Cocoa: The Price Volatility Does Not Diminish the Appeal of This Agricultural Commodity

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In the course of 2024, the price of cocoa has doubled, making one of the greatest pleasures we know, chocolate, more expensive. Specifically, in April, the price of cocoa on the New York Stock Exchange reached its historical maximum at $11,500 per ton, then moderated and slightly decreased in the following months. After reaching these historical peaks, prices reversed the trend and fell by 15%, but it seems they will surge again and continue to grow over time after this correction.

Investors recognize that this agricultural commodity has great long-term appeal, despite the price volatility driven by drought and climate change affecting production. According to Bank of America, it is likely that cocoa price volatility will continue in the short term. The uncertainty around supply and its implications for spot and future cocoa contracts is the main topic of discussion with their clients. According to their latest report, cocoa harvests for 2023/2024 are expected to decrease by 25% to 30% in West Africa, a region that represents half of the global supply.

In fact, the situation has even led the government of Côte d’Ivoire to limit the delivery of cocoa supplies during the mid-crop (May-July, approximately 20% of annual production) to companies with local grinding capacity. In this regard, Bank of America analysts consider that price and futures volatility for cocoa will continue until the end of August, when projections for the main 2024/2025 crop become clearer.

Better harvest production could translate into a price increase for final products such as chocolate. Bank of America believes that major cocoa and chocolate brands will increase their prices by double digits to compensate for cocoa inflation during this period, considering a future cocoa price of approximately $6,000 per ton by 2025. “Reflecting cocoa price inflation, the impact of chocolate price increases on volume (elasticity) and mix (shift to more affordable products) will be key. However, the current price waves occur after two years of double-digit price increases, questioning historical elasticity patterns, especially in the U.S. market, which has been weak so far,” Bank of America points out in its report.

According to NielsenIQ data in the U.S., chocolate market sales have been weak so far this year, with volume down approximately 5% (and value up about 1%), clearly showing some cracks on the elasticity side. In BARN’s opinion, the main culprit remains the structure of the U.S. chocolate market, which is overrepresented in the mass market. The low representation of private labels and value brands (4% and 10% of volume, respectively) means there is a limited supply of low-priced products to prevent consumers from “abandoning” the category. In Western Europe, chocolate market sales have been resilient, with volume down about -2% (and value up about +8%). The main strength of the European market, according to BARN, is its more balanced nature compared to the U.S.

In Bank of America’s view, one of the risks for BARN is the possibility that some of its clients might reformulate their recipes to reduce cocoa content, especially in the U.S. market, to limit their own cost inflation. Although BARN has reformulation capabilities, this would be a volume obstacle as it would cannibalize sales or lead to a net revenue loss if not recovered.

As seen in the first half of 2024 results, Barry’s balance sheet is very sensitive to cocoa price movements, predominantly affecting working capital through the margin call on their short cocoa futures (reflecting the forward purchase agreement). Although the pressure on free cash flow will be intense in FY24 (BofAe: CHF -1.4bn), BARN has the necessary liquidity to face it with: 1) CHF 700 million bonds issued on June 10; 2) CHF 730 million bonds issued on May 5, 2024; 3) a CHF 500 million RCF available; and 4) approximately CHF 430 million in cash available in the first half of 2024 results.

Although it may take time to rebalance the supply and demand of cocoa, this will happen eventually, according to the report. Beyond the positive volume elasticity in the chocolate category resulting from a deflationary environment, in our opinion, the key positive for Lindt will be its ability to retain price increases, which will imply a tailwind for gross margin, likely translating into increased spending on advertising and promotion to continue nurturing brand value. Conversely, Bank of America estimates the impact will be less beneficial for BARN beyond the positive elasticity of the category, as prices will mathematically decrease for them considering the cost-plus model structure.

*Harvests begin in October.

LarrainVial AM Expands Perspectives on the Chilean Economy at Its Seminar

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(cedida) XX Seminario LarrainVial Asset Management

How to get back on the growth path? This is a frequent question in Chile, and LarrainVial Asset Management, one of the leading investment houses in the Andean country, made it the central focus of the latest edition of its annual seminar. To address this, the event—celebrating the 90th anniversary of the investment house’s founding—offered a variety of perspectives, including reflections on the economy, society, and culture in the country.

After a welcome speech from Ladislao Larraín, the general manager of the firm, and an introduction by José Manuel Silva, partner and investment director of the firm, the audience at the W Hotel in Santiago received Sergio Urzúa, economist and professor at the University of Maryland and Clapes UC; María Olivia Recart, economist, former undersecretary of state at the Ministry of Finance and President of Comunidad Mujer; and Cristián Warnken, professor of literature, writer, and communicator.

The three guests at the event analyzed the factors explaining the weak performance of the Chilean economy in recent years and the measures that can be taken in response.

Lost Time

“We must hurry in the search for lost time,” warned Sergio Urzúa in his presentation, calling for “awareness” about the local economy’s situation and the “squandering” the country has done with it, in his view.

The deterioration of the economic momentum in the Andean country, the economist noted in his presentation, began in 2014 and is “a local phenomenon,” not a global one. Additionally, he pointed out, there has been a significant “institutional deterioration.” A reflection of this, he indicated, is the gradual reduction in the country’s credit rating.

What happened? “Anxiety is what played against Chile,” he said, referring to a change in the population’s mindset that led the economy “from jaguar to polar bear,” according to the economist’s analogy.

Some particular variables, he asserted, constitute “silent tax reforms”: the burden on human capital, with various factors impacting potential growth; organized crime, which is becoming a sort of tax equivalent to around 5% of GDP; and the “tax agreement in the living room,” where the fall in real income and the rise in the price per square meter have led 35% of people aged 25 to 35 to live with their parents or in-laws.

Looking ahead, the economist called for “accepting the loss,” acknowledging the lost economic dynamism to bring about change. Additionally, Urzúa urged focusing on three key factors: investment, employment, and education.

We must act now, in the economist’s view, noting that only 5% of countries that have had similar “economic slowdowns” to Chile have managed to reverse them. “Let’s start acting. Let’s set goals,” he indicated.

The Distribution Problem

“To grow again, we need to improve income distribution,” said María Olivia Recart as she took the stage. The issue of equity, she assured, is fundamental to achieving sustainable economic growth.

In this sense, the economist indicated that while it is necessary to address the issue of slow permits in the country, the business sector also has a role to play. “It’s not just about unlocking public policies,” she commented, but companies also need to have a long-term vision to prepare for future threats.

Regarding work, the professional emphasized that there is a “huge gap” in women’s labor participation, with career paths diverging from men’s after having children due to the burden of childcare. “We need universal daycare,” urged the professional.

Additionally, she noted, there is an education problem that goes beyond the public sector. “Our training systems are in crisis,” the economist indicated, adding that “it’s the system. Not just public education.”

Regarding the productivity problem in the country, Recart said that “we must start from the micro and go to the macro.” It’s not just about modernizing the state, she commented, but there are also shortcomings in business management. Especially considering the contextual factors on the table, such as climate change, artificial intelligence, labor market informality, and the deterioration of democracy worldwide.

What remains to be done in the short term, then? For Recart, five key points are: focusing on things that directly affect people, such as service quality in companies and ease of procedures; creating social value; more dynamic public policies; impacts on specific groups; and looking at resilience variables, such as water usage.

The Cultural Factor

The diversity of the panel was expanded by the participation of Chilean intellectual Cristián Warnken, who replaced PowerPoint presentations with a selective pile of books and opened his presentation with a quote from “The Divine Comedy” by Italian poet Dante Alighieri.

The writer and communicator used the protests that marked a long period of political turbulence in Chile, known locally as the “social outbreak,” as an illustrative case. “There is a relaxation of the elites,” he indicated at the LarrainVial event, emphasizing that the elites have “responsibility” in the upheavals.

For the thinker, in addition to a relaxation of “ethical barriers”—with notorious cases of collusion and corruption, for example—the disconnection of the ruling social classes meant that no one could foresee the advent of the protests. And the interpretations were also disparate in the political sphere: while the left saw the process as a demand for revolution, the right chose to deny the existence of popular discontent.

“We are left without a narrative, we are left without leaders,” Warnken said, adding that “crises are not just political and economic” but also spiritual and cultural. In this sense, the thinker assured that Chilean society is currently seeing the effects of phenomena such as the impoverishment of education and the deterioration of civic culture.

What comes next? For the literary figure, “we need order,” but one that is “framed within another order.” In this vein, he called for caution against authoritarianism: “We don’t need a Bukele. Get that out of your heads.”

Have The Elections In The U.S. Had Any Effect On The Performance Of Private Equity?

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In four months, American voters will go to the polls, and for now, the candidates are set with Republican Donald Trump seeking to return to the White House, and current President Joe Biden, who must decide whether to continue in the race after doubts about his candidacy emerged following the debate on June 27.

In this context, American and global investors are increasingly focused on the various aspects surrounding these elections and what has happened in other electoral periods, especially concerning the markets and their indicators. Along these lines, an analysis by Neuberger Berman Group explores what happened during past electoral processes with private equity, in a report prepared by Ralph Eissler, Managing Director and Head of Private Markets Research, and Yiran Wang, Private Markets Advisor.

Among the most important conclusions of the analysis is that while there was some seasonality in private equity performance, on average – the fourth quarter of the year has seen stronger performance and more private equity fund distributions – this effect does not appear to be related to the election cycle.

Moreover, while there is superficial evidence that private equity performs better under Democratic presidents, it does not hold up to deeper analysis, as both the seasonality of private equity returns and its long-term cyclical nature are more attributable to the broader economic and market context.

In the context of the U.S. election season – which will likely have consequences in many ways – it is concluded that investors should continue to follow their strategic private market allocation plans.

Finally, Neuberger Berman Group states that there may be valid inferences and headwinds for certain sectors and industries based on the results of the November elections, but there is little historical evidence that they will have a predictable effect on overall market performance or the relative attractiveness of private equity as an asset class.

A Bit of History

The analysis starts from 1984 and includes a total of 10 election years and 30 non-election years. The first data point indicates that, on average, the performance or volatility of private equity in election and non-election years is very similar, with a rate of 17.8% versus 17.3%, respectively. However, the volatility itself appears to differ, as the annualized standard deviation of quarterly returns during the 10 election years since 1984 is 8.36% versus 6.34% in the 30 non-election years.

However, analysts point out that this is a figure that should not be considered highly relevant, as there has been some exceptional volatility since 2000 that increases the numbers. For example, in 2004 the electoral process went smoothly in terms of private equity returns, as did in 2012 despite the Eurozone debt crisis, and the same for 2016 despite Donald Trump’s unexpected rise as the Republican Party’s presidential candidate.

In contrast, volatility was associated with the year 2000, with a historic boom and bust in sectors heavily represented in private equity; in 2008, when one of the worst financial crises of all time hit; and in 2020, with the onset of the global COVID-19 pandemic.

Fourth Quarter, Clear Effect, But…

Another question the analysts who prepared the document ask is whether U.S. elections have affected private equity performance in the fourth quarter, considering that this process takes place during that period.

In this case, at first glance, there appears to be something: in five of the 10 years (1988, 2000, 2004, 2008, and 2020), fourth-quarter returns deviated significantly from the rest of the year’s performance. However, in three cases, there is a solid explanation: in the fourth quarter of 2000, the dot-com bubble began to deflate; in the fourth quarter of 2008, the consequences of the Lehman Brothers collapse were felt; and the fourth quarter of 2020 benefited from the rebound from the impact of COVID-19.

In the case of the 1988 and 2004 elections, the evidence suggests that the elections may have had an additional effect. In other words, there is specifically a fourth-quarter effect (as opposed to, say, a first-and-fourth-quarter effect, or a second-and-fourth-quarter effect). And most importantly, that fourth-quarter effect is clearly visible and of almost exactly the same magnitude, both in election years and non-election years.

Therefore, there appears to be something notable in fourth-quarter private equity returns, but it is evidently not related to U.S. presidential elections. Analysts point out that the fourth quarter is important regardless of whether it is an election year.

Long-Term Performance Effects

Due to the illiquid and long-term nature of private equity investments, it is also necessary to analyze what has happened over a broader time horizon. The firm’s experts analyze the 40 years from their baseline and define four categories: divided government led by a Democratic president, unified government led by a Democratic president, divided government led by a Republican president, and unified government led by a Republican president.

At first glance, there is no uniform picture of whether the stock markets in general perform better under a divided or unified regime. However, U.S. stock markets tend to perform better under Democratic presidents than under Republican presidents, despite the widespread belief that Republican policies are more business-friendly.

For example, unified Democratic governments were elected in 2008 and 2020, during the global financial crisis and COVID-19, and the immediate post-recovery years, 2009 and 2021, recorded an average annual return of 30.0% for the private sector and an average annual return of 27.6% for the S&P 500 index.

Meanwhile, unified Republican government coincided with more positive gains in the stock markets than a divided government under a Republican president. Under Democratic presidents, the markets performed better on average when the government was divided. Overall, the markets seem to have slightly preferred unified governments.

Still, they highlighted that ultimately, while politicians of all stripes may deserve some credit for supporting or at least not derailing economic cycles, it is the broader economic and market context that determines investment performance, rather than who runs the government or whether they are unified or divided.

AI and Climate Change Top the Priorities of the Insurance Industry

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The International Insurance Society (IIS) has published the results of its 2024 Global Priorities Survey, revealing that, for the first time, artificial intelligence (AI) has emerged as the top priority in Technology and Innovation. More than half of the respondents highlighted its importance, marking a significant increase compared to previous years.

Despite AI’s potential to enhance operational efficiency, over a third of executives reported that their companies are not prepared for its rapid advancement. Concerns include the “slow adaptation of the sector to technological changes and the need for extensive retraining due to an aging workforce.”

The survey, distributed to nearly 20,000 senior executives in the insurance industry worldwide, provides a comprehensive view of the sector’s top priorities. These priorities span Economic, Political and Legal, Social and Environmental, Operational, Technology and Innovation, and Business and Financial categories.

On the other hand, climate change continues to dominate the Social and Environmental agenda, with 60% of industry executives prioritizing it for 2024.

The increasing frequency and severity of natural disasters pose significant challenges, including difficulties in predicting future losses and rising costs that could destabilize insurers, governments, and consumers. These risks are exacerbated by the fact that a quarter of respondents feel their companies are not prepared to address this issue in 2024, the study adds.

Regarding economic concerns, inflation remains the top priority for the third consecutive year, although fears of recession have decreased since their peak in 2022.

Cybersecurity remains a critical concern, with executives emphasizing the need for robust protection against emerging cyber threats related to AI.

The survey also explores growth opportunities, revealing that product innovation is the main focus for two-thirds of executives.

Most respondents plan to target new customer segments or underserved segments, while more than half aim to improve consumer trust and engagement. Encouragingly, nearly all respondents feel prepared to pursue these growth strategies.

The Global Priorities Survey will inform discussions at the 2024 Global Insurance Forum, which will take place from November 17 to 19 at the Hyatt Regency Miami.

The Compliance Risk for Alternative Fund Managers Is Increasing

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The level of compliance risk faced by alternative fund managers is increasing and will increase even further in the next two years, according to a new study by Ocorian and Bovill Newgate, a market leader in regulation and compliance services for funds, corporations, capital markets, and private companies. More investment is urgently needed to address the problem.

The international study among senior executives and senior compliance and risk management executives of alternative fund management firms, which collectively manage around $132.25 billion in assets under management, found that nearly nine out of ten (88%) believe the level of compliance risk their organization faces will increase over the next two years. Of these, more than one in ten (11%) believe the increase will be dramatic.

This increase in risk comes against a backdrop of under-resourced compliance teams and an already high level of fines. Of those surveyed, two-thirds (64%) say their compliance management team is already under-resourced, and more than half of them (34%) feel they are significantly under-resourced. Additionally, the number of fines and sanctions is already high: 67% of respondents admit their organization has already been subject to fines or sanctions for risk and compliance in the past two years. Another 9% admit to having received a request for information or a visit from the regulator in the past two years.

Matthew Hazell, Co-Head of Funds, UK, Guernsey, and Mauritius at Bovill Newgate, said: “Our survey shows a worrying context of fines, sanctions, and under-resourced compliance teams within alternative fund managers, against which nine out of ten respondents believe the level of compliance risk their firms face will increase further in the next two years. It is encouraging that the leaders of these firms recognize these future challenges and know they must act now to stay one step ahead.”

The Ocorian study reveals that the top three areas where alternative fund managers believe they need investment over the next 24 months to address the problem are technology (58%), systems to manage processes and procedures (57%), and hiring relevant and knowledgeable staff (53%).

Matthew added: “Companies must have a deep understanding of their own compliance and risk needs and any possible changes to these through growth or organizational change, to invest wisely in the right systems, processes, and people to protect themselves against these future risks.”

“We recommend following a three-lines-of-defense approach to protect your business: firstly, implementing solid procedures, policies, and training; secondly, thoroughly monitoring these; and finally, reviewing and questioning through independent audit,” he added.

Ocorian’s three-lines-of-defense approach to addressing risk and compliance challenges includes, firstly, creating clear and solid frontline processes and procedures, complemented by both online and in-person training programs for staff. Additionally, they call for building and enhancing a comprehensive compliance oversight function that monitors and evaluates processes and procedures, as well as advises and supports staff and senior management to meet the firm’s obligations. Thirdly, they recommend seeking the review and questioning of the companies’ AML framework through annual independent audits.

World Heritage, Taxes, and a Trip Through Europe: Martín Litwak’s Column

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I visited Greece and Italy. In Italy, I explored Rome, Naples, the Amalfi Coast, the Isle of Capri, Bari, Matera, and Alberobello, known for its Trulli, a symbol of the Apulia region.

The Trulli are traditional houses found in the Itria Valley, in Alberobello, notable for their conical stone roofs. They are charming, beautiful, and picturesque. But they also have a story behind them. Is it real history? A legend? Are legends just real stories amplified by word of mouth? Is real history truly real?

Let’s set those doubts aside and move on. The little houses are divine. Everything is divine, but the story of the Trulli, somewhat unclear, tells us they were erected in the Middle Ages. Their name comes from “tholos,” a Greek word meaning “dome” or “cupola.” Initially, the houses were completely made of stone, from the floor to the tip of the cone that now serves as the roof. And the houses were built and demolished according to tax needs. How is that? Patience, I’ll explain.

The houses were built dry, that is, by placing one stone next to another and one on top of another, without any type of mortar, mud, or support other than the stone itself (a waterproof stone called “chiancarelle”). This gave the house some instability but also the possibility of being easily demolished thanks to a vault located in the center, which, when removed, caused the building to collapse. And that’s what their inhabitants, mostly farmers, did.

When taxes of the time went up, the farmers would demolish their stone houses upon hearing of the imminent arrival of the tax collector. This way, they avoided the new settlement tax imposed by the Kingdom of Naples: without a house, without property, there was nothing to pay. At least until the next inspection.

In a way, it’s the same logic behind irrevocable and discretionary trusts today, right? Without property, there’s nothing to pay…

Anyway, let’s get back on track.

When the tax collector’s visits ceased in the 14th century, the houses, which had already adopted the white walls we see today, were rebuilt with mortar to achieve greater stability.

In Alberobello, the most well-known Trulli are considered a UNESCO World Heritage Site. A beautiful recognition for houses built to meet a demand that persists to this day: tax reduction.

Now that I think about it, perhaps the properties in the United Kingdom with some of their windows bricked up since the window tax was introduced in 1696 should also be declared World Heritage Sites.


There’s also the case of French buildings with mansard roofs (attic style), which were also designed to protect their occupants from certain taxes.

I write this while finishing this dream trip and think about the current leaders’ inability to satisfy a centuries-old, logical demand. It happens in Europe, it happens in America, it happens everywhere. In some places, at least, high tax pressure doesn’t demand so much fiscal effort. In most places, regardless of the existing pressure, the effort is discouraging. And that’s why we do, in some way, what the inhabitants of Alberobello did. They, given the possibilities provided by evolution, sought to prevent the taxman from taking the fruits of their labor. They succeeded by tearing down their own houses. Today, we do it by structuring our assets.

We Favor U.S. Equities and Do Not See a Tech Bubble, Says BlackRock

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BlackRock (WK)

BlackRock presented its investment scenarios for the coming months to the media in Mexico, in the context of what it described as “volatile markets that nevertheless offer great opportunities for financial asset managers.”

“We believe that risks can be taken in the markets at this time; although we have high interest rates, which could justify a common investor maintaining their investments in fixed income, with levels that, for example, in Mexico reach 11% annually and in the United States 5% when two years ago they were at 0%, we consider that if we do not see the broader context that dominates the markets today, we miss out on investments that can be very good, for example, the performance of the S&P500 has yielded an accumulated benefit of 18% this year, not to mention that in 2023 it delivered more than 20%,” said José Luis Ortega, Director of Active Investments at BlackRock Mexico and a member of the fund’s investment committees in the region.

“These interest rate levels that we see both in Mexico and in other parts of the world can sometimes lead us to see ‘mirages’ and miss out on equally or more profitable investments, passing up opportunities to maximize benefits for investors,” said Sergio Méndez, General Director of BlackRock Mexico, who was also present at the media meeting.

There Is No Tech Bubble, We Favor U.S. Equities

“Is there a bubble?” managers and investors ask themselves in light of the stock market’s performance on Wall Street, specifically in the technology sector, which reported a 22.56% gain for the year as of Friday’s close. The BlackRock specialist responds.

“One of the stocks that have led this growth is Nvidia’s. Two years ago, it was below $20; by 2023, it had already recorded a 100% gain, trading above $40, and many people thought we were in a bubble with that performance, but it is currently trading at $130. And if we look at Nvidia’s valuation today with projected future earnings, it is not more expensive than it was two years ago,” explained the head of investments at BlackRock Mexico.

“The amount of profits that this chip company linked to artificial intelligence is generating justifies those valuations, which is why we do not believe there is a tech bubble. We consider the valuations to be justified and believe that the good performance of the technology sector can continue, which is why when we apply it to portfolios, we particularly like having exposure to equities, especially in the United States, due to this technological theme that we believe will continue to be important going forward,” said José Luis Ortega.

The BlackRock executive compared the 2001 versus the current scenarios in Wall Street’s technology sector; he recalled that in 2001, the dot-com collapse was caused by a bubble inflated solely by expectations, with valuations of companies that had nothing concrete. Today is different; the technology industry now does valuations based on recorded profits, making prices more solid.

“We maintain a positive view on taking risks, favoring equities at this time, particularly those in the United States, although we also like other regions like Japan and the United Kingdom, as we believe their valuations are very attractive in both markets. In Japan’s case, we have a central bank with a monetary policy that, while likely to normalize, will not become restrictive, providing significant support to the Japanese stock market,” said the BlackRock executive.

In the debt segment, the investment manager warns that they will continue to seek to capitalize on the short-term income generated, as it is undeniable that 11% in Mexico and 5% in the United States versus 0% a few years ago is very attractive. It is impossible to pass up the opportunity to have investments generating such levels of return with virtually no risk.

However, the fund’s director of investments in Mexico reiterated their desire to capitalize on the equity opportunity they foresee, especially in the United States, as this will allow for more attractive returns for their portfolios in the time horizon.

Be Agile

Despite the current central scenario being linked to risk-taking due to the optimism they perceive in the equity markets, especially in the technology sector, BlackRock also warned that they must remain agile, constantly reviewing the structure of their investment portfolios to make the best investment decisions in changing scenarios.

For example, the great revolution of artificial intelligence will likely be a deflationary factor for the world in the long term, but while all those investments and technological developments are being realized, significant inflationary forces are very likely in the short and medium term.

Therefore, it is important for investment managers to remain agile to capitalize on opportunities that may arise while simultaneously protecting portfolios from inherent risks. Today, it is not possible to stick with a fixed portfolio or investment.

3 Factors Likely to Drive Fixed Income Markets in the Near Future

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So far this year, the macro backdrop for fixed income markets has been ever changeable, reflecting the uncertainty and volatility that investors have had to navigate. The market narrative has been a roller coaster, jumping from one concern to the next, month after month. As we reach the halfway point of the year, it is crucial to understand the factors that are shaping these markets and how they affect fixed income investment decisions.

To shed light on these issues, we enlist the expertise of Colin Finlayson, fixed income portfolio manager for Aegon Asset Management’s strategic global bond strategies. With an insider’s view, Colin analyzes three key factors that are driving fixed income markets today: inflation, economic growth and the interest rate policies of the major central banks. His analysis will give us a better understanding of the underlying dynamics and how these may influence fixed income investment strategies in the coming months.

Starting with inflation, what have you seen so far this year and what are your expectations for the second half of the year?

Inflation has probably been the most important news so far this year, especially in the United States. We have seen the steady decline in inflation become a bit slower and stickier. And this has raised some concern about the degree of interest rate cuts the Fed will be able to implement this year. The Fed’s preferred measure, the underlying PCE deflator, has been moving gradually lower. But the question is whether it is moving enough for the market.

Across the Atlantic, the story is quite different. Inflation has been surprising to the downside fairly steadily in Europe, and the UK is seeing inflation return to the Bank of England’s target, having recently hit 11.1%. This continued decline in inflations is help give some confidence to fixed income markets and is offering support to the outlook for government bonds and therefore broader bond market yields.I wanted to ask you about growth… What is your outlook for growth and how does it affect fixed income investors?

There has been an ongoing debate about whether we are going to see more of a soft landing for economic growth or more of a no-landing scenario where growth starts to reaccelerate. In Europe and the U.K., we have clearly been on a soft landing trajectory as growth has been at more recession-like levels, unemployment has started to rise and the impact of higher interest rates is starting to be seen in household demand and spending.

In the United States, however, growth has been somewhat more robust. The US has benefited from greater resilience in the labor market, but also from earlier fiscal spending, which has been percolating through the system. During the first few months of this year, it looked like there were going to be steady upside surprises in US GDP. But in fact, first quarter growth was weaker than expected and was revised down again in its most recent reading. So in the US, which looked set to deliver more upside surprises, growth is starting to moderate, which is reflected in business surveys, such as the ISM, which are starting to soften. The idea of a soft landing is starting to become more apparent in the US and, again, this is a backdrop that would be more beneficial for bond markets than a no landing scenario, which was feared earlier this year.

I wanted to ask you about growth… What is your outlook for growth and how does it affect fixed income investors?

As far as official interest rates are concerned, central banks are now considering only two paths: hold them or cut them. The European Central Bank (ECB) has already lowered rates along with the Bank of Canada, the Riksbank and the Swiss National Bank, and we believe other central banks will follow suit. With monetary policy at tightening levels, there is no need to keep rates at these elevated levels for an extended period of time. We believe that the Bank of England will be the next major central bank to cut rates and that the US Federal Reserve will follow.

From a fixed income investor’s point of view, the fact that we are talking about rate cuts rather than rate hikes is the most important factor. With growth slowing and inflation returning to target, we expect interest rates to come down at a gradual pace in the coming period. And this will help support fixed-income markets over the next 12 to 24 months.

How do these factors influence the management of Aegon Asset Management’s fixed-income portfolios?

The macroeconomic backdrop is constantly changing, and we try to cut through the noise to construct portfolios with a long-term view of where we believe there is value in fixed income markets. Strategic global bond portfolios are designed to be flexible and unconstrained and can use their flexibility to take advantage of anomalies that arise as data evolves and market value changes. Given our outlook for inflation, growth and interest rates, we believe portfolios with a more flexible approach are well positioned to benefit from changing market conditions over the next 12-24 months.

 

Four Trends Hovering Over the Market: Geopolitics and Economic Transformation, Sustainability, Technology, and Demographics

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Amundi Shares Key Insights from the 2024 Edition of its Global Forum, Amundi World Investment Forum. The event featured in-depth discussions on geopolitical issues, economic transformation, major global macroeconomic trends, and their implications for investment.

In her opening speech, Valérie Baudson, CEO of Amundi, shared her convictions about the state of the world: “The economic outlook is improving, with global GDP growth around 3% in 2024 and 2025. Meanwhile, history and geopolitics are back in focus, with energy transition and technological innovations at the center of geopolitical tensions, as they condition nations’ ability to maintain or gain power.”

The firm shared several key conclusions. The first is that major political and economic changes threaten long-standing trade and security alliances. According to the firm’s perspective, global politics affecting economies was a prominent theme among the speakers. Sanna Marin, Prime Minister of Finland (2019-2023), focused her talk on the current conflict in Europe, stating, “A major game is being played between democracies and authoritarian regimes. What is happening in Ukraine will define the future of democracy.” She urged Europe and NATO to offer “broader perspectives” and reminded that “geopolitics is not the only threat facing humanity; climate change and biodiversity loss are also critical.”

Adam S. Posen, President of the Peterson Institute for International Economics, predicted, “Markets will push interest rates up in the coming years.” Ricardo Reis, A.W. Phillips Professor of Economics at the London School of Economics, explained public debt movements by three factors: “The large current account deficits of China and the rest of Asia caused a significant capital flow into Europe and the United States, investment stagnation due to very few opportunities in the 2010s, and the perception of government bonds as very safe with little inflation risk. Today, all three factors have reversed.”

Additionally, Keyu Jin, Professor of Economics at the London School of Economics, estimated that “the three fastest-growing economies in the coming years will be in Asia: China, India, and Indonesia,” and spoke about “the need for convergence” in the region: “China has room to converge with richer countries, and India also has enormous room to converge with China.”

Gordon Brown, Prime Minister of the United Kingdom (2007-2010) and Chancellor of the Exchequer (1997-2007), concluded the first day of debates with a message of hope, stating, “Even in the most difficult circumstances, even when things are very dark, we must keep hope alive. There are still signs of hope in this global economy that we must build upon, as Mandela said, ‘building for the future.’”

Sustainability, Technology, and Demography

The decarbonization of economies was a major focus. Dinesh Kumar Khara, Chairman of the State Bank of India, highlighted the “immense” potential of his country: “We are now embarking on green energy, which is being adopted significantly.”

Two case studies were presented: Chee Hao Lam, Chief Representative of the Monetary Authority of Singapore at the London Office, discussed how Singapore articulates public policy and mobilizes investors to finance the energy transition. Dr. Kevin K. Kariuki, Vice President of Power, Climate, and Green Growth at the African Development Bank Group, spoke about financing green energy infrastructure in a continent that “needs $25 billion annually to achieve universal access to modern energy by 2030.”

The firm also reflected on how the rapid acceleration of technological development has created new opportunities and pressures. Maurice Levy, Chairman Emeritus of Publicis Group, opened the second day’s debate with a focus on the rise of generative artificial intelligence. In his view, “On one hand, people think AI is probably the dream of tomorrow, which will change lives, especially for companies, their productivity, and profitability. At the same time, there is fear of job cuts and replacement, but most importantly, we need to address the implications regarding the use of deepfakes in democracy.”

Daron Acemoğlu, Professor at the MIT Institute, stated, “The key decision for CEOs will be how to use AI with workers, with human resources: whether they see workers as a cost to be cut or as an important resource that will contribute to their company’s success.” Aurélie Jean, Ph.D. and Computational Scientist, entrepreneur, and author, complemented this statement: “AI does not sufficiently protect workers. Technology owners, developers, scientists, and engineers have a responsibility to provide users with the correct information; they must protect while also fostering innovation.”

Experts remind us that financial services are at the heart of the AI revolution. “There is a huge opportunity to turn European savers into future European investors, and if AI can help with that, it will contribute to a better society,” said Dr. Kay Swinburne, Baroness of Swinburne.

Finally, the firm believes that demographic change is influencing many aspects of our lives. Mauro Guillén, Professor of Management and Vice Dean at the Wharton School, stated, “The key question is how to ride the wave of demographic transformations. India will soon have the largest consumer market in the world due to its younger population, although China will have the largest economy.” Demographics will impact investment trends, as “most of the world’s wealth, between 60% and 80% depending on the country, belongs to people over 60 years old.” Hence the need for “investment platforms to be safe, educational about risks and opportunities, and accessible” for all.

Liquidity Challenges in Private Equity: Where are the Bright Spots?

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If there’s one topic that has dominated the minds of private equity investors in recent months, it’s liquidity. It is so present that you can now even buy T-shirts on Amazon emblazoned with the phrase “DPI is the new IRR”. DPI, or Distributions to Paid-in Capital, measures how much capital a fund has returned to its investors relative to what has been called. Putting DPI ahead of the industry’s widely promoted performance metric IRR (Internal Rate of Return) sends a clear message to managers: stop focusing on returns and start selling stakes to generate liquidity.

The private equity industry is currently experiencing a severe downturn in deal activity. According to S&P Global Market Intelligence, global deal volume fell by 34.7% year-on-year in 2023, reaching its lowest level in five years. Economic uncertainty, public market volatility and geopolitical tensions have made General Partners (GPs) hesitant to sell their stakes, fearing they won’t achieve their desired outcomes. IPOs, in particular, have been almost nonexistent over the past 12 months. As a result, many LPs have received significantly less capital back than in previous years.

Sustained Interest in Private Equity

Distributions from successful exits are, in general, a meaningful source of capital for investors to meet calls on previous commitments. Pension funds, insurance companies and other large investors typically rely on this liquidity stream as they often adhere to allocation guidelines that limit their exposure to alternative investments. When GPs extend their holding periods beyond the typical timeframe, these LPs not only must seek alternative liquidity sources but also face a temporary reduction in their ability to make new commitments to the asset class.

To fully grasp investors’ growing impatience with private equity managers, it is worth looking at the current market phase we are in. Historical data shows that funds launched immediately following recessionary periods have consistently outperformed their peers. Bain & Company has compiled a comprehensive overview of the annual returns achieved by global buyout funds since 1993. For instance, after the dotcom bubble burst, the average IRR for buyout funds was 25% in 2001, 40% in 2002, and 48% in 2003. Similarly, following the global financial crisis, the IRR was 22% in 2009.

Investors Favor Lower Mid-Market Buyouts

Now, with inflation seemingly under control, the European Central Bank has recently initiated its first interest rate cut, setting the stage for an expected economic rebound. LPs also appear to be anticipating a turnaround, as interest in the asset class remains strong. A survey by Natixis of 500 institutional investors globally reveals that over a third plan to increase their private equity allocations in 2024.

However, today’s LPs are more discerning. Unlike in previous years, when money was cheap and almost all private equity segments were thriving, they are now carefully evaluating which sub-segments to include in their portfolios. Recent surveys shed light on the lessons they may have learned from recent market turmoil. Rede Partners, an advisory firm specializing in alternative investments, reports that 50% of institutional investors plan to increase their commitments to lower mid-market buyouts – funds focusing on majority stakes in small and medium-sized companies. A further 46% favor mid-market investments. Large-cap funds, by contrast, are less preferred, with only 10% planning to increase their allocations in 2024.

Stable Distributions Due to a Larger Buyer Pool

Smaller deal sizes naturally lead to a larger pool of potential buyers compared to the large-cap segment where IPOs are often one of the very few available exit channels. Lower mid-market managers typically sell their stakes to a wide range of financial or strategic investors, such as competitors; exit channels that have – for high quality assets – remained open despite the numerous macroeconomic challenges. As a result, distributions to LPs have been relatively stable in the lower mid-market.

That said, the rising appeal of the lower end of the market can also be attributed to additional structural advantages, which become particularly apparent in challenging times. By far the most important is the greater potential for value creation through operational and strategic measures. Medium-sized companies are typically more flexible than large corporations, allowing them to respond quickly to current challenges and seize short-term opportunities, particularly when working alongside an experienced private equity investor. In addition, entry prices and leverage ratios are typically lower, leading to an attractive risk-return profile.

Focus and access are key

Yet it is important to recognize the remarkable heterogeneity of the lower mid-market, characterized by a wide range of manager performance. And: Access is crucial. Managers with proven track record in navigating economic turmoil are in high demand, continuing to complete their fundraising in record time and with significant oversubscription. Given the ongoing economic complexities, we expect to see an even greater concentration on this group of exceptional managers. As a result, focus and access will become increasingly critical to investment success.