Foto: Victor
. ¿Está la Fed cautiva del mundo exterior?
“In mid-September, the US Federal Reserve(Fed) justified its decision to refrain from launching a rate hike by referring to external economic risks.” Says Oliver Adler, Head of Economic Research, Credit Suisse.Which types of risks is the Fed most likely to be concerned about?
“The most obvious impact of the external world on the US economy is via demand for US exports.” He declares. Weakness abroad reduces the latter, slows US GDP growth and thereby depresses US inflation. If the USD appreciates as external demand weakens, the trade effect is amplified: US exports lose out to those of countries with weaker currencies and US imports rise while import prices fall, further dampening US inflation. Explains the expert.
The degree to which the USD appreciates in response to weak foreign demand depends to a considerable degree on the nature of the shock that has caused the foreign slowdown.“If, for instance, a foreign economy slows because its central bank has raised interest rates to counter economic overheating, the foreign currency is supported and the USD’s appreciation is limited. “He adds.
“Recent shocks were not of this nature. The most significant negative event, especially for a number of emerging markets (EM) has been the sharp decline in commodity prices.” Explains Adler. This has led to a sudden loss of income for commodity exporters and a sharp depreciation of their currencies. By default, the USD was boosted. Second, and in part as a result of lower commodity earnings, the risk increased that debts that were built up during the EM boom years would become unsustainable; currencies responded with further declines, again boosting the USD.
“However, it is our sense that financial stability concerns weigh more heavily in the Fed’s calculus than trade– after all, exports to all EM are only about 4% of US GDP. “ He adds. “Indeed, if US interest rates rise in a situation in which EM are financially fragile, then the USA as well as other economies can be negatively affected: most important, typically, is the impact via banks that are exposed to EM, but declines in asset prices can have added negative wealth, confidence and financing effects. While US banks are less exposed to EM than in the EM crisis period of the late 1990s, the financial linkages remain strong. “
“The most important concern for the Fed is arguably that China might “de-peg” its currency from the USD; that becomes more likely if US monetary policy tightens and boosts the USD. A weaker CNY would not only weaken US exports to China, but can also cause considerable financial instability, as the August episode demonstrated: depreciation expectations amplify capital outflows, and FX interventions are needed to stem them. This occurs in the form of sales of US assets, including US Treasuries, which tends to unsettle USD asset markets. With geopolitics suggesting that the USA is averse to seeing the CNY achieve reserve currency status too fast, the pressure for the Fed to consider China’s interests has increased,” concludes Adler.
Teresa Kong. Deuda asiática: un mercado con el tamaño y la profundidad adecuada pero ¿es el momento de invertir?
Latin America fully understands the challenges of investing in Asia, as well as its volatility. Used to 15% yields in the bond market, they also know that such returns come hand in hand with volatility more akin to equity market investing. In other words, Latin American investors are used to sleepless nights because of the markets. This makes Teresa Kong, lead manager of Matthews Asia’s, Asia Strategic Income Fund, feel more comfortable talking to a Miami or LatAm investor about her specialty, Asian ex-Japan fixed income, than to a typical domestic US market investor. In an interview with Funds Society, Kong reveals the challenges and opportunities of Asian fixed income, an asset class that, according to the expert, is under-represented in global fixed income portfolios.
How big is the Asian debt market?
If when investing in emerging debt, we trusted the indices, we would just basically invest in three markets: Russia, Brazil and Mexico. These are the three countries with most debt issued, but not necessarily those with better credit quality or better interest rates prospects and local currency developments. In fact, according to these parameters, Matthews Asia upholds the attractiveness of markets with much lower levels of debt and better credit quality, such as Indonesia, China, and Sri Lanka. Active management prevails.
The Asia ex-Japan local currency debt market was very small twenty years ago, but development has been immense, and its volume now equals three-quarters of the US Treasuries market. According to data from Asia Bond Monitor, in 2014, this market totaled US$8.2 trillion, compared with the US$447 billion it had in 1997. “With its current size, it’s not a market that can be ignored,” said Kong.
The size of this market, however, is not well reflected in the global benchmarks. For example, the Barclays Global Aggregate Bond index allocates only 3% to Asian fixed income ex Japan. “That is very small when you consider the fact that Asia accounts for a third of world GDP and half of global GDP growth.”
“Not only must we understand the magnitude of this growth, but also its quality,” said Teresa Kong. The growing middle class in Asia is an unstoppable phenomenon, and is accompanied by a boom in consumption, which is affecting various industries: insurance, real estate, automotive etc. These companies need funding in order to grow, which explains the extraordinary development of the Asian emerging market debt. “Furthermore, there is now also an internal institutional demand for sovereign debt in local currency. Local insurers need to invest their premiums on long-term debt instruments with maturities to match their obligations. Thus, we see how, Indonesian insurers, for example, have become natural buyers of sovereign debt in their own local currency.”
A market with volume and depth, but is it the right time to invest?
There are three sources of risk and return in the Asia fixed income market- interest rates, credit, and currencies.
Over the past three years, we have seen a strengthening of the dollar which in recent months has been accompanied by a rise in debt yields in the United States. As a result, the carry trade strategy (borrowing money in markets with very low rates, such as Europe and, until recently, the United States, to then invest in countries with higher interest rates, as in some emerging markets) has been losing steam.
All of this coincides with the bursting of the commodities’ “super cycle” for which China is partly responsible by lowering their growth expectations. “We’ll never see China growing at 7.5 % anymore,” said Kong. “We have to think of China more as a developed market than an emerging one, so growths of 5 % are far more plausible.”
For one thing, dependence on commodities by Asian economies is inversely proportional to its price. Unlike in Latin America, almost all countries are net importers of raw materials, so they have benefitted from falling commodities prices.
Linked to low inflation across most of Asia, Kong sees room for interest rates to continue to fall. And, at current credit spread levels, making a long-term investment in Asia credit has historically made sense.
Looking forward, Kong suggests that Asian economies are much more geared to domestic consumption. “The middle class is a reality. In China, over the next ten years we will be much more focused on analyzing domestic consumption data, than that of either exports or inventories. In Latin America, or even in the Middle East, with commodity prices, especially oil, at current levels, it will be very difficult to create wealth.”
Local currencies have been oversold and are looking attractive
As for Asian currencies, although they have experienced depreciation over the last two years, Kong does not foresee a collapse similar to that of Latin America or Eastern Europe Asia because, “in general the current account balances are strong, and there is not a massive participation of foreign investors in the debt markets, with a few exceptions, such as Indonesia, where 35 % of the debt is in international hands, explaining the increased volatility in the exchange rate of the Indonesian rupiah.”
Asian currencies will not fall as much as Latin American ones, as the next 5-10 years will be much better for Asian economies than for those of Latin America,” said Kong.
The strategy led by Teresa Kong is unconstrained, therefore, depending on market expectations, they can move from US Dollar denominated debt to debt denominated in local currencies.
Until September, they held 70% of the portfolio in US dollar denominated debt, given the strength of the currency, but since then they have been increasing their exposure to certain currencies such as the Malaysian ringgit and the Indonesian rupiah, which have faced a punishment that the team considers excessive.
Worried about what Yellen might do? Asian debt offers de-correlation in relation to Treasuries
An additional feature of Asian fixed income, ex Japan, is its low correlation with US Treasuries. The beta of the asset class in relation to Treasuries is 0.50 -0.37 if we only consider the local currency debt- While US investment grade bonds have a beta of 0.70 in relation to Treasuries and the correlation of G8 bonds is even greater. “If you’re worried about the volatility that the Fed can generate in the coming months, the incorporation of Asian bonds in the portfolio, is a factor to consider when diversifying,” said Kong. “It can serve as a relatively safe haven against rate hikes in the United States.”
This strategy is worth considering to diversify a fixed income portfolio, but why opt for a fixed income fund focused on Asia ex Japan, instead of investing in one of global emerging debt? “Latin American investors normally already have a significant position in fixed income from their own region, often through direct investment in corporate bonds of Latin American companies. If they invest in a global emerging debt strategy, the result will be that they double their exposure to Latin America, which in the current market environment may not make sense. We believe it is more interesting to complement exposure to emerging market debt with a differentiated strategy that invests in the Asia ex Japan region,” explained Kong.
A yield-generating strategy, but with controlled volatility
The U.S. version of Asia Strategic Income Fund, domiciled in the United States, was launched in 2011, and in its Luxembourg version for offshore clients, was launched by the end of 2014. It was created with the aim of becoming an alternative to income generating asset classes, but with controlled volatility. “We are more similar to a U.S. High Yield that to an emerging debt fund,” said Kong. The strategy seeks to generate alpha from currencies, interest rates, and credit and to generate attractive risk-adjusted returns. Since its inception in 2011 the volatility of the US fund has been half to one third of that of the emerging markets debt indices.
Despite being an “unconstrained” strategy, it follows a series of parameters to manage portfolio risk: on the one hand, 80% of the portfolio must be invested in Asian debt ex Japan, leaving only 20 % for opportunities in which the team can opt for convertible bonds or even equity. On the other hand, no more than 15% of the portfolio can be concentrated on a single currency or interest rate regime, “introducing tighter control than what you have when investing in the index, which gives some currencies, such as the Korean, a weight of over 20% “.
The Asian fixed income team led by Teresa Kong consists of four people and has the support of 40 Matthews Asia professionals dedicated exclusively to the research and management of investments in Asia. “We sit next to the teams which follow Asian equities, and our exchange of ideas is constant,” explains Kong. They also travel with equity teams to visit both companies and institutions in the area, several times a year, leveraging the resources which Matthews Asia allocates to these markets.
Recently, Matthews Asia has launched its second fixed income strategy, the Asia Credit Opportunities fund, also managed by Teresa Kong’s team. This Luxembourg-domiciled fund focuses primarily on credit issues denominated in dollars in the Asia ex Japan region. Such issues make up 80 % of its assets.
Following the 2008 financial crisis, emerging market debt enjoyed two years of positive performance. Since then, a number of factors specific to this asset class but also independent of it, have intervened to derail its progress. First there was the crisis of confidence that affected all the eurozone peripheral countries in 2010, and particularly Greece in 2011. Two years later, on 22 May 2013, Ben Bernanke announced the end of quantitative easing through an upcoming reduction in the amount of cash injections. In the wake of this “QE tapering“, the index representing the emerging markets’ local debt, the GBI EM Broad Diversified, lost 14% within three months.
JPMorgan local debt index (GBI EM Broad Diversified Index)
At the end of 2014, new pressures arose in the wake of the Chinese economy’s slowdown. Commodities, especially oil, were hit hard. The WTI (West Texas Intermediate)crude oil price plummeted by 59% between June 2014 and January 2015. The local debt market correction gathered pace. Some emerging markets, particularly oil-producing countries, had trouble supporting their currency. Nigeria, for example, decided to devalue its currency by 8% at the same time as raising its interest rate by 100 basis points to 13%.
The deterioration of its fundamentals reflected the difficulties encountered in the universe. In September 2015, S&P cut its rating for Brazil to BB+, which is in the speculative grade. Over the same period, the ratings for Nigeria and Angola were slashed to B+, for Ghana to B-, for Venezuela to CCC+ and for South Africa to BBB-.
Differentiation is still possible
In contrast to countries like Brazil and Russia, other economies have managed to hold out and even profit from the current situation. Generally speaking, these are net importers of commodities like South Korea, Morocco, India and the Philippines. For example, the latter’s rating has risen steadily since 2009.
In fact, the rating for the Philippines, a country with a population of nearly 100 million, climbed from BB- in 2005 to BBB in May 2014. This improvement was confirmed by the direction of its debt (falling constantly for ten years), the dynamism of its economy, and its resilience to the slowdown of the Chinese economy.
Coface lists the main strengths of the Philippines’ economy as follows:
successful economy in electronics (40% of exports)
exports from the country to emerging Asia constantly increasing
household consumption and external accounts benefit from expatriate workers’ remittances
corporate services outsourcing sector is booming
The markets have naturally taken account of these relative strengths and weaknesses. The following graph shows this. It traces the evolution, from a base of 100, of the JPMorgan sub-indices for the debt of Brazil and the Philippines in USD. Apart from the fact that Brazil, the former market star, was already underperforming in the first half of 2012 (it was then that its debt started to get out of control and the real began its long depreciation), we can draw two main observations from this graph:
in 2013, Ben Bernanke’s announcement of tapering (see above) weighed indiscriminately on both issuers,
on the other hand, at the end of 2014 and during 2015, both the slump in oil prices and the depreciation of the yuan affected the Brazilian index without excessively disrupting the Philippines’ debt.
Multi-family offices (MFOs) and wirehouses are the most efficient when adapting to high-net-worth (HNW) trends, according to new research from global analytics firm Cerulli Associates.
“In recent years, the marketplace has rapidly evolved to keep up with developing client needs,” states Donnie Ethier, associate director at Cerulli. “Realizing that effectively advising HNW and UHNW investors requires a long list of complementary services has propelled some wealth managers, especially multi-family offices (MFOs) and many wirehouse advisory teams, to elite status, while other one-time market leaders are left somewhat disoriented and struggling to keep up. Respectfully so, other firms determined that their expertise and resources are best suited for less wealthy investors.”
“The industry-wide leaders by assets, the wirehouses, have generally acclimated; however, MFOs will continue to advance and threaten longtime grasps of HNW and UHNW families,” Ethier explains. “The wirehouses have encouraged the majority of their advisory teams to focus on clients possessing a minimum of $250,000, which has resulted in advisor productivity that is unrivaled by their largest scalable competitors, the banks. Many private banks continue to set asset minimums at $2 million to $10 million, with family-office services beginning at $25 million to $100 million; still, even these elite global brands are battling larger trends.”
Cerulli appreciates that MFOs may never overthrow the wirehouses’ and banks’ rule over the broad HNW market, but the past and future gains will certainly shift marketshare. And, if the traditional leaders do not adapt to larger consumer and advisor trends, it is possible that Cerulli’s projections that favor growth of MFOs could actually prove conservative.
“Providing asset management searches, selections, and asset allocation are, for all intents and purposes, no longer the greatest competitive advantage in the HNW and UHNW marketplaces,” continues Ethier. “Cerulli sincerely believes that, as a channel, MFOs have not only adapted the best, but that they have also moved well ahead of their primary competitors–including the wirehouses–in many key aspects.”
Foto: Andrés Nieto Porras
. La SEC quiere aumentar la transparencia de los dark pools
The Securities and Exchange Commission announced it has voted to propose rules to enhance operational transparency and regulatory oversight of alternative trading systems (ATSs) that trade stocks listed on a national securities exchange (NMS stocks), including “dark pools.”
“Investors and other market participants need more and better information about how alternative trading systems work,” said SEC Chair Mary Jo White. “The proposed changes would represent a critical step forward in delivering greater transparency to investors and enhancing equity market structure.”
The proposal would require an NMS stock ATS to file detailed disclosures on newly proposed Form ATS-N about its operations and the activities of its broker-dealer operator and its affiliates. These disclosures would include information regarding trading by the broker-dealer operator and its affiliates on the ATS, the types of orders and market data used on the ATS, and the ATS’ execution and priority procedures.
In addition, the proposal would make Form ATS-N disclosures publicly available on the Commission’s website, which could allow market participants to better evaluate whether to do business with an ATS, as well as to be better informed when evaluating order handling decisions made by their broker.
The proposals also would provide a process for the Commission to qualify NMS stock ATSs for the exemption under which they operate and to review disclosures made on Form ATS-N. This would provide a process for the Commission to declare Form ATS-N filings effective or ineffective, as well as provide a process to review amendments. The proposed processes would enhance the Commission’s ongoing oversight of NMS stock ATSs.
The SEC is seeking public comment on the proposal for 60 days following its publication in the Federal Register.
Credit unions play a critical role in local economies of countries throughout Latin America and the Caribbean, serving as a vital savings and credit conduit to vast numbers of people, especially those in the lower rungs of the income pyramid who are in many cases, priced out of the traditional banking system.
These organizations, created with the primary purpose of encouraging people of ordinary means to save money while offering them loans, are able to charge lower rates for loans (as well as pay higher dividends on savings) because they are nonprofit cooperatives. Rather than paying profits to stockholders, credit unions return earnings to members in the form of dividends or improved services.
With lower cost structures, they are in a better position to provide millions of unbanked Latin Americans with access to financial services that can have a transformative effect on the social and economic development of nations. This is a particularly important function in a region where the population, according to McKinsey Consulting, remains 65 percent unbanked.
Despite the benefits credit unions provide to large segments of the population, the fact remains that these not-for-profit organizations simply lack the resources necessary to significantly alleviate the exorbitantly high rate of unbanked throughout the region.
So the question becomes: what can these institutions do to increase the effectiveness, efficiency and reach of their vital products and services?
A Challenging Environment
Credit unions, and small banks for that matter, face the same issue as larger banks in that consumers of all kinds are beginning to solidify the digital user experience they expect from all of their service providers, including financial services. As platforms such as Facebook become more and more accessible to individuals in all social and economic levels of society coupled with the exploding penetration of smart phones, which is forecasted to total 219.9 million users by 2018, these users will begin to increasingly demand the same convenience and intuitiveease of use in their financial services. Fortunately, technology today allows for credit unions and small banks to deploy platforms that provide their customers with exceptional capabilities to not only meet their banking needs, but to do so in the mobile and user-friendly manner they want and expect.
Adding to the hurdles faced by credit unions in the region, governments and regulators are adding restrictions that require these institutions to only provide differentiated services to specifically defined market segments through channels not served by traditional branch banking infrastructures.
Finally, with the proliferation of cyber crime, building secure infrastructures that protect the identities of customers is of paramount importance to every single financial services stakeholder.
Technology Changing the Game
Throughout the world, a surge in venture capital investment into financial innovation has created exciting new business models that are poised to effectively and efficiently transform the financial services industry.
Last year, according to Accenture, the financial technology industry attracted over US$ 12 billion in venture capital investment in 2014, fueling the creative innovations in the uses of analytics to evaluate, approve and process financial transactions that are greatly expanding the access to once prohibitively expensive and cumbersome financial services for individuals of ordinary means and small and medium sized enterprises.
Much of the changes in the market paradigm for financial services are being driven by the proliferation of mobile phones, especially the smartphone, which is essentially providing supercomputing power to consumers all over the world. Companies such as M-Pesa, Lenddo, Abra and Konfio are just a few of the thousands of new companies transforming the financial landscape by making world-class financial services available to the masses.
However, systematically scaling and bringing these solutions to large numbers of people remains one of the most daunting challenges for even the most well funded startups.
The ability to partner and collaborate with large institutions that have established customer bases and reach into communities could be a massive “win-win” for both the startups and the credit unions.
This obviously complimentary collaboration has one wrinkle. Most credit unions operate on antiquated technology frameworks that inhibit, if not outright prevent, the onboarding of technologically agile startup solutions onto their core-banking platforms.
Adding to the challenge is the fact that as non-profits, credit unions lack the time, human resources and budgets to invest in updating their technology platforms. Until now, there had been limited options as most core-banking technology companies focused their products on larger bank infrastructures, pricing many smaller players out of the market and putting them in competitively vulnerable positions of not being able to offer state-of-the-art solutions.
Agility is Key
One of the most disruptive aspects of the innovations in fintech are the ability to provide financial services quickly and inexpensively.
The big banks, by in large, have the financial and technological ability, if not necessarily the will and desire, to compete for the unbanked population. If the credit unions and smaller banks do not prepare a strategy to engage in the competition for this huge, untapped market, they may find themselves ultimately outside looking in as their market share decreases.
The other “elephant in the room” is the coming era of millennials. Today, there are 160 million in Latin America, representing roughly 30% of the entire population of the region. These digital natives being raised on social media are a critical market segment for institutions both big and small which must be addressed through smart technology.
So what is the solution? As technology becomes faster, cheaper and more accessible, it allows for the creation of affordable state-of-the-art, digitally agile solutions that can allow credit unions and small banks to operate with the speed, security and sophistication of large, global financial institutions. This enhanced technology capability coupled with the localized understanding of under and unbanked market segments can help credit unions continue to be a critical financial link for millions of consumers.
According to the latest research from Cerulli Associates, “U. S Retail and Investor Advice 2015: Aligning with Investors Goals”, digital advice tools should be seen as an opportunity, not a threat for the traditional advice market in the United States.
“Many industry stakeholders assume that ongoing advances in digital advice platforms will empower investors to handle their financial affairs without the assistance of traditional financial advisors,” states Scott Smith, director at Cerulli. “We believe that while technology innovations will transform how services are delivered, there will be an ongoing, and potentially increasing, demand for personalized financial advice delivered by humans.”
The report focuses on the relationship between investors and financial services firms, and also examines how investors choose their providers, segmenting investors into those who use an advisor, and those who invest through direct providers.
Most households in the U.S. do not have the fundamental understanding of financial topics that allows them to feel comfortable making decisions solely by themselves. An increase in the availability of online tools to help these investors explore their options will drive demand for personalized advice as investors gain a greater understanding of the vast inputs affecting their long-term outcomes.
“Instead of seeing digital advice tools as threats, traditional advice providers will be better served by adopting these tools as introductory elements of their brand that allow prospective investors to better understand the variety of options they are facing,” Smith explains.
“The ubiquitous growth of digital advice platforms is exactly the catalyst needed to accelerate the development of traditional advice providers to serve their clients moving forward,” Smith continues. “Instead of perceiving the growing prominence of digital tools as a threat of disintermediation, traditional advice providers have an exceptional opportunity to encourage their advisors to fine-tune their practice model to capitalize on identified best practices and use technology to enhance their client relationships.”
With China hogging the emerging markets limelight in recent months, it has been easy to lose track of developments elsewhere. With China worries calming now, it seems a good time to review just how bad things have become in Latin America’s biggest economy. President Dilma Rousseff has suffered a series of painful setbacks since her election victory last year, and in many ways is now in political exile despite being nominally in power – approval ratings signal how rapidly the situation has deteriorated (chart 10). The corruption scandal at Petrobras and allegations over accounting irregularities in her campaign and government finances leave the president weakened even as the economy continues its tailspin. The combination of political and economic paralysis has seen a wave of growth and credit downgrades for Brazil, and it is hard to see a rapid turnaround. According to Schroders, it could be years before Brazil recovers meaningfully.
The Petrobras scandal (commonly referred to as the Lava Jato, or ‘Car Wash’), has continued to spread, contaminating larger and larger swathes of the corporate and political sectors in Brazil. It has now reached Dilma’s current political nemesis, Eduardo Cunha, speaker of the Lower House. Unlike much of the scandal to date, this revelation presents a possible boon to Dilma. Cunha is spearheading attempts to impeach the president, and his removal from office would provide an opportunity for Dilma to rebuild relations with the lower legislature. One tentative olive branch, in the form of a cabinet reshuffle which ceded more political power to the party of vice president Temer – the PMDB – appears to have backfired by angering other smaller parties in coalition with the PMDB, which were not included in the largesse. They have now splintered from the PMDB, creating a more fractured Lower House which will be even more difficult to reconcile. The reshuffle, which removed a key ally of the president, also leaves Dilma increasingly isolated within her own government, with former president Lula steadily building control in what some have dubbed a virtual regency (though Lula holds no position of power de jure, he remains influential within the ruling party and popular in Brazil at large). There are concerns that Lula’s next step will be to push for the removal of finance ministerLevy, who has bought the governmentwhat little fiscal credibility it has. Rumors of his resignation on Friday 16th October prompted downward pressure on Brazilian assets but have since been quashed – likely reflecting assurances from Dilma to Levy that the government would continue to back his fiscal consolidation efforts. This drive by Lula is also likely a result of the Lava Jato scandal, which has begun to implicate family members. Political analysts at Schroder’s Eurasia Group suggest that Lula’s only chance of avoiding prosecution would be if he could portray the investigations as an attempt to undermine the left, and that to do this he needs to reinvigorate his traditional electoral base. Attacking fiscal consolidation is one way to do this. It was mentioned above that the rumors around Levy fueled volatility in Brazilian assets. More generally, the backdrop for all of this power broking has been an increased likelihood of impeachment for Dilma, forcing the concessions discussed above. This has generated a good deal of volatility across Brazilian markets, with participants seemingly hoping for an impeachment and fresh government.
Dilma is increasingly powerless and under siege from enemies and allies alike. The corruption scandal is engulfing an ever growing share of the political class and ensuring political energies are focused upon the investigation rather than reform efforts or fiscal consolidation, while those politicians so far untainted are currently deeply unhappy with Dilma – in part because they are being egged on by the Lower House speaker, Cunha. As things stand it is difficult to see how Dilma can lead Brazil out of the mire. Even if Cunha is forced to step down due to the corruption allegations he faces, it is not certain that the new speaker will be any more amenable – there is a strong incentive for the main coalition party, PMDB, to push for impeachment. Vice president Temer, of the PMDB, would then assume the presidency. Though good for the PMDB, this would not necessarily be good for investors, given the exposure of that party to the Lava Jato scandal – so more of the same political paralysis. What would be a good outcome? One possibility is that Dilma’s re-election is declared void. The country’s highest court has authorized an investigation into the president’s re-election accounts, following revelations that kickbacks from a construction firm were paid into the campaign’s coffers. If compelling evidence is found that serious electoral violations took place and were significant enough to impact the race for the presidency, the election result could be revoked. Though obviously a disruptive event, this would clear the way for a more market friendly, and scandal free, government to be elected. They would find they had plenty to do.
The undead economy
Activity continues to flatline, with corporate investment moribund in the wake of the Lava Jato scandal, consumers crushed by their debt burdens (chart 12), and government spending squeezed by attempts at fiscal consolidation. Yet despite this, inflation has continued to climb, in hideous parody of a booming economy. The Brazilian zombie economy, lifeless and yet animated, is enough to make policymakers hide behind the sofa.
Certainly, the current trend is a negative one, as reflected by the recent S&P and Fitch downgrades, which take the country’s sovereign debt within a whisker of junk status, driven by concern over the fiscal consolidation process. Schroders has written many times, too, on the supply side issues plaguing the economy, contributing to the persistent inflation problem, and the ‘Dutch disease’ inflicted by the multi-year commodity boom, which drove up unit labor costs and rendered Brazilian industry uncompetitive. On the fiscal and supply side concerns, there is little hope for immediate relief. The political situationall but guarantees a lack of productive legislation until a new government comes to power, unencumbered by corruption allegations and infighting. However, market forces are beginning – if only by a war of attrition – to generate an improvement in other metrics. For example, unit labour costs (chart 13) have finally begun to decline as unemployment builds, which ought to lead to an improvement on the trade balance, as seems to be happening (chart 14).
All in all, Brazil’s horror story is far from its final act, but perhaps a glimmer of hope is becoming apparent on the very distant horizon. There can though be no painless resolution; perhaps the best case scenario is an early exit for Dilma followed by new elections that allow a purging of the rottenness seemingly embedded at the political core and a new energy with which to pursue reforms.
Sailesh Lad, Senior Portfolio Manager within AXA Investment Managers’ (AXA IM) global emerging markets fixed income team and Olga Fedotova, Head of Emerging Market Credit at AXA IM, discuss their outlook for emerging markets, including the main triggers that could create buying opportunities next year and where the opportunities currently lie for the asset class.
On the future for emerging markets (EMs) Sailesh Lad comments: “While emerging market growth is unquestionably slowing, EMs are still growing at a faster pace than developed markets (DMs). Arguably investors had come to expect growth closer to 5% over the past 20 years, and will in time acclimatise to levels of 3-4% growth. So I think that EM growth will pick up, and will continue to be stronger than DM. Similarly, EM currencies have depreciated a lot in the past year or two, but having appreciated too quickly in the past, we may now see appreciation reoccurring albeit at a slower pace. The fundamental background growth story is still there for EM, and these countries will continue to develop.
“People tend to talk about EMs as a group of very basic countries with little infrastructure, but what is now classed as emerging markets are actually very developed economies in absolute terms, that happen to retain the label.”
Olga Fedotova added: “We are also seeing broad investors become more familiar with EM corporate names now. Investors have moved from a top-down approach to more bottom-up, fundamental analysis, and will increasingly distinguish strong companies that perform well, even in the current currency climate. Ultimately, the strong names will become stronger and therefore more expensive – and weaker companies will continue to struggle.”
Looking ahead to 2016, Saliesh Lad highlighted: “Current market conditions suggest there will be three main triggers that could create buying opportunities and lure investors back to the EM market next year. This includes:
The Federal Reserve will have to provide some clarity on the rate cycle. We think this will start gradually, but with cash levels at four-year highs, ultimately the cycle just needs to start. Investors can identify potential opportunities, but lack the conviction to invest right now because of the persistent uncertainty for interest rates.
China will remain a burning issue, but investors should start to acclimatise to the reality of the economy making a structural shift from an industrial economy to a consumer led one and growth being closer to 6% than 7%. Clarity from China’s authorities on future central bank policy will also be welcomed by investors.
Commodity prices need to stabilise. Ideally we would like to see 3-6 months of stability, particularly in oil and metals, to settle the dynamics for countries with high export dependencies.”
Looking to the more immediate future, Sailesh Lad continues to see solid opportunities in EMs: “While it might be quite a consensus view, I still think that India is a strong growth story. The closed nature of its economy means it is relatively insulated from China’s growth worries. It’s an EM that is still growing, and this insulation provides safe-haven qualities while also promising the potential of attractive returns.”
Olga Fedotova added: “I like Russian and selective Brazilian credits for completely different reasons. The Russian credit story is very robust over a longer time horizon, and technical conditions for Russian corporates remain supportive because of local investors. Russian corporates are also low leveraged, natural exporters, and can comfortably serve their debt, thanks in part to sharp rouble depreciation, prudent cost cutting and more conservative financial policies. Some Brazilian companies are also attractive, but you have to be very careful, as they have underperformed DM and EM alike at the overall level. Stronger names, that are not exposed to oil and gas, with relatively low debt levels and a high proportion of export revenues (for example food, paper and pulp producers) will benefit from cheaper valuations as investor sentiment towards EM is improving.”
According to Detlef Glow, Head of EMEA research at Lipper, assets under management in the European exchange-traded fund (ETF) industry increased from €427.97 billion to €464.15 billion during October.
After performance drove down European ETF’s AUM in September, this increase of €36.18 billion in October has much to thank to it. The underlying markets’ performance accounted for €30.36 billion, while net sales contributed €5.8 billion to the overall growth of assets under management in the ETF segment.
In terms of asset classes, bond funds (+€3.7 billion) enjoyed by far the highest net inflows for the month, followed by equity funds (+€2.8 billion), and alternative UCITS products (+€0.1 billion).
The best selling Lipper Global Classifications in October where:
Equity US with €62.8 billion
Equity EuroZone with €47.2 billion
Equity Japan with €38.3 billion
Amongst ETF promoters, iShares with €4.1 billion (iShares accounts for 49.45% of the overall AUM with €229.5 bn), db x-trackerswith €0.5 billion and Amundi ETF €0.4 billion, were the best selling ones.
The best selling ETF for October was the iShares Core EURO STOXX 50 UCITS ETF, which accounted for net inflows of €460 m or 7.90% of the overall inflows
