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MFS: Why is Reconsidering Active Management Now More Important than Ever?

How much does active management contribute as compared to passive management? With this question, Michael Roberge, CEO, President and CIO of MFS Investment Management opened his presentation at the 2017 MFS Annual Global Analyst and Portfolio Manager Forum, which took place in Boston in mid-May.

According to Roberge, some of their larger and more sophisticated clients, including those who manage sovereign wealth funds and pension plans, are increasing their positions in actively managed funds, contrary to what the average retail client is doing. During his talk, he explained the main reasons why clients should, according to MFS, consider active management in this environment, compared to investing passively.

The Short-Term Mentality of the Bulk of the Market

In the period immediately following Donald Trump’s election in November last year, the market rose between 6% and 7%. For Roberge, even more noteworthy than this rally, was the massive turnaround from the more defensive and higher-quality sectors to much more cyclical sectors, with the expectation that the new administration would reduce taxes and that the regulatory burden would be lower. Likewise, any increase in economic growth was traded: the price of deep cyclical stocks soared and consumer staples companies suffered a fall in prices. This was caused in part by investors who pursued these sectors out of fear of falling behind the benchmark in terms of performance. In a clear example of how the short-term mentality dominates the behavior of the markets, more than five months after Trump’s takeover, a new rotation in the opposite direction was happening. Investors have begun to perceive that it will be difficult for Trump to get approval for significant spending on infrastructure, and that he lacks support for much of his election promises.

According to Michael Roberge, this was clearly reflected in the deep cyclical sectors: US Steel’s stock price, which was US$ 21 per share pre-election, doubled to US$ 42 per share, only to returning a few months later to US$ 21. Meanwhile, MFS ‘strategy was to sell cyclical stocks and buy defensive stocks. The asset manager’s teams look for returns with horizons of three-to-five years, identifying long-term opportunities. This is where the firm thinks it has the greatest opportunity to add alpha to a portfolio.

Higher Volatility

Another factor playing in favor of active management is the minimum volatility period experienced in the last decades. This is largely a consequence of the accommodative policies of central banks.

The European Central Bank, as well as the Bank of England and the Bank of Japan continue with quantitative easing programs; and while the Fed appears to be at the beginning of a rate-hiking cycle, Roberge argued that when inflation is considered, the real interest rate of Federal Funds is negative, which is especially stimulating for an economy growing at around 2%, with the potential to grow at 4%. In the CEO’s opinion, it could be said that all central banks globally, continue to inject liquidity into the system, which not only keeps interest rates low, but also suppresses market volatility.

MFS claims that, in the next ten years, a low growth scenario will persist globally. There is a problem of over-indebtedness and an aging global population in the major developed economies which will cause the world economy to remain below its potential.

For Roberge, the only way to achieve greater growth in real terms would be by fostering an increase in the labor force, something which new immigration policy trends are slowing, or increasing productivity. This last variable is the one that can best be implemented by governments worldwide.

“The global economic environment is still more deflationary than inflationary. In Japan, they have been trying to generate inflation for over 30 years, something that is also beginning to happen in the United States. The latest inflation data (with respect to the previous year) have been downward, even only taking into account the underlying inflation. It could be said that there is an inflation problem at the global level,” said Roberge.

Given these factors, MFS believes that investors can expect a world with lower economic growth, in which there will be greater volatility, as economies will face greater challenges. “There will be new episodes of uncertainty in Europe: Greece will reappear in news headlines due to debt renegotiation, and Italy will hold general elections in May 2018. And finally, the moment central banks begin to remove excess liquidity from markets, higher levels of volatility will be created, which, when added all up, represents a huge opportunity for active management as compared to passive,” he added.

For Roberge, this does not mean that a portion of the portfolio shouldn’t be invested in passive management vehicles, but how much is being spent on active management should be reconsidered.

A Disruptive Environment

According to MFS, another one of the fundamental keys that indicate that it will not be enough to buy the index to achieve the investment objectives is disruption. A large number of industries are going through a disruptive period: “The most obvious example is the retail sector where Amazon is crashing its competitors in the traditional retail segment. More and more sectors are undergoing a period of transformation: Airbnb, for example, has led to a similar change in the leisure industry, Uber has broken into the taxi industry, robo-advisors and smart beta ETFs have hit the financial industry. All of these examples, which highlight the complexity of the environment, make passive management less attractive.”

Now More than Ever, Investors need Active Management

Continuing with the discussion, Roberge highlights two reasons why investors should consider positioning themselves in actively managed vehicles: return and risk management. In relation to the return of the markets in the next ten years, the asset management company expects a global equity return of around 4.3%. This figure is considerably lower than historical returns, especially since starting valuations are very high, meaning most of the opportunities are already priced into the current market prices.

Meanwhile, the expected return for the same term in global investment grade fixed income is roughly 3%. Historically, rates are at very low levels, leaving very little room for capital appreciation gains, and leaving only the coupon search and the spreads on corporate debt as the main source of return for this asset class. Therefore, according to MFS, the average investor who invests in a balanced portfolio could achieve an estimated annual return of close to 4% over the next decade.

These returns make it extremely difficult for the bulk of investors to achieve their retirement goals. Therefore, they will need an additional source of return to achieve their goals, something that can only be achieved through active management and alpha generation,” Roberge said.

In this regard, the alpha in portfolios becomes a more important element than ever. According to MFS projections, for US large cap equities, the contribution of active management in terms of excess return on the index will increase from the 17% registered historically (2% over 10.1%), to 42% (2% over 2.8%). While in fixed income, active management’s contribution will increase from 12% (1% over 7.5%) to 24% (1% over 3.1%).

However, investors have recently stopped believing that there is alpha opportunity and lean instead passive management, seeking only lower commissions, regardless of net returns. In ten years, these investors will be very disappointed if indeed the MFS forecasts are met and their index returns are limited to below the 4% offered by the market, regardless of how low the fees charged by passive vehicles may be. For all of the above, Roberge encourages reconsidering active management as the main way to reach long term investment objectives.

Swanson: “Fundamentals Are Starting to Whip in and Valuations Are Very High”

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The extent of the current geopolitical situation worries investors who focus their discussion between continuing to bet on risky assets or moving toward “haven” assets. Where should investors put their money? During his presentation at the 2017 MFS Annual Global Analyst and Portfolio Manager Forum,James Swanson, Chief Investment Strategist at MFS Investment Management, reviewed what’s happened during the last cycle to determine where the global markets are now, and how investors should position themselves.

The Starting Point

After the market collapse in 2008, when US equity indices fell nearly 50%, the financial press maintained that investment in US stocks was not going to pay off, as GDP growth over the past eight years was well below the 3.5% at which it used to grow. However, Swanson argued that the measure that should really have been taken into account is the generation of free cash flow by companies. In the United States, this metric grew dramatically, reaching levels not previously observed.

Several factors enabled this development, one of the main being globalization. With the onset of the crisis, the American working class was forced to sell its work at a low price, so the companies had an extremely cheap labor force. Likewise, the reduction of interest rates carried out by the Federal Reserve allowed a considerable reduction of the cost of capital. In addition, the use of new technologies allowed the transformation of assets at a lower cost. These elements had repercussions in better ratios, better margins, and finally greater free cash flows.

And where is the cycle now?

Comparing levels of confidence indicators, the so-called “soft data” encompassing various investor sentiment surveys, with data on housing, industry, labor and consumption, known as “hard data”, one can observe a great divergence between both. The fundamentals of the economy lie far below the euphoric feeling that investors are showing, something Swanson says had not been seen before in several cycles. The next question to ask is how these two tendencies will converge.

To clarify this point, Swanson showed the evolution of performance in terms of real cash flow in the US equity market, or what is the same, if one invests a dollar in the S&P 500 index, how much cash flow is obtained after discounting inflation. In the long term, the real cash flow is around 2.6%. During the last recession, this measure fell sharply, but in the next two years it experienced a spectacular recovery, and now, while we are in the last stage of the cycle it has reverted to its long-term average. This, suggests that fundamentals are starting to whip in at the same time market valuations are extremely high.

Even though there is a notion of reflation in the environment, Swanson pointed out that core inflation in Europe, the United Kingdom or the United States is far from the 2% level that central banks would like to see. Another disconnect between perception and reality, in the MFS strategist’s opinion, the massive underlying reflation which sentiment is indicating is not happening.

Clouds on the Investor’s Horizon

One of the first concerns that investors should bear in mind is the growth of consumer income in real terms. Swanson has observed that wage in the last cycle has been somewhat subdued in the United States, Europe and the United Kingdom. He pointed out that it would probably be a residual component of the last recession and the demography of these countries. “Globally, we are going through a particular moment in time, in which baby boomers are retiring from the workforce and are being replaced by a generation with lower wage levels. Incomes in real terms are lower and this is going to have a direct effect on spending.”

The second cloud on the horizon is the economic situation in China. Just a year ago, China’s credit system was expanding, with lower interest rates and greater liquidity. But now the situation is different, government spending has fallen, consumption taxes have risen, housing purchase credit has been tightened and the Shibor rate, the Shanghai interbank rate, is starting to rise. “Every time they have made this kind of movement within the investment cycle, putting the brake on their economy, the consequences have been suffered globally. China is the largest marginal commodity consumer, and commodities play a key role in global inflation levels. At present, we can appreciate a weakening of the price of commodities. However, China has not entered into recession, nor is in the process of doing so, but will see a slowdown in consumption and spending because the monetary impulse is decreasing. This will have repercussions on exports from the United States and particularly from Germany,” Swanson said.

The third cloud that investors should not lose sight of is the production, consumption and the point of the economic cycle in which the United States is currently in. Industrial production, as measured by the ISM Manufacturing PMI index, tends to follow the movement of the money supply. In general terms, a pattern can be observed in which, whenever there is greater liquidity in the system, manufacturing production accelerates and expands. Currently, the real money supply is slowing its growth, showing an anticipated signal that production will also fall. So the bet on reflation may not be sustainable over time. Sales of new residential homes and automobiles are slowing, as are sales of consumer products. Therefore, Swanson invites all those investors who are thinking of increasing their position in risk assets to match the current valuations with the risk of going through a small pullback during the summer or with the risk of entering during the latest phase of the cycle: “We are reaching the eighth-year of the cycle, while the longest cycle ever recorded was 10 years. If you compare the economic situation of the United States with that of a patient who goes to the doctor, we would be talking about a 78 year old person, who could have died a couple of years ago, but is still enjoying relatively good health,” he argued.

Some of the signals that indicate an advanced moment in the cycle are already showing: euphoria replacing fundamentals, a squeeze in margins, and a slowdown in consumer spending. However, what is even more worrying for Swanson is that companies are not reinvesting in their own businesses. According to the MFS strategist, the historical evidence is very clear: companies that can reinvest their capital and obtain a return which is higher than that on their capital, over the long term, their stocks have often outpaced the market. However, companies in the United States, which find themselves with massive amounts of cash flow, decide to repurchase their own stocks or increase their dividends.

The Promises of the Trump Administration

Finally, new accusations of obstruction of justice faced by the US president could have serious consequences, increasing uncertainty and instability in the markets. In any case, if the difficulties faced by the new administration can be solved, infrastructure spending would not be sufficient to compensate for the lack of private sector momentum, and the effects would be lengthened over time. Likewise, the contributions of the promised fiscal reform are not expected to be as relevant as those achieved in the Reagan era. This is, because the baby boomer generation is leaving the workforce and there will no longer be the positive impact of the incorporation of women into the working world in the 1980s. In addition, the proposed tax cuts will affect only roughly 20% of the US population, typically wealthiest individuals, who have a much lower propensity to consume than the working class, and which therefore, will not be a significant stimulus. In summary, according to MFS it is difficult for the US expansionary cycle to go on for much longer and current market valuations are very high.

Henderson Global Growth: A ‘Growth’ Equity Strategy that Selects Stocks from a ‘Value’ Perspective

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The Henderson Global Growth strategy essentially seeks to analyze the underlying business of the companies in which it invests, with a strong focus on those companies that grow in the long term. A global equity portfolio of growth style, but which selects its stocks from a ‘value’ perspective. Two of the four managers that make up the investment team explain its characteristics in detail.

The Management Team

For Ian Warmerdam, Portfolio Manager and Director of the Henderson Global Growth strategy at Janus Henderson Investors, it is imperative to have the best talent in managing a global equity fund. And, that can only be achieved by creating the best conditions to attract and retain talent, with a boutique management culture and entrepreneurial spirit.

That is why he believes that, in a small team of managers, it’s easier to see the results of each manager’s individual contributions: “If you are a good manager or a good analyst and you have confidence in your capabilities, why would you want to be just another cog in the machine in a large management team when you could see the direct result, in terms of risks and rewards, of your investment decisions?”

He also does not expect his team to grow in the short term. Composed of 4 highly motivated and autonomous managers: Ronan Kelleher, Gordon Mackay, Steve Weeple and Ian Warmerdam himself, they all have over 16 years experience in the investment industry and at least 7 years within global equity management. A team that, before joining Global Equities, had already worked together at some point during each of their careers, and which shares investment ideas with the Global Emerging Market Equities team, led by Glen Finegan.

According to figures at the end of March of this year, in total, they manage about 1.5192 billion dollars in assets, with its flagship strategy being the Henderson Global Growth, which, seven years after its launch, manages 604.5 million dollars.

Investment Philosophy

As for the investment philosophy followed by his team, Warmerdam points out that the strategy follows a bottom-up approach: “We spend very little time thinking about geopolitical factors. We believe that the vast majority of companies we value have intrinsic value in their own right. External factors are actually a distraction, when the market moves it creates opportunities, but it is really the business analysis that allows us to invest in the long term.”

Janus Henderson’s team likes to think that when you invest in a company you do it in perpetuity; that kind of mentality helps to focus on stocks with high quality at the franchise and managerial levels, two variables that allow the stock to accumulate value in the long term. “We carry out a strict valuation process, Henderson Global Growth is a growth strategy, but we like to think that we are value investors. We never build the portfolio based on an index, under any circumstances. The core of our investment process is very simple, companies change, industries change, but the important thing is to focus on weighting risks and opportunities. But the financial industry likes to complicate it; the key is not to be distracted by new theories and by terminology.”

Warmerdam admits that it is extremely difficult not to be distracted in a world inundated with news 24 hours a day, macroeconomic and political events broadcast as sensationalist press, and real-time information on stocks and markets. “Following the markets in real time is a huge distraction, which can play tricks on our human emotions when it comes to investing, fear and greed. We look for some kind of gratification that confirms our decisions in the feedback that the market seems to provide, and that is a very dangerous thing to do. Financial markets are the only market in the world that people tend to flee from when there are rebates, this shows how little logic they have.”

What Type of Stocks Make Up the Portfolio?

The fund includes quality stocks that continue to grow over the long term with attractive valuations. When they look for new investment ideas for the fund’s portfolio, they pose six questions grouped into three themes: strength of franchisee, financial fundamentals and management team. In order to include a stock on the follow-up list, and from there to the final portfolio, they must be able to successfully address these questions.

Gordon Mackay comments that the first question asked is whether the company participates in an attractive final market. What they are looking for with this question is to identify markets in which companies continue to grow and where participants can obtain attractive economic returns. Markets with a clear structural growth trend in which, from the consumer’s perspective, the final product is very difficult to differentiate in any significant way. The second question is whether the company has a competitive advantage that is sustainable over time. With this question they seek to determine who the competitors are and how the company is positioned in relation to them.

In terms of financial fundamentals, they look at the quality of earnings, which is usually determined by a strong cash flow component and by high levels of cash flow conversion capability for long-term shareholder returns. Generally, it’s those companies that are able to generate high yield on their own resources (return on equity), which are able to reinvest in their businesses and to keep growing.

“We look for businesses that are able to withstand a downturn in the business cycle. We try to find out how resilient the underlying business itself is, and how strong its balance sheet is; and whether the company has been managed in a conservative way from a financial perspective,” says Mackay. “From the standpoint of portfolio positions, we tend to find fewer companies in the financial sector that are able to meet these criteria.”

For managers of the Henderson Global Growth strategy it’s very important to know the senior management team that manages the company. We are looking for high quality leadership that has been able to allocate its capital historically and which demonstrates ethical practices and good corporate governance. The final question is whether the company’s management team is able to act in the interest of minority shareholders. “We like to see that there is a high level of alignment between the shareholders and the management team. What we prefer is that there are executives who own the same shares that we do in the company, instead of only benefiting from stock options, because when they are part of the shareholder group, they tend to be more conservative in their actions.”

Once a company meets these six requirements, they can potentially be included on a watch list, which typically contains between 80 and 120 securities. That any of these stocks make it into the final portfolio depends on the level of valuation and the analysis of expectations. The Henderson Global Growth portfolio is a high conviction portfolio, which concentrates on between 45 and 60 securities. “When we add a new company to our strategy, we use weights of 1.5% or 3%. When we do not get it right in the valuation of fundamentals, or when the stock is overvalued, it is sold. Each of the portfolio managers has his own inventory of investment ideas, we do not try to cover the entire market,” adds Mackay.

What Trends does the Strategy Follow?

It is a portfolio composed exclusively of long positions, which does not use derivatives to try to improve the performance obtained. In addition, it seeks to focus on positions with growth in the long run, following a series of trends that the management team has identified as secular trends that are still below their intrinsic value. Thus, Mackay comments that, although these trends are not necessarily “undiscovered”, they will represent a significant change over the next five and ten years: the transformation of the internet, innovation in the field of health care, improvement in energy efficiency, consumption growth in emerging countries, and digital payment.

“A clear example of the trend of digital payment is Mastercard. A stock which could be perceived as expensive in terms of multiple P/E with respect to next year, but which, if evaluated over a five-year horizon, can be seen as attractive growth,” Warmerdam concludes.

The Importance of Tactical Management: How to Benefit From Market Volatility Episodes

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In today’s environment, multi-asset strategies remain an indispensable tool for gaining flexibility and diversification. But what elements make it possible to differentiate a multi-asset strategy from its competitors? Cristophe Machu, from the Multi Asset and Convertibles’ team of investment specialists at M&G Investments, explains in detail the approach used by the M&G Dynamic Allocation and the M&G Prudent Allocation strategies, which seek to convert market overreactions into a source of returns for the investor.

Both funds use an approach composed of three different pillars: strategic valuation, tactical valuation and portfolio construction. During the first block, strategic valuation, the management team examines and compares the valuations of the different asset classes in which the strategy invests – equities, fixed income, and currencies – with their fundamentals, to ensure the correct allocation of assets, which will be the portfolio’s main source of alpha. In the second block, tactical allocation, the management team seeks to exploit the opportunities that are generated in terms of volatility from changes in investor sentiment. According to M&G, on average, 18% of market volatility is the result of an excess of optimism or pessimism in investor sentiment, something that affects valuations, but not fundamentals. Finally, in portfolio construction, they focus on finding sources of decorrelation between the different assets. According to M&G, the correlations are not static, which is why they must perform a qualitative analysis over quantitative analysis, in order to understand the degree of correlation that future portfolio assets can reach.

Why is Strategic Valuation the Starting Point?

Returning to the first pillar, Cristophe points out that valuation is a good indicator of future returns, as it allows us to know what returns are expected of an asset and how it is being perceived by investors in the market. In equities, in both the United States and Europe, the current level of the forward P/E multiples can show the expected average yield over five years. Therefore, if you buy shares with multiples between 8 and 10 times, in five years you could realize an annualized yield of 20%. However, if you pay too much for an asset, with multiples between 24 and 26 times, the investor would almost certainly incur a loss.

A second issue that M&G evaluates, in order to try to take advantage of the opportunities it generates in the medium term, is the evolution of market volatility. In this respect, the managers of the multi-asset strategies would try to detect “episodes”, or moments in which quotes for the assets don’t correspond with their fundamentals to add risk to the portfolio. This alternative investment approach, with some contrarian vocation, tries to play tactically with asset allocation, increasing equity exposure when the market is over selling its positions for no apparent good reason. The strategies that follow this approach are called “Episode strategy”.

A good example of this approach is the returns obtained by the M&G Dynamic Allocation fund, which invests around 40% in US equities, compared to the performance of the S&P500 index and to a multi-asset portfolio that starts from the same allocation in US stocks, but that uses stop-loss mechanisms whenever the market experiences a fall, progressively reducing its exposure to risky assets with each decline. Over a period of 20 years, the returns of the M&G strategy would have been substantially higher than those of the market and of the strategy using stop-loss mechanisms, exceeding them by 60% and 108%, respectively.

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Why is it Pointless to Try to Predict the Future?

2016 was a year full of political events, during which the difficulty of guessing when making predictions became quite clear. Many investors were surprised by the vote in favor of Brexit and by Donald Trump’s election as president of the United States. For Cristophe, the most surprising thing about that whole case is that, even knowing the final result, it is still possible to err when reading the expected market reaction. Some market experts anticipated that a Trump victory could mean a precipitous decline in the markets and the beginning of a recession. Far from these predictions, in the weeks following the November election, so-called safe haven assets, gold and Treasury bonds at 10 and 30 years yielded negative returns, while the S&P 500 index performed positively. That is why, in terms of tactical management, none of the asset managers at M&G tries to make predictions, but rather, to benefit from the volatility that different episodes or market events can create.
In this regard, the VIX volatility index could serve as an entry indicator into the equity market, because according to the M&G investment specialist, after a peak of volatility in the VIX, the S&P500 usually experiences a rally in the following years, showing adequate moments for the incorporation of greater exposure to risky assets in the strategies.

Cristophe also points to the purchase by the M&G Dynamic Allocation fund of European, US, British, and Japanese stocks during the months of January and February 2016 as an example of a response to a market “episode”, to then undo these tactical positions in March. Months later, after Brexit, the fund took advantage of the attractive valuations of the banking sector and of certain regions to increase its exposure to these assets. It then sold those positions as soon as the market moved sideways in September of the same year.

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The Importance of Correlations Between Assets
At M&G, they argue that the correlation between equities and fixed income is dynamic and depends on the bond yield. If the bond yields are quite high, close to 10% or higher, there is usually a good source of bond and equity decorrelation. On the other hand, if the bond yields are much lower, below 5%, the ratio between the two assets is positive. This means that, at present, adding fixed income is not as attractive as equities, neither from a valuation point of view nor as a source of decorrelationas compared to equities, therefore, at M&G they do not believe that investing in a traditional multi-asset fund is the right solution for the client

Where is the Value?

Both the M&G Dynamic Allocation fund and the M&G Prudent Allocation fund can take short positions in equities and fixed income. In response to the cycle of interest rate hikes by the Fed, the fund positions itself with a negative duration.
The bond market is in an anomalous situation, where yields remain extremely low in both the United States and the United Kingdom, as well as in Europe and Japan. Taking inflation into account, these bonds have a negative yield, implying that an investor is willing to lose money in the medium term by investing in this type of assets. That is why the fund seeks to generate profitability by positioning itself short in relation to the debt of these countries.

Furthermore, at M&G they believe that, in US corporate credit, specifically in the BBB-rated universe, there may be value, as well as in some emerging markets, such as Brazil, Colombia and Mexico, which offer attractive spreads with respect to US Treasury bonds.

In equities, price is determined by the product of corporate profits and market valuations in terms of P/E multiples. In this regard, at M&G they strive to find sectors or geographical areas that can offer an increase in terms of corporate profits or whose valuations have potential for appreciation. Emerging markets and European equities would have these characteristics, and they hold long positions in both markets. While in the United States, although corporate profits are high, valuations are at their highest, so they hold long positions in some sectors with attractive valuations such as banking, technology, biotechnology, and oil, but for the first time in the fund’s history, they hold a net short position in US equities.

Finally, in the area of foreign exchange, M&G’s multi-asset fund managers prefer emerging market currencies for two reasons: the attractive valuation level of the Turkish Lira, the Russian Ruble, the Mexican Peso and the Brazilian Real, and the carry that these currencies represent against the dollar.

Thornburg Investment: “We Are Interested in those Companies that Are Willing to Share their Profits with Shareholders”

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How can an attractive dividend yield be achieved without giving up future growth and capital appreciation? Thornburg Investment Management looks for global stocks with a solid history of dividend payments and the capacity to increase their dividends over time. Thus, to provide an additional source of income, it also invests in bonds and hybrid securities.

Thornburg Investment Income Builder invests in a broad spectrum of securities that generate recurring income, at least 50% of its core assets are dividend paying shares, while the rest of the portfolio is composed of the fixed-income securities that serve as support.

Thornburg points out the historical importance of dividend yield as a component of shares’ total return. According to a study conducted from 1871 to 2001 over 10 year periods, shares with high payout ratios generated higher future earnings growth rates. In contrast, those companies that distributed a smaller percentage of their profits in the form of dividends, generated negative real earnings in the future.

“When selecting stocks, we focus on those stocks that have the capacity and willingness to pay dividends. By capacity, we mean those businesses that are able to generate cash flows, whereas willingness is more related to the dividend policy that the members of the Board of Directors and the management team have decided to implement. In that respect, we are interested in those companies that are willing to share their profits with shareholders,” they remarked.

Where are the best opportunities?

Diversification is important to the strategy’s performance. Looking at the expected dividend yield for 2018 by country of origin, the UK and Australia are at the top with 4.5%, well above the global average. These are followed by the Nordic countries’ stocks with an average of 3.7%, European stocks (excluding the United Kingdom) with an average of 3.6%, Latin American stocks with 3.5% and Canada with 3%.

“Dividend yield varies considerably around the world. Japan and the United States are among the countries with the lowest dividend yields, with 2.3% and 2.2%, respectively. In Japan’s case, companies are known to accumulate high levels of liquidity, without giving productive use to this cash. In the United States, however, the issue is related to double taxation of dividends: when a company generates a dollar in profit, it taxes 36% at the federal level. In addition, once profit is distributed as a dividend, the shareholder is taxed once more, causing more than half of that dollar generated to end up in the hands of the government. In that respect, we expect some kind of tax reform in the United States to improve the distribution between government and investors, although we don’t believe that double taxation will be eliminated.”

If you evaluate geographic regions in detail, there are higher dividend yields outside the United States, particularly in the United Kingdom, where there is a strong dividend payment culture and no double taxation on dividends. Generally speaking, a high dividend yield is offered in Europe, as there are more quality companies controlled by a family group, which demand the payment of dividends as part of their remuneration.

According to Thornburg, by sectors, there are attractive opportunities in the telecommunications sector, which is why the strategy allocates almost 20% of the portfolio to this sector. The exception is in telecommunications companies in Latin America, which have a lower dividend yield than in the rest of the regions. This is because Latin American companies are currently building their network systems, which requires high cash flows and limits their ability to distribute dividends.

Another sector with high exposure in the portfolio is the financial sector. Except in the United States, the dividend yield of the financial sector is far superior to that of other sectors due to its dividend payment policies. However, they expect that the capital requirements policies demanded of the US banks will change and allow an increase in the distribution of their profits as dividends.

Finally, Thornburg sources point out that it is quite common for the PE and forward PE multiples of the portfolio to be two or three decimal points cheaper than the market as a whole.

As regards fixed income, the fund takes advantage of the flexibility provided by the mandate to reinforce dividend yield with the coupons received by the corporate and hybrid debt instruments in which the portfolio invests. The strategy, with a benchmark index of 25% of the Bloomberg Barclays Aggregate Bond index and 75% of the MSCI World index, currently has a fixed income allocation of less than 10% (As of 5/31/17) because, according to Thornburg’s managers, prices in the fixed income market are manipulated by the effect of central bank actions. They expect this situation to continue until there is a clear change in trend; and they will strive to increase their debt position only when this adjustment will benefit shareholders.

The Factors To Focus On Now

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Today’s low-return environment poses a challenge to investors. We believe investing through a lens of equity style factors—broad, persistent characteristics driving returns—can potentially help investors increase diversification and enhance returns relative to broad market exposure, as we write in our June Global Equity Outlook Focusing on factors. So which equity factors should investor focus on today?

Investors can potentially benefit from exposure to all five major equity style factors for diversification purposes, but returns can be enhanced by tilting or adjusting these exposures through the economic cycle, research from BlackRock’s Factor-based Strategies Group suggests.

The major equity style factors—value, quality, momentum, size and minimum volatility (min vol)—have behaved differently depending on the phase of the economic cycle. We believe there may be years left in the current expansion, as detailed in our latest Global macro outlook. Investors have historically been best rewarded for exposure to momentum in such phases, our analysis of factor performance since 1990 suggests. See the chart below.

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We prefer momentum (stocks trending higher) in today’s economic environment. We also see the value factor (the cheapest corners of the market) potentially performing well in coming quarters against a backdrop of stable cyclical expansion. In periods of stable growth, market trends have historically tended to persist while confidence in value stocks rises. Today’s expansionary economic regime favors risk-seeking factors over defensive ones, we believe.

Momentum and value have had a small negative correlation over the past two decades, our analysis of MSCI index data shows. Yet the relationship is not static—and we see the current economic regime supporting both factors in coming quarters. We see the valuations of both factors as fair. Quality and min vol have historically tended to outperform in economic decelerations, as the chart above shows. But we believe these factors can provide some diversification throughout the cycle to cushion against volatility. The performance of size may depend on U.S. politics. Further delays in tax reform could dampen interest in these more domestically geared companies.
So what are the risks? Momentum investors should keep an eye on market breadth, we believe. This is a measure of the sustainability of the market trend, which measures the number of advancing stocks relative to the number declining. Our analysis shows that nearly 80% of the names in the each of the major U.S., European and Japanese markets were trading above their one-year moving average as of mid-May. U.S. equity markets have posted solid gains in the six to 12 months following this level of breadth, our analysis of S&P 500 data since 1990 shows. We find similar results for other markets. Robust earnings growth in the first quarter reinforced our view that the breadth of equity performance can be sustained.

We see an unexpected economic regime change as the major risk to value. Lower growth and inflation would weaken the fundamental outlook for cheaper stocks. Factor tilting, rather than short-term in-and-out timing, can help balance opportunities with the aim to improve returns without disrupting the long-term benefits of a diversified factor portfolio, in our view. Finally, the economic regime is the biggest driver of factor performance, although combining this with other indicators such as relative strength, valuation and dispersion can produce better results, we find.

Bottom line: We prefer the momentum and value factors in the current environment, but caution that how investors implement them could lead to different outcomes. Read more in our full Global Equity Outlook.

Build on Insight, by BlackRock, written by Kate Moore

Investing involves risks, including possible loss of principal. Investing in small cap companies may entail greater risk than large-cap companies, due to shorter operating histories, less seasoned management or lower trading volumes.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of June 2017 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

©2017 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries. All other marks are the property of their respective owners.
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MFS Investment Management: “We’re Going Through an Unprecedented Period, Markets Are Becoming More Efficient, but Much More Complex”

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The 2017 MFS Annual Global Analyst and Portfolio Manager Forum was held from the 15^th to the 17^th of May in Boston, where the international asset management company, MFS Investment Management, is headquartered. The event was attended by professionals from the wealth management industry and fund analysts from the Offshore and Latin American markets, to meet with the firm’s investment teams and product specialists.

Lina Medeiros, President of MFS International Ltd., was responsible for welcoming over 145 attendees, mostly from Argentina, Chile, Uruguay Brazil and US, who participated in the event. During her speech, she pointed out the company’s pioneering nature in the asset management industry, a track record spanning over 90 years, and that the company remains committed to offering portfolios with strong risk-adjusted returns, low turnover, and high active share.

Medeiros then stressed the long-term nature of MFS’ strategies and the firm’s values: teamwork, constant evolution in the search for long-term solutions for clients, and an absolute commitment to its fiduciary responsibility. She spoke of the firm’s ethos, which is “always doing the right thing for the client” with the greatest dedication possible, and reminded the attendees that the MFS team loves what it does: “We believe that what we do is to help people. Having clients who trust us to manage their wealth is a huge responsibility, and that generates a deep satisfaction that inspires us to remain firm in our convictions.”
It is due to this work ethic, in part, that more than 90% of the firm’s investment vehicles, the MFS Meridian Funds, are in the first half of their respective Morningstar categories over 5 and 10 years as of 31 March 2017. In addition, approximately 70% of the funds rank in the first quartile against their Morningstar peers over 10 years.

A Diversified Business

MFS has more than US$ 450 billion in assets under management. Medeiros presented this figure and defended a solid business model, with capacity to continue leading investment partner of choice in the future due to the firm’s diversified approach across three different dimensions: by channel, by style and by region. MFS institutional business represents about 68% of client assets, with the remaining 32% in retail client accounts. In addition, at the product level, the company offers broad classification by asset class, with its thorough knowledge in different equity disciplines as well as its renewed focus to broaden and deepen its capabilities in fixed income. Finally, at the geographical level, 77% of the business comes from the Americas region, a fact that should not be surprising given the US origin of the firm, strong US-Canada commercial ties, and more than 25 years of presence in Latin America. However, MFS is also devoting considerable resources to grow inEurope and Asia, which they hope will be noticeable in the coming years.

Which Issues are Investors Losing Sleep Over?

Prior to the conferences which followed, Ms. Medeiros presented the results of a study carried out by MFS at the end of last year. In this survey, more than 800 financial advisors and 450 professional buyers were asked which were their main concerns over the next 12 months. For these investors, geopolitical tensions and instability are as relevant as market-driven issues. Another one of the conclusions emerging from this study is that, as far as investment factors are concerned, for clients, the return on a product is just as important as how that return is achieved, showing that the qualitative aspects of the investment process are noteworthy.

Medeiros concluded her remarks by pointing out, that even for long-tenured investment industry professionals, this is an unprecedented period. She stressed that investors should become accustomed to lower-than-expected returns, given the US interest rate environment: “Financial markets, despite being more efficient, are becoming increasingly complex.”

An Overview of the Event’s Agenda

Taking a closer look at MFS Investment Management’s capabilities, Michael Roberge, CEO, President and CIO, reviewed the key differentiating elements of its approach: the search for opportunities through active management, a long-term investment horizon, and risk management .
Later, during the talk entitled “Disruptions, dichotomies, and destinations,” Erik Weisman, the firm’s chief economist, gave his views on the disruptive nature of technology and innovations derived from “Big Data”, as well as the effects they may have on the global economy and on the investment environment.

Following this line of discussion, four equity analysts from the technology and capital goods teams presented the implications of the changes that are occurring in the automotive industry: the vehicle of the future will be autonomous, electric, shared, and connected to a network.

The event also looked at the impact of recent regulatory changes in the financial services industry. Martin Wolin, Chief Compliance Officer, together with a panel of professionals, reviewed the main regulatory developments in the United States and Europe, focusing on the OECD CRS regulations, the MiFID II directive and money laundering prevention policies.

To analyze the global geopolitical situation in detail, MFS invited Alexander Kazan, Managing Director of Global Strategy for the Eurasia Group, who reviewed the economic and political dynamics of the global scene, including China, Russia and the Middle East.

With a focus on the US and other developed markets, James Swanson, Chief Investment Strategist, conveyed his concern about the disconnect between market sentiment and key economic data. Meanwhile, Bill Adams, CIO of the Global Fixed-Income Department, detailed the management company’s ability to find value in credit markets worldwide.

These presentations were accompanied by a series of breakout sessions on the range of MFS products, with the participation of its European, US, and Global equity management teams, as well as the teams from the global fixed income department, including emerging markets, and investment grade corporate debt.

Closing the conference, José Corena, Managing Director for the Americas, reviewed the main topics discussed during the event and thanked the attendees for their presence.

ETF Usage is Accelerating in Latin America

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Although exchange-traded funds are a relatively recent addition to institutional investing in Latin America, ETFs are quickly taking on an important role in institutions’ portfolio management toolkits. Based on the results of interviews with 50 Latin American institutions and trends among institutions in markets with a longer history of ETF investment, Greenwich Associates expects that process of integration to continue and even accelerate in Latin America.

The study finds that, like their counterparts in other regions, most Latin American institutions are starting out with relatively small allocations to ETFs, mainly in equity portfolios. “Through these initial investments, institutions are discovering the efficiency and versatility ETFs can bring to their investment portfolios. As they do so, they are expanding their use of ETFs to fixed income and other asset classes, as well as to a growing range of portfolio applications”. Institutions in Latin America are introducing ETFs to their portfolios first and foremost as a means of obtaining long-term strategic investment exposures and diversifying portfolios. They are then extending ETFs to a host of additional applications, ranging from tactical adjustments and portfolio completion to enhancing portfolio liquidity.

Latin American institutions that use ETFs now invest an average of 7.6% of total assets in them, with allocations poised for growth in 2017. Of Latin American institutions currently investing in equity ETFs, 68% expect to increase allocations next year, with 64% planning increases of more than 10%. More than two-thirds of Latin American institutions currently investing in fixed-income ETFs plan to increase allocations in the next year. Greenwich Associates expects ETF growth rates to accelerate in 2017 and beyond due to several ongoing and emerging trends:

Institutions around the world are experimenting with new and innovative ETF fund structures to help them manage mounting levels of volatility and other challenges facing their portfolios. In Latin America, more than 50% of institutional ETF investors invest in smart beta ETFs, and half of these users plan to increase allocations to them in the next 12 months. Demand appears strongest for smart beta ETFs that generate income and help institutions manage volatility.
Current impediments to investment will give way as Latin American institutions gain experience with ETFs. Factors such as limited availability of ETFs, internal investment guidelines that limit or prohibit use, and concerns about ETF liquidity and expenses have initially slowed the adoption of ETFs in other markets. All of these factors have eased over time as institutions saw early adopters using them safely and effectively.
Institutions will continue integrating ETFs into the mix of investment vehicles they employ in their portfolios, alongside and as replacements for derivatives and other products. Nearly 60% of institutions that use derivatives have diversified their mix of investment vehicles in the past year by replacing an existing futures position with an ETF—mainly for operational simplicity and reducing costs. Looking ahead, 42% of ETF users plan to evaluate existing futures positions in both equity and fixed income for potential replacement.
Institutional demand for ETFs in Latin America will get a boost from the continued proliferation of multi-asset funds. Following a global trend, approximately 40% of Latin American asset managers that invest in ETFs are using them in multi-asset funds and are investing 14% of total assets in ETFs. As Latin American managers launch multi-asset funds, Greenwich Associates expects ETF allocations within those funds to increase.
UCITS ETFs will provide new opportunities for investment. Latin American investors are beginning to initiate their first UCITS trades and are pleasantly surprised by their benefits, including tax and operational efficiencies. As institutions become more familiar with ETFs and seek new ways to employ them, UCITS ETFs will become a significantly larger part of the Latin American investment universe.

Is a Cashless Society the New Reality?

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From barter to cash to checks to online banking, money is an evolving technology that has been part of human history for thousands of years. While cash is expected to remain a significant payment instrument in the near future, Melissa Lin, Finance Editor at Toptal, believes factors such as “contactless” pay systems, increasing mobile penetration, and high costs of cash (ATM fees for individuals, cash storage for businesses, currency printing for governments, etc.) are prompting society to reconsider its ubiquity.

She states as an example, the case of countries like Sweden and India, as well as the EU region, which are adopting cashless habits or policies. “Driven by “contactless” pay technology, increasing digital penetration, costs of using cash, and policy initiatives, the idea of a cashless society is no longer a figment of the imagination.” She says.

Lin believes that in the near term, we are likely to witness a transition to less-cash societies, rather than a switch to cashless societies. Cash still accounts for 85% of total consumer transactions globally. Among established alternatives to cash, cards are the fastest growing payment instrument.

As cashless economy pros she identifies the increased scope for monetary policy, reduced tax evasion, less crime and corruption, savings on costs of cash, and accelerated modernization of citizens. While listing as cons: potential violation of privacy, increased risk of large scale personal and national security breaches, and technology-dependent financial inclusion.

Migrations to a cashless economy include considerations ranging from the purely financial, to those social in nature. Consequently, a country’s specific technological, financial, and social situations will inform its specific benefits, drawbacks, and approach to such a transition. In her opinion, the countries best positioned to go cashless include the US, the Netherlands, Japan, Germany, France, Belgium, Spain, Czech Republic, China, and Brazil.

“We are likely approaching a less-cash future, not a completely cashless future. And, while progress has been made in this transition, it has hardly been universal or uniform. A migration to a cashless economy includes considerations ranging from the purely financial to those social in nature. Consequently, a country’s specific technological, financial, and social situations will inform its specific benefits, drawbacks, and approach to such a transition.” She concludes.

Bolton Global Or Why The Advisors Reinvent Themselves As Independents

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This past year, Bolton Global, one of the 50 largest independent broker dealers in the United States, has seen its team of financial advisors grow substantially throughout the country, and especially in Miami, an important place in the international wealth management industry. The firm has announced the appointments, which, in turn, served as a call for other advisers contemplating, or in the process of, a change. From November 2015 to December 2016 the digital version of Funds Society has published such a series of appointments – The Perez Group, Eduardo Robson, Daniel Aymerich, Soraya Batista-Gracía, Eddie Moreno, Alex Astudillo, Ángela Canas, Tanya Duarte and Archivaldo Vásquez, Felipe Ballestas, Oscar Guevara, Samuel Nunez, Ricardo Morean, and Christian Felix – that we wanted to speak with Ray Grenier, CEO of the firm, to discover the keys to this firm’s irresistible model.

Bolton Global is one of the 50 largest independent broker dealers in the US. With 32 years of track history and 45 branch offices, it ranks among the top of independent firms in annual revenue and AUM per producing FA, across the US. This last year, Bolton Global has seen more than 15 advisors with international clients join the firm, many of whom are based in Miami.

What is the key? Why do financial advisors choose to join Bolton Global? How do they arrive at the firm and what does it offer them? “We do not have an FA recruiting team, we have grown fundamentally through word of mouth.” The best tool to attract new teams of financial advisors are the FAs that already work in Bolton, who refer other teams with quality assets and extensive experience. “A happy team that has the full support of the organization to carry out its work is the best ambassador to attract new talent to the firm,” says its CEO.

Ray Grenier, CEO explains: “Our platform allows FAs to establish their own brand name, capture the equity in their book of business and generate a substantially higher net income after expenses. Bolton provides turnkey solutions to incorporate the business, develop a company logo and company promotional materials, develop and establish a professional website, set up office infrastructure and train staff. We also provide all of the back office and compliance support to process the business efficiently and effectively in accordance with industry rules and regulations.

Through Bolton, FAs have access to all of the capabilities, products and services available through the major wirehouses and private banks.”

We are talking about Financial Advisors who had prior successful careers at the major US wirehouses in 90% of cases, with a client book of over $100 million and 15 or more years of industry experience. Most of them are US citizens or visa holders. Bolton also has several affiliated financial advisors operating from offshore locations in a fully registered capacity.

When talking about attracting clients, Grenier says the financial crisis of 2008 highlighted the importance of financial institution safety and security. BNY Mellon is a global financial institution with the highest safety rankings among the largest US banks. This provides clients with the security that their assets are held through a solid financial institution which also supports international business.

He adds: “BNY Mellon is the oldest US bank, founded by Alexander Hamilton in 1784 and is the world’s largest custodian with more the $30 trillion in assets under custody. It’s clearing subsidiary, Pershing is the world’s largest clearing firm servicing over 100,000 financial advisors working at financial institutions in over 60 countries.

In addition to providing clients with superior safety and security, the BNY Mellon companies furnish Bolton with all of the capabilities, products and services of the major wirehouses and private banks for both domestic and international clients.

As an independent firm, Bolton offers clients a pure wealth management play as the firm does not engage in investment banking or underwriting and generally avoids illiquid products.”

Bolton has a wide mix of customers from the United States, Latin America and Europe. Among the international clients, the firm has a strong representation in Argentina, Spain, Uruguay, Mexico and Panama.

The average account size is over $500,000 with the average relationship over $1 million. Portfolios hold a mix of stocks, bonds, ETFs and mutual funds managed either by the FA or by third party asset managers.

In the international business, around 40-50% of the assets are in mutual funds. Bond portfolios also prevail, as is customary in Latin American clients. Ray Grenier also points out that some of its representatives work with portfolios of UCITS ETFs domiciled in Europe, which represent a tax advantage over US-based ETFs.

Although Pershing is able to carry out the full range of services its clients require, Bolton’s financial advisors (FAs) can also work with a number of local banks that offer advantageous conditions for leveraging their asset portfolios, including international mutual funds. Thus, the FAs that join the Bolton platform can carry out the transition of the assets of their clients without losing functionalities over the broker dealers in which they worked previously.

Bolton provides FAs with a complete set of research tools to manage their client portfolios including recommended buy-sell lists, model portfolios, analytics, and performance reporting. Financial advisors have the flexibility to advise clients on the composition of their investment portfolios in accordance with the client’s objectives and risk profile. “In addition, FAs can use our Separately Managed Account (SMA) platform with access to more than 100 major asset management firms with multiple investment styles to construct and rebalance portfolios on a discretionary basis.” The CEO says. Approximately 40 percent of the business is fee based with 60 percent conducted on a commission or transactional basis.

In addition to portfolio management, Bolton offers clients the full range of account services including on-line account access, BNY Mellon VISA card, check-writing, ACH and bill payment, portfolio lending, multicurrency holding and reporting as well as trustee services. Bolton also provides access to execution and clearing on exchanges in 45 countries.

Goals

Over the last 5 years, Bolton has increased revenue and AUM by an average of 17 percent annually. The company experienced 23 percent growth in 2016. Grenier, says, excited: “We believe that industry conditions will continue to be favorable to Bolton allowing the firm to grow in the 15 to 20 percent range for the next 5 plus years.”

Among the most immediate expansion plans for the branches, the leader says: “The company believes that the Miami market will offer continued strong growth opportunities for the next several years.” He announces Bolton is in the process of opening an office in New York City to house a major wirehouse team that will be joining the firm in 2017 and reminds the firm opened an office in San Diego last year. Additionally, they are evaluating real estate options in Houston. “It’s a market that we look favorably on to open a new office because the establishment costs are relatively low – especially the cost of renting the office – and the international wealth management market has clear potential.” However, for the moment the growth focus for the non-resident business is still in Miami.

The environment and its good consequences

There is no doubt that Bolton Global’s business has grown as a result of the strategic shift of some firms with respect to its international clients. In Grenier’s words: “Many major financial institutions have withdrawn or significantly curtailed their servicing of international clients over the last 5 years. Bolton has definitely benefited from this environment. Sustainability in the international wealth management business requires a firm to limit account opening for only the highest quality clientele and to commit significant resources to AML compliance and surveillance.”

But Bolton has been in market for many years now. “Bolton recognized the potential of the international market as early as 2008 when a Merrill Lynch team in Texas with a non-resident clientele joined the firm. In recruiting from the major wirehouses and private banks, we realized that FAs from these firms would be more likely to convert to the independent business model if we provided them with a complete turnkey package to transition their book including brand development, office infrastructure, staff training and on-site support.”

In Dec 2016, Bolton had 30 international FAs managing aprox. $3.5 billion, and in the last year those advisors joining the firm’s Miami office collectively manage over $1.2 billion in client assets. In 2016, the firm added 5 teams and 5 individual FAs with over $1.5 billion in AUM. (Note: As a significant amount of these assets are still in the process of transfer, they would not all be included in the $3.5 billion number cited above.)

They are all in the process of monetizing the value of their book, improving their compensation and growing their practices with a supportive business partner. All of the recruits mentioned above have joined the firm as a result of a referral or recommendation by another Bolton advisor.

“The firm has the benefit of a robust pipeline of recruits to continue to add high quality teams through 2017 and beyond. In any case, we do not want to have a multitude of FAs, but a good ratio of assets and revenues per representative, “says Ray Grenier, giving clear priority to quality over quantity.

Investing involves risks, including possible loss of principal. Investing in small cap companies may entail greater risk than large-cap companies, due to shorter operating histories, less seasoned management or lower trading volumes.

©2017 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries. All other marks are the property of their respective owners. 184092

©2017 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries. All other marks are the property of their respective owners.
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