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Convertible Bonds Bonanza Creates Theme-Based Opportunities for Investors

darts-102919_1920 — Pixabay CC0 Public Domain. Los activos en fondos europeos alcanzaron los 11,8 billones de euros en 2020

There are as many reasons to believe that equities will continue the rally they began in March as there are to expect another downturn. In either case, volatility is likely to remain high. NN Investment Partners believes that in times of such heightened uncertainty, investors would do well to consider including convertible bonds in their portfolios. In their view, market developments since the coronavirus began have confirmed the relevance their convertible bond investment approach.

A convertible bond is a bond plus an embedded stock option, giving features of fixed income and equities in one instrument. These equity/fixed-income hybrids offer the best of both worlds: their conversion option gives exposure to the upside in share prices, and their bond cashflows provide downside protection should the underlying share price fall.

“The market has certainly responded to the potential merits of convertibles”. NN IP notes a sharp rise in issuance of convertibles over the past quarter: it was USD 16 billion in April, USD 27 billion in May and USD 25 billion in June, amounting to more than USD 67 billion in total. This is about two-thirds of the annual average over the past decade of around USD 100 billion.

The asset manager believes that the reason for the new issuance has to do with the fact that convertibles offer a cost-effective and flexible way for companies to raise capital, either to remain operational or to take advantage of new business opportunities. The current volatility in equity markets means it is also often more attractive than a share issue; the lower coupon rates for convertibles make the running costs much cheaper than those for straight debt.

Martin Haycock, Senior Convertible Bonds Specialist at NN IP, says that around a third of recent issues relate to companies that are in trouble because of the current crisis, such as travel companies, while the majority of issuers are looking for capital to finance growth.

“We are interested in this latter group, which includes companies involved in cybersecurity, cloud computing, batteries/electrification and healthcare, which will see growth in the next three to five years,” says Haycock. “This is why it is crucial to take a thematic approach to navigate economic cycles and invest in the right convertibles.”

Tarek Saber, Head of Convertible Bonds points out that convertible bonds bonanza is underway, as more and more companies see the benefit of issuing convertibles in the post-coronavirus world.

“This is a positive for the asset class and a growing number of investors are embracing the unique historic risk-return characteristics of convertibles and allocating a place for them in their strategic asset allocations,” says Saber. “We would recommend allocations of between 3% and 10%, depending on investors’ appetites. Whatever they choose, they should partner with investment managers who are strict in their investment process and won’t buy new issues just because they might be theoretically cheap at issue, but instead focus on the credit and equity fundamentals of the issuer.”

Taking this into account, the NN (L) Global Convertible Opportunities invests long-only in a portfolio of thoroughly researched convertible bonds. The fund is actively managed and invested in balanced convertibles that provide asymmetrical returns. It aims to outperform the global convertible universe (measured by the Refinitiv Global Focus Index – Hedged) by 200bps per annum.

Active ownership: proxy voting and ESG engagement activities

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Vaun0815 jungle Unsplash — Pixabay CC0 Public DomainVaun0815. Vaun0815

As an active manager, we strongly believe that taking account of environmental, social and governance (ESG) considerations can help us make better long-term investment decisions for our clients. Furthermore, we believe in leveraging the power of investors to trigger positive change. This involves exercising our voting rights systematically in the best interests of our clients and engaging directly with the companies we invest in when we have ESG concerns.

In our latest active ownership report, we present key figures and commentary on our proxy voting and ESG engagement activities. We look forward to continuing our active ownership activities in 2020, both bilaterally and through collaboration with industry partners.

Engagement with corporate issuers

Through our engagement programme, we seek to focus on corporate issuers with material ESG failings in order to encourage them to align their policies, practices and disclosure with established industry best practice.

Corporate engagement examples: ESG in action

German power company on environmental and social issues

We started engaging with this company in early 2019 primarily to press the company to sell off its coal and lignite assets. During the year, the company rotated its assets towards renewables and the company committed to achieve carbon neutrality by 2040.

After multiple bilateral and collaborative meetings (through CA100+), the company made considerable progress on a number of engagement objectives as it:

started to work with the Science Based Target Initiative (SBTI) in order to assess the disparity between the company’s own carbon reduction targets and the goals of the Paris Agreement
committed to improve the alignment of their reporting with Taskforce on Climate-related Financial Disclosures (TCFD) recommendations
begun considering linking executive pay to climate targets
initiated a global review on climate-related lobbying practices to ensure they are consistent with the company’s own climate strategy

Canadian material company on corporate governance issues

In 2019, we engaged with this company to prevent a majority shareholder from acquiring it at what was, in our view, an unfairly inexpensive price. We discussed the issue with other long-term shareholders to better understand their views and exchange concerns. We directly engaged with the company’s board together with the external deal consultant and the case featured in a Canadian newspaper.

In June 2019, we visited the company’s latest acquisition on-site to see for ourselves whether this warranted the corresponding share price decline. We met the company CEO and VP Finance & Strategy to discuss the rationale and activities there. This only strengthened our conviction that the share price fall was unwarranted.

As a result, upon the announcement of a takeover, we emphasised to the board that we were not in favour of the move, especially at the existing offer price. When minority shareholders were asked to vote on the potential takeover bid, our investment team voted against the deal. The bid did not go through due to shareholder opposition and, as such, we achieved our goal and the engagement was closed.

Dialogue with sovereign issuers

For our Emerging Markets sovereign debt strategies, ESG factors are integrated within country risk models. A targeted dialogue with sovereign issuers is part of our active ownership strategy.

In 2019, we partnered with EMpower, a well-respected and innovative global philanthropic organisation focused on youth in emerging economies, in order to enhance their analysis and understanding of long-term sustainability issues.

Brazil: ESG in action

In 2019 our macroeconomic strategist designed a due diligence trip to Brazil to better understand the unique political and economic challenges, as well as gain insight into specific social development issues. Our research showed issues in the quality of spending in education and its diversity and inclusion system. Conversations with the Ministry of Economy show the current administration’s desire to improve Brazil’s business environment and to secure long-term growth for the country. This is an example of the positive feedback loop between improving ESG issues and the overall creditworthiness of a sovereign issuer.

Our ongoing analysis and dialogue surrounding these issues continues away from country due-diligence trips and at times we have an opportunity to act in a collaborative manner with other investors who share our concerns. For example, in 2019 Pictet Asset Management signed an Investor Statement on Deforestation and Forest Fires in the Amazon.

Opinion by Arabella Turner, ESG specialist at Pictet Asset Management.

Proxy voting: Pictet AM’s 2020 voting summary can be assessed here and the past records here.

Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to risks and uncertainties that could cause actual results to differ materially from those presented herein.

Important notes

This material is for distribution to professional investors only. However it is not intended for distribution to any person or entity who is a citizen or resident of any locality, state, country or other jurisdiction where such distribution, publication, or use would be contrary to law or regulation. Information used in the preparation of this document is based upon sources believed to be reliable, but no representation or warranty is given as to the accuracy or completeness of those sources. Any opinion, estimate or forecast may be changed at any time without prior warning. Investors should read the prospectus or offering memorandum before investing in any Pictet managed funds. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Past performance is not a guide to future performance. The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested.

This document has been issued in Switzerland by Pictet Asset Management SA and in the rest of the world by Pictet Asset Management Limited, which is authorised and regulated by the Financial Conduct Authority, and may not be reproduced or distributed, either in part or in full, without their prior authorisation.

For US investors, Shares sold in the United States or to US Persons will only be sold in private placements to accredited investors pursuant to exemptions from SEC registration under the Section 4(2) and Regulation D private placement exemptions under the 1933 Act and qualified clients as defined under the 1940 Act. The Shares of the Pictet funds have not been registered under the 1933 Act and may not, except in transactions which do not violate United States securities laws, be directly or indirectly offered or sold in the United States or to any US Person. The Management Fund Companies of the Pictet Group will not be registered under the 1940 Act.

Pictet Asset Management Inc. (Pictet AM Inc) is responsible for effecting solicitation in North America to promote the portfolio management services of Pictet Asset Management Limited (Pictet AM Ltd) and Pictet Asset Management SA (Pictet AM SA).

In the USA, Pictet AM Inc. is registered as an SEC Investment Adviser and its activities are conducted in full compliance with the SEC rules applicable to the marketing of affiliate entities as prescribed in the Adviser Act of 1940 ref. 17CFR275.206(4)-3.

Pictet Asset Management: Liquidity vs the Virus

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Vast amounts of stimulus have underpinned the markets after the initial shock of the COVID-19 crisis. The question for investors now is whether such support can continue to offset a sharp fall in corporate profits. Below, Pictet Asset Management (Pictet AM) shares their views on fixed income and currencies:

A focus on United States of America:

Global bond markets remain supported by unprecedented monetary stimulus. Pictet AM expects the world’s five top central banks to inject a whopping USD 8.4 trillion of liquidity into the financial system this year, which is equivalent to 14.3 per cent of their countries’ total GDP (1).

All bonds might look attractive against this backdrop. But central bank support must be balanced against the fact that valuations are now exceptionally high – some fixed income asset classes are the most expensive they’ve been in 20 years. Additionally, the global economy appears to be on a path to recovery, which could cause bond yields to reverse course.

Those contrasting signals keep us neutral on fixed income overall. Drilling deeper, among sovereign debt Pictet AM sees the best return potential in US Treasuries. The Fed has been particularly aggressive with stimulus, and Pictet AM expects it to deliver more in the coming months. This will most likely come in the form of yield curve control, which should keep liquidity abundant and Treasuries’ valuations unusually high for a long time.

The stimulus should also be good news for US corporations, which are already beginning to benefit from a pick-up in the economy. The US economic surprise index hit an all-time high in June, for example. Economically, US looks to be in better shape, which supports their overweight stance on US investment grade bonds – particularly as they have the backstop of Fed support should things dip again.

However, Pictet Asset Management is mindful that the economic recovery is still in the early stages, and there are many risks ahead, including the US election and the possibility of a second wave of the pandemic. Pictet AM therefore remains underweight US high yield. Although it is the only fixed income asset class that is not expensive relative to its 20 year history, according to their model, they believe such valuations do not factor in the potential for future defaults. The market is pricing in a default rate of just 7-8 per cent, while Moody’s expects it to reach nearly double that, at 13 per cent.

In the currency market, Pictet AM thinks the euro should benefit from an improving economic backdrop, helped by increased stimulus. The ECB’s TLTRO 3 bank funding programme and the EU’s economic recovery plan are big positives. The former has seen a very good take-up and will boost banks’ earnings as well, while the latter can potentially prove a game-changer for fiscal unity within the bloc. All in all, Pictet AM thinks the euro’s 14 per cent undervaluation against the dollar (see chart) is no longer justified, and upgrade the currency to overweight. Technical trends, such as seasonality, are favourable, too.

Pictet AM also sees potential for a rebound in emerging market (EM) currencies, which are extremely cheap and have lagged the broader ‘risk-on’ rally so far. That, in turn, should benefit EM local currency debt.

To guard against any renewed market volatility, Pictet AM keeps defensive positions in the Swiss franc (whose haven status is complemented by a strong uptick in the domestic economy) and in gold. Although gold has enjoyed a very strong run (up 15.5 per cent since the start of the year), it is still not in overbought territory according to their technical indicators, which makes it a good hedge. Indeed, Pictet AM believes fundamentals – including the possibility of an inflation spike over the medium term, persistently negative real rates and the prospect of a further weakening in the dollar – more than justify the precious metal’s apparently stretched valuations.

Notes:

(1) Data for US, China, euro zone, Japan and UK. Policy liquidity flow is calculated as net central bank liquidity injection over preceding 6 months as percentage of nominal GDP, using current USD GDP weights.

Please click here for more information on Pictet AM’s Investment Outlook.

Important notes

In Canada Pictet AM Inc is registered as Portfolio Managerr authorized to conduct marketing activities on behalf of Pictet AM Ltd and Pictet AM SA. In the USA, Pictet AM Inc. is registered as an SEC Investment Adviser and its activities are conducted in full compliance with the SEC rules applicable to the marketing of affiliate entities as prescribed in the Adviser Act of 1940 ref. 17CFR275.206(4)-3.

Hanneke Smits Will Take Over as CEO of BNY Mellon Investment Management after Mitchell Harris Retires

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The Bank of New York Mellon Corporation announced that Mitchell Harris, CEO of BNY Mellon Investment Management, which includes the Wealth and Investment Management businesses, has announced his intention to retire effective on October 1st. Consequently, the company has appointed Hanneke Smits as new CEO of BNY Mellon Investment Management, and Catherine Keating will continue in her role as CEO of BNY Mellon Wealth Management.

The corporation stated in a press release that both Smits and Keating will report to Todd Gibbons, CEO of BNY Mellon. Furthermore, Smits will join BNY Mellon’s Executive Committee.

“Mitchell has been instrumental in driving our Investment Management business over the last four years as CEO and we wish him all the best in retirement. During a period of tremendous change in the investment landscape, he helped reposition our multi-boutique model and launch new investment capabilities, leaving us well positioned to meet the evolving investment needs of our clients,” said Gibbons.

He also claimed that they are “delighted” to elevate Hanneke into the CEO role for Investment Management. “She has spearheaded Newton’s business momentum and client-centric culture, and we look forward to her leadership within Investment Management. Mitchell has cultivated a strong bench of leaders, including Hanneke and Catherine, who will continue to drive the execution of our strategic priorities to deliver leading investment solutions to our clients underpinned by exceptional investment performance.”

Meanwhile Smits stated that she is “deeply honored” to serve as CEO of BNY Mellon Investment Management. “We have made great progress in building a diversified investment portfolio to help our clients achieve their investment goals. We will build on this strong foundation to continue to drive performance and innovation across our investment products, while also serving as a trusted partner for our clients in today’s rapidly changing investment environment”, said Smits.

Smits will continue as CEO of Newton until October 1st and the company revealed a search is currently underway to replace her. Over the next several months, Harris will work closely with her and Keating to ensure a smooth transition of leadership.

Smits has been CEO of Newton Investment Management, a subsidiary of The Bank of New York Mellon Corporation, since August 2016. Her career spans close to three decades in financial services, including serving as a member of the Executive Committee at private equity firm Adams Street Partners from 2001 to 2014, and Chief Investment Officer from 2008 to 2014. Hanneke is a non-Executive Director to the Court of the Bank of England and serves on the board of the Investment Association.

In addition, she is Chair of Impetus, a venture philanthropy organization that supports charities that aim to transform the lives of disadvantaged young people, and as part of this appointment, she is Trustee of the Education Endowment Foundation, founded in 2011 by The Sutton Trust in partnership with Impetus. She is co-founder and former Chair of Level 20, a not-for-profit organization set up in 2015 to inspire women to join and succeed in the private equity industry. Originally from the Netherlands, Hanneke has a BBA from Nijenrode University and a MBA from the London Business School.

Bolton, When Your Job is to Increase Profits for the Independent Advisor

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After 35 years in the market and with 9 billion in assets under management, Bolton continues to be in the premium segment of service providers to financial advisors, with just one aim: to provide a complete and evolving solution so that at the end of the day the advisor will be more profitable and, as Ray Grenier says, will be able to claim that moving to the world of independent financial advisory service was the best professional decision he ever made.

Bolton’s last few years can be summed up according to its growth data: the firm has been progressing at an annual rate of 20% and although 2020 is shaping up to be a neutral year, by 2021 growth is already projected at between 15% to 20% or more.

“We expect continued growth in international business, as major financial institutions are imposing higher account minimums for offshore clients, as well as limits on the number of countries where they do business, travel restrictions, and lower incomes for financial advisors. To complement this progress and support its market position as a premium brand, Bolton will open a 20,000-square-foot (over 1,800-square-meter) office complex in the Four Season Tower on Brickell Avenue in Miami by 2020,” explains Ray Grenier in this interview with Funds Society.

Bolton opened its first office in 2011 in Miami; this office currently manages over $3 billion in client assets. The New York office on 5th Avenue opened in 2017.

Bolton’s DNA

More than two-thirds of the financial advisors working with Bolton come from Merrill Lynch and Morgan Stanley. Bankers from firms such as Wells Fargo, UBS, CitiGroup, RBC and J.P. Morgan have also moved, with Bolton, into the world of independent financial advice. That results in Grenier positioning its brand in the “premium” segment of the business, since the minimum relationship with Bolton is $100 million of assets under management and recruitment is essentially by invitation.

“We have over 40 teams from the world’s leading banks. This has been achieved without maintaining a full-time recruitment department. Bolton relies on referrals from its affiliated advisors to identify candidates who have a history of successful client acquisition and service and share the company’s values for conducting high-quality business. Affiliation with Bolton is generally by “invitation only,” says Ray Grenier.

Financial advisors obtain higher earnings when they move into the independent world: “Many advisors are in their 50s and their main concerns are retirement planning and business succession. Working at Bolton allows them to save more and then sell the business or transfer it to partners and family team members through a structured buyout. The situation for advisors in large banks is very different because they are employees, the company owns their business book and they receive a small fraction of its value upon retirement,” the executive explains.

According to Grenier, Bolton is currently the highest ranked independent firm in terms of annual revenue and client assets by each financial advisor.

“Our offshore client mix has a very broad base in Latam and in Europe, mainly in Argentina, Brazil, Uruguay, Mexico, Colombia, Venezuela and Panama. Currently, Brazil is a strong growth area for Bolton, but there are opportunities to gain clients throughout Latin America,” says Grenier.

The Future of the Business

Bolton offers turnkey offices to independent consultants, a service that includes premium quality premises for the whole team, fully equipped with the best available technology platforms, as well as the legal, compliance, marketing and accounting infrastructure.

“We are implementing a set of products to support full remote operation capability while meeting our regulatory responsibilities. These technologies include WhatsApp, Microsoft Teams, DropBox Business and Agreement Express, a fully digital document management and account opening system,” said Bolton’s CEO.

The company is also developing a “Concierge Service Network” that will include a database of high-profile service providers who meet the needs of high net worth clients: legal, accounting, event planning, travel, property management and various other services.

“As asset management becomes increasingly cost driven, advisors operating in the high net worth market will need to stand out from the rest by offering more services to add value to the client relationship,” explains Grenier.

For this executive, the most important factor for sustainability in offshore business is to maintain an effective “Anti-Money Laundering Program” (AML), as many of the major banks have been forced to withdraw from offshore business and pay staggering fines due to AML deficiencies.

“There is little or no margin for error when it comes to AML. But we believe that risk can be mitigated by limiting membership to professionals who have a solid reputation for conducting high-quality investment business. Almost all of our recruits are referred to us by our affiliate advisors. In the relatively small universe of LatAm wealth management, they are the best sources for identifying the most reputable teams in the offshore business,” explains Grenier.

Ray Grenier, a Low Profile CEO

It’s very difficult for Grenier to talk about his personal experience as Head of Bolton, as he always insists on speaking in the plural and playing down his importance. How did it occur to him to move from an essentially onshore business to an offshore one? To each question, Grenier answers without triumphalism, with a cascade of market data and objectives.

During these years of Bolton’s continued growth (and success as well) the most rewarding thing for Grenier was the friendship he developed with many financial advisors and hearing them say that moving into the world of independent financial advice was the best decision they could have made.

GAM Hires Jeremy Roberts as New Head of Global Distribution

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Anotación 2020-07-08 094647 — Foto cedidaJeremy Roberts, nuevo responsable global de distribución de GAM.. GAM ficha a Jeremy Roberts y le nombra responsable global de distribución

GAM Investments announced the appointment of Jeremy Roberts as Global Head of Distribution. Roberts will join the asset manager in September from BlackRock, where he was Co-Head of EMEA Retail Sales and Head of the UK Retail Business. He will report directly to Peter Sanderson, Group Chief Executive Officer, and will be a member of the Senior Leadership Team.

GAM has announced in a statement that this is a role recently created as Tim Rainsford, current Head of Sales and Distribution, is leaving the company “to take up a new opportunity”. That’s why a new role of Global Head of Institutional Solutions will also be appointed to assume the responsibilities of Rainsford together with Roberts.

“I’m thrilled to be joining GAM as Global Head of Distribution in September. GAM has an extremely strong management team, a great suite of active products and an innovative, client-centric culture and therefore I’m really looking forward to joining such a talented group of people”, said Roberts, who has 20 years of experience in the industry.

Meanwhile, Sanderson claimed to be delighted with Roberts joining the company. “His leadership experience, enthusiasm and his passion to deliver outcomes for clients make him a great fit for GAM. I am excited to welcome Jeremy to the firm to help us further build on our strong distribution capabilities. I would also like to thank Tim for his contribution to the firm and to wish him all the best for the future”.

Allianz Global Investors Teams with Virtus Investment Partners in the U.S. Retail Market

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Captura de pantalla 2020-07-07 a las 14 — . Pexels

Allianz Global Investors announced a strategic partnership with Virtus Investment Partners that will focus on enhancing both firms’ growth opportunities in the U.S. retail market to existing and potentially new clients.

AllianzGI stated in a press release that Virtus will become the investment adviser, distributor and/or administrator of their approximately $23 billion in open-end, closed-end and retail separate account assets. Meanwhile, AllianzGI’s teams will continue to manage the strategies in a subadvisory capacity, providing continuity for their U.S. retail clients.

Also, their Dallas-based Value Equity team, which manages approximately $7 billion of the assets, will join Virtus as an affiliated manager. The partnership also provides for future joint product development of investment solutions for retail clients in the U.S.

The asset manager pointed out that partnership will enhance Virtus’ offerings, giving it access to AllianzGI’s “deep, global investment expertise while expanding AllianzGI’s access and presence in the U.S retail markets”.

“This new partnership is strategically meaningful for us in terms of scale, fit and growth potential,” said George R. Aylward, President and Chief Executive Officer of Virtus.

Tobias C. Pross, Chief Executive Officer of AllianzGI stated that the partnership is “truly complementary” and will allow them to focus their U.S. distribution efforts on the Institutional, Insurance, Sub-Advisory and Non-Resident markets, “which are more closely aligned with our strengths in other markets”, he said.

Based on current asset levels, the partnership will increase Virtus’ mutual fund assets under management by approximately 40% to $54 billion and its total to $128 billion.

Baruc Sáez has Been Named CEO of Itaú Corpbanca Colombia

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Foto cedidaBaruc Sáez . Baruc Saéz ha sido nombrado nuevo CEO de Itaú Corpbanca Colombia

Itaú Corpbanca announced the resignation of Álvaro Pimentel as Chief Executive Officer of our banking subsidiary in Colombia effective November 1, 2020. Baruc Sáez has been appointed as his replacement.

Sáez is currently director of investment banking for Itaú BBA for Latin America, based in New York. With 10 years of experience in the Itaú group, he has been responsible for consolidating and leading the regional investment banking team.

He also directed the international fixed income platform for debt capital markets, loan syndication and credit structuring. Before joining Itaú, he worked at Marathon Asset Management, Deutsche Bank, ABN AMRO and ING Barings, always in positions linked to the wholesale and investment world. He has a Master in International Economics and Finance from Brandeis University and a Bachelor from Bard College.

Pimentel will return to Itaú Unibanco in Brazil as Executive Director of Itaú Latam based in São Paulo, leading the operations in Argentina, Paraguay and Uruguay, after developing a successful process in Itaú Corpbanca Colombia for four years. This included the introduction of the Itaú brand in the Colombian market, concluding the process of technological and operational integration, and implementing the Itaú culture in the bank’s operation in the country.

Over the next few weeks and until November 1, Pimentel and Sáez will develop a splicing process, in order to carry out a successful transition. Until that date, Pimentel will continue as CEO of Itaú Corpbanca Colombia until this process is completed.

Brown Advisory: “We Have Recalibrated the Models to Include a Global Pandemic Within Our Core Portfolios”

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Entrevista Brown Advisory — Foto cedidaBertie Thomson and Mick Dillon, portfolio managers of the Global Leader fund of Brown Advisory. Brown Advisory: "We Have Recalibrated the Models to Include a Global Pandemic Within Our Core Portfolios"

According to Mick Dillon and Bertie Thomson, portfolio managers of the Global Leader fund of Brown Advisory -the asset manager that MCH Investment Strategies represents in Spain, Italy and Portugal-, this is a unique market event. As long-term investors with a bottom-up style, they argue that the crisis generated by the coronavirus will have a huge impact on economies worldwide. In this interview with Funds Society, both managers explain their view on the equity market.

Q. What conditions need to be in place for us to start seeing a recovery in the global stock markets?

A. As I write this in mid-June 2020, the NASDAQ and the MSCI All World index are close to pre-COVID levels so it seems that stock markets have recovered already. However, there have been delays in when companies might get cashflow, so shortcut valuation multiples have actually gone up.

Q. After the records that the US stock market registered over the last year, was this adjustment in valuations necessary?

A. The shock to demand means cashflows have been delayed and this recalibration of the IRRs means valuations needed to adjust. Whilst we recognize the cost of capital for the companies we invest in may have come down as interest rates have fallen, our investors still need a good return above long-term market averages. We use a 10% WACC for all investments in developed markets as we believe this is the return which our investors need per annum.

Q. What kind of stocks are best resisting this shock?

A. We believe some businesses with non-deferrable demand might be better positioned to weather this shock, or you need straight out pricing power. We have certainly seen some of our companies adapt and rise to the challenges that the pandemic has created, for example our biggest investment, Microsoft, has seen its cloud and office apps benefit from enormous take-up due to work from home sanctions as has Google’s cloud business. Roche, one of our top 10 investments, is seeing a benefit from COVID-19 testing within its diagnostics business. In financials, we have seen Deutsche Boerse benefit from a large uptick in trading volumes and volatility spiking across asset classes where it provides the leading trading, centralised clearing and settlement platforms in Europe.

Q. Is this a good time to buy?

A. It is incredibly difficult to time the market, and that is not our aim. If you have a portfolio of companies with a 25% RoIC that you own for 4 years you will get 100% return on capital. So long as the supply-side isn’t disrupted by competition and your customer keeps coming back, then over time that should deliver. We believe that long-term outperformance is possible with a concentrated portfolio of good quality companies allowing them to compound their excess economic return over a full market cycle.

Q. What is your approach in that sense? Have you made any changes in your portfolios?

A. We maintain a rigorous focus on valuation so that if you buy them cheaply enough, this should deliver attractive long-term (5 years) returns. We also view ESG research as an essential part of our investment strategy and we are now witnessing the increasing focus on these considerations by investors around the world. Recently, we have significantly added to our exposure to emerging market financials, such as Bank Rakyat and HDFC Bank, as their share price valuations started implying enormous value. As an example, Indonesia’s Bank Rakyat has played a critical role in promoting the government’s social agenda by advancing subsidized credit for rural enterprises.

Q. When taking advantage of these opportunities, special attention will have to be paid to risk management. How are you managing portfolios in this coronavirus crisis?

A. We have recalibrated all our models to include a global pandemic within our base case for all our holdings. For some companies, this can even be a benefit, for others it is a terrible disruption to their business. Using a probability weighting system helps to calibrate our IRRs to a better expected return with both base and bear cases. Nonetheless, we see a number of our investments with double digit IRRs over 5 years.

Q. We have also seen an oil crisis in the first quarter of the year. In your opinion, are there more risks on the horizon?

A. There are always more risks on the horizon, but the magnitude varies significantly. We have held no investments categorised in the energy sector since the launch of this Fund. However, we have recently added Aspen Technology to the portfolio, which gives us some exposure to the energy sector. We do believe volatility can create opportunities for long-term investors and we have found in the middle of the crisis the chance to invest in a couple of new companies –like Autodesk and Intuit– that had been on our ‘ready-to-buy list’ for years but we really didn’t think we would get the right price. Suddenly in the midst of the crisis they reached prices giving us tremendous protection and we are now the proud part-owners of two terrific businesses.

Q. What is your outlook for global equities this year?

A. We are absolutely long-term investors and for us that means 5 years. We consider multi-year IRRs and have a 10 year DCF to take us away from short-term swings and to a more steady state environment. Whilst we don’t know about the rest of this year, we have tremendous confidence in our portfolio of high RoIC companies over a 5-year horizon.

Steve Freedman (Pictet AM): “The Planetary Boundaries Framework Is a Way to Look for Solutions to Environmental Challenges”

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Pictet Asset Management (Pictet AM) has been investing in environmental themes for more than two decades. In 2014, the firm decided it was time to step up their capabilities in terms of investing in environmental solutions. For this purpose, Pictet AM adopted the Planetary Boundaries framework. This framework was developed over a decade ago by by a group of 28 leading Earth System and environmental scientists led by Johan Rockström from the Stockholm Resilience Centre and Will Steffen from the Australian National University.

The Stockholm Resilience Centre (SRC) is an international research center on resilience and sustainability science that is a joint initiative between Stockholm University and the Beijer Institute of Ecological Economics at the Royal Swedish Academy Sciences.

What is the Planetary Boundaries framework?

The Planetary Boundaries framework evaluates the current human footprint for nine dimensions of planetary health, -including biodiversity loss, biochemical flows, chemical pollution, land-system change, freshwater use, ocean acidification, ozone depletion and atmospheric aerosol loading-. It then attempts to establish their safe operating space, in other words, how far each of these dimensions can change without risk of provoking sudden, irreversible damage to the environment.

According to Dr. Sarah Cornell, Research Scientist at the Stockholm Resilience Centre, the framework provides a summary overview of how the planetary system changes due to human activity. It is a scientific evaluation of long-term, large scale planetary dynamics and it points out several threats for humanity.

“The Planetary Boundaries framework flags a set of global sustainability critical issues. It is a compilation of the issues that collectively are changing Earth’s system dynamics most profoundly. There is a strong scientific consensus that we are already in a red alert state for several issues. The list of the nine processes and the fundamental justification of the Planetary Boundaries framework itself have turned out to be really robust over this decade of research and application, and actually quite a lot of debate,” explained Dr. Sarah Cornell.

The framework was launched in 2009, updated in 2015 and it is currently undergoing a new updating process. This time the priority among this international science network is to work hard on providing more clarity about the global importance of chemical pollution created by novel human made entities and ultra-fine particles in the atmosphere. The updates have been focusing on what could happen if current economic intensity on the nine dimensions of the Planetary Boundaries framework moved outside of the safe operation space for humanity. The 2015 update included space mapping with some preliminary analysis of interaction between the processes, and right now the SRC is much more focused on functional interactions, working on ideas like the nexus approach to understand the interactions among climate, biodiversity and resource use.

“For most of the Planetary Boundaries, we are not only already in the red alert state, we are also heading on the wrong trajectory. The human drivers of change are intensifying, they are entangling the risks. Even though, for many of the Planetary Boundaries, there is already a global policy consensus that action is needed now. So, the framework provides a long-term global view within our system and it sets today the rapid human changes into the context of non-negotiable dynamics, which are long-term. The precautionary boundaries are defined in terms of avoiding unwanted shifts in our system functioning. They should be considered as a global complement to local impact indicators, and not as a substitute for good practices and policies to deal with local sustainability problems. This framework is scientifically defined and is of interest to business and policy makers,” she said.

Under the 2015 UN Sustainable Development Goals Paris Agreement on Climate, governments agreed that there is a need for a shift towards sustainability and that it must be a priority in this decade. Although policy structures provided to support the change have been around for decades already, there is a huge implementation gap and the world relies to a large extent on corporations for this action to happen.

The scientific community has provided already so much information to governments and authorities, but why is so little happening? The Planetary Boundaries metrics need to be translated into measures of economic intensity of industry activities. This challenge was tackled a few years ago in the research paper “Towards defining an environmental investment universe within planetary boundaries”, written by Christoph Butz (Senior Investment Manager at Pictet AM), Jurg Liechti (CEO and Managing Director at Neosys AG), Julia Bodin (Researcher at Ecole Polytechnique Federale de Lausane) and Sarah Cornell.

“In our scientific publication, we applied some assessments that combined economic flows with estimates on materials and energy resources use, as well as environmental emissions and waste. This life cycle approach gives us a relative impact, being able to compare different types of products, materials, services or industries,” she observed.

For example, the Planetary Boundaries framework measures human impact on climate change in atmospheric concentrations of greenhouse gases on parts per million. However, this measure is not useful for investors, because it focuses on the end state, not the amount of greenhouse gas emitted per unit of economic activity. Instead, the environmental impact for every million US dollar of economic activity can be calculated by dividing the allowable emission level (14.25 billion tonnes of CO2 per year globally, according to United Nations Framework Convention on Climate Change) by the annual economic output (USD 75.6 trillion) to obtain an economic intensity boundary threshold equivalent to 188.5 tonnes of carbon dioxide per million of US dollars of output, 70% lower than the current level of emissions to the atmosphere, which was 639 tonnes per million of US dollars output in 2018.

The application of the Planetary Boundaries framework research provides Pictet AM with an absolute benchmark for comparison, being able to assess if a company’s environmental impact is good enough from a planetary perspective.

“In our work with Pictet AM, we have tried and tested a method to bring global environment megatrends better into the world of investments”, commented Dr. Sarah Cornell.

How is the Planetary Boundaries framework applied in Pictet AM’s portfolios?

As stated by Dr. Steve Freedman, Senior Product Specialist within Pictet Asset Management’s Thematic Equities team, Pictet AM feels it is becoming increasingly urgent to invest in environmental solutions that lead into action on several environmental challenges.

“The Planetary Boundaries framework is one way to visualize the urgency of changes, but information is not enough to create value. Information needs to turn into awareness in a broader portion of the population which leads to pressure on government authorities and ultimately into action. This chain of value has already been played out a number of times in the past”, explained Freedman.

For example, in China, between 2011 and 2012, the so-called air apocalypse episode took place. The levels of pollution were so high in the major cities, that even in a non-democratic regime like China this led to enough pressure to improve in terms of environmental policy making, becoming in many ways a leader in terms of the priorities on the environment. Something similar is happening in Europe, where the European Commission was elected with a green mandate based on the popular awareness of these topics. Global society is going through a phase in which these changes are happening quickly. This is creating both risks and opportunities for investors.

For Pictet AM, the Planetary Boundaries framework is a source of inspiration at three levels. First, the framework is used to build portfolios both in terms of applying a “do no harm” risk perspective on environmental aspects, but also in terms of looking for solutions to environmental challenges. Secondly, Pictet AM also uses the Planetary Boundaries framework as a reporting framework for environmental impact.

When a company’s business model is operating beyond its economic intensity threshold in any of the nine dimensions of the framework, its environmental footprint is greater than the safe operating space. This may not backfire on the company right the way, but taking a long-term view, this is essentially not sustainable. What Pictet AM is ultimately trying to determine here is which companies have an environmental footprint that is compatible with the safe operating space of each dimension. In addition, the firm is looking for types of companies that have products and services that are actively solving environmental challenges, this generally implies a robust business model to resume for the long term.

To obtain the environmental footprint of a company, Pictet AM analyzes every activity in the production of a good or service, from raw material extraction to product use and disposal. They consider the full supply chain and once the sale has been done, they consider the replacement value and their disposal. A comprehensive Life Cycle Assessment (LCA) is performed in more than 200 industries for each of the nine Planetary Boundaries.

“For us, the combination of a Life Cycle assessment with the Planetary Boundaries is really a robust way to incorporate what we think really represents the consensus in environmental science. This methodology is included as part of the screening process when building our environmental solutions portfolios”, said Freedman.

Another aspect of the Planetary Boundary framework is that it can be used as a test of whether a business model is an environmental solution. By using the comprehensive Life Cycle Assessment based on environmental footprints, Pictet AM can check and see what a company’s footprint will be like and whether its business model helps alleviate the pressure on some planetary boundary dimensions. When a company represents an environmental solution, it should be included in the environmental themes of thematic equity portfolios.

For example, the environmental footprint of the global equity markets (MSCI All Country World index) on both freshwater and climate change dimensions is positive. This means that it has an overall negative environment impact. On the other hand, Ecolab, a water company that provides treatment solutions, and Vestas, a company that is one of the key manufactures of wind turbines, have a negative environmental footprint, therefore they contribute for a positive change.

Finally, the Planetary Boundary framework also serves as a reporting method. When Pictet AM talks about investing in environmental solutions, they consider the broader part of impact investing, while they are looking to achieve a positive change. In that sense, Pictet AM believes they need to be transparent about what they are achieving, and they do so by using impact reporting.

Pictet AM looks across portfolios and uses the Life Cycle Assessment methodology to determine their environmental footprint in each of the nine dimensions of the Planetary Boundary framework. The results are then compared to those of a broader global equity index, like the MSCI All Country World Index. This provides an overview of the impact that using a robust scientific framework has on Pictet AM’s investment process.

“Science is evolving, and this is not a static process, but this explanation should give you a glimpse of where we stand as of now”, concluded Freedman.