Frontier markets are often attractive to investors as they include countries or economies that are underdeveloped. In this Q&A, Matthews Asia Portfolio Manager Robert Harvey discusses his current views on investing in frontier markets.
What is the current outlook for frontier markets?
It’s important to remember that not all frontier markets are created equal. Some countries have better demographics, better positioning regionally or globally and better political systems, infrastructure and legal framework. A deficiency in any of these areas is a challenge, but opportunities arise when you see positive change. In my view, Asian frontier and smaller emerging markets overall have been out of favor for a while and valuations are now attractive, especially when compared with their growth potential.
When are frontier markets most attractive for investment?
Frontier markets are often attractive to investors as they include countries or economies that are underdeveloped. This means they have the potential to grow, although this potential often is not yet realized. Frontier markets are usually most attractive to invest in when they are most out of favor. Pessimism means you can often buy attractive shares in companies at low prices. When investors become pessimistic, when media reports are largely negative, that is the time to invest in my opinion.
What is the difference between frontier markets and emerging markets?
There is no real difference between the two. At a basic level they are definitions created by benchmark providers. If you compare Sri Lanka (a frontier market) with India (an emerging market), for example, you will see Sri Lanka is much more developed by most economic metrics. For 2018, India had per-capita income of approximately US$2,000, for instance, while Sri Lanka had per-capita income of around US$4,200. Broadly speaking, the definitions are a convenient suggestion or indication of how underdeveloped a country might be.
What is the typical profile of a frontier market investor?
Frontier markets offer huge potential, but it is a complex segment. Investors must have time on their side. Complexity in frontier markets comes from many areas: domestic politics, global commodity prices; domestic economies; foreign exchange movements and domestic business cycles. Their small relative size can also result in a magnified impact on stock prices by changes in investor sentiment. These markets are mostly not suitable for investors who have a shorter time horizon. I think frontier markets are also more suited to investors who are looking for low correlations against developed market indices and who are looking for lower overall volatility. That being said, the complexity of these markets requires a good active manager who understands these complex markets and can discover opportunities for investors.
What are the risks that frontier markets investors should assess before entering a market?
Risks include high oil prices that can materially impact emerging and frontier markets, but the impact differs by country. In the Middle East, high oil prices are a big positive and can help boost both the external accounts and the investment and spending within a country and the region. High oil prices are a negative for oil-importing countries such as Sri Lanka and Pakistan. High oil prices can result in higher import bills, a weaker currency and ultimately higher inflation and interest rates. Therefore, we believe investors should have a long-term time horizon and be prepared to endure volatility. Try not to invest when frontier markets are making news. Just because a market moves up or down, it is not a reason to sell it—only sell if the fundamentals change.
Can you share your investing strategy for frontier markets?
Our approach to emerging and frontier markets is no different than how we look at Asia’s developed markets. We use on-the-ground, bottom-up fundamental analysis to select stocks with a long-term time horizon, mainly focused on the growing consumer demand in these underdeveloped countries. We believe in on-the-ground research and meeting management teams face to face.
Banco Santander International (BSI) is carrying out a series of changes in the organizational structure of BPI, its international private banking business, which is led by Jorge Rossell.
Under the helm of Alfonso Castillo -who is adding the area of Products and Investments to his current responsibilities over Commercial and Global Private Wealth-, there are new appointments to these three areas, Funds Society was able to learn from sources familiar with the matter.
The former Products and Investments area, which was led by Javier Martín Pliego, is being divided into two units: the Products area which will be led by Isidro Fernández, who will also continue serving as Head of Alternative Investments and Funds; and the Investments area, led by Manuel Pérez Duro, until now responsible for AIS at BSISA (Switzerland and Bahamas). Martin Pliego will remain in Santander Group but is leaving the unit.
Within the internal structure of the Investments area, Carlos Ruiz Antequera is to become Chief Investment Officer, incorporating the investment stragegy team. Verónica López-Ibor will lead the Discretionary Portfolio Management team andMiriam Thaler will take on the role as new head of Investments in BSISA (Switzerland and Bahamas).
The Commercial area, under the new leadership of Eugenio Álvarez, will also experience some notable changes: Juan Araujo will be the new Regional Director for Venezuela. He will be based in Geneva. In addition, Yolanda Gargallo and Borja Echanove are to become BSI Branch Managers in New York and Houston, respectively.
With these changes, which will become effective on January 1, the entity will seek to continue growing in the European and Latin American markets. Since the beginning of 2019, Rossell – head of BPI and CEO of BSI- has been looking to boost the group’s business. He reports to both Victor Matarranz, Head of Santander Wealth Management, and to the recently appointed, Tim Wennes, CEO of Santander in the US. Wennes took on the position at the beginning of this month, after Scott Powell left the firm to become COO of Wells Fargo.
On Wednesday, December 11, more than 100 executives from the financial sector in Miami and Latin America belonging to more than 70 companies attended the first FlexFunds Seminar Series in Miami.
The series of global seminars on securitization of assets organized by FlexFunds and held, among other cities, in Mexico, Dubai, Madrid, Singapore and Sao Paulo, had in its Miami edition speakers such as Daniel Kodsi, CEO of Participant Capital and Royal Palm Companies; Mario Rivero, CEO of FlexFunds and Colin MacKay, Responsible for the Americas of Intertrust Group.
According to Emilio Veiga, CMO of FlexFlunds, having taken the Seminar series to Miami was a wise decision, given the success of the event.
FlexFunds seminars provide asset managers, hedge funds and family offices with the best practices and latest trends in securitization of assets, an increasingly popular practice that is expanding to a variety of industries.
Photo: The White House. A Disappointing Deal, and a Healthy Economy
President Trump called it “amazing,” and U.S. Trade Representative Lighthizer said the China deal is “remarkable.” In my view, however, it is merely the best trade deal in the last 36 months of Chinese history, and it falls well short of two key objectives. Because the deal sets highly unrealistic goals for U.S. exports to China, the risk of disappointment and a return to tariff battles remains, so corporates in both countries are unlikely to feel secure enough to resume investment spending. Second, there are no signs that the two sides are preparing to use this pause in the tariff dispute to reconsider the poor direction the bilateral relationship is taking, towards decoupling and confrontation.
Despite this disappointing deal, the Chinese government seems relatively comfortable with the pace of economic growth and job creation, and is preparing only a very modest stimulus for 2020, designed to stabilize growth by mitigating the impact of the dispute with the U.S. and weaker global demand. I expect the consumer-driven economy to remain healthy next year, and the risks are largely on the upside: if the trade deal does lift the cloud of uncertainty, business sentiment will improve, leading to stronger CapEx spending and reduced pressure on wages. If the deal collapses, Beijing will implement a larger stimulus, to counter the negative impact on sentiment. The key downside risks next year are policy mistakes by Beijing; and if the trade deal fails, Trump could respond with dramatic efforts to contain China’s rise, which would be negative for sentiment.
Deal risks
Based on the few details provided so far, the deal doesn’t appear to represent a significant improvement on the current trade framework. Lighthizer said over the weekend that the 86 page agreement—which he described as “totally done”—will be signed in early January, and presumably more details will be available then.
I’m less concerned about the absence of breakthroughs than I am about the agreement’s highly unrealistic sales targets, which could set up the deal to fail, leading to a return to tariffs or even a full-blown trade war.
In an interview over the weekend, Lighthizer said that the Chinese government has committed, in writing, to dramatically raise the level of its imports from the U.S. “Overall, it’s a minimum of 200 billion dollars. Keep in mind, by the second year, we will just about double exports of goods to China, if this agreement is in place. Double exports. We had about 128 billion dollars in 2017. We’re going to go up at least by a hundred, probably a little over one hundred. And in terms of the agriculture numbers, what we have are specific breakdowns by products and we have a commitment for 40 to 50 billion dollars in sales. You could think of it as 80 to 100 billion dollars in new sales for agriculture over the course of the next two years. Just massive numbers.”
Massive, yes. But realistic? U.S. agricultural exports to China peaked in 2012 at US$26 billion, and none of the American agricultural experts I’ve consulted think it is possible to double that in the near future. My contacts in Washington say that the US$40 to 50 billion target was not based on a detailed assessment of China’s demand nor on the ability of American farmers to quickly expand output of soybeans and other crops. It was a politically expedient target.
The concept of quickly doubling the value of overall U.S. exports to China is equally dubious—even if the baseline is this year’s reduced level of US$88 billion for the first 10 months of this year. The historical peak was US$130 billion in 2017.
There are a few ways this could play out. First, China could buy record amounts of U.S. agricultural and manufactured goods, but well short of the targets set out by Lighthizer. Trump may be satisfied, claiming success because historical records were reached.
Second, failure to reach the sales targets may not be enough for Trump, despite the record purchases, and he will escalate the tariff dispute. That may lead Chinese officials to decide that further negotiations are pointless, leading to a trade war which damages both economies, although Beijing has far more resources to mitigate the impact.
Third, Washington may fudge the data to come closer to the sales target. We’ve heard talk, for example, of counting the sales of goods produced in third countries with American intellectual property, such as semiconductors made in Singapore and Taiwan, as U.S. exports.
(Never mind the silliness of asking the Chinese government to commit to purchasing a set amount of American goods, irrespective of market conditions, at the same time the U.S. is pressing Beijing to establish a more market-driven economy. It is also worth noting that to date, China has declined to comment publicly on the sales targets. That will presumably change after the deal is signed.)
The uncertainty of how this will evolve, and how Trump will respond, means that this deal is unlikely to reassure American and Chinese CEOs, who have been deferring CapEx in response to uncertainty over the bilateral trade dispute. Removing that uncertainty was the negotiators’ top job, and they appear to have failed.
I would be delighted to be proven wrong in early January, when the deal is signed and details are published. Maybe there will be a clever plan to explain how China can buy so much American stuff so quickly. Maybe the details will show that the deal is in fact so good that, combined with NAFTA 2.0, it made last Friday, in Lighthizer’s words, “probably the most momentous day in trade history ever.”
Despite the disappointing deal, China’s economy will remain healthy
I’d like to repeat a few important points from the October 18 issue of Sinology. I wrote that if the U.S. and China fail to conclude a trade deal, I will be very concerned about the longer-term relationship between the U.S. and China—the country which accounts for one-third of global economic growth, larger than the combined share of growth from the U.S., Europe and Japan. Failure to reach any deal would have a profound impact on the global economy. But, I will be less worried about the near-term impact on China, as the main engine of its growth— domestic demand—remains healthy, and Beijing has a significant store of dry powder it could deploy to mitigate the impact of an all-out trade war with Washington.
Last year, net exports (the value of a country’s exports minus its imports) were equal to less than 1% of China’s GDP. And the contribution from the secondary part of GDP, manufacturing and construction, has been declining. This will be the eighth consecutive year in which the tertiary part of GDP, consumption and services, is the largest part; last year, three-quarters of China’s economic growth came from consumption.
This is especially important right now, because the domestic demand story should continue to be fairly well insulated from the impact of the Trump tariff dispute.
Modest monetary policy changes
This is one of the reasons I expect monetary policy will be only slightly more accommodative next year, and I do not expect aggressive expansion of credit flows or dramatic interest rate cuts. There may be modest easing compared to this year, but the objective will be to stabilize growth in response to trade tensions with the U.S. and slower global demand, not an effort to reaccelerate growth. As has been the case this year, aggregate credit outstanding (augmented Total Social Finance) will likely expand faster than nominal GDP growth, but not to the extent in past years. Beijing is fairly comfortable with the pace of economic growth.
Less focus on deleveraging, more on risks
There will be less focus on deleveraging in 2020, but Beijing is likely to continue to take steps to reduce financial system risks. A modest boost to fiscal spending (see below) will push up the deficit a bit, but because this debt is all within Party-controlled institutions, the risk of a systemic crisis will remain very low. Chinese government economists recently told me they expect the fiscal deficit/GDP ratio to rise to 3% from 2.8%, and after a government that sets economic policy guidance, officials said the focus is on keeping the “macro-leverage ratio basically stable,” rather than on reducing that ratio.
I expect further consolidation of smaller banks as well as a continuation of this year’s experiments of selected defaults by state-owned and private firms, in an effort to push investors to price risk. I do not expect the government to relax their tight controls over off-balance-sheet (shadow) financial activity.
Modest infrastructure boost
Officials I met with in Beijing this month indicated that there will be a modest increase in infrastructure investment next year following this year’s surprisingly slow growth rate. But I do not expect this to return to the much higher levels seen a few years ago. Some of the infrastructure will be financed by an increase in “special construction bonds,” which may rise to about RMB 3 trillion from the current RMB 2.15 trillion. If this happens, it will support modestly stronger industrial activity and materials demand.
Residential resilient
Residential property should remain resilient, although I do not expect significant policy changes. The property market has held up better than expected this year, and I think the government feels that policy is about right: not too tight or too loose. Over the first 11 months of the year, new home sales by square meter are up 1.6%, vs 2.1% a year ago and 5.4% two years ago. New home prices in 70 major cities were up 7.6% YoY in November (basically in line with nominal income growth), compared to 10.8% a year ago and 6% two years ago. Inventory levels are reasonable. Residential property investment has been rising at a double-digit pace for 23 consecutive months, but that is likely to cool off a bit next year. The government continues to reiterate the policy that “houses are for living, not for speculation,” and there is no sign that the government will relax the current policies related to property.
Modest improvement in CapEx likely
Investment spending by private firms has been weak, largely due to uncertainty resulting from the ongoing Trump tariff dispute. I expect modest improvement next year: if the trade deal is successful, that will reduce uncertainty. If the deal fails, Beijing is likely to take policy steps to encourage capex spending.
The China consumer story should remain strong in 2020
This is important because the consumer and services (tertiary) part of the economy is the largest part, and last year accounted for 75% of China’s GDP growth. (Figure 4 shows the growth in per capita consumption expenditure, which includes a wider range of services compared to the retail sales data. Services now account for 50% of household consumption.)
A continuing outbreak of African Swine Fever has led to lower pork supply, which has pushed up the price of pork, China’s primary protein source. Headline consumer price inflation will remain elevated next year, driven entirely by pork. Core inflation, at 1.4% YoY now, should continue to be low, and inflation should not have a significant impact on consumer sentiment.
Although monetary policy will not have much impact on live pig supply, as was the case during previous hog disease outbreaks, Beijing will cautiously limit policy expansion so that higher food inflation will not change people’s inflation expectations and spread food inflation to other areas.
Foto cedidaAlberto D'Avenia, Managing Director y Head of US Non-Resident Business (NRB) y Latam Retail en Allianz Global Investors.. Alberto D’Avenia (Allianz Global Investors): “Para 2020, desplegaremos nuestro negocio y profundizaremos en nuestro enfoque de asesoramiento”
Alberto D’Avenia, Managing Director and Head of US Non-Resident Business (NRB) and Latam Retail at Allianz Global Investors, makes a positive balance of 2019. Throughout the year investor’s main concern has been to achieve returns, and preserving capital. D’Avenia considers that that objective has been fulfilled at Allianz GIobal Investors, where the work they do together with private bankers and financial advisors has been fundamental. This and more in the following interview with Funds Society.
What were the main worries that the investors had this year?
Generating income with capital preservation are in general the 2 main features that non-resident private client in the non-resident business require. The year has been positive even for moderate balanced portfolios, and the average low volatility has had the risk management component take a back seat like it always happens in those occasions, but risk management must keep playing a crucial role in a 2020 year that has the making of a more complex financial scenario.
And how did you manage it?
We have seen favour from clients in our more traditional fixed income and balanced solutions like Income and Growth built to this aim, but we have also worked with our distribution partners to introduce diversification solutions in the liquid alternative space, like our option-based Structured return, providing a favourable decorrelation from traditional markets and absolute return, all weather approach, that we believe will come in handy once volatility spikes.
For the next year (2020), what do you think that will be the principal events to consider? How can you take advantage of it or transform into an opportunity?
We position a trio of major economic and political factors as key events to monitor: US elections, trade developments and central banks liquidity – on a lesser extent, but still significant, we have a second trio made of oil supply, food-security fears and growing US-China competition which could create additional risks for portfolios. This in a 2020 that we see characterised by a deceleration in global growth (triggered by slower US and Chinese economies) and continued uncertainty about how monetary policy and politics will move markets.
These factors will offer a number of “risk-on/risk-off” movements, especially in an era where a single tweet can determine significant volatility shifts; in these occasions, beta returns are normally flat. Hence, risk management will be paramount. In this environment, investors should aim to keep their portfolios allocations consistent to their convictions and actively manage risk – not avoid it. These are, in fact, moments where Money weighted return (what clients are getting out of each own’ s investments) tend to differ from Time weighed returns (returns of investments “on paper”) because of trades dictated by fear and greed. The support of the private bankers and advisers will be paramount to consistent investment approach in those volatile phases, and this is why we keep investing in significant communication on topics like behavioural Finance and risk advisory with our dedicated unit risklab.
Investment opportunities in highly valued markets will be rarer and searching for cheaper ones that also generate return potential from dividends or income might be the right approach. Attractive returns can be pursued from less volatile dividend-paying stocks in value sectors such as energy and from themes that capture global, disruptive trends.
We will keep pursuing the benefit of alternative investments such as private credit, infrastructure debt and equity, and absolute-return opportunities tend to be less correlated to fixed income and equities over time, offering an additional source of diversification potential.
AllianzGI is also a recognised leader in ESG informed and integrated investments; we believe in the merits of long-term sustainability of companies that can be best assessed when incorporating ESG factors into investment decisions.
Choose carefully among over-owned US equities; consider undervalued European stocks and emerging-market debt; look to alternative investments for less correlated returns; keep up the hunt for income against a backdrop of low yields.
Finally, careful on passive investment – their backwards looking nature (indexes and funds tracking them are determined in the past) can be significantly tested by news headlines. They can be part of a general portfolio allocation, but in the light of an actively managed strategy set to invest with conviction
During 2019, which were the most popular funds or demanded by the investors?
As said before those favouring a more cautious approach to high yield like Allianz Short Duration High Income and Global Selective HY, those clearly aimed at a risk managed process to ensure a consistent income, like Income and growth and finally thematic investments, offering access to stories with long-term global growth potential, like Allianz Global Artificial Intelligence.
In this way, what do you think that will be the trend in 2020?
We do not believe private clients (and hence, our distribution partners) needs will change dramatically – probably, after 2019 good results, a more cautious approach will be required but still with income generation at the helm. Diversification and risk management will become even more important going forward.
During this year, did you implement some new services or solutions for the investors?
2019 has been a seminal year, after all our office in Miami has been up and running around summer, so we have invested in establishing our brand and its core value proposition: partnership approach oriented to advisory and consultative partner relationships, risk management support with our dedicated unit risklab, ESG integration in our investment process. As far as investment solutions go, we have positioned Allianz Structured Return (it is more a suite of solutions than just one fund, that is the pure portable alpha strategy) and we believe it will be a real game changer especially in high volatility scenario going forward. Same for our socially responsible solutions (SRI) which are available by the main platforms our partners work with, Pershing and Allfunds bank.
Do you have any plan or idea to develop new services for the clients?
If 2019 has been the year of fitting in the market, 2020 will see full deployment of our service model. We have ambitious plans of investing with our partners in our advisory approach, putting risklab, our ESG research and behaviour finance at the core of our offer, together with our best investment solutions.
As a company, what have been your main successes this year?
Our main goal this year has been positioning our brand in the full US non-resident and Latina America Wealth management markets, and our decision to open an office in Miami has been crucial to that. We have signed a number of new distribution agreements with US local independent and Latin America partners, and we have been able to increase the level of cooperation with those we were already working with. Due to our physical absence from the market, we were being looked at in terms of “best of” investment opportunities in our Ucit and while we are obviously thrilled to be able to provide the market with best in class funds, our partnership approach and the richness of above described solutions is now fully available to our partners, getting our relationships to the next level.
Photo: Pxfuel CC0. Stocks Are On Track for Solid 2019 Returns
The U.S. stock market started November with a sharp two-day rally sparked by a strong October jobs report that calmed recession fears. This set the stage for stocks to move higher for the month and to continue the 2019 series of record closing highs.
During the month, there were temporary sell offs from negative trade war related news but these were followed by positive headlines that moved stocks higher. On balance, improving trade negotiations, Brexit clarity, a resilient U.S. consumer and an accommodative Fed kept stocks on track for solid 2019 returns.
The M&A event catalyst for the three day pre-Thanksgiving spike in stock prices was ‘merger Monday’ when a flurry of large deals were announced including: Charles Schwab’s $26 billion transaction for TD Ameritrade, LVMH with a $16.2 billion deal for Tiffany, and drug maker Novartis in a $9.7 billion takeover of The Medicines Co. The global M&A volume wave that started in 2014, as measured in U.S dollars, continues to roll along with $2.73 trillion in 26,321 announced pending and completed transactions through November 30, 2019 versus $3.07 trillion in 30,225 deals in 2018 according to Bloomberg data.
Relatively unknown hotel operator Unzio Holdings (3258.T) was targeted with a rare domestic hostile bid from Tokyo travel agent H.I.S. Co (9603.T) in July. This catalyst has surfaced intense interest from prominent global private equity firms, banks, and hedge funds, all attracted to Unzio’s Japanese and other real estate properties selling at a discount, while also testing Prime Minister Abe’s efforts to boost shareholder returns for foreign buyers with revamped corporate governance and disclosure. The unprecedented cross-border hostile and friendly bidding war for Unizo heated up on November 24 when it said it had received six more buyout offers in addition to the deal proposed by Blackstone Group. More M&A activity to come…
Column by Gabelli Funds, written by Michael Gabelli
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Disclaimer:
The information and any opinions have been obtained from or are based on sources believed to be reliable but accuracy cannot be guaranteed. No responsibility can be accepted for any consequential loss arising from the use of this information. The information is expressed at its date and is issued only to and directed only at those individuals who are permitted to receive such information in accordance with the applicable statutes. In some countries the distribution of this publication may be restricted. It is your responsibility to find out what those restrictions are and observe them.
Some of the statements in this presentation may contain or be based on forward looking statements, forecasts, estimates, projections, targets, or prognosis (“forward looking statements”), which reflect the manager’s current view of future events, economic developments and financial performance. Such forward looking statements are typically indicated by the use of words which express an estimate, expectation, belief, target or forecast. Such forward looking statements are based on an assessment of historical economic data, on the experience and current plans of the investment manager and/or certain advisors of the manager, and on the indicated sources. These forward looking statements contain no representation or warranty of whatever kind that such future events will occur or that they will occur as described herein, or that such results will be achieved by the fund or the investments of the fund, as the occurrence of these events and the results of the fund are subject to various risks and uncertainties. The actual portfolio, and thus results, of the fund may differ substantially from those assumed in the forward looking statements. The manager and its affiliates will not undertake to update or review the forward looking statements contained in this presentation, whether as result of new information or any future event or otherwise.
Peter Stockall, courtesy photo. Peter Stockall se une a iM Global Partner, fortaleciendo su plataforma de distribución internacional
iM Global Partner, a leading investment and development platform focused on acquiring strategic investments in best-in-class traditional and alternative investment firms in the U.S., Europe and Asia, appointed Peter Stockall to lead sales in the US Offshore and Latin America region.
Peter, based in Miami, will enhance iM Global Partner’s international expansion, spearheading the business development efforts in this very important region within the Americas. He will offer US Offshore and Latin America investors access to a wide range of strategies managed by the outstanding partners of iM Global Partner, ranging from US equities to liquid alternative strategies. Peter will report to Jose Castellano, Deputy CEO and Head of International Business Development.
Castellano said: “I am delighted to welcome Peter to our international sales team to support our rapidly developing Latam and US Offshore platforms, which have already been in place for more than a year. His experience covering the Americas will be a valuable asset in helping to develop the operational distribution capability of our current and future U.S., European and Asian Partners.”
Peter has 16 years of experience working for leading asset managers. Before joining iM Global Partner, Peter was responsible for sales of the Carmignac Mutual Fund range in the US. He spent four years, between 2012 and 2016, as Offshore regional Sales Consultant for Pioneer Investments, where he was responsible for sales of offshore mutual funds and alternative investments to financial advisors across all channels in the Southeast, Caribbean, and Panama territories. Peter started his career at Merrill Lynch providing Financial Advisors with sales support and investment guidance in both New York City and Asia regions. Peter has also been part of the Oppenheimer Funds and Capital Group sales teams.
Courtesy photo. Los diferenciales de los bonos híbridos y subordinados pueden estrecharse más durante el primer semestre de 2020, según Nicoló Bocchin de Azimut
A year ago, when Nicoló Bocchin, Head of Fixed Income of the Italian manager Azimut, started to manage the AZ Multiasset Sustainable Hybrid bonds fund, one of the main changes he introduced was to add subordinated bonds of financial companies, especially insurance companies, to its portfolio of corporate hybrid bonds.
“Hybrid bonds allow European issuers to finance themselves without jeopardizing their rating, if they follow the methodology established by the rating agencies, while insurance companies issue subordinated bonds for solvency reasons, but have features in common”, explains Bocchin in an exclusive interview with Funds Society.
Thus, by introducing insurance subordinated bonds, they enhance diversification thanks to instruments “that have almost the same structure as a corporate hybrid bond and provide the same spread,” explains the manager.
For this same purpose, the manager explains that recently they have also added AT1 instruments, known as CoCos in the portfolio, because it is “an asset class that we use tactically to enhance the return of the portfolio and that we like a lot. It is more volatile that hybrid and insurance but again it provides us with diversification nad coupon flows that are very helpful for the time being,” explains Bocchin.
Currently, the portfolio of the AZ Sustainable Hybrid fund is composed of 45% corporate hybrid bonds, 27% subordinated bank bonds and 24% insurers. Bocchin explains that there is generally one or two notches difference between the hybrid or subordinated bond rating and the issuer’s rating, depending on the degree of subordination and that in this type of asset “the investor is rewarded for the subordination, in a title with greater volatility, but with a spread similar to that of the High yield segment and an investment grade default risk.”
Short on underlying interest risk
Another characteristic of its investment style is that it is managed based on spreads, not yield, which implies that the two components that make up the total yield are broken down. The quality of the issuer and the macro environment and the impact on the government yield are analysed separately. Consequently, based on this approach and its current outlook for interest rates, they have recently reduced the sensitivity of the portfolio.
“In Europe we are in negative yield environment in the German curve which we think is not fully justified. We have mid to long term view in the way we manage our portfolio,we think that negative rates is a distortion of the market and perhaps in 2-3 years’ time with a bottoming out of growth and a pick up in inflation, which can occur, interest rates will slowly go from negative back to zero,” says the manager.
Consequently, its current position is that they have a long credit portfolio and short underlying interest rate risk Bocchin explains, “the current duration of our portfolio is 4.5 years, but the interest rate sensitivity of the portfolio is less than 3 years because I am almost 2 years short in futures both in the German curve and the small component in the Italian curve.“
Implementation of ESG Criteria
Another differentiating aspect of his management style is the application of ESG criteria in selecting the securities that are part of the portfolio. “Since we started managing the fund, the percentage of issuers that meet ESG criteria has increased from 75% to 95%,” says the expert, who applies this filter based on the criteria established by his external provider Vontobel.
In the same line the manager adds that, although these types of instruments are mostly issued by European entities, he predicts a great development of ESG issuers in emerging markets in the coming years and confirms that Azimut has the necessary resources and experience to take advantage of this opportunity.
2020: A year to Benefit from the Carry
In terms of return of this type of assets, the fund has had a very significant one during the year, although Bocchin points out that the profitability of the year 2019 has to be seen together with that of 2018 due to the strong spread widening at the end of 2018 and its subsequent recovery during 2019. Based on this good performance, in July 2019 they slightly reduced the risk of the portfolio by decreasing its exposure in AT1 and reinvesting in corporate hybrids and some insurers.
With respect to 2020, the manager points out that the profitability of 2019 will be very difficult to replicate. However, although the spreads are at levels close to 200 basis points, the manager believes that there is still room for further reductions, especially during the first half of 2020.
“With the QE the ECB is buying Investment Grade credit so investors see a squeeze in spreads and yield among IG, and they need to look for yield in the lower part of the capital structure,” explains the manager.
In short, by 2020 they expect a return between 2-4% in euros (that is, between 4.6% and 6.6% in dollars) under optimistic scenarios, although they do not rule out periods of volatility caused mainly by disappointment regarding Chinese growth .“2020 is the year where you should appreciate the fact that this type of instruments have a carry. We don’t expect a big spread compression, although there will be some, and the performance will be basically the yield of the portfolio”, concludes the manager.
Since 2018 China A-Shares have been included in MSCI Indices. Improvements in accessibility are expected to accelerate further inclusion of the China A-Shares in the near term. In this Q&A, Matthews Asia Portfolio StrategistJeremy Murden offers his views on this and China’s motivation to increase accessibility.
What Changes have been made to the MSCI Indices?
With the rebalance on November 27, 2019, index provider MSCI has completed the planned increase of both the weighting and breadth of China A-shares exposure in its emerging markets index as well as its China index and other regional indices.
In 2019, the inclusion factor rose to 20% from 5% through a three-step implementation process of 5% increments that began in May. In addition to the increase in allocation to the existing securities, MSCI also increased the breadth of the securities by including ChiNext shares as well as mid-cap stocks. Following the rebalance, Chinese A-share securities now make up approximately 4.2% of the MSCI Emerging Markets Index, an increase from 0.72%, and China exposure including A-shares now makes up approximately 33.6%.
Why were these changes made?
The move follows the successful implementation of the initial 5% inclusion of China A-shares in 2018 and wide support for the weight increase from international institutional investors. MSCI consulted with a large number of international institutional investors, including asset owners, asset managers, broker/dealers and other market participants worldwide as part of its review process.
Additionally, there was significant growth in the adoption of A-share investment by international investors as the number of northbound Stock Connect accounts grew from 1,700 before the June 2017 inclusion announcement to over 7,300 in February 2019. The Stock Connect programs in recent years linked the Shanghai and Shenzhen stock exchanges to the Hong Kong Stock Exchange and enabled foreign investors to buy A-shares with fewer restrictions.
Are further increases expected?
Yes. While no future increases are currently scheduled, MSCI is in regular contact with the China Securities Regulatory Commission (CSRC) regarding the proposed improvements in market accessibility that would lead to an increase in the inclusion factor.
What are key improvements the CSRC would need to make before inclusion is increased?
A key driver of the increase to 20% from 5% inclusion was the significant advancements in accessibility, including a tightening of the trading suspension rules and a quadrupling of the daily Stock Connect quota in 2018. MSCI highlighted nine potential improvements as a road map to a potential 100% inclusion.
The four areas that MSCI views as most pertinent to increasing the inclusion factor beyond 20% are:
Access to hedging and derivatives as the lack of listed futures and other derivatives products hamper investors’ ability to implement and risk-manage a large-scale inclusion
Change the current settlement cycle of T+0/T+1 to the emerging market standard of T+2 as the current short settlement period presents operational risk and tracking challenges
Align the trading holidays of onshore China and Stock Connect as the misalignment creates investment frictions
Create the availability of Omnibus trading mechanism in Stock Connect to better facilitate best execution and lower operational risk.
The next tier of improvements that MSCI communicated to the CSRC are:
Further reduce trading suspensions. There have been visible improvement lately, but trading suspensions in the China A-shares market remain unique when compared to other emerging markets
Improve access to the Chinese renminbi for stock settlement as direct access to the renminbi for stock settlement could represent a more-efficient foreign-exchange option for global investors
Improve access to IPOs and ETFs as both remain outside the scope of Stock Connect.
Open stock lending and borrowing. While short-selling is technically allowed, there currently is no functioning stock lending and borrowing market
Improve the stability of the Stock Connect universe as changes can create turnover issues in the maintenance of indexes.
What are potential next steps?
According to Sebastian Lieblich, MSCI’s Global Head of Equity Solutions, MSCI has been pleasantly surprised by the pace of accessibility improvements that have been implemented by the CSRC over the past 12 to 18 months. Beijing has indicated that access to derivatives and the alignment of holiday schedules are likely to be addressed in the near term. The change in settlement time is more complex, but still could be implemented swiftly. If the present momentum continues, “in a relatively short time frame, the launch of a public consultation on a major change could be announced.”
While the 2019 increase has been a move from 5% to 20%, Mr. Lieblich felt that given the pace of improvements, moving forward there is no need to grow the inclusion factors in 15% to 20% increments. He stated there is no prescribed path from here and the timing and extent of further inclusion will be directly driven by the timing and extent of accessibility improvements. While nearly all of the second-tier steps would need to be completed to reach 100% inclusion, incremental improvements will accelerate inclusion in the near term.
In addition to an increase in the inclusion factor, MSCI could continue to broaden the universe of A-shares to include the small-cap universe in indices to align China A-shares with the global standard of 85% of adjusted free float market cap. Beyond that, the securities trading on the new Shanghai Stock Exchange’s Science and Technology Innovation Board (STAR Market) could be included if they meet requirements of the MSCI GIMI Methodology and the eligibility of the stock connect programs linking the mainland markets and Hong Kong.
Finally, the exposure of Chinese A-shares in MSCI indices is still limited by the current 30% foreign ownership limit. Any opening from that limit would result in an increase to the adjusted free float market cap of all A-shares at the next index rebalance without any action by MSCI. Depending on the scale of the increase, it could have a multiplicative effect on the increase in A-share inclusion.
What is China’s motivation to increase accessibility?
China is primarily driven by a desire to draw institutional assets into its domestic market, according to our MSCI source. While many developed equity markets are 80%+ institutionally owned, China remains the inverse with only 20% institutional ownership. That has led to higher volatility as annual turnover in the A-share market in 2017 was 222% versus 116% for the U.S. Access to a larger pool of institutional capital, which tends to be more stable and long term in nature, would help reduce volatility in the market.
What would a move to 50% inclusion and beyond mean for the MSCI emerging market index?
Holding all other factors constant, a move to 50% inclusion from 20% inclusion would increase the exposure of A-shares in the MSCI Emerging Markets Index to 9.8% from its current level of 4.2% and increase China exposure to 37.5% from 33.6%. At full inclusion, China would represent 43.1% of the benchmark, 17.8% of which would come from A-share exposure. Looking ahead further, if South Korea and Taiwan, which are already considered to be developed economies, were to graduate to developed- market status per MSCI, China would make up 48.2% of the index at 50% inclusion and 54.0% at full inclusion.
How could this benefit investors?
The current Chinese exposure within the MSCI Emerging Markets Index and other indices is heavily weighted to mega-cap internet companies and large Chinese banks. This and future increases in A-shares exposure, and a further broadening of the universe to include small-cap stocks, will allow the indices to better reflect the opportunity set within Chinese equities.
Additionally, there was an estimated $1.9 trillion in assets that track the MSCI EM Index as of March 2019. While flows into A-shares from active managers are difficult to predict, the growth of the benchmark weight is likely to translate to inflows to the space and larger exposure from active managers who track the index.
Will pressure from U.S. politicians affect A-share inclusion?
While there has been pressure from U.S. policymakers, led by Florida Senator Marco Rubio, to remove Chinese stocks from indices, MSCI remains focused on the needs of global investors. Per MSCI, all indices use a fully transparent rules-based methodology. MSCI stated it will not make changes to existing indices or delay a planned allocation due to political pressure, only to changes in market access.
Additionally, the U.S. Thrift Savings plan at the center of the political pressure recently announced its decision to maintain its current benchmarks and China exposure after its board and consultant concluded maintaining the exposure to China was in the best interest of plan participants.
How much experience does Matthews Asia have with China A-shares?
Matthews Asia has extensively studied and invested in China’s domestic A-share companies for many years. In 2014, our firm was awarded a Qualified Foreign Institutional Investor (QFII) license and quota that enabled us to invest directly into China’s domestic securities market, including the market for China A-shares. We also have participated in A-shares via the Stock Connect programs.
We continue to be attracted by the fundamentally sound merits of many local companies listed in China. We realize that many quality A-share companies in growing industries can be priced at rich valuation multiples, however, which makes our experience of carefully vetting them critical. We believe long-term investors can benefit from exposure to A-shares.
At Matthews Asia, our focus has always been on taking a fundamental approach to finding leading A-share companies that are poised to benefit from the country’s structural shift toward its domestic economy.
Pixabay CC0 Public Domain. Aberdeen Standard Investments prevé una recuperación del crecimiento global en forma de L “y no de V” en 2020
Tentative signs have emerged that a trough in global economic activity growth is beginning to form, although the strongest evidence is coming from soft rather than hard data at present, says Aberdeen Standard Investments in a recent publication. Their global growth forecasts support that sentiment, driven by the expectation that geopolitical uncertainty will moderate at the margin, while the significant monetary support delivered this year supports the real economy. However, they expect any recovery in global growth to look “much more like an L-shape than a V”.
The fundamental drivers of geopolitical risk are still in place, constraining business investment, and monetary policy efficacy is lower than at earlier stages of the current expansion. “Indeed, we expect the world’s two largest economies (the US and China) to actually slow further in 2020, which will lessen the scope for improvement in those economies that were much weaker in 2019″.
Although markets have priced in growth stabilisation, the asset manager doesn’t think they price in a moderate recovery in industrial output and corporate earnings. As such, it expects further gains in the price of risk assets as we roll forward into 2020.
The strategy in global markets
When it comes to global markets, ASI identifies an “upside asymmetry” for some higher carry investments. “Risk assets are rallying and diversifiers are selling off, but changes in ‘hard’ data seem too insignificant to be the catalyst yet”.
However, the direction of ‘soft’ information has been noticeably more positive as optimism is rising that US-China trade tensions will abate; monetary easing from the Federal Reserve and other central banks has been substantial; and there has been an uptick in some leading indicators.
“As investors, our perennial question is whether markets have accurately adapted to these changes or overshot economic reality”, the asset manager points out. Its “tactical asset allocation process” offers a useful way to consider this.
In this respect, in August, they defined their ‘late cycle slowdown’ scenario as a world where the Global PMI was below 50, global EPS growth was somewhat negative and US core inflation was materially below target at 1.5%. “That was fairly close to the economic reality at the time and yet, under that scenario, we forecast equity returns of only a further 5% decline”.
By contrast, their ‘moderate recovery’ scenario began to reflect equity upside of 10-20%, depending on the region. This asymmetry had been widening at the same time that investors were widely considered to be bearish in mindset (AAII surveys) and positioned in quite a risk-averse way (BAML Fund Manager Survey).
“The relief rally we have seen has therefore been in line with the modest improvement in trade rhetoric, the ongoing easing in monetary policy and the apparent basing in leading indicators that catalysed an improvement in investor sentiment”.
Looking forward, ASI thinks they must assess whether asymmetry still exists or whether further momentum can only come from hard-data improvements. Their economists forecast that growth is going to trough but that the recovery may look more L-shaped than V-shaped, so, for their tactical asset allocations scenarios, their expectation is for “an environment that looks more like a ‘moderate recovery’“. This would see the global PMI rise a little further, a return to modest earnings-per-share growth (single digit) and gently rising inflation.
“Despite this scenario being more optimistic than a continued slowdown, the rally we have already seen leaves us forecasting only a further 5% upside in the US, Japanese and European equity markets in the near term”. If growth does improve, the asset manager sees potentially more upside in UK and EM equities (10-20%) given their more elevated risk premiums.
Importantly, ASI considers the previous asymmetry of upside-to-downside equity returns has now evaporated and, at this stage of the recovery, sees more asymmetry in their credit forecasts than for equities. In that sense, they believe spreads in high-yield and EM are still fair and their carry returns more backstopped by monetary easing. “As a result, we see these credit markets as providing better risk-adjusted returns, even though we continue to benefit from some equity exposure in particular markets”.
In this respect, in August, they defined their ‘late cycle slowdown’ scenario as a world where the Global PMI was below 50, global EPS growth was somewhat negative and US core inflation was materially below target at 1.5%. “That was fairly close to the economic reality at the time and yet, under that scenario, we forecast equity returns of only a further 5% decline”.
“Despite this scenario being more optimistic than a continued slowdown, the rally we have already seen leaves us forecasting only a further 5% upside in the US, Japanese and European equity markets in the near term”. If growth does improve, the asset manager sees potentially more upside in UK and EM equities (10-20%) given their more elevated risk premiums.