CC-BY-SA-2.0, Flickr. Credit Markets: Confidence Returns, but is it Sustainable?
Stephen Thariyan, Global Head of Credit at Henderson, reviews the credit markets in Q1 highlighting the ‘two-thirds—one-third’ nature of the markets. Financials came under particular pressure over the quarter exemplified by Deutsche Bank’s ordeal. While investors are happy to be back in the markets for now, as central banks have acted effectively to bring confidence back, challenges lie ahead in 2016. Thus, Stephen believes investors should be prepared for volatility to resurface.
Can you give a brief summary of corporate bond markets in Q1 2016?
It was a tough start to the year. It seems that in the first two months, particularly in February, the markets were discounting all the possible bumps in the road for 2016: concerns about central bank policy, illiquidity, Brexit, the oil price, China and growth in general. This led to quite a major sell-off across all capital markets, both debt and equity.
The end of February and March then saw a strong recovery, essentially based on the oil price, rallying from a low of US$26 upwards. That resulted in good returns, especially in high yield and emerging markets; total returns being positive across most currencies, across most credit markets, and excess returns again being broadly flat across most credit markets. So, a quarter of two thirds/one third: a very poor start and a strong recovery that continued into Q2.
Can you explain why the financial sector underperformed, particularly Deutsche Bank and subordinated banks/insurers more broadly?
The financial sector came under particular pressure in the first quarter. This was based on a combination of issues. Deutsche Bank in a way personified this with a situation that led to a significant sell-off in its bond prices, CDS and equity price. In a negative interest rate world, the core way the banks make money is challenged (ie, use short-term borrowing to lend for longer periods). This means significantly reduced returns from investment banking, especially in trading, fixed income, commodity and currency.
Banks, such as Deutsche, reported their first major loss in around eight years and there is a huge degree of outstanding litigation surrounding these banks, totalling billions. The last point was, especially with respect to Deutsche, concerns about the AT1 securities, contingent capital notes, which are complex subordinated financial securities, in existence to increase the capital buffer. There was a rumour that Deutsche would not pay its coupon, and even though these securities are designed to protect the public, the potential triggering spooked investors. Deutsche did recover the situation, but for the first time it felt a bit like 2008.
So financials generally took an awkward situation largely on the chin, given that central banks, especially in Europe, are trying to make banks lend money. Banks, however, are deleveraging, carrying lots of liquidity and struggling to find borrowers to borrow that money.
What is the outlook for credit markets and what themes are likely to drive the markets?
We are at an interesting point. We have suffered from a difficult first few months in 2016. The central banks have come in and almost acted in unison, with the European Central Bank subtly talking about a movement in monetary policy, but more importantly, the purchase of corporate bonds in the next few months. They haven’t given any details but the sheer fact that they are prepared to do it has given the markets confidence that there is a bidder for bonds.
It is debatable how effective that would be but the markets have rallied as a result. That combined with the Fed being a little more dovish a week later gave the capital markets, debt and equity, a huge fillip. Equity markets strengthened, bond markets strengthened, new issuance has started and the oil price steadied. A combination of all those events and generally benign data means that the investor seems happy to be back in the market again.
There is a degree of suspicion about how long this will last, but I think as we have said ever since the back end of last year, given all the different events that could occur in 2016, we are in for a volatile time. Certainly central banks have acted effectively so far in giving investors the confidence that they should be back in the markets buying both debt and equity.
CC-BY-SA-2.0, FlickrPhoto: Heribert pohl. Misperceptions of Thailand
On a recent research trip to Thailand, I had the chance to evaluate some commonly held misperceptions about the long-term outlook for the country’s economy.
One common misperception about Thailand, for example, is that its rapidly greying population makes its markets and companies relatively unattractive for investments compared to neighboring countries like the Philippines, Vietnam, Myanmar and Indonesia. We believe that this generalization discounts the dynamism of several Thai companies. The opportunity set for many companies extends beyond the country’s population of about 68 million. Thai companies have made progress, branching out to nearby countries to participate in their growth and to take advantage of more youthful populations. Similarities in culture and business practices have made it easier for companies to expand profitably in the surrounding region.
Another misperception is that Thailand, with its GDP per capita at approximately US$6,000, is stuck in a middle-income trap. The fear is that Thailand might not be able to graduate from an economy based on manufacturing and agriculture to one more specialized in services. The Thai economy does indeed need to restructure its workforce since roughly 42% of the population works in the agriculture sector, contributing less than 11% to GDP.
However, we believe that policy frameworks to enable the country to graduate to a knowledge-based economy are in place. For example, the government’s continued investment in education, which accounted for over 21% of the national budget in 2012, has resulted in a tertiary education enrollment rate amongst the highest in ASEAN.
A common mistake amongst foreign investors in recent years is to divide Thailand regionally along “Bangkok” and “Upcountry.” The inference is that the “Upcountry” is significantly under-developed and heavily dependent on agriculture. But based on our research, we believe that this division is, perhaps, too simplistic. For instance, our analysis of shopping mall operators has uncovered “rural” malls that are, in fact, in large towns thriving due to tourism and cross-border trade.
Economic Restructuring
We have also discovered that locals, especially bureaucrats, still believe Thailand to be quite resilient to various internal and external shocks. They call it “Teflon Thailand,” to suggest nothing can stick to it. But they may be overestimating that level of resiliency. Thailand still has not recovered from the 2014 national coup d’état. The replacement of the democratically elected government and appointment of a junta-led government has led to a period of both uncertainty and policy inaction. A consequence of this has been the loss of foreign direct investment market share to countries such as Vietnam, the Philippines and Indonesia.
We believe a restructuring of the economy is necessitated by Thailand’s aging population, slower global growth and competition from neighbouring countries. The government seems to understand the urgency of the situation and has unveiled a series of policies to improve the country’s basic infrastructure. Over the short to medium term, this should help. Over the longer term, we would like to see an environment that accommodates a more sustainable governance system that inspires confidence from local and foreign investors to commit long-term capital to the country.
Tarik Jaleel is research analyst at Matthews Asia.
CC-BY-SA-2.0, FlickrPhoto: Glenn Waters. Abenomics is Alive and Well
Despite the disappointment that the Bank of Japan (BOJ) did not act this week, one should not listen to those proclaiming the death of Abenomics. Indeed, it is alive and well.
Many people somehow suggest that Abenomics has so far been a failure, but this is only partially true if you were expecting miracles. The truth is:
Even after its recent rise, the current level of the Yen compares favorably with the 78:USD level before Abenomics;
TPP (the Trans Pacific Partnership) was successfully negotiated, which requires substantial economic reforms, especially in the heretofore heavily protected agricultural sector.
The 2% CPI target was ambitious, but CPI ex food and energy is now near 1% compared to flat or negative prior to Abenomics
Japan now believes in shareholder value, share buybacks and improved pretax profit margins, which have soared to record high, especially in the non-Yen sensitive service sectors
Corporate taxes were lowered by a massive amount, so recurring net profit margins are improving even faster than pre-tax margins
When looking at the overall economic picture, not the macro-economic statistics, which likely do not accurately reflect the new economy and often get revised, one sees full employment, stable or rising property values (after decades of wealth-sapping declines), and solid international competitiveness in advanced industries
Political stability reigns whereas previously the prime minister was an annually revolving door; and lastly (although there are many more examples)
Women are increasing their share of the labor force and over 200,000 kindergarten slots have been created in the last two years.
As for the BOJ, the likely reason why it decided to wait this week was to make certain that its next step was perfectly organized logistically, compared to its negative-rate decision in January. Certainly, the logistics for an ECB-style TLTRO (Targeted Longer Term Refinancing Operations)-like program is much more complicated than simply increasing QE purchases, and requires much more planning and transparency. But delay does not mean surrender, and if anyone thinks that Governor Kuroda is not fully dedicated to achieving positive inflation expectations, they are gravely mistaken and will likely be unhappily surprised when the BOJ takes its next large action, likely in June.
TLTROs, which provide negative-rate funding to banks if they can prove that it is going towards increased lending, are necessary, as in January, negative rates on excessive reserves led analysts to cut banks’ earnings estimates, which led to a broader equity sell off. Since price (including asset prices like real estate and equities, in order create the “wealth effect”) inflation is a key part of Abenomics, banks must not be penalized too much, or else lending and equity prices will not rise steadily.
Besides TLTROs, the next BOJ move will also likely increase the amount of bank reserves that are not subject to negative interest rates. We also expect an increase in ETF purchases to a level that will start to have monetary policy implications instead of just being symbolic of the BOJ’s desire to increase risk appetite by the Japanese people.
As for the fiscal “arrow,” “Helicopter money” is a vague and controversial term. If it means a hazard and extraordinary surge in fiscal spending financed by monetary injection, then such is not likely. However, Japan is soon going to increase fiscal spending substantially, especially due to the earthquake, and the BOJ will indirectly finance much of this.
Thus, the monetary and fiscal “arrows” will accelerate soon, while the economy is likely to continue growing at a moderate rate. It would be helpful if the US would pass TPP, but even if it does not, Japan will likely implement most of the reforms anyway, as such are obviously necessary, especially in the demographically challenged agricultural sectors. Other reforms, including in the labor markets, will also help prove that Abenomics is alive and well. It is critically important, however, that Japanese corporations are pro-active in this effort. They need to invest more locally, rather than abroad, and to be more creative, along with entrepreneurs, in creating new ventures, especially in green technologies. Abenomics is not just about the Prime Minister and his team, it is about Japan’s future as a whole.
CC-BY-SA-2.0, FlickrFoto: e_mole
. Jemstep, SigFig and Vanare Added to Pershing's Platform
Invesco recently announced that it will collaborate with Pershing to offer Jemstep Advisor Pro, the firm’s digital advisor-focused digital solution, to Pershing’s clients. Jemstep Advisor Pro will enable RIAs and broker-dealers on the Pershing platform to seamlessly onboard prospects and effectively service investors. It is expected to be available on Pershing’s NetX360 platform in the third quarter of 2016.
“Pershing serves a wide range of investment firms including RIAs and broker-dealers, and the Jemstep Advisor Pro platform offers the capabilities to satisfy the needs across our spectrum of clients,” said Jim Crowley, chief relationship officer at Pershing. “Jemstep Advisor Pro is distinct in that it combines Invesco’s leading world-class investment capabilities with best-in-class digital technology to enhance the financial experience for advisors and end investors.”
Jemstep Advisor Pro is open architecture which allows investors to access a variety of professionally selected investment options across mutual funds and ETFs. Unlike peer tools that focus on market-cap-weighted indexing, Jemstep Advisor Pro also gives home offices new and differentiated insights to help track advisor progress, view client data in aggregate, enhance portfolio management offerings and services, manage risk, and an opportunity to broaden their client reach to address intergenerational needs.
CC-BY-SA-2.0, FlickrPhoto: Neal Fowler. Time To Take A Step Back?
As a disappointing first quarter earnings season rolls on, I am beginning to feel more cautious about the markets in the months ahead. We’re in the midst of a third consecutive quarter of poor profits and cash flows, and what’s most troubling is the weakness that’s spreading beyond energy and exporters to a broader swath of companies in the index. To me, this is a signal to reduce risk in many portfolios.
Why the increasing level of concern? The three previous earnings recessions of the last 50 years that were caused by a combination of tumbling oil prices and a strong dollar tended to last two quarters. But this pronounced downturn in earnings has now stretched into a third quarter. By now, I would have expected sales and profits to have rebounded, with consumers responding to the “energy dividend” that has accompanied the tumble in oil prices. And the pass-through from lower input costs should have driven an increase in overall economic activity, fueled by higher real consumer incomes. That has not yet happened. I find it both discouraging and an ominous sign for risk assets.
Reevaluate your asset mix
With new money, investors may want to contemplate standing aside for now. An appropriate response for existing diversified portfolios could be to reevaluate their quality mix, and to consider favoring a tilt toward shares in companies with sustainable dividend yields and toward high-quality bonds, perhaps US corporate credits.
Although I don’t believe the present backdrop signals the beginning of a US recession, it does mean that we are now experiencing a protracted earnings recession. To resume favoring risk, I’d need to see the following:
A recovery in capital expenditures
An improved revenue line for US-based multinationals
A sustained improvement in emerging markets
Improved pricing power on the back of an increase in global inflation
Additional concerns
Aside from the concerns expressed above, there are a number of other issues that the market needs to confront. In particular, because of the growing weakness in earnings, the current price-earnings ratio for the S&P 500 is too high, at 16.3x.
Seasonal trends are not particularly favorable in the months ahead. The May–October period is historically characterized by sideways market movements, delivering indifferent returns to investors when viewed over many decades. As the popular saying goes, “Sell in May and go away.” This year, in particular, investors can afford to wait for more clarity from the data flow.
Generally, market participants tend to be cautious in the months leading up to major elections. And with this year’s US election likely to be contentious, that caution may be justified. Further risks that may warrant caution are the Brexit referendum on 23 June and a Spanish general election days after, as well as concerns about Greece’s ability to meet its financial obligations over the coming months.
The macroeconomic environment has proven less dynamic than expected in recent months. US government income tax receipts have slowed despite still-robust employment data. New single family home sales, though solid, have not met my expectations. Auto sales are losing momentum after a very strong 2015. And most importantly, the profit share of gross domestic product, one of the most important forward indicators I follow, has started to slide.
While the current US business cycle remains strong by many measures, like job and wage growth and corporate profit margins, the equity markets are laboring to produce the earnings and margins that we’ve come to expect in recent years.
Our job will be to follow the shifts in the markets and the economy, and it’s our hope that our current concerns will be temporary.
But for now, it might make sense to take a step back.
James Swanson is Chief Investment Strategist at MFS Investment Management.
CC-BY-SA-2.0, FlickrPhoto: InvertmentEurope. Roderick Munsters Appointed Global CEO Asset Management of the Edmond de Rothschild Group
The Edmond de Rothschild Group has decided to entrust the management of all of its Asset Management business to Roderick Munsters from May 10, 2016. He replaces Laurent Tignard who leaves the Group to pursue new professional opportunities.
Edmond de Rothschild confirms its willingness to accelerate the development in France and abroad of one of the Group’s flagship business, representing over CHF 85 billion (€78 billion) in assets under management (at 31.12.2015).
Roderick Munsters (1963) has both a Dutch and a Canadian nationality. He was Chief Executive Officer of Robeco Group from 2009 to 2015 (EUR 273 billion AUM at end-2015). He also headed Robeco’s subsidiaries RobecoSAM (Sustainable Investing) in Zurich and Harbor Capital Advisors (US multi-manager) in Chicago. From 2005 to 2009 he was a member of the Executive Committee and Chief Investment Officer of ABP and APG All Pensions Group.
Roderick Munsters will report to Ariane de Rothschild and is part of the Group Executive Committee as Global CEO Asset Management.
“We are very pleased to welcome Roderick Munsters. He will bring a wealth of experience, strong knowledge of international financial markets, entrepreneurial spirit and recognised ability to generate long-term performance” said Ariane de Rothschild, Chairwoman of the Edmond de Rothschild Group Executive Committee.
“I am very pleased and proud to join the Edmond de Rothschild Group and its teams in France and abroad” said Roderick Munsters. “Edmond de Rothschild is a leading reference in Asset Management. The Group is a forerunner of alternative multi-management since 1969, high-yield bonds in the 70s and currency overlay more recently. It is an honour to have the opportunity to take part in the Group’s European and international development and to support the further growth of its reputation”, adds.
CC-BY-SA-2.0, FlickrAntonio Díaz Bonnet. Antonio Díaz Bonnet to Join Compass in Mexico
After more than 20 years at Privest, Antonio Diaz Bonnet left the company he founded to join Compass.
The finance specialist who began his career in Inverméxico and was part of Probursa before and during the merger with BBVA -after which he was in charge of several divisions including private banking, national and international promotion, as well as institutional advisory, will start with its functions in Compass on Monday May 16th.
Diaz Bonnet’s departure includes his structure of private banking investors, which will also join Compass. There as Diaz Bonnet told Funds Society, his clients’ assets will join Compass’ nearly 31 billion dollars in assets under management. “With this, my clients are going to have a very important, and dynamic platform”. He also mentions that given that in Mexico Compass is also a fund operator, he remains “an independent consultant with no conflict of interests or restrictions, which allows for client’s assets to remain in the brokerages they choose.”
Diaz Bonnet is optimistic about the new challenge and his role in growing Compass’ market share in Mexico, as “the expansion of Mexico is one of Manuel Balbontín’s priorities” he said.
CC-BY-SA-2.0, FlickrPhoto: Frontriver. Mirage or opportunity in the ‘beta desert’?
High yield bonds were one of the principal beneficiaries of the adoption of quantitative easing (QE) by the US’ and other central banks in response to the global financial crisis. This new wave of monetary policy provided little incentive for savers to deposit cash as long-term interest rates were forced down to unprecedented low levels, unleashing powerful ‘reach for yield’ dynamics as investors searched far and wide for higher returns. This pushed global high yield credit spreads down to lows of 3.6% and absolute yields to 4.9%, in June 2014 (source Bloomberg).
The fallout from the orgy of credit that characterised the run-up to the global financial crisis was mitigated by aggressive central bank policy, which ensured a surprisingly orderly refinancing of the banks’ highly indebted balance sheets. As such, the level of distress was actually quite low compared to earlier cycles and given the scale of the 2008 crisis. In the end, the market reached absurd valuation levels and, with the winding down of the QE programme (‘taper tantrum’), a bear market cycle began to unfold. This was unusual and due to the disconnection between the market and underlying cyclical fundamentals, a direct result of central bank intervention.
The mispricing of an asset normally creates the conditions that lead to a reversal in its fortune, which allows a move back towards its long-term fair value. The post financial crisis bull market in high yield bonds is a particularly good example. Lower quality companies were able to refinance too easily, and, in many cases, took on too much cheap debt, leaving themselves vulnerable to a sustained low growth, low pricing power environment or to material changes in pricing. An example is the shale oil and gas sector which was able to access a seemingly inexhaustible amount of cheap debt at rates wholly incommensurate with the risks. The energy sector made up 9% of the US high yield bond market 10 years ago and rose to become 15% of the market before the oil price began its freefall.
The sell-off in the high yield bond market, partly triggered by the decline in oil prices, undermined confidence in credit markets, and, by extension, growth assets generally. This, in turn, culminated in the cathartic sell-off in January and February 2016 and propelled high yield bonds, formerly so expensive, to what we considered end-of-cycle levels and relatively cheap. Nominal bond yields reached levels in excess of 10% (in the US) and spreads had gone from lows of 335 to 890 basis points (source Bloomberg).
Such levels discounted a rise in default rates to well above 8%, the equivalent of pricing in a recession. Market price behaviour in this episode was typical of how, over the short term, investors can become detached from fundamental reality. This prompted us to re-establish a position from a zero weight across our multi-asset total return strategies, believing as we did that the current low growth, low interest rate cycle has considerably further to run. Having arguably been among the least attractive growth assets, high yield bonds had become the most attractive in the short space of two years.
We re-allocated to high yield bonds sooner than we had originally anticipated. Circumstances presented an opportunity to buy assets at a risk premium, which arguably offered investors the prospect of very attractive risk-adjusted returns over the medium term, even if this featured a relatively severe recession. Furthermore, through careful ‘bottom-up’ selection of individual securities, we were able to lower the prospective default risk of the position, compared with simply owning a passive exposure to the asset class. As long-term investors became aware of the attractiveness of high yield valuations, markets rallied powerfully. High yield spreads have now fallen sharply from 890 to 700 basis points, rendering the case for high yield less compelling, but given the cyclical dynamics, we still regard it as an attractive asset class over the medium term.
Market dislocations and irrational investor behaviour can present excellent opportunities for medium to longer-term investors who focus on fundamentals and valuations. Of course it is not just about recognising the opportunity, but being able to act rapidly and decisively, because windows of opportunity can, as in this case, close rapidly.
Philip Saunders is Co-Head of Multi-assets at Investec.
Kwok Chern-Yeh, Head of Investment Management at Aberdeen Asset Management in Japan.. "Do We Dare to Invest in Japan?" - Aberdeen
We interviewed Kwok Chern-Yeh, Head of Investment Management at Aberdeen Asset Management in Japan. Chern moved to Tokyo in 2011 from Singapore, where he had worked in management since 2005. Aberdeen currently has a team of 6 people dedicated exclusively to investing in Japanese equities, supported by an Asian equity team of 38 investment professionals located in 10 offices spread throughout Asia and teams around the world.
Why should investors look at a country with a challenging macro environment?
Japan is the second largest individual market worldwide, after the United States, by number of listed companies. This is a very large market with leading companies which are global leaders in their respective industries and very well managed. If we look at the Japanese market, we see it has great depth. It consists of 3,000 companies, of which 1,900 are listed on the first section. Among these, we selected a very small number of well-managed companies with strong and healthy balance sheets and with respect for shareholders. We manage very concentrated portfolios. Both the Large Cap and Small Cap strategies have fewer than 40 companies.
The investor must differentiate between Japan’s economic situation in general and the situation of individual companies. In regards to macro data, there are two facts which for the time being are not expected to change. First, we have the fastest aging population in the world, because life expectancy is rising, and the birth rate is still very low. And secondly, we face a high government debt and a persistent deflation problem. In regards to this second issue, there are certain sections of the market where there is obviously no pressure on prices, but in others, where there are players with considerable market share, a rise in prices is possible.
But if we analyze the micro data, things are much more interesting and different. Unlike the government, companies have large cash flows, and also currently, their growth is not dependent on the Japanese economy. They are multinational companies in which less than 20% of their business is concentrated in Japan. These companies have been increasing their incomes from abroad for some time, and this circumstance enables companies to benefit from growth in other parts of the world, especially in Asian emerging markets with rapid growth, in which the middle class is driving the demand. In addition, many of the best companies have begun to outsource their production to countries with lower-costs. Aberdeen’s objective is to select those companies that are the best performers in a struggling economy.
How does the currency effect affect the results of the export-oriented companies?
The stocks in our portfolios have international exposure, but need not necessarily be exporting companies per se. Many of our companies outsource production and sales outside Japan, this is important from the currency point of view, since this part of the business is not affected by the strength of Japanese currency since production costs are not in yen. The only currency-effect we could find in this case would be at the time of transferring benefits to yen. However, high-end production is usually located in Japan and this section of business itself is affected by the currency effect. Japanese companies are comfortable with an exchange rate of 100-115 yen vs the dollar. With an exchange rate below 100 yen per dollar, it is more difficult for these companies to make money. Regarding the RMB its devaluation does not have to be a problem either for companies that produce in China, which are many nowadays.
Regarding portfolio composition, do you seek the same sectors for Small Cap strategies than for Large Cap strategies?
No, in reality, the opportunities that can be found in both strategies are different, for example, in the Large Cap strategies, there are some good options in automotive companies, while in Small Cap strategies, the most interesting companies are those that produce automotive parts. Another example would be pharmaceutical companies, which are attractive to Large Cap strategies, while for Small Cap strategies we focus more on companies which produce medical devices and equipment.
Is there any improvement taking place within the corporate governance of Japanese companies?
In general, we are feeling encouraged because new measures and improvements in corporate governance are being implemented, but they are still insufficient and the process is very slow. The main problems facing foreign investors have been, and still are, the shortage and low efficiency of the information provided by companies, not looking after shareholders, and not taking into account their profitability, as well as maintaining very high cash levels.
The new corporate governance code based on the OECD’s Principles of Corporate Governance, which came into force in June, aims to address these problems. Regarding the quality of the information provided by the companies, it is still inadequate, and should be expanded. Something similar is happening with the relationship between companies and shareholders. Some companies are taking steps to support this good interaction, even exceeding regulatory standards, and on occasions, legislation itself is later responsible for adjusting these measures. Finally, the problem of excessive levels of cash in companies should be addressed. This is a long-standing problem, motivated by economic events of recent decades. After the banking crisis in the eighties, banks endeavourednot to grant credit to businesses, which led companies to adjust to growing without debt, and to have high amounts of cash on their balance sheets. Companies believe they need this cash because for a long time they were denied credit and now don’t know how to work otherwise. It is clear that these reserves should be returned to shareholders, but this practice will take a long time to become effective.
What are the difficulties that an analyst or investor may encounter when investing in the Japanese market as compared to other markets? Why is it good idea to invest in Japanese companies?
I believe that there is no substantial difference between investing in the Japanese market or any other market such as American or British. Perhaps the greatest difficulty we encountered in the Japanese market is, as I said earlier, that the information offered by companies is not very efficient. The Japanese economy is the second largest by market capitalization; however, the Japanese stock market has not been sufficiently covered by analysts: only 14% of assets invested in Japan correspond to companies with analyst coverage, compared to 71% in Asia-Pacific ex-Japan. This situation favors us because Aberdeen has been analyzing Japanese companies first hand over the past 30 years, and we have been able to find very good opportunities.
An example of these good opportunities in which we have invested and are still investing, are companies with great market capitalization in which dividends have grown substantially in recent years. Companies with stable ROE and EBITDA, strong balance sheets, and good fundamentals, and which do not depend on the evolution of the domestic economy. These are the type of companies in which Aberdeen invests for their Japanese strategies: quality companies, even if it involves having to pay more for them in some cases, because in the medium term, returns exceed the benchmark. If we compare the average P/E of our strategies with the benchmark, we will see that ours is higher. But this should not lead to confusion, because the benchmark is weighted down with very low PERs from banking companies and the automotive sector, and may seem cheap, but it really isn’t, as structurally, these sectors are trading at very low ratios.
What are the technical factors that will affect the Japanese market during the coming months?
In July, we have elections in Japan for the Upper House. Shinzo Abe is trying to reform the economy but has another intention for the long term, which is to reform the Constitution, and for that he needs votes, time, and to gain in popularity by presenting a package of measures to stimulate the economy before the elections, since the Abenomics plan has not worked as it was initially intended to, and the economy remains weak.
And, in regards to the restructuring of the pension funds, is it stimulating investment in Japanese equities?
The GIPF, the world’s largest pension fund, (the Japanese government’s pension fund) has already adjusted its allocation in Japanese equities raising it from 12% to 25%. If small pension funds did the same, it would lead to an increase in investment in Japanese companies in the short term. This remains to be seen, but normally these pension funds often operate by following the steps of GIPF.
How have Japanese investors been acting in recent years?
The Japanese domestic investor mentality is changing very gradually. When markets rise, they feel encouraged to invest in Japanese equities, but the proportion of their wealth in these assets is still very low.
And Latin American and US Offshore market investors?
Japan has been ignored by foreign investors for many years, it is an educational issue. The Latin American investor currently has around a 5% exposure in the Japanese market, the US Offshore investor, however, has been more receptive during the last two years, but despite this, Japanese exposure is not higher than 10%.
Is it possible for the international investor to cover yen fluctuations in the strategy’s net asset value?
Although these strategies are denominated in yen, there is a class denominated in dollars (hedged) which covers the currency effect, and which is the most popular for Latin American and US Offshore market investors.
Photo: KayGaensler, Flickr, Creative Commons. The Miami Selectors Event is Brought to a Close with Debates on Equities, Flexible Strategies, and High Yield
The second edition of the Funds Selector Summit held in Miami, organized by Funds Society and Open Door Media, offered in its second and final day, investment ideas focused on equities with different perspectives (European Equities with long-only and long-short strategies, US Small Caps, European and Emerging Equities with a value investment approach), global High Yield and flexible strategies (in equities, fixed income and emerging market debt) of fund management companies Allianz Global Investors, Legg Mason Global AM, Schroders, Brandes, Edmond de Rothschild AM, and Aberdeen AM.
European equities are still the trend, both with long-only and long-short strategies. In the first area, Matthias Born, Senior Portfolio Manager of European Equities at Allianz Global Investors, presented a high conviction strategy focused on new ideas of structural long-term growth (with features such as structural growth, cost leadership, technology leadership, or a superior business model). The strategy (currently with 70 billion Euros in assets) is managed very actively and stock picking is a key factor because, in the long term, the growth style does not necessarily have to beat the market.
Allianz Europe Equity Growth Select is designed specifically to take advantage of the main strength of its investment team: the selection of securities with a bottom-up approach. The fund has the potential to evolve well in both bull and bear markets, where it shows resistance “due to stock picking and to the companies in the portfolio,” explains the fund manager. He normally invests in about 30-35 names, with a maximum position of 6% and a focus on the universe of European large and midcaps. As investment examples, Born spoke of companies such as Infineon, Inditex, Reckitt Benckiser, or Coloplast. The names he most overweighs in his portfolio are Infineon, Reckitt Benckiser, SAP, Hexagon, Prudential, Novo Nordisk, Ingenio, DSV, Legrand, and Richemont; by sectors, he favors information or industrial technology, while he has no exposure to utilities or telecommunications. By country, he is overweight in Germany, Denmark, and Sweden. The fund’s turnover is usually below 20%.
He explained that growth is the main catalyst for the performance of the portfolio, as it is what determines the long-term evolution of the shares. “In Europe, which will continue to experience an environment of low growth and inflation for years, it’s even more important to have such a long term strategy,” he said. The individual weight of each company is based on the level of conviction which reflects growth criteria, quality and valuation: “We seek high profits and price setting power,” says the fund manager. He looks to not being influenced by the benchmark and being agnostic as to countries and sectors; and also giving importance to SRI criteria. Normally, the companies in his portfolio do not pay high dividends because they use their capital for new investments.
One can also capitalize on the European stock market with long-short strategies. Mike Gibb, Product Specialist at Legg Mason Global Asset Management, spoke about a way to invest with a long-short strategy in the European market. He also showed how the Legg Mason Martin Currie European Absolute Alpha fund investment process, managed by Michael Browne and Steve Frost, is flexible enough to weather this market environment, while offering an attractive risk-return profile. It is a high-conviction directional strategy (not market neutral), which aims to capture two-thirds of the market upturns and only part of the downturns. The net exposure may vary between -30% and 100% and typically invests in between 40 and 70 companies (about 35 in the long portfolio− focusing on companies with great products and balance sheets, margin growth and innovation− and about 35 in the short− companies with declining margins and market share, poor balance sheets, poor management, low entry barriers…) all selected from a universe of 600 companies), and focusing on the mid-cap universe with a purely bottom-up approach.
The process includes quantitative and qualitative analysis, visits to companies (about 300 each year) and a thorough evaluation. “Fund managers try to identify changes at the company level and how these can affect their business and their stock price,” explains the expert. They also apply a macro-level filter with a system of traffic lights. Currently, he has a neutral vision of the asset, being neither too optimistic nor pessimistic.
“Volatility reigns in the markets and we try to capture returns while controlling risk and potential downfalls. The challenge is to capture the growth of companies in the region: Europe is a place with big companies but also with companies with problems and pressures on margins… and so the long-short concept works very well and helps to avoid problems and protect capital.” In his opinion, this strategy fits well into the portfolios.
Value style…
Meanwhile, Gerardo Zamorano, Emerging Markets’ Fund Manager at Brandes Investment Partners, also offered his perspectives on Equities, which his company manages from a value perspective and with strategies for the global stock market as well as emerging, European, or American markets. The investment process consists of three phases: analysis (by investment teams), valuations (investment committees make the final decisions), and portfolio construction (also the responsibility of the investment committees). With the conviction that in the long-term value outweighs markets and that with the current environment− after years of the style’s worst performance due to the financial crisis− there is great opportunity in this investment style.
In emerging markets, valuations are close to the levels seen on previous crises but, since then, there have been strong improvements in fundamentals. “The situation is much healthier than in the late 90s,” says the expert. Value had performed better than growth but since 2014, it has performed worse. Therefore, securities with this bias are cheaper than in the past. The Brandes Emerging Markets Value Fund invests in companies of all capitalizations, leverages overreaction to macro factors and negative feelings (e.g. political events) leverages the lack of understanding or coverage of individual firms ( “we explore all corners of the market “) and build concentrated portfolios that manage risk with conviction. They also include into their investment universe, companies from border markets and companies from developed markets with characteristics which are more similar to those from emerging markets. In total, they usually have between 60 and 80 names. Currently, some key overweights are in the consumer discretionary sector, Brazil, Russia and Hong Kong, and underweights in Taiwan, South Africa, China, or the information technology sector. They also like Panama.
In Europe, Zamorano also points out the attractiveness of valuations and opportunity in the Brandes European Value fund. Overweight in the oil and gas sector, food, and countries like Italy and Russia, while underweight in banks, health, and countries such as Switzerland and Germany. The fund includes investment in emerging European markets, currently at around 10%. Companies such as GlaxoSmithKline, Engie, Sanofi, BP and ENI are among its top 10 positions.
US Equities
There are also opportunities in US equities. Jason Kotik, Senior Investment Manager of US equities at Aberdeen Asset Management, spoke about investment in small caps companies. “Overall, the US economy grows at a slow pace, but good quality companies can be found. Two thirds of the economy is consumption and is in good shape.” Overall, companies are in good financial health and valuations are not too aggressive, says the expert. “We are not investing on the economy, but on the companies,” he reminds us.
Regarding equity flows, investors are wary after the rally experienced, but in that rally the small caps lagged behind the large caps. So valuations in the small caps are now more attractive. “Historically, small caps do better than large ones, and also usually perform well even in scenarios of interest rate hikes,” the fund manager pointed out. The reason: when rates climb it’s due to an improvement in the economy (higher growth and inflation) and the small caps usually have greater exposure to the US domestic economy. In addition, they can be protagonists in processes of M&A, usually with significant premiums, and have less coverage by analysts, giving advantage to active managers.
In the company, they believe that corporate fundamentals support this investment, they speak of a modest but positive macro scenario and believe valuations are fair. In a more volatile scenario, the dispersion has also increased and makes stock selection more important. For the expert, the markets will remain volatile given the upcoming elections in the US, the uncertainty about monetary policy and macro doubts, which can lead to some correction but can also benefit asset management companies like Aberdeen. “We like boring names in which the others aren’t interested,” says the expert, who expects returns around the mid-single-digit. With its strategy (Aberdeen Global-North American Smaller Companies Fund, which also invests a small part in Canada) is able to offer a better return than the market, he explains, both in bull and bear markets. Currently overweight in sectors such as materials, consumer staples, industrial, and communications services, he has a strong underweight position in finance and utilities.
In Fixed Income…
In fixed income, Wes Sparks, Head of Credit Strategies and Fixed Income at Schroders in the United States, explained the opportunity which credit, investment grade and high yield, represent globally. “We are optimistic in IG and HY but we must be aware that there has been a big rally in a very short period of time: the global high yield has risen more than 12% since February,” he reminds us. For this reason, and as far as fundamental and technical factors are concerned, the management company remains optimistic on the asset, but is somewhat concerned about its valuations. “The fundamental and technical factors of high yield are more positive than in investment grade debt, but valuations are less attractive than in February. It is even a faster recovery than the sell-off and usually it does not work that way,” says Sparks; hence his caution in the asset. “It’s not expensive, but there is no safety margin,” he adds.
But he insists that the fundamentals are positive: “The risk of default is not a widespread threat.” In the United States, he speaks of many fallen angels during the first quarter, which he sees as very attractive opportunities. In terms of flows, the management company uses extreme flows in funds as a contrarian indicator: if there is output, it coincides with strong sales and falling prices, which is followed by recovery. And there is support from long term investors: “In an environment of low interest rates, investors continue to seek profitability and high yield is one of the assets in fixed income with the highest potential. We are seeing demand for long-term investors, such as pension funds,” he adds.
The fund manager denies that there may be a strong sell-off in high yield from now on, but believes that investment grade debt, by presenting better valuations, can be a better place to be in the medium term, because it has not experienced such a strong rally in recent months. “Valuations are more positive, and the asset has a more diversified buyer base which supports the market,” he says, although he clarifies that he is confident that high yield will beat IG over a twelve month period. “We have confidence in both assets, the returns will be positive in twelve months,” he adds.
In his global HY fund (Schroder ISF Global High Yield), he is committed to companies with cash, good margins and profits, pricing power, and manageable leverage, and regarding the US, he speaks about domestic-market-oriented defensive sectors (not impacted by the dollar and commodities at low levels) such as health or gambling, or companies that benefit from low gas prices (restaurants, automotive industry….). The fund is underweight in sectors related to raw materials (energy, basic industries…) and sees more value in other sectors such as communications.
Regarding central banks, Sparks believes the Fed will not be very aggressive in its rate hike because it will take into account international problems, while central banks in Japan and Europe will remain accommodative. Treasury bonds will rise in the coming months, but not too much, he says. Regarding the risks, he acknowledges that the interest rate is higher in IG than in HY, denies a cycle of widespread defaults (it will be reduced to the metals, mining, and energy sectors, he believes) and believes the next cycle of defaults will be in two years, in 2018. Regarding illiquidity he says that markets must compensate for it.
Flexible Strategies…
Kevin Thozet, Product Specialist in the Asset Allocation team and Sovereign Debt at Edmond de Rothschild Asset Management, shared the company’s positioning of flexible and dynamic funds in Global Fixed Income, Emerging Fixed Income, and European Equities. “Flexibility is part of our DNA and we define it as active management and investment without restrictions. We seek opportunities wherever they are, and we are flexible to invest in different market segments and vehicles.” The company believes that with the return of volatility, liquidity shortages, and greater market movements, this philosophy is more necessary than ever to create value. Because, regardless of vision on markets, the key is to be able to adapt quickly to whatever happens, the company comments.
His global fixed income fund tries to beat the market and obtain absolute returns, and it can invest across the fixed income universe. As some examples of that activity and how they try to capture the opportunities, he explains that when tapering started in 2013, they invested on assets that suffered, such as emerging debt, because they had conviction; during the Chinese crisis last year, they built positions in convertibles to benefit from the rebound in November 2015; this year, with strong volatility and widening spreads on the government debt of Greece and Portugal, they saw it as an opportunity and increased exposure to Portugal. With regard to profitability, credit and public debt have been the largest contributors on an annual basis, but so have emerging debt and convertible bonds.
As for the company’s emerging market strategy− in UCITS format and domiciled in Luxembourg−, in the management company they have a contrarian and opportunistic approach without restrictions, are agnostic regarding benchmark, and are also able to invest in the entire universe (public and private debt). The largest position in the portfolio today is Ukraine (they see opportunities particularly in the corporate segment). Another conviction of the portfolio is Venezuela (with positions in both public and private debt): it’s not a commitment to its economy, but it does offer a very asymmetric profile between risk and return, says the fund manager. Also, an opportunistic coverage, although they are positive on emerging market debt, is investment in CDS in China. In 2013, emerging markets suffered heavy falls but the fund achieved positive returns.
The fund manager also spoke about the company’s flexible strategy in European stock market, which has some core, 60%, concentrated in equities with conviction, and above it, a hedge with derivatives to generate returns and reduce volatility and protect markets in case of falls.
