilead, and Everbridge’s $2 billion deal to be acquired by Thoma Bravo. Deal activity in 2024 has improved compared to 2023, and attractive spreads on deals have created additional opportunities to generate absolute returns.

February was a relatively good month for the convertibles market. With a few notable exceptions, many companies reported earnings and issued guidance that was better than anticipated moving underlying equities higher. Additionally, there has been a bid for convertibles that will need to be refinanced in the coming year. In some cases, this has been from the issuer themselves, but we have also seen a number trade higher in anticipation of a refinancing round. Issuance has picked up substantially with many companies coming back to our market to refinance these upcoming maturities. This new paper has largely been attractive, offering higher coupons and a greater level of equity sensitivity.

 

Opinion article by Michael Gabelli, managing director at Gabelli & Partners 

Some Positive Takeaways from 2023 for 2024

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Crédito: Michael_Luenen
Pixabay CC0 Public DomainAuthor: Michael_Luenen

What a difference one quarter, let alone one year, can make.  Markets entered 2023 battered and bruised.  A war in Ukraine and a war on inflation threatened to wreck the global economy.  Cracks emerged as a succession of banks (Silicon Valley, Signature, First Republic, Credit Suisse) failed.  In keeping with recent history, Congress took us to the precipice before agreeing to more spending.  Tragically, another front has opened in the battle against the axis of Russia/Iran/China.  Yet, notwithstanding signs of economic deceleration, inflation appears headed south while employment remains steady.  Remarkably, the odds that the Federal Reserve pulls off a soft landing have grown; as Chair Powell noted in his most recent testimony: “so far, so good”.

Merger Arbitrage concluded the year on a strong note as Pfizer successfully completed its acquisition of Seagen (SGEN-NASDAQ) for $43 billion in cash. This followed a comprehensive second request process conducted by the U.S. Federal Trade Commission (FTC). Additionally, Bristol-Myers received U.S. antitrust approval in Phase 1 for its acquisition of the targeted oncology company, Mirati Therapeutics (MRTX-NASDAQ), contributing to a positive antitrust sentiment. Deal spreads, including those for Capri Holdings (CPRI-NYSE), Albertsons (ACI-NYSE), and Amedisys (AMED-NASDAQ) among others, firmed in response. Global M&A activity reached $2.9 trillion, marking a 17% decrease compared to 2022. However, the U.S. market remained robust with $1.4 trillion in announced deals, maintaining a level comparable to 2022.

Worldwide M&A totaled $2.9 trillion in 2023, a decrease of 17% compared to 2022 activity. However, fourth quarter deal making increased 23% sequentially compared to third quarter 2023, an encouraging sign that deal making may be recovering. The US remained a bright spot for deal activity with deal volume of $1.4 trillion, a decline of about 5% and accounting for 47% of worldwide M&A (compared to 42% in 2022.) Energy & Power was the most active sector with deal volume that totalled $502 billion and accounted for 17% of overall value. Industrials, Technology and Healthcare M&A each accounted for 13% of total M&A in 2023. Private Equity acquisitions totalled $566 billion and accounted for 20% of total deal activity. Despite PE deal volume declining 30% compared to 2022, it was still the sixth largest year on record for PE acquisitions.

Reflecting on a volatile year in the convertible market, we have some positive takeaways. Issuance returned to pre-pandemic levels at relatively attractive terms. We expect the pace of issuance to accelerate in 2024 as companies face a maturity wall that must be refinanced. We expect the allure of relatively lower interest rates in convertibles will bring many more companies to our market offering continued asymmetrical return opportunities. Additionally, convertibles that were issued at unattractive terms at market highs in 2021 have generally found bond floor and some offer a compelling yield to maturity. Companies that can have been repurchasing these bonds in an accretive transaction, or refinancing them by issuing converts with a more attractive profile. We expect this trend to continue in 2024 and continue to look for opportunities in this segment of the market.

 

 

Opinion article by Michael Gabelli, managing director at Gabelli & Partners 

Investors lean towards conservative positions: 81.3% of portfolio managers confirm

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2022 will be remembered as a challenging period for financial markets, characterized by the ineffectiveness of traditional strategies and notable losses in global stock indices. Amidst this scenario, portfolio managers were forced to face the sale of positions backed by illiquid assets, highlighting the critical need for adaptability in investment management.

The rapid rise in interest rates in the United States and the Eurozone, driven by the urgency to curb runaway inflation, became a fundamental trigger for financial challenges. Additionally, the threat of recessions in major developed economies and geopolitical uncertainty created a landscape full of uncertainties for portfolio managers.

In this context, the 1st Report of the Asset Securitization Sector, sponsored by FlexFunds, serves as a tool to understand how financial advisors in different regions deal with the complexities of the current financial environment. The report analyzes short-term expectations, challenges in portfolio management, and key trends in the asset securitization sector through a series of questions directed at industry experts from over 80 companies in 15 countries in LATAM, the United States, and Europe.

In situations of uncertainty and volatility, portfolio management must seek the redistribution of financial resources to minimize risks and maximize returns. Portfolio diversification among different assets, sectors, and industries is a traditional strategy, but it is crucial for clients to understand the risks associated with each financial product. A delicate balance between risk and return, along with periodic rebalancing, becomes essential to maintain long-term goals and strategies.

Macroeconomic variables play a fundamental role in investment decision making. Economic growth, interest rates, inflation, the labor market, and government policies directly impact the health and performance of an economy. In this regard, the study conducted in this area has been broken down into four questions:

What variables will have the greatest influence on the markets in the next 12 months?

The results in Figure 1 show that almost half of the respondents believe that the main variables influencing the markets in the coming months will be interest rates and inflation, with interest rates being the primary variable considered by 78% of the sample, followed by inflation at 64.8%. Distrust in financial institutions is a factor considered by 17.6% of respondents.

Thus, the main variables to watch in the coming months are inflation and the evolution of interest rates until the end of their upward cycle.

Considering that uncertainty is an inherent characteristic of financial markets, experts were asked if they believe investors are demanding more conservative positions. 81.3% of respondents believe that their clients are indeed demanding more conservative positions, compared to 14.3% who disagree with this statement, as seen in the following graph:

 

The situation in the financial markets during the year 2022/23, with losses in major indices and returns on stocks, investment funds, and assets, has generated an increase in perceived risk, increasing aversion to it. Both portfolio managers and investors are more inclined to modify their investment strategies to redistribute their portfolios towards more conservative positions.

The 1st Report of the Asset Securitization Sector provides portfolio managers with insights based on the survey results from nearly a hundred industry experts, where their expectations about interest rates and a possible recession in the United States over the next 12 months are also addressed. Download it now to learn their response and the main trends within the sector: Will the 60/40 model continue to be relevant? Which collective investment vehicles will be more used? What is the expected evolution for ETFs? What factors to consider when building a portfolio?

Portfolio Management 2024: What are the top 10 challenges for capital raising and client management?

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Portfolio management faces several complex challenges that require the constant attention of industry professionals. The 1st Annual Report of the Asset Securitization Sector, sponsored by FlexFunds, highlights the top 10 challenges facing portfolio managers when raising capital and acquiring clients.

Raising Capital and Acquiring Clients: A Competitive Battleground

Tightening regulations, which can increase costs and create barriers for new investors, is one of the first complications portfolio managers encounter. Intense competition to attract clients and capital adds to this challenge, especially when differentiation between financial products is minimal.

Lack of understanding on the part of investors and clients about investment strategies and financial products can generate fear and indecision, especially in environments of low returns or lack of liquidity.

However, market uncertainty, arising from volatility or structural factors, stands out as the most problematic factor for acquisition.

FlexFunds’ report studies the main trends in asset management, which included the participation of more than 80 companies from 15 countries in LATAM, the United States, and Europe. This report reveals that 68.1% of participants consider uncertainty the most significant challenge, followed by lack of liquidity (15.4%) and financial system insecurity (12.1%). These factors accounted for 95.6% of the responses.

 

Market volatility undermines investor confidence and increases risk aversion, delaying investment decisions. Overcoming these challenges requires tactics that address uncertainty and improve client understanding of investment strategies.

Difficulties in Client Portfolio Management

According to the FlexFunds’ report, investment portfolio management faces several complex challenges, the top 10 of which stand out:

  1. Client risk tolerance: Each client has a different risk tolerance, requiring careful balance in portfolio composition.
  2. Market volatility: Financial markets are inherently volatile, requiring frequent adjustments to maintain portfolio balance.
  3. Changes in economic conditions: Economic and market conditions impact asset returns, requiring adaptability in investment strategy.
  4. Proper diversification: Achieving optimal diversification can be challenging, requiring in-depth analysis and specialized knowledge.
  5. Asset selection and active management: Identifying strong asset investment strategies and actively managing the portfolio involves constant monitoring and informed decision-making.
  6. Costs and fees: Balancing costs with the quality of services and results is essential to maintaining the client’s net return.
  7. Effective communication: Clear and effective communication is crucial to understanding the client’s changing needs and ensuring trust over time.
  8. Compliance and regulation: Keeping compliant with regulations and ethical standards is essential for asset managers.
  9. Managing client emotions: Handling client emotions during volatility is crucial to avoid impulsive decisions.
  10. Relative performance and expectations: Addressing client expectations and explaining relative performance is vital to maintaining trust.

When industry professionals in more than 15 countries were asked, “What are the main difficulties you face in client portfolio management?” respondents identified reporting (37.4%), back-office (20.9%), front-office (17.6%), the accounting process (11%), and middle-office (7.7%) as the primary challenges in portfolio management.

Dive into a detailed analysis of the difficulties in portfolio management. From risk tolerance to emotional client management, FlexFunds’ 1st Annual Report of the Asset Securitization Sector reveals the daily complexities that portfolio managers face. Discover how industry leaders address market volatility, appropriate diversification, and regulatory challenges.

Download the full report to uncover innovative strategies, practical solutions, and exclusive insights on portfolio management in the competitive financial world 2024. Will the 60/40 model remain relevant? Which collective investment vehicles will be most utilized? What is the expected evolution of ETFs? What factors should be considered when building a portfolio? among others.

More than 50% of asset managers continue to bet on the 60/40 model

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Did the year 2022 destroy the relevance of the 60/40 model? Are portfolio managers willing to implement other options? What alternatives are available in the market for asset managers to facilitate portfolio diversification? According to FlexFunds, a leading company in the design and launch of investment vehicles (ETPs), uncertainty becomes the playing field, and adaptation becomes imperative.

FlexFunds, has taken the initiative to prepare the 1st Report of the Asset Securitization Sector: a study of the main trends of these financial instruments to raise capital in international markets. This report reveals that despite poor results in the last year, more than half of the surveyed asset managers continue to bet on the 60/40 portfolio diversification model (request this full report by sending an email to info@flexfunds.com).

The 60/40 portfolio management model is an asset allocation strategy that involves a 60% weighting of the portfolio in equities and a 40% in fixed-income assets. This approach is commonly used by portfolio managers as a way to diversify risk and ensure a certain level of return in an investment portfolio.

The year 2022 marked a dark milestone for 60/40 portfolios, worsening even the negative returns experienced during the economic crises of 2001 and 2008. Traditional recipes failed, and both the fixed-income and equity markets suffered significant losses. The war in Ukraine and the rapid rise in interest rates in the U.S. and the eurozone created a very complex scenario where the orthodoxy of the price relationship between stocks and bonds was not met.

To the question, “Do you think the 60/40 portfolio composition model worked in the last 12 months?” more than 68% of asset managers and investment experts answered that the 60/40 model did not work, while 15.4% believe it did. However, 16.5% of the sample does not have a clear opinion on the matter. It is worth noting that among those who believe it did not work, almost 75% think it was due to the rise in interest rates, while nearly 10% argue that it was due to the decrease in equities.

Amid the uncertainty, portfolio management becomes a delicate art. Diversification, a cornerstone, was challenged by the lack of correlation between fixed income and equities. Traditional strategies, such as the 60/40 model, faltered, revealing their vulnerability to the changing economic and financial paradigm.

However, despite the majority of respondents agreeing that the 60/40 model did not work, when asked, “Do you think the 60/40 model will remain relevant?” 59% of asset managers and investment experts believe that this strategy will continue to be relevant. This fact highlights two aspects: first, its future application will depend on how the markets and economic conditions evolve, and second, perhaps paradoxically, it contradicts the earlier assertion that most respondents believe it did not work in 2022, yet now there is a majority opinion that it will remain a relevant strategy.

The global trend in portfolio diversification with new asset classes such as real estate, crypto assets, and private equity offers divergent alternatives to the classic 60/40 model in the international market. FlexFunds, through its asset securitization program, provides investment managers with the flexibility to design a portfolio with multiple asset classes and repackage it for distribution through Euroclear to private banking platforms.

How should asset managers adapt? What investment vehicles do investment advisors prefer to diversify their portfolios? What are the industry’s biggest challenges for clients and capital acquisition? Discover all of these key trends and more in the 1st Report of the Asset Securitization Sector by FlexFunds, which gathers the opinions of more than 80 asset managers and investment experts from 15 countries in Latin America, the U.S., and Europe.

Request it by sending an email to: info@flexfunds.com

Securitization: Transforming Assets into Bankable Assets through ETPs

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Kanhaiya Sharma - Unsplash

In the dynamic world of finance, asset securitization has emerged as a valuable bridge to multiple private banking platforms, enabling the conversion of underlying assets into what is known as “bankable assets”. “Bankable assets” can be effectively distributed through various private banking platforms. This process has become even more powerful by incorporating exchange-traded products (ETPs) as key tools for transforming underlying assets into bankable assets, the FlexFunds team explains in an analysis:

Securitization: a path to liquidity

Securitization is a financial process that goes beyond merely converting liquid or illiquid assets into securities. It also uses ETPs as instruments for this transformation. This process can become quite complex, but thanks to FlexFunds’ solutions, it can be carried out in an agile, straightforward, and cost-effective manner.

FlexFunds’ securitization program is crucial in facilitating access to multiple private banking platforms by designing and launching investment vehicles, similar to traditional funds, that enable strategy management and global distribution to international investors.

Securitization for multiple asset classes

One of the most notable advantages of securitization is its flexibility. It is not limited to a specific class of asset, which means both liquid and illiquid assets can be securitized. Most importantly, private banking treats these operations as debt, streamlining the process of registering a FlexFunds ETP compared to the complex and lengthy verification procedures associated with traditional funds.

Advantages of the asset securitization process

Asset securitization offers multiple advantages that make it attractive to both financial advisors and investors:

  1. Improved liquidity and access to alternative sources of financing: Securitization converts illiquid assets into tradable securities, providing financial institutions with additional liquidity and access to alternative sources of financing.
  2. Customization of securitized assets: It allows institutions to structure securitized securities according to investors’ preferences and needs.
  3. Diversification of investments: Securitized securities can be backed by various types of assets, enabling investors to diversify their portfolios and reduce exposure to specific risks.

How are assets converted into Bankable Assets?

The process of converting assets into bankable assets through an ETP is relatively straightforward for FlexFunds’ clients. In five simple steps, they can bring their ETP to market, facilitating access to investors in the global capital markets:

  1. Design the investment strategy for your ETP.
  2. Sign the Engagement Letter.
  3. Conduct Due Diligence.
  4. Create the ETP.
  5. Issue the ETP.

Once this process is completed, advisors can market the product, which combines a series of assets into a single investment vehicle, simplifying the investment process for their clients.

The Role of ETPs in Modern Finance

ETPs are exchange-traded products that track the performance of underlying assets, such as indices or other financial instruments. They trade on exchanges similarly to stocks, which means their prices can fluctuate throughout the day. However, these prices fluctuate based on changes in the underlying assets.

Since the launch of the first ETF in 1993, these funds and other ETPs have grown significantly in size and popularity. According to ETFGI data, as of the end of July 2023, ETFs in the United States reached a record of $7.6 trillion in assets under management (AUM). Their low-cost structure has contributed greatly to their popularity, attracting assets away from actively managed funds, which typically have higher costs.

By the end of July, the U.S. ETF industry had 3,180 products totaling $7.6 trillion in assets, from 289 providers listed on three exchanges.

Trends Toward 2027

According to a report by Oliver Wyman, Exchange-Traded Funds (ETFs) are projected to account for 24% of total fund assets by 2027, up from the current 17%. As of December 2022, total ETF assets under management in the U.S. and Europe reached $6.7 trillion, experiencing steady growth with a compound annual growth rate (CAGR) of approximately 15% since 2010. This growth is nearly three times faster than that observed in traditional mutual funds.

Despite various trends, such as increased demand from retail investors, tax and cost advantages, favorable regulation, growing demand for thematic ETFs, and direct indexing, positively influencing the growth prospects of ETFs, their launches face various challenges. These challenges include the high costs associated with establishing infrastructure and significant risk of failure. These obstacles have given rise to white-label ETF providers, a relatively novel business model that allows fund providers to bring their strategies to market quickly and efficiently.

Additionally, there is anticipated strong focus on technologies like artificial intelligence and autonomous learning to gain competitive advantages and provide greater value to customers. These trends also open up opportunities for wealth managers to expand their business models, especially concerning non-bankable assets, which represent a significant and growing portion of individuals’ total wealth today.

Asset securitization through ETPs offers innovative financial solutions that enhance liquidity, expand financing options, and enable portfolio customization. These strategies align with future trends in the financial sector, which are moving towards personalized solutions and adopting advanced technologies. FlexFunds stands out as a leader in this transformative industry, providing advisors with unique opportunities in modern finance.

If you wish to explore the benefits of asset securitization in greater depth, do not hesitate to contact our experts at info@flexfunds.com