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Thoughts from a “Gringo” on his Brazil Trip

As a Uruguayan and American that has been working in Brazil or with Brazilians since 1995, I have never seen the country in this way. In 2012, while I was visiting Brazil, I went for a jog early one beautiful morning in Vitória, the capital city of Espirito Santo. Espírito Santo state is Brazil’s largest producer of petroleum and Vitória is an important port for exporting iron and steel from companies like Vale or CST.

As I stopped to hydrate, I realized that the coconut water I bought from a street vendor in this secondary city, was more expensive than a Vita Coco coconut water in New York City or arguably Tokyo! There were clear fundamental reasons BigSur became bearish on the economic growth of the country, on the Brazilian Real and on all Brazilian asset markets. A decade of prosperity fueled by the commodity boom, allowed Brazil to hide problems in its legal and political framework rather than build stronger institutions during its good years.

For the Brazilian families that were clients of ours at that time, we strongly recommended that they diversify outside of Brazil. Fast forward four years later to current day, and the country is arguably in its deepest crisis ever! I have just returned from a trip with a colleague from Intermediate Capital Group, a USD 23 billion in AUM specialized credit manager, with over 26 years of history investing in private debt across the globe. I wanted to share some thoughts about what’s going on in Brazil – while we believe this is a very idiosyncratic Brazilian crisis, we think we can shed some light from our admittedly “gringo” perspective.

A Long Road Ahead to Improve the Economy

Brazil’s economy is facing its worst recession since the 1930s. Its economy is expected to contract by 4-5% this year, after shrinking 3.8% in 2015 (which was its fastest deterioration in 35 years). This could translate into a loss of about 8-9% of GDP in two years, which some economists constitute as a depression.

Many factors led to Brazil’s current situation. There were a series of ill-founded policies, including an excessive increase in consumption through lines of credit, cheap interest rates below the break-even point and an artificially valued exchange rate to control inflation. Brazil also has a lack of trade agreements with the main global economic blocks, and many public entities use “creative” accounting methods. These types of policies enabled the country to achieve a few years of growth above its potential, buoyed by the boom in commodities, and also helped by artificially low inflation, unemployment and fuel prices. In addition to economic decline, many expect an unemployment rate around 12%, a sharp fall in family income and decreases in investment and consumption. Government debt is now rising quickly to a level where reversal becomes extremely difficult and painful to administer. Brazil was downgraded by all rating agencies to junk status, both in terms of local debt and foreign debt.

We believe it’s going to be a long road for the economy to come out of its paralyzed state, and the process will not be quick or easy. Why? This is a highly rigid economy, with a heavy use of indexing. With strong unions, regressive labor laws and a cumbersome judicial system together with poor infrastructure there are many “bottle-necks” in the economy – inadequate roads, a dearth of rail lines, and strapped ports, all hampering the flow of products to market. The cost of moving soy, the number 1 export product in the country, from the grain belt in Brazil’s the interior state of Mato Grosso to the port of Santos in São Paulo state, is close to four times what it costs a farmer in Illinois to get his soy crop to New Orleans

All of this also leads to an incredibly high cost of doing business. The famous “custo Brazil” has many components, including high taxes (36% of GDP, way out of line with the 21% average for upper-middle-income countries), rocking import duties and rigid labor laws that make it hard to use workers efficiently. High interest rates mean firms must spend a packet on financing; high crime adds heavy security costs to their overheads. A terrible education system makes Brazil the world’s second-hardest place for firms to find the skills they need, according to Manpower Group

In the 2016 World Bank’s Cost of Doing Business, Brazil comes 116th in the world (down from 111th in 2015). Some of the high “cost of doing business” factors where Brazil compares unfavorably with OECD countries and even other Latin-American countries include:

Number of procedures and Number of days to start a business;
Number of hours per year of time to pay taxes – Brazil is the ranked the number 1 most time consuming tax system in the world!;
Cost to export; Cost to import; Time to resolve insolvency; and Time to resolve litigation

By analyzing Brazil’s economic prospects for the next few years, we have come to the conclusion that the country will need low real interest rates to recover its ability to grow, and that inflation should remain controlled. We do not see either of those conditions present anytime soon.

A Paralyzed Political Situation with No Clear Solution

While the country is completely paralyzed, it is clear that a political catalyst is needed. However, with or without impeachment we see no deep political change foreseen any time before, and probably during, the 2018 elections. Most likely, we will see one set of crooks is being replaced by another. With or without impeachment of President Dilma Rousseff, Brazil is confronting a host of challenges that would complicate a new government’s ability to revive a sinking economy and ease unrest inflamed by months of bitter political jousting. Any alternative government will be led by politicians that are corrupt and involved in the scandals, especially the centrist PMDB, considered a “party for hire”. Thus, with or without the Senate’s impeachment, we view the political situation as fragile and unstable.

Vice President Michel Temer from the PMDB party, (which shared power with the president’s Workers’ Party before splitting off in March) stepped down as leader of the PMDB this month. This happened after a Supreme Court justice made a preliminary ruling that any impeachment of Ms. Rousseff may extend to Temer, as he’s also being investigated for funding Ms. Rousseff’s 2014 campaign with bribes. The scandal doesn’t end there: on the other side of the coin, the legislator overseeing impeachment, Mr. Eduardo Cunha, is also facing charges and indictment alleging that in 2006, he helped orchestrate a USD 40 million bribe in exchange for two contracts to build floating oil platforms for Petrobras. This illustrates just how difficult it will be for the country to turnaround, as the roots of corruption are deep. Mr. Cunha’s first political patron, ex-President Collor, returned to government 15 years after his impeachment. He was elected to the Senate, put in charge of an ethics committee and will be among those voting on Ms. Rousseff’s impeachment. Does it get more ironic than this?

According to non-profit Transparência Brasil, 60% of Brazil’s federal legislators have been convicted or are under investigation, for crimes ranging from corruption to electoral fraud to assault. The PMDB party could form a new government, but it’s riddled by internal rivalries. The most pressing challenge for Mr. Temer and any new government would be to mollify Ms. Rousseff’s enraged hard-core base. The country will be overrun by social mobilizations, strikes, and workers’ occupations by the homeless and landless. After months of uncertainty and hardship, this frazzled country is inevitably headed for more of the same.

The problem in Brazil is that legislators have immunity. The lead prosecutor in the Petrobras case calls for an overhaul of these rules; saying corruption runs so deep that even the dozens of convictions in the Petrobras investigation won’t be enough to root it out. For a country to get rid of corruption and impunity and change its culture, they will have to alter the institutions. And this is not even on any table at the moment. The other complicating factors that add to instability are that no other political party or leadership has capitalized yet from the population’s distrust and the complicated political system with 35 parties. While it’s not our base scenario, the danger of Brazil following Venezuela’s path is latent.

Cultural Change and Structural Reforms are still Far Away

The crony capitalistic economic model introduced by the Workers Party (PT) generated an explosive growth in debt and huge distortions in the assignment of resources and credit in the economy. Some analysts estimate that around 50% of all corporate loans were subsidized. To reverse the explosive growth of debt, several structural economic reforms will need to be implemented. On the government budget, the main focus must be on reducing compulsory expenditures guaranteed by the constitution, so as to give the government higher flexibility when tax revenues drop. This must include a social security reform, a change in the calculation of the adjustment of the minimum wage and pensions, greater decoupling of budgetary revenue, and greater flexibility in labor laws, to name just a few. But it’s yet very soon to guess what the new economic model will look like.

We do not believe there are any real political alternatives and there is no focus on structural nor institutional change. The economic model and the culture will change once new processes are in place, not just because Judge Moro is going after corrupt politicians and entrepreneurs. We consider this a good first step and a necessary one. However, we do not view it as a sufficient reason for a change in the way Brazil operates. In a Harvard Business Review paper called “Culture Is Not the Culprit” by Jay W. Lorsch and Emily McTague, the authors conclude that culture isn’t something you “fix.” Rather, in their experience, cultural change is what you get after you’ve put new processes or structures in place to tackle tough business and economic challenges (like reworking an outdated strategy or business model). The culture evolves as you do that important work. We are far away from this in the Brazilian model. In the meantime, the corruption scandal is keeping the “Animal Spirits” depressed, as net investment is negative and there is no investment in infrastructure or intensive capital goods industries. There’s yet no catalyst for a change, as there’s no deadline for the persecution of entrepreneurs. However, similar to the dynamic we are seeing in US and Europe, the Brazil M&A space has benefitted from interest of multi-national companies making strategic acquisitions. These are companies looking to buy developed and performing assets with a strong foothold in the country – they can avoid the risks of building businesses or infrastructure assets from scratch this way.

M&A (Mergers & Acquisitions) activity is strong

One theme we’re paying attention to is the serious uptick in M&A activity in Brazil. The fourth quarter of 2015 was the third best quarter for M&A since 1995, with deal volume reaching USD 22.6 billion. This has continued into the first quarter of this year, and bankers are optimistic that the trend will remain for the short term. The near 45% depreciation in the Brazilian real against the dollar since mid-2014 has made Brazilian assets more affordable for foreign investors, attracting buyers from Europe, the US and increasingly Asia. The Brazilian market, with an overall population of 200 million and a large youth demographic (25% of population) is important for many long-term strategic investors, who this point in the cycle, believe they are getting access to a market they need to be in for a cheap price. We’re seeing this especially in infrastructure, consumer goods and consumer discretionary companies.

Farming is Brazil’s one Bright Industry

Brazil’s farmers look set to produce record crops of soy, coffee and sugar cane this year, while cattle ranchers and chicken and hog farmers foresee reaching new heights for exports. Agriculture was the only sector of Brazil’s economy to expand last year, by 1.8%, while overall GDP shrank 3.8%.

The whole world has to eat, and Brazil makes its living from agriculture. Brazilian farming continues to undercut its counterparts in the U.S. and Europe as it is the most efficient producer in the world. This is for two reasons: 1) Brazil became a lot more competitive last year because of the weaker real; and 2) agriculture offers a rare example of a Brazilian sector that is globally competitive. The

country’s largely inefficient manufacturers are still heavily protected by tariffs and import taxes, but the government took the opposite approach with agriculture. Starting in the 1990s, it reduced subsidies and eliminated export taxes while increasing investment in agricultural research. Farmers responded with a rapid expansion of the area under cultivation and a burst of investment that made them among the most productive and efficient producers in the world. Soy products and coffee are the locomotive of Brazil’s agricultural sector. Only the value of soybean and soybean-product exports went from USD 23.9 billion in 2011 to USD 31.3 billion in 2014. Even as sales retreated to USD 27.9 billion last year, soybeans still dethroned iron ore as the country’s most valuable export.

Conclusion

While good economic times do not necessarily make for smooth politics, bad politics generally go hand in hand with an underperforming economy. Certainly, Brazil needs to resolve its political crises before it can tackle its economic woes. The problem is that a successful impeachment vote may simply lead to another equally unstable government — with an administration led by vice-president Michel Temer, also dogged by corruption accusations and questions of legitimacy, it would be near impossible to pass necessary (but unpopular) fiscal reforms.

A question we have is whether Brazil could turn into the next Venezuela, or can it follow Argentina’s path? If Brazil does not “do their homework” and institute structural reform and cultural change, the country can go into a collapse similar to Venezuela. We view this as a low probability scenario, but it cannot be discarded. If Brazil can “clean house” and rid itself of the same old types of politicians, and bring in a leader without ties to corrupt institutions, like Argentina has done with Macri, there may be a chance at a turnaround. It’s still unclear which path Brazil will follow.

It’s also important to note that transitions, even peaceful ones, are messy and take time: Argentina’s economy is likely to shrink this year before the new government produces a turnaround. In Brazil (as ironically in Venezuela), even if there is political change tomorrow, it will take a long time for their economies to regain balance. Markets have been trading Brazil in a binary fashion lately — any development suggesting a rising chance of impeachment leads equities and the currency to rally and vice versa. Caution and patience are warranted. Nibbling for (distressed) opportunities seems the right approach.

Opinion by Ignacio Pakciarz, CEO and co-founder at BigSur Partners.

If The Economic Scenario Were To Be Stagflation?

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If deflation occurs in Europe, there is no evidence to suggest it would persist, as most countries are flooding their economies with additional money backed by public debt. Furthermore, inflation is on the rise, albeit slowly in some countries. I would like to share a perception that first occurred to me in 2010. What if the European economy faced a scenario of stagflation, that is to say a combination of economic stagnation compounded by persistent unemployment and moderate inflation? This is a matter I would like to discuss.

What are the attributes of this footprint stagflation? Besides the aspects of state solvency, they are the same as the symptoms as witnessed during the 1970s: a low rate of economic growth combined with a marginal decrease in productivity, structural and high unemployment (structural dislocations characteristic of economy), underutilization of production capacities, low expectations of earnings (at least in the medium-term), low capital investment to moderate a scarcity of bank credit for private investment, balance of trade deficits and widespread deindustrialization.

The effects of stagnation can essentially be detected by structural unemployment, which is already well established in some areas. Beyond the visible effects the retirement of a significant portion of baby boomers have, (which merely postpones the problem of their replacement income to future governments) unemployment is related to different phenomena: industrialization, inadequate education, exhaustion of the growth model by debt, lack of flexibility in the labor market, entrepreneurship and especially weak ancillary mindsets that have not yet integrated into growth areas. There are also issues surrounding immigration; for example, will it be redesigned to ensure new continued growth in employment?

Inflation meanwhile is not a desirable solution, since it poses a risk of self-power and only nominal increases in state spending. It would appear that as a consequence, this unavoidably leads to the monetary rediscounting of public debt. Of course, inflation depletes returns, especially since the savings are invested in fixed income securities. But as Keynes advanced (1883-1946), “it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier.

“Some economists even argue an iconoclastic theory that the banking, state and economic crises are the result of a period characterized by excessive disinflation. This period, known as “the great moderation” apparent between 1985 and 2005, would benefit from the expansion of trade areas (through globalization) and a low-cost accessibility to employment pockets, to mask the reality of the repayment of private and public debt. The expansion of demand did not lead to an inflation crisis because western governments absorbed this by their trade deficits.

Why does the perception of inflation raise the specter of secular deflation with many economists (which constitutes a strong collective preference for liquidity and is often confused with disinflation)? Because money created ex-nihilo with coupons which become claims on other coupons, and recalling the words of the economist Jean-Baptiste Say (1767-1832) “the currency is just a veil”, as implemented by the central banks, is a treatise on the future, meaning reimbursement will become uncertain. It is indisputable that the States and also the central banks are currently conducting a monetization of the debt with its corollary of liquidity creation and possible delayed inflation. The recent measures therefore create money without creating a capital.

Finally, we must ask ourselves how European monetary authorities dared to simultaneous impose an extremely low annual inflation target of 2%, whilst authorizing Member States to increase their public debt in such proportions that the most intuitive way to reduce its weight or to reduce its relative value is through inflation as the ECB now intends to stimulate.

Bruno Colmant – Bank Degroof Petercam

Michael Gordon, New CEO for United States at Lombard International

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Lombard International, a global leader in wealth structuring solutions for the high net worth market, appointed Michael Gordon as CEO of its U.S. operations effective May 2, 2016. He will report to John Hillman, Executive Chairman of Lombard International.

Gordon joins Lombard International from his role as Global Head of Insurance Solutions at BNY Mellon. Additionally, he served as Chief Executive Officer of Tiber Capital Management, LLC, a wholly-owned subsidiary of BNY Mellon focused on managing assets for insurance and reinsurance companies. Before BNY Mellon, Mr. Gordon was an executive at New York Life Insurance Company, leading investment and insurance product management, sales and marketing functions.

The announcement is part of a series of strategic developments for Lombard International including the formal launch, in September 2015, of its global life insurance-based wealth management business. This announcement followed the successful integration of Luxembourg-headquartered Lombard International Assurance with U.S.-headquartered Philadelphia Financial.

John Hillman, Executive Chairman of Lombard International, said: “We are thrilled to have someone of Michael’s experience and background to guide Lombard International in meeting our aggressive ambitions for U.S. growth and achieving our goal of building a world class investment platform.”

Lombard International specializes in providing multi-jurisdictional wealth planning solutions through its partner networks across the United States, Europe and Latin America, issuing life insurance policies and annuities from the United States, Luxembourg, Guernsey and Bermuda. Global assets under administration are in excess of USD 75 billion with a global staff number of over 500, including more than 60 technical experts specializing in 20+ jurisdictions.

Trinidad & Tobago Set to Become a Premier Financial Centre

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Trinidad & Tobago continues to make great strides towards becoming a recognised international financial centre. To be a successful financial centre these days there are a number of factors that a location simply must get right. Factors like a strong regulatory environment, the rule of law, transparency and co-operation with the international community are all in the news at the moment and are vital in becoming a successful centre. They are also critical in building a strong reputation. In order to get these factors in place, Trinidad & Tobago has forged some strong international partnerships which are informing the country’s development as an international financial centre.

In 2015 Trinidad & Tobago signed a memorandum of understanding with the Toronto Financial Services Alliance (TFSA) to help work collaboratively with other international financial centres to promote robust and transparent regulatory frameworks. Janet Ecker, President and CEO of the TFSA said that amongst other benefits “The memorandum will help strengthen Trinidad & Tobago’s position as an emerging financial centre and will support increased investment from international financial companies.”

Trinidad & Tobago has also been working closely with the widely respected international law firm Herbert Smith Freehills (HSF). Andrew Roberts, a partner at HSF, said: “We are delighted to be helping Trinidad & Tobago ensure that their regulatory systems meet the expectations of the international community. Trinidad & Tobago’s commitment to offer the highest standards of regulatory oversight is very encouraging.”

Trinidad & Tobago has recently become a member of the Commonwealth Enterprise & Investment Council (CWEIC) a membership organisation based in London that promotes trade and investment by facilitating engagement between Government and the private sector throughout the Commonwealth. John Pemberton-Pigott, the CWEIC Director of Programmes, remarked that “Businesses require a set of values under which trade and investment can take place – transparency; good governance; respect for the rule of law; enforceable physical and intellectual property rights; equal opportunities and a diverse workforce. Lord Marland, Chairman of the CWEIC said that “our relationship offers Trinidad & Tobago a great opportunity to reach out to the Commonwealth financial community to promote itself as the premier financial centre for Latin America.”

Trend-Following and Crisis Alpha

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Managed futures strategies have demonstrated the ability to maintain diversifying characteristics when most needed, in a market crisis. In this interview with Robert Sinnott, a portfolio manager at AlphaSimplex Group, subsidiary of Natixis GAM, he discusses crisis alpha, diversifying factors, daily liquidity, and fees. But first, he explains why “the trend” has been his friend during the first few months of 2016.

2016’s market environment has been bumpy. How has your managed futures approach behaved?

We follow a trend-following strategy across global stocks, bonds, currencies, commodities. So in 2016, where the S&P 500 has gone down more than 10% and then come back up, it has been a time when trend-following strategies have shown their diversification benefits. These gains have come from multiple asset classes, including going both long and short in global currencies and both European and U.S. fixed-income.

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How do you know when to get in and when to get out?

This systematic trend-following strategy is fundamentally a dynamic asset allocation strategy. We are figuring out when to go long markets and when to go short based on market momentum. We use a mix of quantitative models that track price trends in global markets over short-, medium-, long- and variable time horizons. When the models indicate an up-trend in a particular market, that signals a time to buy that asset; likewise, down-trend indicators will signal a time to sell and often go short these assets.

In terms of an investor’s overall portfolio, if you are thinking about when to enter and exit a strategy that itself is figuring when to enter into and exit out of a market, you are going to compound your challenge. What we find for managed futures, especially trend-following strategies, is that they serve as a long-term diversifier for overall portfolios. Also, I think having a strategic allocation approach rather than a tactical allocation approach makes more sense. If you try to time it, you have a good chance of missing the benefits, as we saw in January of this year. By the time you got in, most of that advantage was probably already experienced by the current holders.

Is liquidity ever an issue?

Because managed futures strategies generally trade liquid futures and forward contracts, they may not be exposed to the illiquidity costs and concerns of many other alternative assets or alternative strategies. Now, while it is possible that a futures market might become illiquid, this is much, much less likely to occur than we might see in other alternative strategies.

What is crisis alpha, and how important is it to ASG?

Crisis alpha is a very, very important concept. It’s actually a differentiating feature for managed futures relative to many other alternative asset classes. Some trend-following strategies have not only provided positive returns during most historical crisis periods, but they actually seem to provide additional positive return during these periods of crisis in excess of their average return in other market environments. This tendency is known as crisis alpha. I should point out that even strategies that have strongly documented historical crisis alpha may not provide positive returns in every crisis and that past results are not indicative of future results. Nonetheless, over the long term, we think strategies that exhibit crisis alpha may serve as a good diversifier in a portfolio, because they may provide returns when other investments are contributing to losses.

When we think of managed futures strategies as a group, it’s important to understand that not all managed futures strategies do the same thing. It depends on what approaches a particular strategy employs. Some focus in on very short-horizon trend signals, while others will only track very long-horizon trends. Still others, including AlphaSimplex, follow short-, medium-, and long-horizon trends, trying to get a more diversified approach.

Can you talk more about the diversifying factors of your strategy?

Because the ASG managed futures strategy considers global stocks, bonds, currencies and commodities, we have many different opportunities to follow throughout the world. We consider everything from the South African rand and the Mexican peso to the German Bund to the U.S. 10-year and beyond.

When we are looking at the positions and how the strategy moves, we get diversification from a broad asset set of liquid exchange-traded futures and currency forward contracts. Diversification also comes from being able to go both long and short in each of these contracts.

So this translates into a true diversifier for investors’ overall portfolios?

Yes, I believe so. A managed futures strategy has the potential to diversify investors’ portfolios in three ways. First, you have the potential for strong performance in down markets. Second, low to non-correlation with other asset classes. And finally, you gain exposure to more types of assets that may help your portfolio even in non-crisis periods.

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Higher fees are often associated with managed futures strategies. Why is that?

Well, first of all it’s important to think about what goes into these strategies in terms of infrastructure and trading. We have a 24-hour trading desk that trades in all of the global markets. In addition to that, you have to remember these strategies first came out in the hedge fund area, which has considerably higher management fees.

What type of allocation should investors have in their portfolio?

Obviously it is important for investors to work closely with an investment professional to arrive at the right amount for their portfolio. But, for investors with a large equity allocation, it might make sense to have a meaningful managed futures component in their portfolios because of that propensity of managed futures to provide crisis alpha, as well as diversification from equity risk.

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RISKS: Diversification does not guarantee a profit or protect against a loss. Managed futures strategies use derivatives, primarily futures and forward contracts, which generally have implied leverage (a small amount of money used to make an investment of greater economic value). Because of this characteristic, managed futures strategies may magnify any gains or losses experienced by the markets they are exposed to. Managed futures are highly speculative and are not suitable for all investors. Commodity trading involves substantial risk of loss. Futures and forward contracts can involve a high degree of risk and may result in potentially unlimited losses. Short selling is speculative in nature and involves the risk of a theoretically unlimited increase in the market price of the security that can, in turn, result in an inability to cover the short position and a theoretically unlimited loss.

In Latin America: This material is provided by NGAM S.A., a Luxembourg management company that is authorized by the Commission de Surveillance du Secteur Financier (CSSF) and is incorporated under Luxembourg laws and registered under n. B 115843. Registered office of NGAM S.A.: 2 rue Jean Monnet, L-2180 Luxembourg, Grand Duchy of Luxembourg. The above referenced entities are business development units of Natixis Global Asset Management, the holding company of a diverse line-up of specialized investment management and distribution entities worldwide. The investment management subsidiaries of Natixis Global Asset Management conduct any regulated activities only in and from the jurisdictions in which they are licensed or authorized. Their services and the products they manage are not available to all investors in all jurisdictions. This material is provided by NGAM Distribution, L.P. This material is provided for informational purposes only and should not be construed as investment advice. There can be no assurance that developments will transpire as forecasted. Actual results may vary. The views and opinions expressed may change based on market and other conditions. Past performance is no guarantee of, and not necessarily indicative of, future performance. 1483285.1.2

Is Gold More Productive Than Cash?!

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Is gold, often scoffed at as being an unproductive asset, more productive than cash? If so, what does it mean for asset allocation?

There are investors that stay away from investing in gold because it is an ‘unproductive’ asset: the argument points out gold doesn’t have an intrinsic return, it doesn’t pay a dividend. Some go as far as arguing investing in gold isn’t patriotic because it suggests an investor prefers to buy something unproductive rather than investing into a real business. In many ways, it is intriguing that a shiny piece of precious metal raises emotions; today, we explore why that is the case.

Investing is about returns…
Each investor has their own preference in determining asset and sector allocations. Some investors prefer to stay away from the tobacco, defense or fossil fuel industry. During times of war, countries have issued bonds calling upon the patriotism of citizens to support the cause. At its core, however, investing, in our assessment, boils down to returns; more specifically, risk-adjusted returns. The “best” company in the world may not be worth investing in if its price is too high. Similarly, there may be lots of value in a beaten down company leading to statements suggesting profitable investments may be found “when there’s blood on the street.”

Gold is not only unproductive, but has a storage cost and is expensive to insure. So what could possibly be attractive about gold?

Investors like nothing…
We wonder where all these patriotic investors are hiding. That’s because if we look at long-term yields, they are near historic lows throughout the developed world, with many countries showing near zero or even negative yields on governments bonds. Differently said, many investors rather get a negative yield on the safest investments available to local investors (disclaimer: U.S. regulatory point of view, foreign government bonds aren’t considered “safe”) than invest in so-called productive assets: a corporate bond may qualify as a ‘productive asset’ if a company uses the proceeds to invest in future ventures; yet, in today’s environment, corporations frequently issue bonds to buy back shares. Why do investors prefer “nothing” – as in no or negative returns – over investing in productive assets? And if investors really like negative returns, is gold – that doesn’t have an intrinsic return, suddenly attractive?

Productivity is king
On April 7, Fed Chair Yellen joined an “International House” panel with all living former Fed Chairs: Bernanke, Greenspan and Volcker. When Bernanke was asked whether we need more fiscal stimulus as monetary policy may have reached its limits, we interpreted Bernanke’s long-winded answer as agreeing to the basic notion that it would be helpful to ramp up fiscal spending. Little coverage was given to Greenspan’s response: “No!” Focusing on the U.S., he said unemployment is close to what’s historically considered full employment: if fiscal spending were to be ramped up, we might get a short-term bump in growth due to the induced government spending, but we would foremost get wage inflation and increased deficits that will come back to haunt us. Instead, he argued, we need policies that increase productivity: when you are near full employment, the way you grow an economy is to increase the output per worker. He suggested the best way to increase productivity is to encourage investments.

While we acknowledge that not everyone agrees with Greenspan’s policies over the years, we believe he is dead right on this one. So why the heck aren’t investors investing? Why are they buying bonds yielding just about nothing?

Investment is dead…
There may be many reasons why investors are on strike. Current low inflation, in our view, is a symptom, not a cause of that. At its core, we believe investors don’t think they get rewarded for their risky investments. Our analysis shows that investors in recent decades have – on average – focused on ever more short-term projects. That is, projects that require massive investments with an expected return in twenty years rarely happen these days.

In his book “Civilization: The West and the Rest,” economic historian Niall Ferguson makes the point that what differentiates the West from ‘the Rest’ is the rule of law. When there’s certainty over the future rules and regulations, i.e. when the rules of the game are clear, investors are more likely to invest. We believe that rule of law has been deteriorating, but not necessarily in the most apparent way:

Regulatory risks. We allege regulatory burdens have substantially increased in many industries. This increases the barriers to entry (stifling innovation), as only large players can afford to comply with the rules. If we take the U.S., gridlock in Congress, has caused regulatory agencies to increasingly change the path of regulations without legislative process. The cost of doing business has gone up in many industries, from finance to pharmaceuticals to energy, to name a few.
Government debt. We allege investments are at risk when governments have too much debt. That’s because the interests of a government in debt is not aligned with the interests of savers. A government in debt may be tempted to induce inflation, increase taxation or outright expropriate wealth. In our assessment, investors need to be convinced government deficits are sustainable for them to have an incentive to invest.

Neither government deficits nor regulations are new phenomena, of course. But we believe it’s concerns over trends like these that are key to holding back investments. It’s often argued that the U.S. can print its own money and, as a result, will never default. Possibly, but that doesn’t mean the U.S. won’t induce inflation or find other ways to tax investors. And while there are solutions to any problem, investors must be convinced that those that benefit risk takers will be embraced. Eurogroup chief Dijsselbloem, at the peak of the Eurozone debt crisis phrased it well, arguing that we cannot expect long-term investments if we don’t tell people where we want to be in ten years from now. While a crisis is apparent when Greek government bonds rattle global financial markets, the global strike by investors to invest in productive assets may be just as alarming.

Demographics
But aren’t demographics at least partially to blame for the low rates? It cannot be entirely a view about fiscal deficits and regulations? Sure enough, we agree that demographics put downward pressure on real rates of return. Yet, we see this as part of the same issue: we could introduce policies that encourage workers to be productive longer rather than retire at age 65. Instead, we have policies in place that have enabled many to go into early retirement by claiming disability benefits. With increased life expectancies throughout the world, we feel retirement at age 65 has become a major fiscal burden.

Is gold now good or bad?
As we have pointed out many times in the past, it’s not gold that’s good or bad. Gold doesn’t change – it’s the world around it that does. We believe an investment in gold should be looked at in the context of an overall portfolio construction. There, one should look at the expected risk and expected return of any asset one considers including in a portfolio. Please read our Gold Reports for more in-depth analysis of gold’s low correlation to other assets that might make it a valuable diversifier; you may also want to read our recent analysis Gold Now as to why we think gold might be good value for investors. For purposes of this discussion, however, we like to put gold in the context of productive assets. Our interpretation of the bond market suggests investors are shunning productive assets these days. Part of that may be concerns by investors that they will not be rewarded, with part of that due to what may be excessive government debt and regulations; another attribute may well be valuations, as we believe monetary policy has pushed many so-called productive assets into what may be bubble territory. Following this line of reasoning, reasons to hold gold in a portfolio may include:

We may be pushing the can down the road. A belief that policies in place have not put us on a sustainable fiscal path. Concerns of ballooning entitlement obligations come to mind. Namely, we are pushing the can down the road. Importantly, we don’t see a change in that trend for some time, if at all.
Regulatory uncertainty is only increasing. Regulations are strangling businesses, discouraging investments.

In contrast, reasons to reduce gold holdings in a portfolio may include, with respect to the above bullet points:

Recent government deficits have been improving; folks have always complained about the long-term outlook, but when push comes to shove, politicians will find solutions.
Both small and big business have always complained about regulation, there’s little new here.

Phrasing it this way, it’s not a surprise that an investment in gold often has a political dimension. We caution, however, that gold is anything but political. As such, it may be hazardous to one’s wealth to make investment decisions based one’s political conviction. Instead, investors may want to take a step back and acknowledge that investors in the aggregate give a thumbs down to investments as evidenced by the low to negative long-term yields in the U.S. and other countries.

Gold: cash or credit?
Before we settle the discussion on gold being ‘unproductive,’ let’s clarify that cash isn’t productive either: the twenty-dollar bill in your pocket won’t earn you any interest either. To make cash productive, you need to put it at risk, if only to deposit it at a bank. With FDIC insurance or similar, such risk might be mitigated for smaller deposits. Gold is no different in that regard: to earn interest on gold, one needs to lend it to someone. Many jewelers are only leasing the gold until they find a buyer for the finished product; to make this happen, someone else is earning interest providing a loan in gold. Many of today’s investors don’t like to loan their gold, concerned about the counter-party risk it creates. The price such investors pay is that they don’t earn interest on their gold, a price those investors think is well worth paying.

Gold more productive than cash?
The reason we started this discussion wondering whether gold may be more productive than cash also relates to the fact that real rates of return on cash, i.e. those net of inflation, may be negative in parts of the world. There are many measures of inflation and some argue that government statistics under-represent actual inflation. As such, each investor might have his or her own assessment where inflation may be. However, when real rates of return on cash are negative, it may be appropriate to say gold is more productive than cash.

In summary, anyone who thinks that we are heading back to what might be considered a ‘normal’ economy, might be less inclined to hold gold, except if such a person believes that the transition to such a normal economy might be a bumpy ride for investors (due to the low correlation of the price of gold to equities and other assets, it may still be a good diversifier in such a scenario).

However, anyone who thinks history repeats itself in the sense that governments over time spend too much money or over-regulate, might want to have a closer look at gold. There may well be a reason why gold is the constant while governments come and go.

For more information you can join Axel Merk’s webminar ‘What’s next for the dollar, currencies & gold?‘ on May 24th.

David Schwartz, FIBA: “Compliance. Compliance. Compliance”

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With FIBA’s annual Wealth Management Forum in Miami just a few days away, we interview David Schwartz, CEO, FIBA, about the industry landscape.

What are the biggest challenges facing the industry in 2016?

The challenge is always “Compliance. Compliance. Compliance”. Regulations continue to be more stringent while the cost of compliance becomes more expensive. This year, however, the theme of FIBA’s forum is “Transformation and Opportunities: The Consolidation Conundrum.” The challenges for 2016 relate to factors that are driving transformation of the industry. The large players are leaving the business, or reducing their involvement. This creates both new opportunities for smaller firms and problems for the industry. We are seeing, and will continue to see, growth in small family-owned wealth management companies. At the same time, we are also seeing more use of digital and the emergence of Robo Advisors. At the same time, the industry is undergoing a gender shift. Over the next few years, half of the world’s wealth will be owned by women. There is also a generational shift as the Millennials acquire their wealth. The industry has to adjust to all of these changes, while remaining compliant.

Addressing one issue at a time, why are the bigger players exiting the industry?

Compliance. There is a lot of due diligence required, and lots of risk involved if you don’t dig deeply enough to uncover the true owner of an asset. The Panama Papers show just how complex it is to see who really owns what. Tax transparency laws have big players questioning just how far they have to go in order to meet compliancy regulations.

Is compliance easier for smaller, family firms?

Smaller firms do not need all the infrastructure required by larger wealth management firms. They have the luxury of being able to concentrate more directly on their clients.

How is the industry responding to the trend towards Robo Advising?

The industry is embracing Robo Advising in two different ways. Some firms are creating their own robo management service in-house, and others are acquiring small, FinTech companies and bringing these in house. Still others are partnering with Robo Advisers. An excellent example is BlackRock, one of the largest global investment firms. BlackRock acquired FutureAdvisor, a small robo firm, and now RBC and BBVA., are partnering with BlackRock’s FutureAdvisor and integrating the service to digitally augment the advice given by their financial advisors.

That clearly demonstrates how digital is transforming the industry, and how quickly these changes can occur. How do industry professionals keep pace?

The goal and the mission of FIBA is to educate our members on the latest trends. We’ve established various groups to study the issues and present them to our members via webinars, conferences, workshops, seminars, forums and other channels. For example, we recently held a webinar on the Panama Papers, and although the advance notice was short, over a thousand members participated.

Can you elaborate on some of the educational programs you provide?

We provide a comprehensive program of learning opportunities, and professional certifications throughout the year. Our Anti-Money Laundering or AML conferences are the largest in the U.S., attracting on average 1,400 attendees from 40 countries around the globe. Our AML certification courses, which are available both online and in the classroom, are among the most respected in the country. To date, FIBA has certified more than 6,000 individuals in compliance and thousands more in technology, bank security, trade finance and related specialty areas. We also hold regular conferences and instruction on technology innovation, bank security, trade finance, and other areas critical to our industry.

Money laundering is an ever-present threat, and compliance a continuous challenge, do you work closely with the regulators?

To stay on top of developments, FIBA frequently meets with regulators in Washington. Our primary focus is on educating our members and helping them comply with new or changing regulations. As advocates for our members, we also work to influence policy. We submit comment letters and position papers to legislators and regulators, and are respected voice for the industry. In running so many varied programs, we invite the regulators to participate and share best practice ideas. As an example, Robert Villanueva of the US Secret Service will be one of the presenters at FIBA’s Wealth Management Forum in May. His topic, “How the Criminal Underground is Targeting the Financial Sector and our Brokerage and Retirement Accounts,” will help wealth planners understand and recognize cyber threats, and how to respond, the regulators have a job to do, and by collaborating we can all stay ahead of the criminal element.

In addition to the Wealth Management Forum, FIBA is hosting several other international conferences in May—plus AML certification courses and other programs, including a Women’s Leadership Program. How do you plan and execute so many events, and remain on top of new developments around the globe?

In keeping our members informed, we stay agile and flexible—and busy. Yes, this month FIBA is hosting our 32^nd CLACE conference on Foreign Trade May 22-24. From May 24-2, we will present our 19^th annual FIBA ATFA conference on Trade Finance and Forfaiting. We begin our planning about six months in advance, and revise topics as changes occur or new trends emerge. We stay flexible and adapt to the hot buttons. As mentioned earlier, we responded to the Panama Papers immediately with an informative webinar.

There are a lot of hot buttons for the industry right now. How did you land in the “hot seat” as CEO of FIBA?

I am a banker by experience, with more than 30 years as a senior banking professional within the international banking arena. And I am a lawyer by training. When the first and only CEO of FIBA stepped down, it seemed like a perfect fit for me to step into the position. And it has been exciting.

What is the composition of FIBA’s membership base?

We have about equal numbers international financial institutions, our core membership, and non-financial professionals who support or provide services to our industry in some way, including legal professionals, technology solution providers, consultants and others. We are always open to new members.

Michael Ganske, New Head of Emerging Markets Fixed Income at AXA IM

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AXA Investment Managers (AXA IM) appointed Michael Ganske as Head of Emerging Markets Fixed Income. He joins AXA IM in May 2016 from Rogge Global Partners where he was a Partner and Head of Emerging Markets (EM). Michael will report to Chris Iggo, CIO Fixed Income.

Michael has more than 15 years of experience in EM Fixed Income. Prior to his role at Rogge Global Partners, Michael was a Managing Director and Divisional Head of EM Research at Commerzbank (2007-2013) and a Director and Head of EM at Deka Investment GmbH (2004-2007), and Vice President and EM Fixed Income Portfolio Manager at DWS Investments, Deutsche Bank Group (2000-2004).

John Porter, Global Head of Fixed Income at AXA IM, commented: “We are pleased to welcome Michael on board and confident that his in-depth experience will further enhance our global emerging markets fixed income team and capabilities. We have invested heavily in this team with the hire of Sailesh Lad, Senior Portfolio Manager, and Olga Fedotova, Head of EM Credit Research, last Summer. Michael is a key appointment for our team and demonstrates the scale of our ambition in this space as well as our belief that investors will continue to find emerging market debt as an attractive asset class.”

Michael will lead a global team of 12 investment professionals based in London, Paris, Hong Kong and Mexico, managing approximately €5 billion of EM and Asian debt, across three flagship mutual funds and several segregated institutional mandates. The EM Fixed Income team is fully embedded in the AXA IM Fixed Income investment process. Michael’s appointment follows the decision in June to create a global emerging markets (GEM) fixed income team in support of the continued attractiveness of the EM asset class. Michael will be based in AXA IM’s London office.Michael is a German native, holds a Bachelor’s and Master’s degree in Economics from the University of Augsburg, and a Doctorate in Economics from the University of Hohenheim. Michael is also a certified Financial Risk Manager and Chartered Financial Analyst (CFA).

Goldman Sachs Announces Simplified Pricing Structure for ActiveBeta ETFs

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Goldman Sachs Asset Management recently announced that it will implement changes to its fee and fee waiver arrangements for its ActiveBeta Exchange-Traded Funds. Effective May 1, 2016, a unitary management fee structure, together with a reduction in the management fee rate, will be implemented for the US Large Cap, European, international and Japan equities ActiveBeta ETFs.

Under the unitary fee structure, GSAM will be responsible for paying substantially all the expenses of each Fund. The total annual Fund operating expenses will be of 0.09% for the U.S. Large Cap Equity and of 0.025% for the Europe, International and Japan Equity ETFs.

Additionally, the current expense limitation arrangement for the Goldman Sachs ActiveBeta Emerging Markets Equity ETF will be made permanent. Under this arrangement, the Fund’s expenses are capped, subject to certain exclusions, at 0.45%.

The Most Important Investment Lesson in the World for Warren Buffett is…

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At the annual meeting of his Berkshire Hathaway, Warren Buffett stated that the US, the economy and his company would continue to grow saying, is a “remarkably attractive place in which to conduct a business.” He also defended his favorite stocks, mentioning he has “not seen evidence that convinces me that it’ll be more likely I reach 100 if I suddenly switched to water and broccoli,” but not everything he said was positive. Besides mentioning that some of his holdings are hitting tough spots, the Oracle of Omaha did warn about the risk of derivatives, and against consultants and Hedge Funds.

In his opinion, and given several years of poor returns, “probably the most important investment lesson in the world,” includes ditching expensive money managers. “Supposedly sophisticated people, generally richer people, hire consultants. And no consultant in the world is going to tell you, ‘Just buy an S&P index fund and sit for the next 50 years,’” he said. “You don’t get to be a consultant that way, and you certainly don’t get an annual fee that way.” His bet that a Vanguard Group Inc. fund that tracks the S&P 500 Index could beat a basket of hedge funds from 2008 through 2017 is going strong, with a 21.9% return from the bundle of hedge funds picked by Protege Partners while the S&P 500 index fund soared 65.7% in the last 8 years. The profits of the bet will go to charity.

On a follow up interview, Buffett also mentioned that he might consider taking money out of banks if they charge for deposits. Charlie Munger and him also criticized Valeant Pharmaceuticals, and Buffett, a Hillary Clinton supporter, implied that any one president, even Trump, could not derail the US economy, or his company’s business completely. “We’ve operated under price controls, we’ve had 52% federal taxes applied to our earnings… I will predict that if either Donald Trump or Hillary Clinton become president Berkshire will do fine.” He concluded.