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Legg Mason: “There is a Greater Movement towards Global Diversification by Brazilian Investors”

During the ninth edition of the Annual Forum of Local and International Specialists for the Discussion of Economic Challenges in Brazil, which was held at the Unique Hotel in Sao Paulo on the 1^stof December, Western Asset, a subsidiary of Legg Mason received professionals of the investment world, with the objective of discussing the challenges Brazil faces in the short term.

Joe Sullivan, Legg Mason’s President and CEO welcomed attendees to the event. After his speech, Ken Leech, Chief Investment Officer for Western Asset, explained how the global scenario has been extremely benign for emerging markets in general, and for Brazil in particular, and what the chances are that this scenario will continue in 2018 .

Then, in a first panel, the government’s microeconomic reform agenda was analyzed as a catalyst for growth. Moderated by Paulo Clini, CIO for Western Asset Brazil, the debate was attended by Joao Manoel Pinho de Mello, Special Secretary of Microeconomic Policies of the Ministry of Finance, Walter Mendes, President of the Petros Foundation, and Marcelo Marangon, Executive Vice President of Citibank , who evaluated which are the most advanced microeconomic reforms to resume economic growth.

During the second panel, they examined how presidential elections will influence the agenda of fiscal reforms, analyzing the possibilities of achieving a fiscal balance in a turbulent political situation. On this occasion, the moderator was Adauto Lima, Chief Economist at Western Asset Brazil, and the panel counted with the contributions of Bernard Appy, Director of the Fiscal Citizenship Center, Caio Megale, Finance Secretary for the municipality of Sao Paulo, and Christopher Garman, Eurasian political consultant.

Strongly committed to Brazil.

The Brazilian economy has recently recovered from one of its worst crises in decades, and is finally returning to positive terrain. Interest rates remain at low levels, but investors worldwide have a strong interest in the yields offered by Brazilian debt.

“Interestingly, investors in Brazil think that their interest rates are at low levels due to their history, but when you think about the performance of the 10-year US Treasury bond, which is somewhat above 2%, in the German bond rate, which stands at 0.4% and the Japanese rate that is close to 0%, and you compare them with the interest rates in Brazil and the possibility that the currency will appreciate as the economy improves , you can get a very attractive return,” said Ken Leech during the press conference with journalists.

Meanwhile, Joe Sullivan added that they had increased exposure to Brazilian debt in all those portfolios in which the portfolio’s mandate allows it: “We have positions in Brazilian sovereign local debt and in certain Brazilian corporate bonds, usually denominated in dollars.”

Although the situation has improved in the Latin American giant, it’s still of vital importance that there is a fiscal reform in Brazil. “Our expectation is that some kind of fiscal reform will be approved, if not this year, the next, but we believe it will be enough to maintain support in favor of Brazilian debt securities. The Brazilian policy has turned towards a government more favorable to the markets, although the elections always introduce an element of uncertainty. We hope that this type of policy will continue, but we are prepared for what may come.”

Regarding how the normalizing process by central banks may affect emerging markets, Leech said that they hope that this time it will not be a problem: “If you think about the last three years, from 2013 to 2016, when the central banks were decreasing their interest rates, unlike in other periods, the rates in emerging markets rose, with a divergence of direction between the rates of developed countries and that of emerging countries. Our vision is that if the central banks begin to raise interest rates it will be because growth has improved and if this is true, then interest rates in emerging markets would not go down. With inflation so low, our vision is that interest rates are going to rise very slowly, so there should be no great impediment for emerging markets.”

The local investor’s appetite for diversification increases

Brazilian investors first became interested in international equities with exposure to currency. Many investors did not hedge currency because they really needed high volatility to compensate for the high rates that Brazil had until just a few years ago. In the last year, there has been an enormous success in hedged strategies because investors no longer need to have exposure to currency risk to find international investment alternatives that provide competitive returns when compared to the local interest rate level.

In any case, the demand from institutional and retail clients is different. The institutional client seeks long-term returns and is interested in variable income products that invest in infrastructure and global fixed income products, because they are a very powerful diversifying element as compared to local debt.

“Brazilian investors have the great advantage of having one of the highest interest rates in the world. So it’s not easy to find Brazilian investors wanting to invest outside of Brazil, where interest rates are much lower. But for the first time, Brazilian interest rates are at their minimum in decades, with inflation close to 3%. Many of their assets are invested in Brazil, but we have seen a growing interest in buying global returns. We believe there will be a greater movement towards global diversification on the part of Brazilian investors,” concluded Joe Sullivan.

EMD Should Shift From Being Beta To Alpha Driven

| By Gabriela Huerta | 0 Comentarios

As liquidity is slowly drawn from the global economy, the recent wall of money beta- driven rally is likely to morph into a market with higher dispersion, in which BlackRock thinks alpha opportunities may take a stronger role as a source of excess returns in 2018.

According to Sergio Trigo Paz, Managing Director, Head of BlackRock’s Emerging Markets Fixed Income and Pablo Goldberg, Managing Director, Head of Emerging Markets Fixed Income Research and Portfolio Manager, EM high-yielding bonds will be delivering positive total returns in 2018 as developed market central banks gradually normalize monetary policy. As monetary policy normalization continues, a proper assessment of country-specific EM idiosyncratic risks and active differentiation is key to future returns and volatility of portfolios.

According to them, a ‘reflationary’ environment is supportive of further strengthening of emerging countries’ fundamentals, and in turn validates tighter spreads and stronger currencies in EMD. However, they are aware that EM countries find themselves at very different points in their business cycles, which should lead to divergent monetary policies.

Blackrock believes the best news are coming from Latin America, which has finally departed recession in 2017 and could grow 2.4% in 2018. They continue to like high yield oil exporting countries and stay short duration, and favor unconstrained strategies that allow dynamic duration management. Which is why they believe investors may want to consider switching from indexing to alpha strategies that may more efficiently capture the opportunities provided by a more volatile market that may likely gyrate between these alternative scenarios during 2018.

“We believe that a more flexible allocation to local debt, between IG and HY, and a dynamic duration management, to accommodate U.S. curve shifts, provides the potential to maximize excess returns for the rest of the year,” they conclude.

New York Stock Exchange Celebrates 94th Annual Christmas Tree Lighting

| By Gabriela Huerta | 0 Comentarios

The New York Stock Exchange will celebrate its traditional Annual Christmas Tree Lighting on November 30th. The 94th annual lighting of the NYSE Christmas Tree, to celebrate the holiday season, will have Z-100 on-air personality DJ Nico as emcee this year. The ceremony will feature musical performances from 2:30pm – 6pm including the Rockettes, Chilina Kennedy and The Drifters of Broadway’s Beautiful and appearances by the Budweiser Clydesdale, Miss America Cara Mund, Daymond John of ABC’s Shark Tank, Mr. Met, Macy’s Santa Claus and many more.

The Closing Bell will be rung by performing artists and notable guests participating in the Tree Lighting ceremony. The NYSE Christmas Tree will be illuminated at 5:00 p.m.

There will also be photo Ops with Macy’s Santa Claus and the Budweiser Clydesdale, and Twitter will serve Hot Cocoa to the public.

You can watch the live feed of festivities in this link.

John Stopford (Investec): “The Market Does Not Believe the Fed, Thinking it’s The Boy Who Cried Wolf”

| By Meritxell Sedo | 0 Comentarios

Is it possible to find opportunities in a bond market that has remained bullish for 35 years? According to John Stopford, Head of Multi-Asset Income at Investec Asset Management, there are still possibilities to find value in fixed income markets, although they are increasingly difficult to locate.

During the Investec Global Insights 2017 celebration in Washington, the manager reminded attendees of the origin of the current context. It all began when, at the end of the 70s, after a period of high inflation, Paul Volker, Chairman of the Federal Reserve, decided to put an end to the growth of the money supply. Since then, and except for short periods in 1994 and 2008, fixed income has not stopped rising in price. If we add to this a much lower growth than in previous times, with secular stagnation, as argued by Larry Summers, former Vice-President of Development Economics and Chief Economist of the World Bank, the result is an environment in which rates of developed governments are excessively low and will most likely not increase significantly. The real growth of the US GDP has decreased, and inflation has also diminished, although the Fed can now manage a restrictive monetary policy, the change will be slow, incremental and will take a while to increase.

“If clients expect to see US Treasury bonds back to 5% returns, they are probably wrong. Since the financial crisis, central banks have injected billions of dollars into financial markets, but the costs of expansive monetary policies are now beginning to outweigh their benefits. Central banks have begun to eliminate their excess supply, which will surely trigger a rise in rates. The Fed estimate is a rise of 60 basis points, it’s not much, but we must get used to these figures. We should not expect increases of 200 basis points, potentially being able to reach 50 – 100 basis points at some point during this new cycle,” Stopford pointed out.

Another issue that should worry investors is the US package of fiscal easing measures. An increase in the country’s budget deficit could raise interest rates, and given the point at which the cycle is located, it may also push up inflation expectations. “If the US deficit increases materially, real bond yield rates could be pushed upwards. The question is whether Donald Trump will be able to get approval for a 3.5 trillion dollar budget, because he needs each of the Republican senators to vote in favor. Both the application of an expansive monetary policy and the withdrawal of central banks are actually risks. The Fed has already shown all its artillery. In one of her latest presentations, Janet Yellen basically mentioned that inflation is a mystery; an alarming statement coming from the person whose aim is to control inflation in the world’s largest economy.”

According to the Investec manager, the recent weakness in inflation is partially transitory and he expects it to reverse sometime next year. Inflation can also be driven by lower unemployment, a weaker dollar, and firmer commodity prices. And, if the fiscal expenditure package is finally approved, it would have an inflationary effect at this stage in the cycle.

Returning to the economic normalization program, the Investec manager said that the Fed wants to continue raising rates, he believes that now is the appropriate time to abandon the quantitative easing policy, reversing bond purchases in its balance sheet. “Rates will not rise to 5% levels; they will probably stay at 2.5% levels. Furthermore, the market does not believe the Fed, thinking it is the boy who cried wolf, even though the Fed has already narrowed the market down to a greater extent than was expected during the past year. But, perhaps now is the time when the market should probably converge with the median of the Open Market Committee’s projections.”
As regards the positioning of the portfolio, the Investec manager recommends being careful with a potential sovereign crisis in the short term; mentioning that the opportunities could be in countries such as Australia, the Czech Republic, and Canada.

Corporate debt

On the corporate credit side, there are two reasons why credit spreads are at levels as low as the current ones. The first issue is the risk of recession, if you compare the spreads of high-yield debt in the United States with the probability of entering a recession, you can see that there is a strong correlation in their behavior, especially when there is a sudden movement. A recession causes companies’ balance sheets to begin to suffer, and it’s then when they cannot pay the debt they borrowed. According to Stopford, the current risk of entering recession is low, at least for the next 6 to 12 months.
The second metric that must be taken into account is the absence of volatility. The VIX is the measure of the cost of insuring a portfolio, the implied volatility in equities, which is to a certain extent the equivalent of buying insurance. But at the moment investors are more focused on obtaining returns, and are willing to trade security for returns. “If the credit spread indicates how much uncertainty there is around companies in the future, the VIX is exactly the same issue for equities. You can see that they both move together, so it should not be surprising that credit spreads are so compressed. Can they remain at that point? Yes, for a while, because thereis still not much volatility in the short term and monetary policy is still not affecting enough.”

Although Stopford recommends lower exposure to corporate debt due to its limited risk premium, the fact that the environment remains favorable for growth, suggests that opportunities could be found in the diligent selection of credit.

Emerging market debt

Investors continue to worry about everything that did not work in emerging markets in 2012 and during the period 2015 -2016. But the main opportunities could probably be found within this asset class, real bond yields are above the US rate, which is negative, as in most developed markets. Some emerging markets continue to cut rates and some have begun to raise them gradually. In addition, there are numerous idiosyncratic risks, so it pays to be selective. “You should not invest all your money in emerging markets, you should have a diversified portfolio, but this asset class shows good performance between fundamentals and valuations.”
In emerging markets the debts of Israel, Hungary, Chile, Peru, and Mexico are at reasonably attractive levels.

Foreign currency positions

Currencies usually behave much like a roller coaster. The good news is that they don’t usually move together, so it’s usually a field of opportunities. In this regard, Investec recommends taking advantage of the relative optimism seen in Europe as compared to the United States, cautiously selling the euro against the dollar. At the same time it sees an opportunity to position itself long in the currencies of certain emerging markets, such as the Czech koruna, the Indian rupee, the Mexican peso, the Hungarian forint, the Indonesian rupee, the Chilean peso, the Peruvian nuevo sol, the Egyptian pound, the Thai baht, and the Turkish lira.

Investec’s Richard Garland will Run the Ice Marathon as Part of His 7 Marathons in 7 Continents Plan

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Richard Garland, Managing Director for Investec has pledged to run Seven marathons in Seven continents, looking to raise 100,000 US dollars for the Adam J Lewis Education Foundation. Garland will match 100% of all donations.

The Adam J. Lewis Preschool (AJLP) is a nonprofit community-based preschool serving three-, four-, and young five-year-olds, located in the West End of Bridgeport, CT—a community faced with deep-seated challenges and limited educational opportunities. AJLP was founded in memory of Adam Lewis, who died in the World Trade Center on September 11, 2001.

He has already ran 5 marathons in 4 continents: New York, Boston, London, Lewa, Kenya and Tokyo. On November 24 he will be running the Ice Marathon in Antarctica, which will be his 5th continent.

This race, which takes place at an altitude of 700 metres, presents snow and ice throughout, an average windchill temperature of -20C, and the possibility of strong Katabatic winds to contend with. The four-day 2017 itinerary will see competitors fly from Punta Arenas, Chile, on November 23rd, returning on the 26th.

Garland told Funds Society that this will be his first time running a marathon in the snow and that he has been preparing mentally given that, unlike other marathons- there will be no cheering along the route, and thus, runners -about 50 or 60 of them, have to rely upon themselves to push onward in the hushed, indomitable surroundings.

Please help him achieve his target by donating here.

MFS: “The Market Forgets that When Credit Liquidity Dries Up, There Is No Turning Back”

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Pilar Gomez-Bravo was recently appointed Director of European fixed-income for MFS Investment Management. She also serves as Lead Portfolio Manager for MFS Meridian Funds Global Total Return and MFS Meridian Funds Global Opportunistic Bond. Pilar shared her views on the global debt markets during the 2017 MFS European Investment Forum in London.

Beginning with the disparity between what the US Federal Reserve is saying with regards to rate hikes and what the markets are anticipating, the Gomez-Bravo says the markets are probably right. “The Fed has been lowering its neutral rate, which indicates the extent to which they expect to raise rates, dropping now to 2.75%, whereas the 10 year yield is even lower at 2.3%. Every time there has been a difference between market expectations and those of the Fed, it’s the Fed that invariably moves towards the market. The Fed’s rate policy guides the short end of the yield curve and that is where its communication and guidance is focused. What Central Banks would really like is to be able to control the long-term slope of the curve because it determines the level of accommodation of monetary policy.”

Likewise, Pilar Gomez-Bravo doesn’t see rate hikes in Europe in the short term, although she does acknowledge that the European Central Bank will want to avoid any mistakes as it manages the exit of its public asset purchase program. They also want to assure the markets that they are not going to change the deposit rate, which is currently still negative. “At a time when the unemployment rate has fallen, and growth is on the rise, the European Central Bank will begin to consider that it makes sense to stop buying assets and injecting liquidity into the market. Another issue is that the ECB doesn’t have many more options, given the criteria established for the purchase of government assets. The time will come when it can no longer maintain the guidelines that were established in the buying process. The ECB will want to avoid creating panic -similar to what happened during the Taper Tantrum in 2013, which led to widespread selling of risky assets and a drastic rise in interest rates- largely due to poor communication from the Fed.”

At MFS they expect Draghi to continue to gradually reduce the ECB’sdebt balance due to the lack of alternatives. They will also try to create as much distance as possible between the decision to withdraw liquidity from the market and the commencement of the interest rate increases. “It‘s possible that the European economy will continue to strengthen and we could see rate increases well before the end of 2018, which is what is currently priced into the market.”

What is the expected inflation scenario?

It’s expected that there will be very little upward inflationary pressures, mainly due to the market structure. Globally, there is an immense amount of debt, which limits the extent to which rates can be rise without leading to a recession. In addition, there are certain demographic problems in the United States and other developed countries that prevent inflationary pressures on the labor side. “The generation of Baby Boomers who tend to have very high wages is beginning to retire, and the generations replacing them earn much less. Companies are not investing and there is no growth in productivity in the United States, indicating that inflation will be contained. In a world dominated by technology and demographic shifts, conventional wisdom stops working. We’ve seen unemployment fall, without a meaningful increase in inflation, particularly in the United States. In Europe, disruptive technology are not having the same impact that we’ve seen in the United States, where companies like Amazon or Airbnb suppress pricing pressures. That’s why we could see rising inflation in Europe before it takes hold in the United States. In both cases inflationary pressures will probably come from wages and commodity prices, and in particular from oil prices, if we see sustained upward pressures in either of these two variables, we will change our vision on long-term inflation.”

The importance of credit selection

In an idyllic period of low inflation and low growth, the business cycle is much further along in the United States than in Europe. Until now, MFS had had a preference for US companies, because it’s a large deep market, with a lot of diversification and credit capacity. “The United States offers relatively high rates compared to other countries, but the cycle is coming to an end; while in Europe it still has further to go. Eventhough we have to account for European and US credit valuations, we do think that Europe may offer somewhat more value because the technical valuation is supported by the European Central Bank which continues to buy bonds.”

At present, credit selection, of a specific bond or issuer, through analyzing its parameters and fundamentals, that leads to investing in bonds on which there is a high conviction, has much more potential to deliver alpha than directional positions, since the latter have their performance limited to that of a market that is trading at high valuations. “Investing in higher-conviction securities makes sense for two reasons: you can avoid potential losses of some market issuers and concentrate the portfolio in those names where we see greater potential for outperformance. We have also been reducing systemic credit risk in our portfolios, while looking to generate more opportunities by investing in specific credits, which we believe will lead to a longer lasting source of alpha.”

The emerging credit market

In emerging markets, after the 2017 super rally, we see value in certain countries whose fundamentals have significantly improved, such as in Indonesia, India, Brazil and Argentina. We continue to see value in emerging market debt, both in hard currency and in local currency.

Is now the time to add more risk to the portfolios?

The current bull market is approaching nine years. MFS is positioned somewhat defensively because they are expecting a market correction and current risk adjusted valuations are not as attractive. Still, Gomez-Bravo argues that there are still opportunities for investors and that the more flexibility one has the better: “If you manage funds that are more global, or if you have a multitude of factors to choose from, you diversify the portfolio while removing risks. But we are still waiting to see what happens with tax reform and fiscal policy in the US. The market forgets that when liquidity dries up there is no turning back. During the last crisis, many investors weren’t able to sell their short duration floating rate bonds, and they had to settle for 50 cents on the dollar. Taking on a lot more risk for an extra 30 basis points doesn’t make sense in this environment”

Grover Norquist Highlights Speaker Lineup at 7th Annual FLAIA Global Macro Perspective 2018 Conference

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As part of its long-standing effort to help fund managers, investors and family office leaders identify macroeconomic trends, geopolitical risks and where to allocate money next year, the Florida Alternative Investment Association (FLAIA) is sponsoring its seventh annual A Global Macro Perspective 2018 Conference in Miami on December 5, 2017.

The daylong event, which is co-sponsored by the international law firm Greenberg Traurig, is expected to attract money managers from Florida, New York, Europe and Latin America. This year, it will take place at the law offices of Greenberg Traurig in downtown Miami. The conference immediately precedes Art Basel week, the world’s largest modern art show.

“We are now a full year into the Trump Administration, which has placed its trade, foreign policy and tax reform agendas on the table”, said Michael Corcelli, Founder and Chairman of FLAIA, and Managing Partner of Miami-based Alexander Alternative Capital.

Highlighting the speaker lineup for A Global Macro Perspective 2018 is Grover Norquist, President of Americans for Tax Reform and regarded as the most powerful tax advocate in Washington, who will share his perspectives on Tax Reform policy in the United States. Norquist chairs the Washington, DC – based Wednesday Meeting, a weekly gathering of more than 150 elected officials, political activists, and movement leaders.

The day’s featured panel discussions will include:

Tax Reform and the impact the proposed plans in Congress will have on rates for corporations and individual taxpayers across America.
Opportunities in Alternative Investments: Outlook for 2018.
The Emergence of Digital Money and Blockchain Technology: A look at the emergence of the cryptocurrency market and the pitfalls of self-regulation.
Quantitative Investment Trends: Perspectives from Data Driven Managers: A look at how the macro environment impacts trading signals, and how artificial intelligence and machine learning can add value.

To register for the conference, click here.

BlackRock Launches New China A-Share Opportunities Fund

| By Gabriela Huerta | 0 Comentarios

BlackRock has launched the BlackRock Global Funds (BGF) China A-Share Opportunities Fund. The Fund is designed for investors looking for growth, alpha and diversification from the China A-Share market.

The Fund is a liquid, long only, Systematic Active Equity (SAE) UCITS strategy targeting consistent alpha on an annual basis. The strategy uses a combination of both traditional quantitative signals and more innovative big data and machine learning insights. Together, these tools are used to identify around 300 companies for investment from a universe of 1,300 Chinese companies in the Shanghai, Shenzhen and Hong Kong Exchange Stock Connect programme.

The Fund will be managed by the SAE team in San Francisco, with trading executed in Hong Kong. The team comprises more than 80 investment professionals across research, portfolio management and investment strategy. Dr Jeff Shen, PhD, co-chief investment officer of active equity and co-head of investments within SAE, leads the portfolio management team. He is supported by Dr Rui Zhao, PhD, who is co-portfolio manager on the fund.

Jeff Shen comments: “We’ve been applying systematic investment methods to equity markets for over thirty years and more recently, we’ve been researching and applying new methods – big data, machine learning and artificial intelligence – to our models. We find these insights have extraordinary relevance in a market like China where data is quite often available and the market is large and complex. We have been managing this strategy for institutional investors for five years, and we are very excited to offer this strategy to retail investors in a vehicle that provides daily liquidity.”

Michael Gruener, Head of EMEA Retail at BlackRock, adds: “China is one of the largest stock markets in the world, but due to restrictions on ownership, foreign investors have had very little exposure to Chinese domestic equities. Now, with access to onshore Chinese companies through the recently opened Stock Connect programme, investors have the opportunity to invest in a previously untapped market.”

Michael Roberge: “If Berkshire Hathaway Were a Mutual Fund, Warren Buffet Would Have Been Fired as a Manager”

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Investors are at a crossroad. To be able to obtain the same level of returns as in the past and achieve their investment goals, they must take on roughly three times more risk than that of two decades ago. During the 2017 MFS European Investment Forum in London, Michael Roberge, CEO, President, and CIO of MFS Investments Management, emphasized the secular and cyclical difficulties facing investors and the importance of choosing active managers who are both committed to investing with a long-term time horizon and have conviction in their portfolios.

Secular challenges

Following the Global Financial Crisis, the prolonged approach of central banks around the world was to try to stabilize the economy by keeping rates low. This approach has resulted in extremely low interest rates persisting, with some countries even dipping into negative yields. These low interest rate levels have completely changed the investment environment, helping to push both bonds and stocks to maximum valuation records. Many investors, including MFS are asking what will this environment lead to? While asset prices are expensive today, the lower-for-longer rate environment is likely to dampen returns for both equity and stock investors in future business cycles. With that backdrop, investors will be challenged to achieve their investment goals and we can expect to see many investors taking on greater risk to achieve the same historical return they would expect to achieve in a more normal environment. To illustrate the case, Michael Roberge mentioned a study by investment services consulting firm Callan Associates. The report shows that in 1995, in order to obtain an average return of 7.5% — which is the average yield that most pension plans expect to obtain in the long run – an investor would need to allocate approximately 73% to bonds and 27% to cash. The volatility of the portfolio, measured by its standard deviation, was around 6%, so that the investor was not really exposed to excess risk. In the following decade, the deterioration of interest rates has meant that, to achieve the same return of 7.5%, new asset classes must be introduced. Investors have to expand the allocation beyond the fixed income and cash instruments, needing instead to add riskier exposure to equities and alternative assets, for example. The new portfolio would now need to invest 52% in fixed income, 40% in equities and 9% in alternative assets, including exposure to private equity and real estate. This results in a more complex portfolio which incurs greater risk, with a volatility of 8.9%, representing a 50% increase relative to the portfolio of the previous decade. Moving forward another 10 years, in 2015, following the Global Financial Crisis and a dramatic drop in interest rates, central banks significantly increased their balance sheets with quantitative easing measures. To achieve the same return of 7.5%, the portfolio now would need to invest 12% in fixed income, 63% in equities, and 25% in non-traditional assets. Given the complexity of this portfolio, the risk rises up to 17.2%, tripling the risk level of 20 years ago. “This explains the current stress of investors globally, because they can see the potential for lower future returns as compared to those currently and in the past. Of course, they still have to meet their investment goals. The problem now is that they have to take greater risks to achieve them,” said Roberge.

Cyclical challenges

While the United States is experiencing its second longest economic cycle since World War II, it is impossible to predict how much longer this cycle can last. Obviously, you can say that the end is approaching, and investors should be starting to think about preserving capital instead of increasing their risk.
Global economies have performed relatively well. Inflation is still not a problem, and central banks remain relatively accommodative. This adds up to a favorable environment with low volatility. Investors have been forced to take greater risk, being compelled to participate in the equity market. This works “until it stops working.” Historically, when entering periods of low volatility, investors often show signs of market complacency, and according to Roberge, a surge in volatility and market pullback is probably not that far off. At present, investors are not discriminating between companies with positive results and companies with negative results, the cycle seems to have forgotten the possibility of the market incurring a correction.

The importance of the time horizon and conviction in the portfolios

MFS emphasizes the importance of understanding both time horizon and conviction, two factors which are often overlooked in this long business cycle. In a low volatility, low interest rate environment investors have been forced to take on greater risk across multiple asset classes, including less-liquid opportunities, like infrastructure and private equity to achieve returns.

First, the investment horizon must be determined within the market cycle, because that determines the managers’ evaluation criteria. The market cycle can be determined from either peak to peak or trough to trough. In order to correctly assess a manager’s performance within an asset class, the complete investment cycle must be taken into account. However, despite the fact that 57% of institutional investors define a complete market cycle between 7 and 10 years, managers’ performance is usually measured within a range of 1 to 3 years. This is clearly a disconnect in the evaluation process of investment managers.“Studies carried out in this respect show that failure to give managers time to complete a cycle results in lost performance. Specifically, between 1% and 2% per year, a figure which may seem not very high, but which, given the current level of low interest rates, can be a problem for investors, especially when compounded over time. Now, given where we are in the cycle, is the ideal time to identify ways to preserve capital. It is an environment in which active management tends to perform better. In a market at such an advanced stage in the cycle, investors continue to pursue the market’s beta, when in fact they should be doing precisely the opposite”.

Returning once more to the issue of the importance of long-term investment, Roberge referred to Warren Buffet, who is considered by many to be the world’s best investor: “If we compare Berkshire Hathaway’s returns over the past 30 years against the S & P 500 Index, it can be seen that the firm which Buffet leads surpasses the market index by 600 basis points. However, if you look at different three-year periods, approximately 37% of the time his company trailed the market. If it had been a mutual fund, Warren Buffet would have been fired as manager. But being Warren Buffet, he’s allowed time to make good, long-term decisions and let them slowly materialize. As a consequence, the returns obtained at various 10-year periods exceed the S&P 500 Index in 95% of the time. Quite simply, time matters. It’s necessary to allow an investment manager’s conviction to deliver the alpha clients need to achieve their long-term financial goals.”

Ian Heslop (Old Mutual GI): “Our Strategies are Not a ‘Black Box’, but Rather a Very Transparent ‘Glass Box’

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During his presentation at the OMGI Global Markets Forum in Boston, and questioning conventional investment thinking, Ian Heslop, Head of Global Equities at Old Mutual Global Investors, explained the double difficulty of forecasting market behavior. It’s often quite easy to make a mistake when forecasting, but even when the outcome of an event has been forecasted successfully, guessing the market reaction is just as complex. “If someone had been able to foresee the Brexit result, they could have guessed the market’s behavior for about 7 days. If someone predicted that Donald Trump would be elected for president, they could have guessed market behavior for about 7 hours. As a team, we try not to forecast, especially as regards market reactions.”

Another important issue, according to Heslop, is that investors have lost confidence in active management. In the United States, only 27% of active managers are able to beat the S & P 500, the main reason is that many fund managers are not taking enough risks to beat the index: “Firstly, if investing in an active fund which is not taking sufficient active risk, but which charges active management fees, the return will be lower than the index. Secondly, the S & P500 index is also said to be a very efficient index, which it is, to a certain extent, but to attribute the lack of higher yields to the index’ efficiency is to greatly simplify the argument. The difficulty in consistently outperforming it is real enough, but I don’t think it’s based on the efficiency of the index itself. The third reason would be concentrating on a particular style. Active funds are often cyclical in nature. Sometimes it is the value style that gains the favor of the market, in others it is the growth style, or the quality, if the fund only takes into account a particular style of investment, it will not be letting compound interest act correctly, lagging behind the market at some stage.”
As a result, investors have turned their backs on active investment by investing more than US$ 1.4 trillion in US equity ETFs since 2007. “The main problem with indexed products is that investors think they are buying diversified exposure to the US equity market, when in fact the portfolio’s performance comes from 10 shares of the S & P 500. Partly, because these companies represent a significant part of the economy, but to a larger extent it’s due to flows. “

Helsop cited as examples those ETFs that invest in the 100 less volatile stocks of the S & P 500 index, the valuations of which, in terms of price to book value rates, have increased substantially, increasing from 2.37 times in 2013 to 3.59 times in 2017. Another trend is the purchase of equity ETFs with high dividends. Investors often do not take into account their exposure in terms of risks, and are unaware that they are actually buying risk of size, momentum, market sensitivity or beta. “It should be noted that some of the dislocations in the US equity market are directly dependent on the extensive use of ETFs by investors, both from the point of view of market capitalization and from the point of view of exposure of styles in the portfolio. Investors find it very attractive that a particular investment environment can work all of the time, but this is not the case.”

How do we solve the problem?

The market sentiment and perceived level of risk in the market are two factors that determine which type of values are going to perform better than the index. At the end of the first quarter of 2016, the markets were going through a scenario of high volatility with a very negative sentiment. With a macroeconomic scenario very different to that in 2008, the market reflected an environment with little appetite for risk, behaving in the same way, but for very different reasons. Looking at the market’s behavior during the third quarter of 2017, the markets’ scenario is of low volatility and high optimism, where risk appetite has increased. “The approach that active management must take in both scenarios is different, so obtaining results above the index is extremely difficult, being especially complicated if it aims to forecast the outcome of an event and the market’s behavior towards it, something which depends on the sentiment. However, if we try to locate which moment the market is at by measuring its evolution against the change and then adjusting the portfolio accordingly, we will be somewhat behind the market, but we maximize the time in which we have a signal located, being able to discard noise. On the negative side, if we see a very abrupt change over a very short time, it will take a while for the portfolio to adjust. For each period of rapid adjustment to a new state in the market, there are multiple periods of time in which there is no direction in the market, minimizing the loss in those moments.”

The investment and stock selection process

Old Mutual Global Investors’ global equity team uses five variables or themes to identify which type of company will achieve a good result at each moment in the cycle: a dynamic valuation that allows them to be alert at every moment of the cycle and to buy a certain style of investment, sustainable growth, which looks for opportunities within the market, analyst sentiment, which allows them to assess what happened in the company, the company’s management team, whose communications are used to control whether they are acting in the best shareholder interest, market dynamics, with which they try to understand the demand and supply of each stock.

“Our way of managing strategy is not a ‘black box’, but rather a very transparent and rigorous ‘glass box’. We invest and create portfolios in a very rigorous way. The investment process uses the five themes to have or not to have assets in the portfolio. We look at metrics for valuation, quality, growth, revenue, information, momentum, and trends, but what really sets us apart is that we are trying to understand the motives that make a stock perform well. There are environments in which the market is willing to buy stocks of a certain style: value, growth or quality, and if at that time you maintain exposure to that particular style in the portfolios, it will most likely add return to the portfolio”

Helsop also commented that what really matters to the management team is to know the elements that are influencing the market’s direction, something that is the key to understanding how the investors will behave. “We try to respond to the requirement that clients have for a different type of alpha, without forecasting or minimizing the amount of forecasts we use. In our alpha generation process we don’t consider a top-down macroeconomic analysis or a fundamental bottom-up analysis, but we mix all the factors and the result is a different approach that provides the opportunity to diversify”.

Funds under the same approach

With nearly 18 billion in assets under management, Old Mutual Global Investors’ equity team manages a number of different strategies; all of them with a high active share. The Old Mutual North American Equity fund strategy, the Old Mutual Global Equity Fund and the Old Mutual Global Equity Income fund are long-only strategies. The first one has about 200 securities in the portfolio and has been managed by Ian Heslop’s team since 2013. The second one has approximately 450 securities and the third has 500 securities and doesn’t invest in those classic names that pay a high dividend and that the rest of funds have in their portfolios. Lastly, the Old Mutual Global Equity Absolute Return strategy with over 650 names in the portfolio is market neutral, being a clear example of how the five factors combine to generate alpha in a different way from the rest of the market. This fund manages about 11 billion dollars in assets.