Photo: wolfgang11. What Would 2018 Look Like for Private Equity Investors?
2018 is expected to have an increase in global growth and, according to William Charlton, Managing Director at Pavilion Alternatives Group, most institutional investors are maintaining or increasing their allocations to private equity.
While growing economies generally would be beneficial to most private equity fund managers, with the possible exception of distressed managers, Charlton believes that 2018 is shaping up to be a year of challenges as well as opportunities. “The capital deployment issue is one of the known knowns, but as Donald Rumsfeld has argued, the bigger risk may well be from the unknown unknowns.” He states.
In his opinion, the biggest challenge facing the U.S. venture capital market is the IPO environment. “While the IPO market showed some signs of recovery in early 2017, several IPOs were not well received and it remains very difficult to successfully navigate the intricacies of taking a company public.” On a more positive note, he expects the repatriation of large amounts of capital currently held by public companies in off-shore accounts due to the tax reform, a situation he considers could impact positively on an already robust acquisition market.
Meanwhile, in Europe, fundraising activity has increased recently while both deal flow and exits have been declining in the European buyout market, and EBITDA multiples “are up significantly over recent years and are approaching the lofty levels already seen in the United States. If prices remain high and expected economic growth remains bounded, European fund managers will be challenged in 2018 to generate historically attractive private equity returns commensurate with their risk profiles. Furthermore, the uncertainty induced by Brexit adds to the complexity of accurately assessing risk-return exposures across the region.”
In contrast to the mixed measures for both the U.S. and European markets, deal flow, exits, and fundraising are up in Asia-Pacific private equity markets. Given the region’s export-dependent nature, Charlton believes investors focused on it will face the continued challenge of investing in companies that can be successful even in the event of a decrease in global demand.
Regarding oil and considering its prices have enjoyed a steady recovery puting them at a level Charlton believes are attractive investment opportunities, he believes a challenge “is identifying quality private equity fund managers that can consistently generate attractive returns when the underlying value of their assets are highly dependent on a decidedly volatile commodity.” In infrastructure, he believes the biggest challenge will be identifying assets that have the potential to generate attractive returns despite the higher entry prices.
Private credit markets have seen rapid growth in recent years as many institutional investors seek a broader opportunity set to increase returns in their fixed income portfolios. Consequently, private credit is enjoying a strong fundraising market. However, it appears that some fundamentals in private credit markets may be weakening. The increased interest in private credit has led to a decrease in spreads as well as an increase in covenant-lite deals. “If the recent economic recovery does not sustain, we could be seeing the initial phases of a perfect storm in global credit markets. If so, distressed fund managers may be well-positioned to take advantage of current overly lenient terms. The challenge in credit markets for 2018 will be finding fund managers that are able to issue loans with terms that provide some protection in the event of an economic decline.” He concludes.
Pixabay CC0 Public DomainJackmac34. Institutional Investor Journals to Join Pageant Media
Pageant Media, the business information specialist, acquired the Institutional Investor Journals (II Journals), a business which produces in-depth, original and practical research in global investment and finance aimed at professional institutional investors. The portfolio consists of 12 titles, covering various disciplines in portfolio management and has an extensive online archive of almost 10,000 research articles. The Journal of Portfolio Management is the flagship title, recognised as the authoritative practitioner research title.
Pageant Media is one of the financial sector’s fastest growing providers of intelligence and insight. The company, founded in 1998, provides membership services offering senior professionals – across a range of industries, including hedge funds, mutual funds, private equity and real estate – exposure to market leading news and analysis, data and events.
This acquisition provides Pageant Media with synergy opportunities within its existing market-leading products, notably Fundmap, HFM Global and Fund Intelligence, and will increase the company’s reach in the institutional investment space.
Commenting on the announcement, Charlie Kerr, Chief Executive of Pageant Media, said: “The II Journals are recognised across the asset management sector for their excellence in providing senior professional investors and leading academics with informed and thought-provoking technical analysis. We look forward to investing further in these titles and are excited to begin thinking about the ways in which the specialist knowledge exhibited in these journals can bolster the growing information and networking services we provide to our hedge fund, private equity, real estate and mutual fund communities.”
Institutional Investor Journals were previously owned by Euromoney Institutional Investor, with the business located in New York. Staff will join Pageant Media’s New York offices.
Photo: Pxhere CC0. Cooperation Between Fundinfo and UBS Fondcenter for Fund Data Management
UBS and its group company Fondcenter have commissioned fundinfo to procure and source fund data from fund providers and asset managers. In order to provide efficient, legally compliant investment advice, UBS Fondcenter’s external and internal partners require on-demand access to complete, accurate and up-to-date fund information, including MiFID II and PRIIPs data. They also rely on the openfunds standard for fund data that was launched and is being continuously enhanced by UBS Fondcenter, Credit Suisse and Julius Bär.
“Fundinfo has many years of experience in the procurement, validation and distribution of fund information and meets our high quality requirements”, says Christophe Hefti, head UBS Fondcenter at UBS Asset Management. “By partnering with fundinfo, we can concentrate on our core competencies and expand our range of services, including data preparation. At the same time, we are providing fund providers with an experienced partner for high-quality fund data and document management.”
“After working successfully with UBS Fondcenter for many years in the area of fund document management, we are pleased and proud that UBS Fondcenter has now placed their trust in fundinfo to perform their fund data management” says Jan Giller, Head of Sales & Marketing at fundinfo. “It is a privilege and a strong testament to our capabilities that the largest asset manager in Switzerland has chosen to work with fundinfo to procure their fund data”.
Foto cedida. It’s That Time of Year…For Tax Loss Harvesting
December has historically been a very favorable month for the US equity markets. Whether this is due to the big institutional money managers being strongly incentivized to help the market end the year on a positive note, or just from the psychological boost that comes from the holidays, we may never truly know. What we do know is that the last couple of weeks of the year can bring some additional selling pressure on stocks that have had sharp declines during the year. Very simply, this is caused by tax-loss selling, a process where investors that are subject to U.S. tax laws will “harvest” (i.e. sell) positions that have a loss in order to reap a tax benefit. For those holding positions prone to tax loss selling, it can be like rubbing salt in your wounds as your positions that have not fared well this year get dumped right around Christmas time.
This year we may experience an exaggerated version of this effect for several reasons. The main one is that investors are expecting tax reform to be signed, sealed and delivered for 2018. All else being equal, investors would rather sell a losing position now in December where it gives them the most benefit rather than selling a few months later for a lesser reward. The most obvious impact from tax reform is the reduction of the rate for the highest tax bracket. This incentivizes investors to harvest their losses in 2017 while the highest marginal tax rate is still 39.6%. Short term capital gains (those of less than 1 year) in the US are taxed at your personal rate and not the 20% used for long tern gains. The Senate version of tax reform will give the wealthy a bit of a bonus by shaving that maximum personal rate to 38.5%.
Furthermore, one of the features of the proposed tax reform is the elimination of an investor’s ability to select which lot to sell. Currently, if an investor has purchased a stock at several different points in time (creating multiple “lots”), and he wants to then sell a portion of his position he can select which lot is most advantageous from a tax perspective. This usually means selling the lot with the largest loss. The proposed tax reform includes a provision that would disallow that practice and force investors to sell the oldest lot first in a FIFO manner (First In First Out) regardless of the gain or loss which amounts to a backdoor capital gains tax increase. Although we do not yet know if this will make it to the final version of tax reform, investors are very likely to be taking action and selling affected positions before 2018.
With the S&P 500 up 18% this year, most investors are sitting on some hefty gains and to the extent that profits are being taken, the pressure to offset the tax impact increases. However, the selling may not be limited to this year’s losers either. The tech sector has had a massive gain this year and could cause some institutional funds to do a bit of portfolio rebalancing before yearend. This may even lead to a bit of a vicious cycle as investors trying to align their portfolios to benefit from tax reform (specifically the lowering of the corporate tax rate), which would entail selling off stocks within sectors that have low tax rates such as technology and rotating to sectors that typically pay high tax rates (financials, consumer and telecom). The more technology stocks with large gains that are sold, the more demand there will be to harvest some of those losers.
Many of the big losers that can see additional selling are clustered within the consumer discretionary and the energy sectors. Within consumer discretionary, the traditional brick and mortar department stores have been one of the worst groups in the market as their businesses struggle against the move towards ecommerce. Even with the recent rally these stocks have had in November, many of them remain far below their 2016 levels. For example, JC Penney is down 61%, Sears Holding is down 54% and Signet Jewelers is down 43%. Even bellwether retailer, Macy’s, is down 27% this year. Outside of direct brick and mortar retail, athletic apparel distributor Under Armour is down 53%. In the energy sector, quite a few service companies were bid up after President Trump’s election in the last 2 months of 2016. However, 2017 has been a different story as US Silica is down 41% and Hi-Crush Partners has been well crushed for 46%. Retail and energy are not only groups where potential tax loss selling candidates can be found, as generic drug maker Teva Pharmaceuticals is down 55%.
Agnieszka Gehringer and Kai Lehmann, courtesy photos. As Rules Regarding the Creation of Synthetic ETFs Become More Stringent, They Could Have an Impact on Growth
According to Agnieszka Gehringer and Kai Lehmann, members of the Research Institute of Flossbach von Storch, ETFs go beyond passive investment, due to their hyper trading activity and the latest innovations in the field of smart beta. In this interview with Funds Society, the experts also warn of the uncertain behavior of ETFs in turbulent periods, something not yet tested, and are confident of the industry’s potential for growth in Europe, although, they are aware the stricter rules on the creation of synthetic products could be a drag on its development.
What do you intend when you doubt that ETFs are passive?
The ETF are often put in the context of passive investment, based on the fact that they follow the performance of a certain index. This is exactly the idea staying behind the traditional index funds – an invention of Jack Bogle dating back to 1976. But Bogle aimed at providing an instrument for a long-term investment in stock market by simply following the index. To the contrary, ETF investors are very much short-term focused. They trade ETF shares very actively, indeed hyper-actively. This is what we find in our analysis based on the three biggest equity ETFs tracking respectively the German DAX, the US S&P 500 and the FTSE 100 in the UK. The volume of the ETF shares traded on average every day is four times higher than the traded stocks of the underlying indices. This hyper-activity brings the idea of passive investment ad absurdum.
Has the innovation propagated the creation of ETFs which can be called active? Isn’t it a contradiction? How does the passive and active investing complement one another in an ETF?
Besides the traditional ETF there is indeed a growing interest in the so called smart beta ETFs. Whereas the traditional ETF are supposed to reconstruct 1:1 the index performance based on the market caps of the index constituents, smart beta ETFs weight the basket of the underlying securities based on alternative criteria, called factors. In this way, they aim at performing better than the market and thus better than traditional ETFs. These factors may relate to some kind of assessment of accounting metrics of the index constituents, like book value, dividends, or cash flows, or to still other factors, such as low volatility, undervaluation or expected momentum. In this sense, smart beta ETFs add an active layer with respect to traditional ones: they are not only actively traded, but render the underlying investment choice active as well. Is it a contradiction? I wouldn’t say so – it is more an enhancement on the activity scale. But the important thing to note is that such “active” choices are not comparable with the investment decision made by an active asset manager who thoroughly analyse the entire business model of a company in order to assess its intrinsic value. Smart beta strategies are focused on fast-track, partial, rather than thorough, and more quantitative, rather than qualitative assessment of companies.
Due to this innovation, could ETFs push the active strategies aside?
Given the current popularity of ETFs, be it traditional or smart, it wouldn’t be surprising to see further rise in the relative share of ETF-managed funds. At the same time I would doubt whether it is in the interest of ETF investors to fully eliminate active investment strategy. In the end ETFs freeride on the contribution which active managers deliver to the efficient price building on capital markets. By the same token, we can’t exclude that upon the attainment of a certain critical mass on capital markets by ETFs, the price building process might get into difficulties.
It is often stated that both types of investment strategies would survive. What would be the role played by the one and the other?
It is plausible to expect that both ETFs and active management will coexist. On the side of ETFs, they have been surely attractive so far, given the positive past performance on capital markets and their warranty of obtaining the performance of the underlying index. They could be thus appropriate for investors willing to simply follow the market. At the same time, not much is known so far about ETFs’ performance under difficult weathering conditions on capital markets. Only when markets enter more turbulent waters will we be able to assess the true performance of ETFs. For now ETF investors should keep this uncertainty in mind. On the side of active managers, and especially of those following a consistent and well-founded investment strategy, they will continue to play a role in enhancing the price setting on markets, especially when we see some market turmoil.
In your opinion, which was the major innovation in the world of ETFs during the last years?
The original idea of following the market in order to enjoy the long-term positive return at a rock-bottom cost is quite revolutionary. Their invention may have helped to get in touch with capital markets. But today there is not much left out of this. To the contrary, the hyper-activity of ETF trading and allegedly “smart” investment choices of smart beta ETFs could pose more risks than benefits, should capital markets experience turmoil in the future.
In launching of novelties (smart beta, currency hedging (?), …), where could the next innovations go in the world of ETF?
Given the past creativity in the field of ETFs, the innovation could go anywhere. Just think of the different kinds of thematic or even esoteric ETFs, like for instance “biblically responsible” ETFs… If this trend continues, the question will be increasingly about the risk-reward balance of less diversification and less market liquidity versus chances to pick up an index performing better than the others. All in all, there seem to be less and less well-founded investment choices.
Is the use of ETFs changing – from tactic to strategic positioning? Does this generalization in the use regard all types of investors?
This seems to be particularly the case for institutional investors. In the past, they were using ETF for cash equalization and transition management. But now the growing use for core exposure can be observed.
Comparing the markets, the European with the US market, Europe is lagging behind, but could still catch up. How much could the European industry grow?
The size of the ETF market in Europe is indeed significantly smaller than in the US. Precisely, the total assets held by US-ETFs now add up to about 3.3 bn. USD whereas its European counterparts are currently approaching the roof of 1 bn. USD. There is surely catching up potential for Europe. At the same time, there are some important regulatory changes applying next year, which could decelerate the process. Precisely, rules regarding the creation of the so called synthetic ETFs become more stringent. Accordingly, given the current non-negligible share of synthetic ETFs in Europe, this could have an impact on growth and the speed of convergence between the European and US ETF market.
Could the regulation have an impact on the use of ETFs and why?
As mentioned above, the regulation is already having an impact on the use of – in this specific case synthetic – ETFs. But more generally, given that ETFs can still be considered as relatively new to the financial market reality, the regulators have to gather information and experience regarding the functioning of ETFs. This task is not easy and regulators could lack the necessary information to set up well-functioning rules. And the past teaches us that unfortunately sometimes it needs an external shock to discover the loopholes in the system. Hopefully this time is different.
Pixabay CC0 Public DomainCourtesy photo. Inflation Is Unusually Dormant… For The Moment
Data continues to point to the broadest synchronised expansion the world has experienced in more than a decade as advanced and emerging markets continue to gain momentum. Labour markets are recovering at a rapid pace and, although the unemployment rate in Europe is still above pre-crisis lows, in the US, it has reached a low of 4.1% and in Japan, it sits at just 2.8%. And yet, inflation is oddly muted. Indeed, the average inflation rate in the OECD countries is 1.5%, down from 2.2% in 2012 and well below central banks’ official target of 2%. How is this possible, also considering that the balance sheets of the four largest central banks have exploded to USD 14 trillion in assets?
The first explanation could be that the recovery has been slow. Growth rates are still below pre-crisis levels as investment, trade and, to a lesser extent, consumption have lagged. As for labour markets, in the US for example, one reason why the tight labour market has not led to a sharp acceleration in wage growth is that the fall in the unemployment rate is the result of a change in labour supply as a large number of baby boomers have retired, thereby reducing the participation rate. This has also impacted wage growth because the pay checks of retirees are likely to have been higher than those of entrant workers. Moreover, what really impacts inflation is unit labour costs and not nominal or real wage growth and the recent improvement in productivity has allowed unit labour costs to fall over the past year. Finally, although quantitative easing and ultra-low interest rates have succeeded to boost financial asset prices, they have failed to lift inflation. This is due to the extreme slack the financial crisis caused in the economy. Slack which today is far lower as economies have recovered.
An undeniable cap on inflation also comes from exchange rate variations. The dollar, for example, impacts headline inflation through its direct impact on commodities but it also affects core inflation which excludes energy and food. A rise in the dollar makes foreign imported goods cheaper, thus increasing competition for domestic producers which pressurises them to reduce prices. The 26% rise in the dollar from mid-2014 to end 2016 and the 60% drop in oil prices during that same period were therefore much to blame for the low level of prices.
More structural factors such as disruptive technologies and globalization have also played a role in capping prices. E-commerce companies, Airbnb and Uber have enabled more price transparency as well as an additional supply of goods and services for clients, thus leading to slower inflation. Worldwide integration has given firms the possibility to move their production facilities across borders at lower costs. However, does this benefit consumers or the firms’ profit margins? And although all these topics seem reasonable, research has shown only a reduced impact on inflation.
Surprisingly, the most important driver for inflation are inflation expectations. Surprisingly also, they are backward looking as they seem to be correlated with recent or coincident inflation. The most likely outcome therefore continues to be low levels in inflation. But let’s not forget that inflation is a lagging indicator. While the correlation between core CPI and GDP growth over the last twenty years is only around 5%, when GDP growth is lagged by six quarters, the correlation jumps to 80%. The stronger growth which started in the second half of 2016 should therefore start to impact inflation soon. Moreover, a further depreciation of the dollar or a persistent spike in oil prices are possible risks. Even though inflation has continued to fall below expectations, we could be reaching an inflection point and we may see inflation trend higher. Hopefully it will be at a controlled pace!
Pixabay CC0 Public DomainPhoto: elenlackner. WisdomTree Buys ETF Securities’ European Exchange-Traded Commodity, Currency and Short-and-Leveraged Business
ETF Securities has agreed to sell its European exchange-traded commodity, currency and short-and-leveraged business to WisdomTree Investments the Nasdaq-listed (ticker: WETF) and New York headquartered global exchange-traded product provider.
The business being sold comprises all the European operations excluding the ETF platform. The business being sold to WisdomTree has $17.6 billion of AUM spread across 307 products, including the flagship gold products PHAU and GBS. The business has a comprehensive range of commodity, currency and short-and-leveraged products and more than 50 dedicated staff.
WisdomTree and ETF Securities will work to ensure that integration is seamless and expect no change to the current high standards of service and operations experienced by our customers and partners.
The sale is subject to regulatory approval and is currently anticipated to close in late Q1 2018.
Graham Tuckwell, Founder and Chairman of ETF Securities, comments: “We are pleased to be selling our European exchange-traded commodity, currency and short-and-leverage business to WisdomTree and to become the largest shareholder in the company. I believe this combination creates a uniquely positioned firm which will flourish in the years ahead, continuing to deliver huge value for customers and stakeholders. ETF Securities has a strong cultural fit with WisdomTree as both firms have been built from scratch by teams who have worked closely together for many years and who show an entrepreneurial spirit in seeking to deliver innovative and market leading products for their customers.”
Mark Weeks, the UK CEO of ETF Securities says: “This transaction creates a leading independent global ETP provider which is well positioned to compete in the rapidly growing European ETP market. We have complementary expertise, product ranges and customer networks. We both continue to challenge the status quo to provide customers with a range of differentiated products. In this industry customers want and value firms like ours, which provide broader choice.”
Yerlan Syzdykov, courtesy photo. Venezuela On the Edge of a Cliff: Lets Be Cautious
A full Venezuelan sovereign default scenario would be one of the most complex events of its type and would require a large-scale restructuring, according to Yerlan Syzdykov, Deputy Head of EM at Amundi AM who does not see anuy rapid solution to the restructuring process.
What is your analysis of recent events in Venezuela?
President Nicolas Maduro recently announced the Republic of Venezuela’s intention to restructure all foreign debt, thus recognising the country’s current debt load as unsustainable. The nation missed a coupon for about $200ml and failed to make the payment by the end of a 30-day grace period, triggering the rating agencies downgrade to default. A meeting of the International Swaps & Derivatives Association will follow shortly to discuss whether a week- long delay on bond payments from the state oil company will trigger default-insurance contracts on those securities. We think Maduro’s move is part of a political game to increase his chances of re-election in 2018, and it follows an attempt to consolidate power by the regime, including sweeping victory in recent gobernatorial elections – despite a 21% approval rating at the time. With this political capital in hand, pushing bond payments further out, Chavismo1 now turns to the debt issue. To further delay and complicate the negotiation process, the Republic invited bond holders to Caracas on 13 November to begin restructuring negotiations. The meeting was chaired by Venezuelan Vice President Tarek El Aissami. Among the attendees was the Economy Minister Simon Zerpa. who also serves as CFO of PDVSA, the state oil company. Both Mr El Aissami and Mr Zerpa have been sanctioned by the US, which inhibits US persons participating in the discussion. No specific proposals seemed to have emerged from the meeting but government officials insisted they plan to continue to service obligations.
What is the market expecting for the near future?
The restructuring announcement changes the prevalent consensus towards both Venezuela and its related quasi-sovereign bonds. The market was expecting Venezuela to service into 2018 and then seek to restructure the Republic only. Now the market has begun to debate the Republic’s specific timetable and the range of potential outcomes. With Maduro in power, the range of outcomes is narrow. The market’s assessment of the probability of a transition, and therefore Maduro’s future, will be important drivers of bond prices. Maduro’s recent comments confirm that the Republic plans to include PDVSA and other Venezuela quasi- sovereign issuers in the restructuring programme. PDVSA and the electricity company Elecar collectively have $750m in coupon arrears on $66bn of outstanding bonds. It appears that the government is proposing to address these arrears collectively or concurrently with the Republic. The Republic may be attempting to protect PDVSA by going for a restructuring. Considering the complexity of the government’s position, the decision to restructure may reflect a desire to negotiate a more favourable outcome, which is unlikely, in our view.
What happens if Venezuela should default? A full Venezuelan sovereign default scenario would be one of the most complex events of its type and would require a large-scale restructuring. Only the Republic knows Venezuela’s total debt level, which is estimated to be around $150bn. US investors hold some 70% of Venezuelan hard currency debt. This introduces further complication to an already complex situation, given the prevailing US sanctions. Creditors include recipients of promissory notes, as well as those with material trapped capital – such as airlines. This creates a potential burden on the state through unresolved claims. It also contributes to uncertainty around bond servicing, as the total size of these claims is not widely known.
Who could come to the rescue?
We see quite limited options. Venezuela does have some assets, even though foreign currency reserves have declined in the past years. The country has an equivalent of $1.2bn in SDR2 reserves with the IMF, and around $7.7bn in gold. Further external support from Russia is also a possibility. The government could also negotiate an extension to several Chinese loans due at the end of this year. Venezuela getting further loans from Russia or China remains a low probability event, in our view. China is unlikely to bail out the government, having previously declined to revise the terms of a loan. The IMF enters the process facing a number of challenges. It is said to regret its role in the recent Greek bailout. At that time, the Fund was pressured to take a 30% participation, a transaction it says it now regrets. This may influence the Fund’s path of engagement with the Republic. The Fund enters the discussion with incomplete and outdated information. Venezuela had reduced contact with the IMF in recent years. The fund’s first challenge will be to develop a precise understanding of the situation – a goal that may take time to be achieved. Holdouts present a real challenge to any attempted restructuring or re-profiling of maturities. Another wildcard: in the US, a creditor with a court judgement is entitled to attach receivables, which means creditors could seize oil payments. As a result, the Fund might alter its traditional approach and attempt a more direct resolution. For example, the Fund might move to engage the market earlier by going for an early debt haircut; should it go down this route, we expect considerable scepticism. Lastly, IMF’s decision to support the restructuring and commit any funds to the country has a complex political dimension given antagonistic relationship between Venezuelian government and the US. Overall, we believe that the Venezuela story will persist for several years.
Where does the state oil company PDVSA stand in all of this?
PDVSA enters restructuring talks with c. $42bn in outstanding bonds, of which $29bn are USD-denominated. 2016 EBITDA has been estimated at $15bn compared with $66bn in 2011. The company currently operates 44 rigs, down from 70 a few years ago. PDVSA’s oil production is likely to have fallen below 2.0 mm bpd (barrel per day), (-11% YoY), as sanctions complicate oilfield equipment purchasing. PDVSA ships around 1mm bpd to service borrowings from China and Russia, as well as to service other political commitments made by the regime. This limits the amount of production available for debt servicing. PDVSA is a different legal entity than the Republic, hence an event that impacts the Republic doesn’t automatically impact the company (so called cross-default). The Republic’s intention may be to protect PDVSA and oil flows ensuring access to petrodollars. Sovereign bondholders, however, will immediately seek to attach those flows through legal remedies based on the legal argument of ‘alter ego’. Furthermore, it is unlikely that the IMF would allow the Republic to default while PDVSA continued to service.
Would you expect any spillover from the Venezuela crisis?
Contagion among EM is mitigated by a number of factors. Firstly, the possible default of Venezuela has been well flagged. In fact many investors believed Venezuela should have defaulted long time ago. Secondly, fundamentals in EM are currently generally strong and the spreads reflect a healthy macro background. Most countries are not overleveraged, and we see current account surpluses in many EM economies. Where there is a potential contagion is around US refineries. Venezuela supplies crude to many US refineries, particularly those around the Gulf. These refineries produce gasoline and are configured to take Venezuela’s sour crude. A slowdown in Venezuelan output could reduce US gasoline production, which might alter inflation or growth characteristics. While that is theoretically possible, at this juncture it does not look likely.
In Russia, some petroleum companies are invested in PDVSA (mainly Rosneft, but also Gazpromneft and Bashneft). There is also a reported miss on a payment to ONGC, the Indian state oil company. Were Venezuela would service its debt or restructure, the result would be immaterial given the relative size of the exposure for those companies. In an unlikely scenario of a blockage of the Venezuelan oil exports, US majors and oil servicing companies will have a negative but limited impact.
Do you see opportunities emerging from the crisis?
The timing and tone of the government’s proposals may have a material impact on discussions, successful or otherwise. PDVSA, as the country’s main source of hard currency export earnings, could give exposure to Venezuelan yields from a possibly advantaged position if an event occurred. Given the overall uncertainty, the complexity of both PDVSA and the Republic’s capital structure, and the unknown size of overall liabilities, it is too early to make a meaningful assessment of potential recovery value. An additional consideration is about alternative investment opportunities – if Venezuela’s interest rate spread continues to widen, it might pull investment from other, higher-risk debt issuers: the composition of return from EM could shift in character. Overall, we remain very cautious on Venezuela, we don’t see any rapid solution to the restructuring process, and we continue to look for tactical opportunities as they emerge with risk control as a priority for our investors.
Foto cedidaSimon Fox, Senior Investment Specialist at Aberdeen Standard Investments, courtesy photo. Aberdeen: “Diversification Across Funds Should Mitigate Market Falls"
Investors have to deal with both short-term volatility and downfalls risks. For Simon Fox, Senior Investment Specialist at Aberdeen Standard Investments, the adequate way to deal with this is to better diversify your portfolio. As he explains in this interview with Funds Society, at a difficult time for traditional fixed and variable income, he finds the most compelling opportunities through a range of diversifying assets, such as emerging market debt in local currency, investment in infrastructure and asset backed securities.
What does provide an ‘alternative’ approach to markets? Is it about looking for new sources of alpha or is it about protecting against risks?
Multi asset investing has evolved considerably since the Global Financial Crisis. Today’s investors are looking for a more explicit focus on their own objectives – such as a cash or RPI+ return; or maybe a consistent level of income. In the past a simple blend of stocks and bonds may have delivered decent returns, but not without significant volatility. Looking forward, historically low bond yields and challenging equity markets mean that even the returns achieved in the past look unlikely to be delivered in the future.
To address these challenges, we believe that investors should further diversify their portfolios. In particular, there are, today, a broader array of asset classes available and accessible to investors via UCITS regulated investment structures. Our Diversified Asset team seeks out fundamentally attractive long-term investments across listed equities, private equity, property, infrastructure, high yield bonds, loans, emerging market debt, asset backed securities, alternative risk premia, insurance linked securities, litigation finance, peer-to-peer lending, aircraft leasing, healthcare royalties and other asset classes.
Combining these asset classes in a diversified portfolio results in the attractive returns coming through in a much more consistent fashion than any one asset class in isolation. This approach is very transparent and does not rely on complex derivatives trades or our ability to trade in and out of markets over short-term horizons. This makes the approach easy to understand and robust to differing market conditions.
What are the main risks that you currently appreciate and how could alternative strategies help to mitigate them?
Investors have to contend with both the risk of short-term volatility and also the risk of failing to generate the growth (or income) that they need over the longer-term.
We believe that the right foundation for dealing with both of these is to better diversify the portfolio. As we have seen over the last few years, equity markets can, and do, suffer large drawdowns over short time periods – notably in the summer of 2015 and the start of 2016. By being more diversified, our multi-asset funds have experienced much smaller drawdowns through these periods; as such, they have also been able to compound positively as the markets have recovered.
And talking on risk, we could mention the low rates risk… do you see a bubble in fixed income? And could this bubble burst in some markets? How do you manage this risk in the funds? – Central Banks: what do you expect from Fed? Which will be the next steps of ECB? How do you manage all this issues in your portfolios?
When building our portfolios we make use of sophisticated optimization techniques and other quantitative modelling; but we also believe that it is important to consider the possible future risk scenarios that risk models won’t capture. Most recently we have assessed the possible impact of a North Korea/US conflict, a global pandemic and secular stagnation – as well as a rout in bond markets. While we regard it as a very low probability, there is nonetheless a risk that the US Fed is forced to raise interest rates rapidly over the next 12 months to deal with inflationary pressures and the prospect of a substantial fiscal stimulus. This scenario would see Treasury yields spike higher and equity markets fall. While our multi-asset funds would likely be down in this scenario, we would expect them to provide significant protection relative to a more traditional balanced portfolio.
Often this exercise throws up a call for some portfolio protection (put options, gold, etc) as minds become overly focused on the worst-case scenarios. However we remain of the view that the diversification across the funds should mitigate market falls to a large degree and that portfolio protection strategies are typically not cost effective. The recent reduction in equities is an example of our more preferred route to risk reduction especially when stretched equity valuations make the risk-reward trade-off less attractive. We currently have no exposure to traditional fixed income – either government bonds or investment grade credit.
Brexit: Which risks do you appreciate related to this process? Do you place the portfolios at a specific way in the run-up of Brexit?
At the start of 2016 – ahead of the UK referendum – we modelled a Brexit impact in our scenario analysis. In practice, the diversified and global nature of our portfolios, as well as share class specific currency hedging, meant that Brexit had little impact on our portfolios.
About Multi-Asset spectrum: in which segment do you see more opportunities of returns: in risk assets or in those assets with lesser risk?
Our asset allocation is derived from a longer-term outlook than many multi-asset funds, with a 5 year view of risk and return the main driver of our positioning. The chart below shows our current outlook for various asset classes. It highlights that traditional bonds – investment grade credit and government bonds – offer limited return potential (and, in some scenarios, limited diversification benefit). Equities still offer a premium over risk free assets, but this has narrowed over the last 6 months, notably in the US where valuations looked stretched on a range of measures. As such, we find the most compelling opportunities across a range of diversifying assets. This includes local currency emerging market debt (benefitting from good yields and strong fundamentals); infrastructure investments (which we can access through REIT-like investment trust structures); and asset backed securities.
Taking into account the environment of markets: do you consider necessary to reduce the expectation of returns or is still possible to obtain good returns with an alternative and multi-asset approach?
As can be seen from the chart above, our 5-year view is that traditional assets will under-perform relative to history. However, by being able to diversify the portfolio across a broader array of asset classes, we continue to believe that we can meet our long-term return targets for our funds while maintaining a volatility well below that of equity. Since inception our growth strategy has outperformed its Cash+4.5%pa return target, net of institutional fees, with a volatility of c.4.5%pa. Our ability to access a range of compelling opportunities stems from our ability to identify and access a broad range of asset classes in a liquid form. This is driven by the breadth and depth of resources we have across a range of investment specialisms.
Could you give us some examples of investments you currently hold in the portfolio? I mean some bets on relative value, for instance.
Within social infrastructure we have taken a couple of new positions recent months – adding Bilfinger Berger Global Infrastructure (BBGI) and International Public Partnerships limited (INPP). Both INPP and BBGI provide exposure to a large portfolio of Public Private Partnerships/Private Finance Initiative projects across the UK, continental Europe, Canada, Australia and the USA. These provide attractive, government-backed and largely inflation-linked long-term cash flows.
Within our special opportunities sleeve we have also made a new allocation BioPharma Credit. This holding provides exposure to a diversified portfolio of debt backed by the assets or royalties of biotechnology firms. Benefitting from the premium associated with specialist lending, Pharmakon Advisors are targeting an 8-9%pa return from a portfolio offering significantly different return drivers to other exposures in our Funds.
CC-BY-SA-2.0, FlickrPhoto: Eric Golub
. Why We Are In The Silver Era For Hedge Fund Strategies
Three years ago K2 Advisors, part of Franklin Templeton Investments, launched its first UCITS Liquid Alternatives fund, the Franklin K2 Alternatives Strategies Fund. At the time, some would have argued that the macroeconomic conditions were not favorable for certain hedge-fund strategies. While they haven’t for a number of years, but now this may be changing.
Monetary policy looks to be shifting in some countries, currencies are becoming more volatile and geopolitical risks have intensified of late.
“We think these fundamental elements could drive alpha opportunities for skilled hedge fund managers to capture. Many think that hedge-fund strategies are super-charged and high-octane. We would argue hedge-fund strategies are actually meant to be dull, with low volatility. But hedge-fund strategies can also provide diversification and long-term capital growth potential.” Says Brooks Ritchey, Senior Managing Director, Head of Portfolio Construction, K2 Advisors.
His team believes that low interest rates are often an overlooked factor in regard to hedge-fund strategy performance. Now, as US interest rates are making slow but steady strides upward from historic lows, they think certain hedge-fund strategies may be finding new opportunities to show their mettle.
“If the US Federal Reserve (Fed) continues to raise interest rates this year and next, we think it could cultivate an environment for certain hedge-fund strategies’ to flourish. Rising interest rates have historically been associated with lower cross asset correlations, creating more alpha opportunities for hedge funds,” adds Ritchey.
Additionally, K2 Advisors reminds us that rising interest rates have typically led to future periods of above average alpha, as represented by the Hedge Fund Research Index Fund Weighted Composite Index (HFRIFWI).
The illustration below shows a positive correlation between alpha and interest rates. The average level of alpha rose to the highest level at 14.07% during the measured period, where the US 10-year Treasury yield stood at 7.05%. Based on what we’ve seen in the past, they think hedge-fund managers could have the opportunity to capture that alpha, or outperformance, as US interest rates continue to rise.
For Ritchey, global geopolitical risk is another element that should drive a change in the landscape for hedge-fund strategies. On the back of recent geopolitical tensions, major currency spreads have widened, and historically wider spreads have benefitted hedged strategies’ alpha. “This is particularly noticeable within the Group of Seven (G7) economies, since they coordinate and attempt to manage major exchange rates in a way that leaves their currencies closely linked. As a result, we might not yet be in the golden era for hedge-fund strategies—the most-ideal environment for managers to capture alpha—but we could be approaching the silver era, where favourable opportunities are starting to appear.” He notes.
Allocating Toward Market Themes
Not all hedge strategies will fair equally as conditions change. K2 Advisors expects that the event-driven hedge-fund space, for example, may face headwinds as central banks globally begin to normalize interest rates. Event-driven hedge funds often seek to profit from merger-and-acquisition (M&A) corporate activity, which, in their opinion, could be diminished as interest rates rise. Global macro strategies, however, may benefit from rising rates. The global- macro space has seen an increase in trading volume over the last two months, and the firm anticipates this trend will continue.
“We’ve seen evidence that the current market landscape could become a nurturing environment for certain hedge-fund strategies, but we’re only just at the beginning and believe more opportunities could crop up during this silver era.” He concludes.
