High Yield in the Crosshairs

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¿Compensan las asignaciones estratégicas a los segmentos de menor calidad en la deuda high yield?
CC-BY-SA-2.0, FlickrPhoto: Brian Jeffery Beggerly. High Yield in the Crosshairs

Investing in high yield bonds is not for the faint of heart. That said, the risks associated with below-investment-grade bonds are frequently overstated and couched in hyperbole, believes David P. Cole, CFA, Fixed Income Portfolio Manager at MFS.

Late last year, investors beat a thunderous exit from high yield bonds, which in turn reverberated through financial markets as analysts pondered the implication of deteriorating credit markets on the US economy. More recently, investors have made a U-turn, and high yield has witnessed inflows again and spreads have tightened. Talk of a US recession has similarly subsided.

According to the expert, high yield bonds are subject to a cyclicality that mirrors the economic cycle — and default risk is an important factor in total investment returns. If one understands the cyclical backdrop of the high yield asset class and adopts an investment approach that involves prudent security selection, particularly in the lower-credit-quality segment of the market, high yield bonds can make a compelling addition to a well-diversified portfolio. 

“The asset class has historically delivered a risk-return profile somewhere between higher-quality fixed income and equities, and has exhibited characteristics of both markets over full market cycles. In the period from 1988 to 2015, the Barclays U.S. High Yield Corporate Bond Index delivered a compounded annualized total return of 8.1% — more than the 6.6% return of the Barclays U.S. Aggregate Bond Index but less than the 10.3% return of the S&P 500 Index”, points out.

High yield bonds can offer diversification against interest rate and equity risk. With relatively low interest-rate sensitivity compared with other fixed income asset classes, the US high-yield market may offer a buffer against a rise in interest rates.

Prudent security selection in the lower-quality segment

Volatility in the lowest-rated high yield bonds can be significant. For this reason, it’s important to focus on differentiation in return and risk characteristics by credit quality, as the returns of the lower-quality segment of the market can vary quite meaningful from that of the overall high yield market.

Historically, highlights Cole, investors have not been adequately compensated for a strategic allocation to lower-quality segments of the high yield market, as the perceived carry advantage is often offset by capital losses due to defaults. Compared to the higher-quality portions of the high yield market, the lowest-rated high yield securities (CCCs) have produced lower compounded returns given the variance drain — losses incurred from heightened volatility because of the wealth erosion caused by downdrafts in security prices — associated with their significantly higher return volatility.

“While lower compounded returns argue against a strategic overweight to CCCs, this market segment also displays a greater dispersion of returns than those in the higher-rated BB or B portions of the market. This suggests potential opportunities to add value by selectively investing in CCC securities, especially on the heels of a significant selloff, when credit spreads have widened substantially”, explains the MFS portfolio manager.

Consequently, says Cole, a tactical allocation to the lower-quality segment of the high yield market can be appropriate when one is being sufficiently compensated for taking on the additional price risk. In the current environment, for instance, energy and mining companies may become attractive. However, investments in these lower-rated securities must be carefully weighed against the overall risk profile of the portfolio, as they can be both distressed and highly illiquid.

“December’s headline-driven selloff in high yield, prompted by a small handful of high yield strategies that ran into trouble with overweight positions in commodity sectors and CCC-rated securities, provided a stark reminder of just how important it is to manage credit risk in high yield”, concludes.

For MFS, the high yield market provides an opportunity for investors to gain exposure to the credit market with an asset class that provides diversification and an attractive return profile over time. Investing in this market also requires prudence, an eye for identifying inflection points, and favoring certain names — such as those on the higher-quality tier of the credit quality spectrum — to deliver attractive risk-adjusted returns.

Emerging Markets Equities: Positioning And Opportunities in Henderson’s View

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Henderson: “Resulta imposible predecir cuándo llegará la recuperación cíclica a los emergentes”
Glen Finegan. Emerging Markets Equities: Positioning And Opportunities in Henderson's View

Glen Finegan, Head of Emerging Market Equities at Henderson, provides a detailed update on his strategy covering recent market drivers, performance and activity, and his outlook for the asset class.

How have the emerging markets performed so far this year?

A sharp decline for the MSCI Emerging Markets Index in January was followed by a strong rally during February and March, leading to a gain for the asset class overall during the first quarter of 2016.

Against this backdrop the Henderson Emerging Markets Strategy, outperformed a rising market. The investment in gold producer Newcrest Mining and significant exposure to companies listed in the unpopular Brazilian, Polish and South African markets helped. The strategy’s Egyptian and Nigerian holdings performed poorly and fell during the quarter.
Over the last year the strategy declined less than the benchmark. Our approach of owning high-quality companies with properly aligned controlling shareholders and strong track records of delivery aided relative performance.

What can you tell us about your portofolio allocation?

We added to the strategy’s Brazilian positions during January’s market fall only to reduce these somewhat towards the end of the quarter following a rapid increase in valuation. We are confident the strategy owns high-quality businesses with strong franchises that will enjoy cyclical recovery when it comes. Predicting the timing of this is, however, impossible, meaning we remain extremely valuation sensitive.

Emerging consumption ¿Cómo ha funcionado el tema del consumo en los mercados emergentes?

We fully disposed of the strategy’s SABMiller position during the first quarter. The discount to Anheuser-Busch InBev (ABI)’s takeover offer has narrowed considerably and the deal still has to clear a number of regulatory hurdles. In the unlikely event it should fail there would be substantial downside in this stock.

Our search for high-quality, reasonably-valued consumer companies in India resulted in the purchase of a new holding in leading cement producer Ultratech.

Cement consumption in some less developed markets shares the same fundamental driver as basic fast moving consumer goods, namely improving living standards. Indian cement sales are conducted mostly in cash and demand is largely driven by the need for improved housing. Housing in India is primarily financed by savings and construction is often as wholesome as adding a small room to an existing property. More than 90% of cement sold in India still comes in bags rather than in bulk, indicative of this being a consumer-driven market. Furthermore, per capita consumption of cement remains low, meaning there is scope for this to increase over time.

What is Ultratech’s appeal?

A unique feature of Ultratech is its network of over 50,000 dealers throughout India selling “Ultratech” branded cement. This network is far larger than any of its competitors and has enabled the company to reach an almost 40% market share in rural India.

Ultratech is one of the crown jewels in the Aditya Birla Group, accounting for approximately 10% of group revenues. Aditya Birla is a family-controlled industrial group led by Kumar Mangalam Birla. Since becoming Chairman in 2004, after the passing of his father, Kumar has shown an ability to take a long-term approach to building strong franchises in a number of industries, including cement. He is also recognised as a leading advocate for strong corporate governance in India.

With the backing of the Birla family, we believe Ultratech will continue to take a leading role in the consolidation of India’s fragmented and overly-indebted cement industry.

What about China?

We have continued building a position in Fuyao Glass following a meeting with its Chief Financial Officer. Fuyao is China’s leading auto glass manufacturer and serves well-known carmakers in China and now also in the US and Europe. The company is a governance leader in China thanks to its far-sighted controlling shareholder who has insisted on global auditing standards since listing in 1993 and emphasised research and development investments to protect the long-term profitability of the franchise. We find the company’s current valuation undemanding given its opportunities for growth.

What is your strategy going forward?

Weak rule of law combined with many undesirable political and business leaders mean there are parts of the emerging markets universe that are cheap for a reason. We are not deep value investors and aim to avoid being seduced by low-quality companies trading cheaply. Neither are we outright growth investors and we continue to avoid what we believe are overvalued but growing South Asian consumer businesses. Instead, as bottom-up stock pickers our focus is on combing unpopular markets for good-quality companies trading at reasonable valuations.

Negative Rates Have Overstayed Their Welcome

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Los tipos de interés negativos han dejado de ser bienvenidos
CC-BY-SA-2.0, FlickrPhoto: T-Mizo. Negative Rates Have Overstayed Their Welcome

Low rates are a problem. An article las week in The Wall Street Journal notes that more than $8 trillion of sovereign debt now trades at negative rates. But negative rates have now overstayed their welcome, and policymakers need to consider the unintended consequences.

This problem is something the Federal Reserve is already aware of, though it is unclear if other central banks are too, points out Kathleen Gaffney, Co-Director of Diversified Fixed Income, and Henry Peabody, Diversified Fixed Income Portfolio Manager at Eaton Vance, in the company´s blog.

Both belive that there was a time for emergency measures. While the global economy is not out of the woods, and an adjustment to higher rates would be painful for a few groups, marginally higher rates would likely be a positive at this point. However, explain the managers, this would require central bankers to admit that they are not central planners and there are limits to monetary policy.

“When global central banks began their march to zero, it was well-intentioned. Lower rates spur investment and increased money supply lead to inflationary pressures as the cost of capital is reduced. But something has changed. It’s unclear what precise threshold was crossed, but incentives and risks have shifted. This brought with it unintended consequences that outweigh the benefits of 0% rates”, say.

The cost of capital is artificially low and distorting the capital markets. Corporations, at least partially at the behest of the short-term nature of many shareholders, began to embrace the low risk-adjusted return by buying back their own shares. So yes, an extended period of emergency monetary policy has benefitted some.

However, Gaffney and Peabody highlights that this has come at the expense of savers. “Savers have been forced out of bonds and into equities in order to pick up lost return. Now, the volatility in the equity market has an outsized impact on psychology and, perhaps, spending. The impact on savers has been so severe that many are highlighting the ironic and sad increase in “liabilities” associated with low returns; attaining goals is that much harder”.

According to the experts, the Fed (and other central banks) would be well-served to increase rates and generate both a more meaningful cost of capital, as well as improve income for savers. Higher rates would likely ease the pressure on consumers, allowing them to spend. This, along with well needed infrastructure spending and fiscal expansion could lead to a greater demand for credit. Higher rates would be supported by fundamentals. A higher rate would also be an affirmation of growth, and would also likely bring a focus back to long term projects and capital expenditure.

This thinking, along with relative value, is behind Eaton Vance positioning in commodity related credit as well as currencies that will benefit from the combination of supportive policy and private capital inflow, and away from interest rate risk.

“The adjustment to get to higher rates will potentially be painful for some, particularly those expecting a low volatility world to persist. Capital will likely flow toward sectors of the market that offer a cushion against higher rates, and credit with improving fundamentals”, they conclude.

 

How Important is the Valuation of High-quality Companies?

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¿Cómo de importante es la valoración a la hora de incorporar una empresa de alta calidad en la cartera?
CC-BY-SA-2.0, FlickrPhoto: Lucas Hayas. How Important is the Valuation of High-quality Companies?

Does the valuation of a high ROIC company matter? If Q1 companies have typically outperformed, is there any benefit to also selecting cheaper companies, or should we simply remain agnostic to stock valuation?

According to Investec experts, they prefer to use free cash flow (FCF) yield as their valuation metric as it captures the cash-generating power of the business, rather than the income statement profits, which are based on accrual accounting and are more vulnerable to manipulation by management. Moreover, the FCF yield better reflects the available cash that can be reinvested into a business for future growth, or returned to investors.

The next graph prepared by Investec shows that valuation does matter, and is more important for companies with low ROIC (those in Q4). The highest return at the individual stock level appears to be achieved by investing in companies with a high ROIC and FCF yield. Historically, investing in these companies has provided outperformance of 3.8% per annum. Meanwhile, investing in the most expensive companies with a Q1 ROIC has typically resulted in modest underperformance of 1.2%. Importantly, this analysis takes no account of the final ROIC of the company like the prior charts, and does not, therefore, assess the sustainability of high returns.
 

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“We believe in exercising caution when operating in these areas of the market. A combination of high ROIC and seemingly cheap valuation can imply the market is anticipating a structural problem with the company’s business model, often meaning that returns have a high probability of fading fast. In this scenario you need a fundamental understanding of the inner workings of the company’s business model to properly assess the sustainability of returns. In our experience, we rarely find such an opportunity that is attractive on a risk-adjusted basis over a long-term investment horizon,” says Investec.

Alternatively, they suggest, to purchase a stock with a Q4 FCF yield, “we require the business model to be impeccable with structural trends that mean we are compensated with above average growth and limited uncertainty. Again, these types of opportunities tend to be few and far between. Lofty valuations are often caused by market over-exuberance around future growth, resulting in long-term underperformance. Consequently, we select moderately valued companies with a high ROIC that we believe can be maintained over the long term.”

Implications for portfolio construction
To generate outperformance they aim to construct a portfolio for their Investec Global Franchise Strategy that, in aggregate, maintains a Q1 ROIC. Figure 7 tracks the Investec Global Franchise Strategy’s ROICs against the median quartiles for the market and shows that this aim has been met for almost the entire lifespan of the strategy. “We believe this is a positive indicator for its future performance, as we have confidence that the companies that make up this portfolio have competitive advantages to maintain their current high returns. Crucially, this confidence is based on our detailed bottom-up analysis of these companies and an assessment that their ROICs are sustainable over the long term.”
 

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“Valuation plays an important role in our investment process. Although we believe that quality companies deserve a premium valuation, we are not willing to include overpriced stocks in our portfolios. For us, investing in high-quality companies only makes economic sense if FCF yields are superior to long-term bond yields. This comparison comes from the stable and consistent cashflow generation of these companies, many of which have bond-like characteristics,” they conclude.

Schroders Enters into Market for SME Direct Lending Through a Partnership with NEOS Business Finance

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Schroders entra en el mercado de financiación directa para pymes y nombra responsable de Marketing para EMEA
CC-BY-SA-2.0, FlickrPhoto: Moyan Brenn. Schroders Enters into Market for SME Direct Lending Through a Partnership with NEOS Business Finance

Schroders today announces that it has entered into a strategic relationship with Dutch direct lending firm NEOS Business Finance. Schroders has acquired a 25 per cent. stake in the business.

Launched in 2012, NEOS Business Finance provides institutional investors access to an alternative debt financing platform for Dutch small and medium-sized enterprises (SMEs). The company has developed an approach to give SMEs access to small to medium size loans through a standardised issuance and loan terms process.

NEOS Business Finance will provide investment advisory services to Schroders in connection with the management of investment funds of Schroders’ clients investing in SME financing.

NEOS Business Finance has an extensive network and broad client base. To date, NEOS Business Finance has launched one investment fund funded by two large Dutch pension funds. In addition NEOS Business Finance works with the largest Dutch bank ABN Amro to source SMEs in need of financing. This complements Dutch government policy which encourages pension funds and other institutions to actively participate in local economies.

Philippe Lespinard Co-Head of Fixed Income at Schroders said: “Small and medium enterprises (SMEs) in Europe are increasingly looking to obtain debt financing from non-bank lenders. Part of this trend is explained by the decreasing supply of credit in that space by commercial banks who face increasingly onerous capital requirements on loans perceived as risky by regulators and supervisors. On the demand side, borrowers expect faster approval times and lower collateral requirements than afforded by banks’ traditional processes and systems. These conflicting trends open up a space for non-bank actors to provide growth financing to SMEs on simpler and faster terms.”

Repurchasing Confidence: The Potential Benefits Of Stock Buybacks

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Los datos demuestran que las empresas con programas de recompra de acciones superan al mercado a largo plazo
CC-BY-SA-2.0, FlickrPhoto: Susanne Nilsson. Repurchasing Confidence: The Potential Benefits Of Stock Buybacks

There’s no substitute for a well-run company with solid fundamentals, steady earnings growth and a seasoned management team. But investors in even the most profitable firms are always looking to add value. Two commonly used methods for bolstering corporate shareholder value are dividends and stock buybacks.

A company may decide to repurchase outstanding stock for many reasons — to telegraph confidence in the company’s financial future, return cash to investors in a tax-efficient manner (shareholders typically pay taxes on dividends) or simply to reduce the number of shares outstanding. In some cases, buying back shares just makes good financial sense – particularly when a company’s stock is trading at a discount, explains Thomas Boccellari, Fixed Income Product Strategist at Invesco.

A positive buyback performance track record

For these same reasons, investors may wish to consider companies with a propensity for repurchasing shares. A company stock repurchase is like reinvesting a dividend without incurring taxes.

“Consider also that the shares of companies that repurchase stock have tended to outperform and exhibit lower volatility than the broader market. In fact, studies show that buyback announcements have historically led to a 3% jump in stock price on average, and that the subsequent average buy-and-hold return over four years was 12%” points out the strategist.

And he adds, “the chart below shows the dollar amount of share buybacks for companies within the S&P 500 Index since 2004, as well as the performance of the NASDAQ US BuyBack Achievers Index relative to the S&P 500 Index. A rising orange line indicates that the NASDAQ US BuyBack Achievers Index (BuyBack Index) outperformed the S&P 500 Index; when the orange line is falling, the BuyBack Index underperformed the S&P 500 Index”.

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So, according to the expert, while past performance is not a guarantee of future results, you can see that when the dollar amount of buybacks increased, as shown by the purple line, the stock of companies that repurchased shares (as measured by the BuyBack Index) generally outperformed the S&P 500 Index. Conversely, when the dollar amount of buybacks decreased, the stock of companies that bought back shares generally underperformed the broader market.

The benefits of international buyback shares

While stock buybacks have long been popular as a means of returning cash to shareholders in the US, they are also gaining favor internationally ­— particularly in Japan and Canada, poins out.

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“Investing in international companies with a history of buying back outstanding shares offers the added advantage of international exposure — including geographic diversification and, in some cases, more attractive valuations than US-based companies. With both interest rates and stock valuations currently low, I believe international companies will increasingly view share repurchases as a sound investment proposition and a means of enhancing shareholder value”, concludes.

The PowerShares International BuyBack Achievers Portfolio tracks the NASDAQ International BuyBack Achievers Index and provides diversified exposure to international companies that repurchase their own shares.

Why Do Chileans Invest in Chile? Should We Follow Their Example?

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¿Por qué los chilenos invierten en Chile? ¿Deberíamos seguir su ejemplo?
Courtesy photo. Why Do Chileans Invest in Chile? Should We Follow Their Example?

Luis Felipe Céspedes, Minister for Economy, Development, and Tourism of the Republic of Chile, shared his overview on the current situation of “the most competitive economy in Latin America,” its optimistic forecasts and investment opportunities in the country –which was placed 35th in the Global Competitiveness Index– for the more than 200 participants in the World Strategic Forum. We had a chance to interview him after his speech at the event held in Miami last week.

Céspedes attributes the success of this Southerneconomy on the strength of four key elements: its institutions and the communication between them, the macroeconomic framework, the financial system and the commitment to the country’s openness and global integration. “We need to generate savings which will later be invested,” he said, referring to the financial system, adding that the vocation of integration with the economy of the rest of the world is not only governmental but a commitment of the country.

The reality is that Chilean investors represent a tiny part of the capital which the wealth management industry manages in Miami, since, say the experts, Chile presents conditions of security, stability, and opportunities for investment which are rare in the region. The Minister agrees and explains that the process of internationalization of companies, the strong growth of the economy, and its openness made it very attractive to invest in Chile. To this we must add that the government recently carried out a tax reform plan that included a capital repatriation plan, with a preferential tax rate of 8% so that fortunes held offshore would be returned to the country.

Chilean investors who wish to seize the opportunities offered by foreign instruments can do so without major difficulties, contrary to what happens in other economies in the region. According to a report by ALFI, the Association of the Luxembourg Funds Industry, of the 100 most international fund managers in the world, 57 have their products registered in Chile. And according to a study by Global Pension Assets Study, published by Willis Towers Watson, Chile is the market where the volume of pension fund assets under management grew the most globally, according to CAGR figures over the last 10 years (in local currency), up to 18%.

Cespedes insists that “the growth of the Chilean economy is due to its own engines” even though it “benefits when neighboring countries do well”. With a GDP of $ 22,972 (ppp), and a net public debt with a surplus of 3% of GDP, the minister explained that the state budget is consistent with the long-term forecasts, so that, for example, “this year we have adjusted our budgets to the lower copper prices and its long-term forecasts”. Unemployment is at around 6%, inflation fluctuates between 3 and 4%, and growth forecast for this year stands at 2%.

Challenges

The great challenge is to increase productivity; that is difficult partly because the Chilean labor force is very small -half of that in the OECD countries- and its economy is concentrated in several, but limited sectors. In this respect, the government has set several objectives: to generate diversification, attract investors, establish policies to improve competitiveness and provide opportunities for innovation.

Mining

One of the country’s great talents and major industries is mining. Chile is the largest copper producer in the world and accounts for 30% of world reserves of a mineral which represents 60% of its exports, 20% of revenues in the state coffers through taxes, generates 11% of all employment and accounts for 13% of the country’s GDP. The question is can copper play a new role in the development of the Chilean economy?

“We have to attract investments”

It’s complicated, but doable. At least, that’s what is deduced from the optimistic speech of this finance professional, and from the policy stating that “we have to attract investments” in order to improve technology and innovation, the connection between demand and providers, care for the environment, and develop the production process to adapt it to global needs, promoting exports of other, already manufactured, copper-related products.

Opportunities

Following the fall of oil prices and the sharp rise in energy prices, the government took action: “Since 2013, the government has reduced the price of energy by 40% and investment in the energy sector is now greater than that allocated to copper. We have attracted new investors to the energy sector,” the satisfied Minister for the Economy pointed out.

According to the minister, opportunities currently lie in mining development, sustainable tourism, healthy food, construction, creative economy, the fishing and fish farming sector, technology, and health services.

“The five largest companies in the world did not exist 20 years ago, however, the 10 largest Chilean corporations are all more than 20 years old,” he says, convinced that the key is to attract innovative minds.

Profile

Luis Felipe Céspedes Cifuentes is Minister of Economy, Development and Tourism of the Republic of Chile. He previously held various positions in the Central Bank of Chile, the last as Director of Research; he was chief economist adviser to the finance ministry, a professor at several universities, both in Chile and in the United States, and author of numerous publications on monetary, fiscal, and currency exchange policies.

Revenge of the Bonds – Why a US Inflation Scare is Looming

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Presupuesto de riesgo: gasta con sabiduría
CC-BY-SA-2.0, FlickrPhoto: Scott Hudson. Risk Budget: Spend It Wisely

“Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair” – Sam Ewing (baseball player)

According to Aneet Chachra and Steve Cain from Henderson, discussing inflation far too often devolves into a cage match between the “deflation forever” team versus the “hyper-inflation is coming” camp. The former has gained the upper hand with ECB President Mario Draghi pushing through a comprehensive easing package while Google searches for “helicopter money” are surging.  However, based on recent economic data and the stabilization in commodities, a moderate pickup in inflation is more likely ahead. Meanwhile, the US Treasury Inflation-Protected Securities (TIPS) market appears to systematically underestimate future inflation due to structural reasons. Thus, bond markets and the Federal Reserve could be “behind the curve” necessitating two or more rate hikes in 2016 with a knock-on effect on medium-term yields. This is not a call for persistent, surging inflation, but rather a view that fixed income markets are overly optimistic in disregarding the risks of higher inflation.

February headline consumer price inflation (CPI) in the US was just +1.0% year-over-year (YoY), however core CPI (which excludes food & energy) rose +2.3% YoY, its highest reading since 2008. This wide differential was mainly due to lower commodity prices, especially crude oil which fell -32% YoY through February 2016. However, the March 2016 decline is much smaller at -20% YoY, and the futures curve projects that oil’s year-over-year change will turn positive during the fourth quarter of 2016.

Another deflationary force has been the rising US dollar which gained 20% over the last two years, reducing the cost of imported goods. But the year-over-year change for the dollar index just turned negative for the first time since mid-2014. This will gradually make imports more expensive for US consumers, although with a typical lag of 6-12 months.

Importantly, lower unemployment is finally driving higher wages with companies passing on some of the post-crisis profit margin expansion to employees. Fourteen US states have raised their minimum wage in 2016, with California (the most populous state) poised to further increase its minimum from $10/hour to $15/hour over the next five years. Labour markets have recovered not just in the US and the UK, but the unemployment rate in Japan is below pre-crisis levels. European unemployment remains elevated but has been improving since 2013.

Given all the above factors are widely known – why do TIPS still only forecast annual inflation of about 1.6% over the next decade? Perhaps TIPS prices are biased. There is an argument that TIPS should be expensive relative to nominal bonds as they are one of the few ways to directly hedge inflation risk.

But the available evidence since TIPS were launched in 1997 shows the exact opposite. Even with fairly benign inflation over the last 20 years, realized 5-year and 10-year inflation has averaged above TIPS-implied forecasts at issuance. The average gap has been about 0.35% per year ie. TIPS buyers have generally outperformed nominal bondholders.
 

Despite their valuable inflation protection qualities, why have TIPS historically been under-priced? Two reasons stand out. The first is their liquidity is poor relative to regular US bonds – traders joke the acronym really stands for “Totally Illiquid Pieces of Stuff”. Secondly, inflation expectations are often highly correlated to equity market moves particularly during large sell-offs. Hence TIPS do not provide the diversification to risk portfolios that other bonds do.

The generally negative correlation of nominal treasuries offer significant hedging benefits and are likely expensive to reflect this “crisis alpha” value – especially in the era of Risk Parity funds. Thus nominal treasuries are overvalued, TIPS are undervalued, and both distortions artificially compress the implied inflation rate forecast. An alternative measure that uses nominal 10-year yields minus trailing 12-month core CPI shows that real US 10-year rates are currently near 30-year lows of -0.5% per annum.
 

An interesting historical precedent is the 1985-1988 period when oil prices collapsed from above $30/barrel in late 1985 to below $10/barrel in 1986 pushing inflation lower. However, starting in 1987 (see black line below) a gradual rebound in oil prices drove a spike in CPI. This led to several Fed rate hikes and a significant selloff in US treasuries, with bond yields rising from 7% to above 9% within six months. 

“Although we are unlikely to see a bond selloff quite as severe as 1987 given sluggish world growth and low yields globally, fixed income markets appear to be ruling out even a modest spike in rates.  We should also not underestimate the highly stimulatory effects of cheap energy on importing nations where offsetting shale oil industries do not overwhelm them – eg. the Eurozone and Japan.  Remarkably, Fed funds futures are only pricing in one rate hike this year, while US 10-year yields have fallen about 30bps in the last five months despite a concurrent 40bps rise in core CPI. Stronger inflation data and consequently a rise in bond yields appear to be an underappreciated risk,” they conclude.

Source: Bloomberg, as at 30 March for all data, unless otherwise stated.
 

Now Is The Time To Flock To Asian Equities, Says Pinebridge Investments

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Asia ex Japan equities are set to benefit from the second wave of the “flying geese” economic model, according to global asset manager PineBridge Investments.

In its most recent whitepaper: Why it’s Time Time to Flock to Asian Equities, PineBridge Investments explains that as developing markets move up the value-chain, long-term investment themes across the region are emerging, including increasing  demand for premium goods and services in sectors including healthcare, media, tourism and telecommunications.

Wilfred Son Keng Po, Portfolio Manager, Asia ex Japan Equities at PineBridge Investments, says:  “The dynamic we’re now seeing is that ambitious and well-managed companies in Asia are being buoyed by progressive population trends, increased wealth, better education and social welfare, and supportive government policies for innovation and entrepreneurship. We believe this new trend offers equity investors significant potential in the years to come.”

In its original incarnation, the “flying geese” economic model   saw a cascade of technology transfer from Japan to the “Asian tigers”: Hong Kong, Singapore, South Korea, and Taiwan. But PineBridge explains that a second iteration is now in operation that includes China, Southeast Asia and India.

“Both China and India are vast markets that are becoming manufacturing and innovation power houses, supported by Asean nations. These Southeast Asian economies provide both the natural resources and value-added manufacturing products and services to drive domestic demand as well as to boost manufacturing sectors for exports,” adds Elizabeth Soon, Portfolio Manager, Asia ex Japan Equities at PineBridge Investments. 

“We believe that while economic growth in Asia is impacted by US interest rates, commodity prices, and the pace of structural reforms, the progression of developing economies along the value-chain will continue be the main driver for powerful, long-running investment themes across several industries, despite the economic headwinds.”

These investment themes include:

  • Domestic demand will continue to expand, helping the consumer retail sector, especially in China where the government is re-directing the country’s economic growth from an investment and export platform to one based on household consumption.
  • Southeast Asia’s expanding middle class will also provide a strong market for branded consumer goods. This rapidly growing demographic segment is spending money on mobile phones, internet access, and online shopping. Some of the fastest growing sectors have been in technology, media, both outbound and inbound tourism and telecommunications.
  • Meanwhile, aging populations in countries such as Singapore, Taiwan and South Korea mean that health care – including hospitals, pharmaceuticals, and technology will be another opportunity for investors.

PineBridge says that for investors in Asia ex Japan equities to succeed, sectoral trends such as domestic consumption should be considered a main driver of growth but not looked at in isolation. Detailed analysis of company performance, management, balance sheets and potential, is needed as broad-brush investment style choices such as size, growth, value, and momentum are unlikely to be rewarded due to continued market volatility.

“Investors can use the volatility caused by macro factors to look for durable and high-quality companies within consumer sectors that are both driving the region’s growth and supplying demand for premium products and services across the flock of flying geese,” adds Mr. Son Keng Po.

Fannie Wurtz appointed Managing Director, Amundi ETF, Indexing & Smart Beta

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Fannie Wurtz, nombrada managing director de Amundi ETF, Indexing & Smart Beta
Photo: Fannie Wurtz. Fannie Wurtz appointed Managing Director, Amundi ETF, Indexing & Smart Beta

Amundi continues to develop its ETF, Indexing and Smart Beta, which are major components of the Group’s strategy. In this context, Fannie Wurtz is appointed Managing Director of the ETF, Indexing and Smart Beta business line under the supervision of Valérie Baudson, member of Amundi’s Executive Committee.

Fannie Wurtz is Managing Director of ETF & Indexing Sales at Amundi. Prior to joining Amundi in February 2012, she was responsible for ETF Institutional Sales and Amundi ETF business development with French & Swiss institutional clients at CA Cheuvreux from 2008.

In addition, the Board of Directors of CPR Asset Management has appointed Amundi’s Valerie Baudson as CEO of the company. CPR Asset Management is a subsidiary of Amundi which manages, in particular, thematic equities with close to €38bn in assets under management.

The CPR Asset Management Board of Directors has also promoted Emmanuelle Court and Arnaud Faller, respectively, to Deputy CEO heading business development and Deputy CEO heading investments. Nadine Lamotte has been confirmed as Chief Operating Officer responsible for Administration and Finance. The above named make up the Management Committee which also includes Gilles Cutaya, Head of Marketing and Communication.