Wikimedia CommonsFoto: Pxhere CC0. Desde la beta al alfa: cómo debería cambiar la inversión en deuda emergente
As liquidity is slowly drawn from the global economy, the recent wall of money beta- driven rally is likely to morph into a market with higher dispersion, in which BlackRock thinks alpha opportunities may take a stronger role as a source of excess returns in 2018.
According to Sergio Trigo Paz, Managing Director, Head of BlackRock’s Emerging Markets Fixed Income and Pablo Goldberg, Managing Director, Head of Emerging Markets Fixed Income Research and Portfolio Manager, EM high-yielding bonds will be delivering positive total returns in 2018 as developed market central banks gradually normalize monetary policy. As monetary policy normalization continues, a proper assessment of country-specific EM idiosyncratic risks and active differentiation is key to future returns and volatility of portfolios.
According to them, a ‘reflationary’ environment is supportive of further strengthening of emerging countries’ fundamentals, and in turn validates tighter spreads and stronger currencies in EMD. However, they are aware that EM countries find themselves at very different points in their business cycles, which should lead to divergent monetary policies.
Blackrock believes the best news are coming from Latin America, which has finally departed recession in 2017 and could grow 2.4% in 2018. They continue to like high yield oil exporting countries and stay short duration, and favor unconstrained strategies that allow dynamic duration management. Which is why they believe investors may want to consider switching from indexing to alpha strategies that may more efficiently capture the opportunities provided by a more volatile market that may likely gyrate between these alternative scenarios during 2018.
“We believe that a more flexible allocation to local debt, between IG and HY, and a dynamic duration management, to accommodate U.S. curve shifts, provides the potential to maximize excess returns for the rest of the year,” they conclude.
Is it possible to find opportunities in a bond market that has remained bullish for 35 years? According to John Stopford, Head of Multi-Asset Income at Investec Asset Management, there are still possibilities to find value in fixed income markets, although they are increasingly difficult to locate.
During the Investec Global Insights 2017 celebration in Washington, the manager reminded attendees of the origin of the current context. It all began when, at the end of the 70s, after a period of high inflation, Paul Volker, Chairman of the Federal Reserve, decided to put an end to the growth of the money supply. Since then, and except for short periods in 1994 and 2008, fixed income has not stopped rising in price. If we add to this a much lower growth than in previous times, with secular stagnation, as argued by Larry Summers, former Vice-President of Development Economics and Chief Economist of the World Bank, the result is an environment in which rates of developed governments are excessively low and will most likely not increase significantly. The real growth of the US GDP has decreased, and inflation has also diminished, although the Fed can now manage a restrictive monetary policy, the change will be slow, incremental and will take a while to increase.
“If clients expect to see US Treasury bonds back to 5% returns, they are probably wrong. Since the financial crisis, central banks have injected billions of dollars into financial markets, but the costs of expansive monetary policies are now beginning to outweigh their benefits. Central banks have begun to eliminate their excess supply, which will surely trigger a rise in rates. The Fed estimate is a rise of 60 basis points, it’s not much, but we must get used to these figures. We should not expect increases of 200 basis points, potentially being able to reach 50 – 100 basis points at some point during this new cycle,” Stopford pointed out.
Another issue that should worry investors is the US package of fiscal easing measures. An increase in the country’s budget deficit could raise interest rates, and given the point at which the cycle is located, it may also push up inflation expectations. “If the US deficit increases materially, real bond yield rates could be pushed upwards. The question is whether Donald Trump will be able to get approval for a 3.5 trillion dollar budget, because he needs each of the Republican senators to vote in favor. Both the application of an expansive monetary policy and the withdrawal of central banks are actually risks. The Fed has already shown all its artillery. In one of her latest presentations, Janet Yellen basically mentioned that inflation is a mystery; an alarming statement coming from the person whose aim is to control inflation in the world’s largest economy.”
According to the Investec manager, the recent weakness in inflation is partially transitory and he expects it to reverse sometime next year. Inflation can also be driven by lower unemployment, a weaker dollar, and firmer commodity prices. And, if the fiscal expenditure package is finally approved, it would have an inflationary effect at this stage in the cycle.
Returning to the economic normalization program, the Investec manager said that the Fed wants to continue raising rates, he believes that now is the appropriate time to abandon the quantitative easing policy, reversing bond purchases in its balance sheet. “Rates will not rise to 5% levels; they will probably stay at 2.5% levels. Furthermore, the market does not believe the Fed, thinking it is the boy who cried wolf, even though the Fed has already narrowed the market down to a greater extent than was expected during the past year. But, perhaps now is the time when the market should probably converge with the median of the Open Market Committee’s projections.” As regards the positioning of the portfolio, the Investec manager recommends being careful with a potential sovereign crisis in the short term; mentioning that the opportunities could be in countries such as Australia, the Czech Republic, and Canada.
Corporate debt
On the corporate credit side, there are two reasons why credit spreads are at levels as low as the current ones. The first issue is the risk of recession, if you compare the spreads of high-yield debt in the United States with the probability of entering a recession, you can see that there is a strong correlation in their behavior, especially when there is a sudden movement. A recession causes companies’ balance sheets to begin to suffer, and it’s then when they cannot pay the debt they borrowed. According to Stopford, the current risk of entering recession is low, at least for the next 6 to 12 months. The second metric that must be taken into account is the absence of volatility. The VIX is the measure of the cost of insuring a portfolio, the implied volatility in equities, which is to a certain extent the equivalent of buying insurance. But at the moment investors are more focused on obtaining returns, and are willing to trade security for returns. “If the credit spread indicates how much uncertainty there is around companies in the future, the VIX is exactly the same issue for equities. You can see that they both move together, so it should not be surprising that credit spreads are so compressed. Can they remain at that point? Yes, for a while, because thereis still not much volatility in the short term and monetary policy is still not affecting enough.”
Although Stopford recommends lower exposure to corporate debt due to its limited risk premium, the fact that the environment remains favorable for growth, suggests that opportunities could be found in the diligent selection of credit.
Emerging market debt
Investors continue to worry about everything that did not work in emerging markets in 2012 and during the period 2015 -2016. But the main opportunities could probably be found within this asset class, real bond yields are above the US rate, which is negative, as in most developed markets. Some emerging markets continue to cut rates and some have begun to raise them gradually. In addition, there are numerous idiosyncratic risks, so it pays to be selective. “You should not invest all your money in emerging markets, you should have a diversified portfolio, but this asset class shows good performance between fundamentals and valuations.” In emerging markets the debts of Israel, Hungary, Chile, Peru, and Mexico are at reasonably attractive levels.
Foreign currency positions
Currencies usually behave much like a roller coaster. The good news is that they don’t usually move together, so it’s usually a field of opportunities. In this regard, Investec recommends taking advantage of the relative optimism seen in Europe as compared to the United States, cautiously selling the euro against the dollar. At the same time it sees an opportunity to position itself long in the currencies of certain emerging markets, such as the Czech koruna, the Indian rupee, the Mexican peso, the Hungarian forint, the Indonesian rupee, the Chilean peso, the Peruvian nuevo sol, the Egyptian pound, the Thai baht, and the Turkish lira.
Pilar Gomez-Bravo was recently appointed Director of European fixed-income for MFS Investment Management. She also serves as Lead Portfolio Manager for MFS Meridian Funds Global Total Return and MFS Meridian Funds Global Opportunistic Bond. Pilar shared her views on the global debt markets during the 2017 MFS European Investment Forum in London.
Beginning with the disparity between what the US Federal Reserve is saying with regards to rate hikes and what the markets are anticipating, the Gomez-Bravo says the markets are probably right. “The Fed has been lowering its neutral rate, which indicates the extent to which they expect to raise rates, dropping now to 2.75%, whereas the 10 year yield is even lower at 2.3%. Every time there has been a difference between market expectations and those of the Fed, it’s the Fed that invariably moves towards the market. The Fed’s rate policy guides the short end of the yield curve and that is where its communication and guidance is focused. What Central Banks would really like is to be able to control the long-term slope of the curve because it determines the level of accommodation of monetary policy.”
Likewise, Pilar Gomez-Bravo doesn’t see rate hikes in Europe in the short term, although she does acknowledge that the European Central Bank will want to avoid any mistakes as it manages the exit of its public asset purchase program. They also want to assure the markets that they are not going to change the deposit rate, which is currently still negative. “At a time when the unemployment rate has fallen, and growth is on the rise, the European Central Bank will begin to consider that it makes sense to stop buying assets and injecting liquidity into the market. Another issue is that the ECB doesn’t have many more options, given the criteria established for the purchase of government assets. The time will come when it can no longer maintain the guidelines that were established in the buying process. The ECB will want to avoid creating panic -similar to what happened during the Taper Tantrum in 2013, which led to widespread selling of risky assets and a drastic rise in interest rates- largely due to poor communication from the Fed.”
At MFS they expect Draghi to continue to gradually reduce the ECB’sdebt balance due to the lack of alternatives. They will also try to create as much distance as possible between the decision to withdraw liquidity from the market and the commencement of the interest rate increases. “It‘s possible that the European economy will continue to strengthen and we could see rate increases well before the end of 2018, which is what is currently priced into the market.”
What is the expected inflation scenario?
It’s expected that there will be very little upward inflationary pressures, mainly due to the market structure. Globally, there is an immense amount of debt, which limits the extent to which rates can be rise without leading to a recession. In addition, there are certain demographic problems in the United States and other developed countries that prevent inflationary pressures on the labor side. “The generation of Baby Boomers who tend to have very high wages is beginning to retire, and the generations replacing them earn much less. Companies are not investing and there is no growth in productivity in the United States, indicating that inflation will be contained. In a world dominated by technology and demographic shifts, conventional wisdom stops working. We’ve seen unemployment fall, without a meaningful increase in inflation, particularly in the United States. In Europe, disruptive technology are not having the same impact that we’ve seen in the United States, where companies like Amazon or Airbnb suppress pricing pressures. That’s why we could see rising inflation in Europe before it takes hold in the United States. In both cases inflationary pressures will probably come from wages and commodity prices, and in particular from oil prices, if we see sustained upward pressures in either of these two variables, we will change our vision on long-term inflation.”
The importance of credit selection
In an idyllic period of low inflation and low growth, the business cycle is much further along in the United States than in Europe. Until now, MFS had had a preference for US companies, because it’s a large deep market, with a lot of diversification and credit capacity. “The United States offers relatively high rates compared to other countries, but the cycle is coming to an end; while in Europe it still has further to go. Eventhough we have to account for European and US credit valuations, we do think that Europe may offer somewhat more value because the technical valuation is supported by the European Central Bank which continues to buy bonds.”
At present, credit selection, of a specific bond or issuer, through analyzing its parameters and fundamentals, that leads to investing in bonds on which there is a high conviction, has much more potential to deliver alpha than directional positions, since the latter have their performance limited to that of a market that is trading at high valuations. “Investing in higher-conviction securities makes sense for two reasons: you can avoid potential losses of some market issuers and concentrate the portfolio in those names where we see greater potential for outperformance. We have also been reducing systemic credit risk in our portfolios, while looking to generate more opportunities by investing in specific credits, which we believe will lead to a longer lasting source of alpha.”
The emerging credit market
In emerging markets, after the 2017 super rally, we see value in certain countries whose fundamentals have significantly improved, such as in Indonesia, India, Brazil and Argentina. We continue to see value in emerging market debt, both in hard currency and in local currency.
Is now the time to add more risk to the portfolios?
The current bull market is approaching nine years. MFS is positioned somewhat defensively because they are expecting a market correction and current risk adjusted valuations are not as attractive. Still, Gomez-Bravo argues that there are still opportunities for investors and that the more flexibility one has the better: “If you manage funds that are more global, or if you have a multitude of factors to choose from, you diversify the portfolio while removing risks. But we are still waiting to see what happens with tax reform and fiscal policy in the US. The market forgets that when liquidity dries up there is no turning back. During the last crisis, many investors weren’t able to sell their short duration floating rate bonds, and they had to settle for 50 cents on the dollar. Taking on a lot more risk for an extra 30 basis points doesn’t make sense in this environment”
Pixabay CC0 Public DomainPhoto: elenlackner. WisdomTree Buys ETF Securities’ European Exchange-Traded Commodity, Currency and Short-and-Leveraged Business
ETF Securities has agreed to sell its European exchange-traded commodity, currency and short-and-leveraged business to WisdomTree Investments the Nasdaq-listed (ticker: WETF) and New York headquartered global exchange-traded product provider.
The business being sold comprises all the European operations excluding the ETF platform. The business being sold to WisdomTree has $17.6 billion of AUM spread across 307 products, including the flagship gold products PHAU and GBS. The business has a comprehensive range of commodity, currency and short-and-leveraged products and more than 50 dedicated staff.
WisdomTree and ETF Securities will work to ensure that integration is seamless and expect no change to the current high standards of service and operations experienced by our customers and partners.
The sale is subject to regulatory approval and is currently anticipated to close in late Q1 2018.
Graham Tuckwell, Founder and Chairman of ETF Securities, comments: “We are pleased to be selling our European exchange-traded commodity, currency and short-and-leverage business to WisdomTree and to become the largest shareholder in the company. I believe this combination creates a uniquely positioned firm which will flourish in the years ahead, continuing to deliver huge value for customers and stakeholders. ETF Securities has a strong cultural fit with WisdomTree as both firms have been built from scratch by teams who have worked closely together for many years and who show an entrepreneurial spirit in seeking to deliver innovative and market leading products for their customers.”
Mark Weeks, the UK CEO of ETF Securities says: “This transaction creates a leading independent global ETP provider which is well positioned to compete in the rapidly growing European ETP market. We have complementary expertise, product ranges and customer networks. We both continue to challenge the status quo to provide customers with a range of differentiated products. In this industry customers want and value firms like ours, which provide broader choice.”
Yerlan Syzdykov, courtesy photo. Venezuela On the Edge of a Cliff: Lets Be Cautious
A full Venezuelan sovereign default scenario would be one of the most complex events of its type and would require a large-scale restructuring, according to Yerlan Syzdykov, Deputy Head of EM at Amundi AM who does not see anuy rapid solution to the restructuring process.
What is your analysis of recent events in Venezuela?
President Nicolas Maduro recently announced the Republic of Venezuela’s intention to restructure all foreign debt, thus recognising the country’s current debt load as unsustainable. The nation missed a coupon for about $200ml and failed to make the payment by the end of a 30-day grace period, triggering the rating agencies downgrade to default. A meeting of the International Swaps & Derivatives Association will follow shortly to discuss whether a week- long delay on bond payments from the state oil company will trigger default-insurance contracts on those securities. We think Maduro’s move is part of a political game to increase his chances of re-election in 2018, and it follows an attempt to consolidate power by the regime, including sweeping victory in recent gobernatorial elections – despite a 21% approval rating at the time. With this political capital in hand, pushing bond payments further out, Chavismo1 now turns to the debt issue. To further delay and complicate the negotiation process, the Republic invited bond holders to Caracas on 13 November to begin restructuring negotiations. The meeting was chaired by Venezuelan Vice President Tarek El Aissami. Among the attendees was the Economy Minister Simon Zerpa. who also serves as CFO of PDVSA, the state oil company. Both Mr El Aissami and Mr Zerpa have been sanctioned by the US, which inhibits US persons participating in the discussion. No specific proposals seemed to have emerged from the meeting but government officials insisted they plan to continue to service obligations.
What is the market expecting for the near future?
The restructuring announcement changes the prevalent consensus towards both Venezuela and its related quasi-sovereign bonds. The market was expecting Venezuela to service into 2018 and then seek to restructure the Republic only. Now the market has begun to debate the Republic’s specific timetable and the range of potential outcomes. With Maduro in power, the range of outcomes is narrow. The market’s assessment of the probability of a transition, and therefore Maduro’s future, will be important drivers of bond prices. Maduro’s recent comments confirm that the Republic plans to include PDVSA and other Venezuela quasi- sovereign issuers in the restructuring programme. PDVSA and the electricity company Elecar collectively have $750m in coupon arrears on $66bn of outstanding bonds. It appears that the government is proposing to address these arrears collectively or concurrently with the Republic. The Republic may be attempting to protect PDVSA by going for a restructuring. Considering the complexity of the government’s position, the decision to restructure may reflect a desire to negotiate a more favourable outcome, which is unlikely, in our view.
What happens if Venezuela should default? A full Venezuelan sovereign default scenario would be one of the most complex events of its type and would require a large-scale restructuring. Only the Republic knows Venezuela’s total debt level, which is estimated to be around $150bn. US investors hold some 70% of Venezuelan hard currency debt. This introduces further complication to an already complex situation, given the prevailing US sanctions. Creditors include recipients of promissory notes, as well as those with material trapped capital – such as airlines. This creates a potential burden on the state through unresolved claims. It also contributes to uncertainty around bond servicing, as the total size of these claims is not widely known.
Who could come to the rescue?
We see quite limited options. Venezuela does have some assets, even though foreign currency reserves have declined in the past years. The country has an equivalent of $1.2bn in SDR2 reserves with the IMF, and around $7.7bn in gold. Further external support from Russia is also a possibility. The government could also negotiate an extension to several Chinese loans due at the end of this year. Venezuela getting further loans from Russia or China remains a low probability event, in our view. China is unlikely to bail out the government, having previously declined to revise the terms of a loan. The IMF enters the process facing a number of challenges. It is said to regret its role in the recent Greek bailout. At that time, the Fund was pressured to take a 30% participation, a transaction it says it now regrets. This may influence the Fund’s path of engagement with the Republic. The Fund enters the discussion with incomplete and outdated information. Venezuela had reduced contact with the IMF in recent years. The fund’s first challenge will be to develop a precise understanding of the situation – a goal that may take time to be achieved. Holdouts present a real challenge to any attempted restructuring or re-profiling of maturities. Another wildcard: in the US, a creditor with a court judgement is entitled to attach receivables, which means creditors could seize oil payments. As a result, the Fund might alter its traditional approach and attempt a more direct resolution. For example, the Fund might move to engage the market earlier by going for an early debt haircut; should it go down this route, we expect considerable scepticism. Lastly, IMF’s decision to support the restructuring and commit any funds to the country has a complex political dimension given antagonistic relationship between Venezuelian government and the US. Overall, we believe that the Venezuela story will persist for several years.
Where does the state oil company PDVSA stand in all of this?
PDVSA enters restructuring talks with c. $42bn in outstanding bonds, of which $29bn are USD-denominated. 2016 EBITDA has been estimated at $15bn compared with $66bn in 2011. The company currently operates 44 rigs, down from 70 a few years ago. PDVSA’s oil production is likely to have fallen below 2.0 mm bpd (barrel per day), (-11% YoY), as sanctions complicate oilfield equipment purchasing. PDVSA ships around 1mm bpd to service borrowings from China and Russia, as well as to service other political commitments made by the regime. This limits the amount of production available for debt servicing. PDVSA is a different legal entity than the Republic, hence an event that impacts the Republic doesn’t automatically impact the company (so called cross-default). The Republic’s intention may be to protect PDVSA and oil flows ensuring access to petrodollars. Sovereign bondholders, however, will immediately seek to attach those flows through legal remedies based on the legal argument of ‘alter ego’. Furthermore, it is unlikely that the IMF would allow the Republic to default while PDVSA continued to service.
Would you expect any spillover from the Venezuela crisis?
Contagion among EM is mitigated by a number of factors. Firstly, the possible default of Venezuela has been well flagged. In fact many investors believed Venezuela should have defaulted long time ago. Secondly, fundamentals in EM are currently generally strong and the spreads reflect a healthy macro background. Most countries are not overleveraged, and we see current account surpluses in many EM economies. Where there is a potential contagion is around US refineries. Venezuela supplies crude to many US refineries, particularly those around the Gulf. These refineries produce gasoline and are configured to take Venezuela’s sour crude. A slowdown in Venezuelan output could reduce US gasoline production, which might alter inflation or growth characteristics. While that is theoretically possible, at this juncture it does not look likely.
In Russia, some petroleum companies are invested in PDVSA (mainly Rosneft, but also Gazpromneft and Bashneft). There is also a reported miss on a payment to ONGC, the Indian state oil company. Were Venezuela would service its debt or restructure, the result would be immaterial given the relative size of the exposure for those companies. In an unlikely scenario of a blockage of the Venezuelan oil exports, US majors and oil servicing companies will have a negative but limited impact.
Do you see opportunities emerging from the crisis?
The timing and tone of the government’s proposals may have a material impact on discussions, successful or otherwise. PDVSA, as the country’s main source of hard currency export earnings, could give exposure to Venezuelan yields from a possibly advantaged position if an event occurred. Given the overall uncertainty, the complexity of both PDVSA and the Republic’s capital structure, and the unknown size of overall liabilities, it is too early to make a meaningful assessment of potential recovery value. An additional consideration is about alternative investment opportunities – if Venezuela’s interest rate spread continues to widen, it might pull investment from other, higher-risk debt issuers: the composition of return from EM could shift in character. Overall, we remain very cautious on Venezuela, we don’t see any rapid solution to the restructuring process, and we continue to look for tactical opportunities as they emerge with risk control as a priority for our investors.
Pixabay CC0 Public DomainRodolfo Campos Villegas en su toma de protesta, foto PENSIONISSSTE. Afore Pensionissste Grants its First Investment Mandate to BlackRock
Short after a change in leadership in Afore Pensionissste, with Rodolfo Campos Villegas, as its new CEO and Ruben Omar Rincón Espinoza, as its new CIO, the Mexican pension fund is really shaking things up. An example of this is that they have granted their first investment mandate.
Sources close to the operation told Funds Society that Afore Penionissste has chosen BlackRockto invest part of their portfolio in european equities. Up until recently the afore had very small international allocation given it is one of the three ones that is not allowed to invest in derivatives and thus, properly hedge risks, but things are about to change.
One of the highlights of this pension fund is that it has the lowest fees of the Mexican system charging only 0.86%, while the system’s average is 1.03%.
Campos Villegas also plans to grow their allocation to the energy sector while reducing Mexican government debt.
Foto: Dennis Jarvis. BlackRock lanza un fondo con exposición al mercado chino de acciones clase-A
BlackRock has launched the BlackRock Global Funds (BGF) China A-Share Opportunities Fund. The Fund is designed for investors looking for growth, alpha and diversification from the China A-Share market.
The Fund is a liquid, long only, Systematic Active Equity (SAE) UCITS strategy targeting consistent alpha on an annual basis. The strategy uses a combination of both traditional quantitative signals and more innovative big data and machine learning insights. Together, these tools are used to identify around 300 companies for investment from a universe of 1,300 Chinese companies in the Shanghai, Shenzhen and Hong Kong Exchange Stock Connect programme.
The Fund will be managed by the SAE team in San Francisco, with trading executed in Hong Kong. The team comprises more than 80 investment professionals across research, portfolio management and investment strategy. Dr Jeff Shen, PhD, co-chief investment officer of active equity and co-head of investments within SAE, leads the portfolio management team. He is supported by Dr Rui Zhao, PhD, who is co-portfolio manager on the fund.
Jeff Shen comments: “We’ve been applying systematic investment methods to equity markets for over thirty years and more recently, we’ve been researching and applying new methods – big data, machine learning and artificial intelligence – to our models. We find these insights have extraordinary relevance in a market like China where data is quite often available and the market is large and complex. We have been managing this strategy for institutional investors for five years, and we are very excited to offer this strategy to retail investors in a vehicle that provides daily liquidity.”
Michael Gruener, Head of EMEA Retail at BlackRock, adds: “China is one of the largest stock markets in the world, but due to restrictions on ownership, foreign investors have had very little exposure to Chinese domestic equities. Now, with access to onshore Chinese companies through the recently opened Stock Connect programme, investors have the opportunity to invest in a previously untapped market.”
Foto cedidaSimon Fox, Senior Investment Specialist at Aberdeen Standard Investments, courtesy photo. Aberdeen: “Diversification Across Funds Should Mitigate Market Falls"
Investors have to deal with both short-term volatility and downfalls risks. For Simon Fox, Senior Investment Specialist at Aberdeen Standard Investments, the adequate way to deal with this is to better diversify your portfolio. As he explains in this interview with Funds Society, at a difficult time for traditional fixed and variable income, he finds the most compelling opportunities through a range of diversifying assets, such as emerging market debt in local currency, investment in infrastructure and asset backed securities.
What does provide an ‘alternative’ approach to markets? Is it about looking for new sources of alpha or is it about protecting against risks?
Multi asset investing has evolved considerably since the Global Financial Crisis. Today’s investors are looking for a more explicit focus on their own objectives – such as a cash or RPI+ return; or maybe a consistent level of income. In the past a simple blend of stocks and bonds may have delivered decent returns, but not without significant volatility. Looking forward, historically low bond yields and challenging equity markets mean that even the returns achieved in the past look unlikely to be delivered in the future.
To address these challenges, we believe that investors should further diversify their portfolios. In particular, there are, today, a broader array of asset classes available and accessible to investors via UCITS regulated investment structures. Our Diversified Asset team seeks out fundamentally attractive long-term investments across listed equities, private equity, property, infrastructure, high yield bonds, loans, emerging market debt, asset backed securities, alternative risk premia, insurance linked securities, litigation finance, peer-to-peer lending, aircraft leasing, healthcare royalties and other asset classes.
Combining these asset classes in a diversified portfolio results in the attractive returns coming through in a much more consistent fashion than any one asset class in isolation. This approach is very transparent and does not rely on complex derivatives trades or our ability to trade in and out of markets over short-term horizons. This makes the approach easy to understand and robust to differing market conditions.
What are the main risks that you currently appreciate and how could alternative strategies help to mitigate them?
Investors have to contend with both the risk of short-term volatility and also the risk of failing to generate the growth (or income) that they need over the longer-term.
We believe that the right foundation for dealing with both of these is to better diversify the portfolio. As we have seen over the last few years, equity markets can, and do, suffer large drawdowns over short time periods – notably in the summer of 2015 and the start of 2016. By being more diversified, our multi-asset funds have experienced much smaller drawdowns through these periods; as such, they have also been able to compound positively as the markets have recovered.
And talking on risk, we could mention the low rates risk… do you see a bubble in fixed income? And could this bubble burst in some markets? How do you manage this risk in the funds? – Central Banks: what do you expect from Fed? Which will be the next steps of ECB? How do you manage all this issues in your portfolios?
When building our portfolios we make use of sophisticated optimization techniques and other quantitative modelling; but we also believe that it is important to consider the possible future risk scenarios that risk models won’t capture. Most recently we have assessed the possible impact of a North Korea/US conflict, a global pandemic and secular stagnation – as well as a rout in bond markets. While we regard it as a very low probability, there is nonetheless a risk that the US Fed is forced to raise interest rates rapidly over the next 12 months to deal with inflationary pressures and the prospect of a substantial fiscal stimulus. This scenario would see Treasury yields spike higher and equity markets fall. While our multi-asset funds would likely be down in this scenario, we would expect them to provide significant protection relative to a more traditional balanced portfolio.
Often this exercise throws up a call for some portfolio protection (put options, gold, etc) as minds become overly focused on the worst-case scenarios. However we remain of the view that the diversification across the funds should mitigate market falls to a large degree and that portfolio protection strategies are typically not cost effective. The recent reduction in equities is an example of our more preferred route to risk reduction especially when stretched equity valuations make the risk-reward trade-off less attractive. We currently have no exposure to traditional fixed income – either government bonds or investment grade credit.
Brexit: Which risks do you appreciate related to this process? Do you place the portfolios at a specific way in the run-up of Brexit?
At the start of 2016 – ahead of the UK referendum – we modelled a Brexit impact in our scenario analysis. In practice, the diversified and global nature of our portfolios, as well as share class specific currency hedging, meant that Brexit had little impact on our portfolios.
About Multi-Asset spectrum: in which segment do you see more opportunities of returns: in risk assets or in those assets with lesser risk?
Our asset allocation is derived from a longer-term outlook than many multi-asset funds, with a 5 year view of risk and return the main driver of our positioning. The chart below shows our current outlook for various asset classes. It highlights that traditional bonds – investment grade credit and government bonds – offer limited return potential (and, in some scenarios, limited diversification benefit). Equities still offer a premium over risk free assets, but this has narrowed over the last 6 months, notably in the US where valuations looked stretched on a range of measures. As such, we find the most compelling opportunities across a range of diversifying assets. This includes local currency emerging market debt (benefitting from good yields and strong fundamentals); infrastructure investments (which we can access through REIT-like investment trust structures); and asset backed securities.
Taking into account the environment of markets: do you consider necessary to reduce the expectation of returns or is still possible to obtain good returns with an alternative and multi-asset approach?
As can be seen from the chart above, our 5-year view is that traditional assets will under-perform relative to history. However, by being able to diversify the portfolio across a broader array of asset classes, we continue to believe that we can meet our long-term return targets for our funds while maintaining a volatility well below that of equity. Since inception our growth strategy has outperformed its Cash+4.5%pa return target, net of institutional fees, with a volatility of c.4.5%pa. Our ability to access a range of compelling opportunities stems from our ability to identify and access a broad range of asset classes in a liquid form. This is driven by the breadth and depth of resources we have across a range of investment specialisms.
Could you give us some examples of investments you currently hold in the portfolio? I mean some bets on relative value, for instance.
Within social infrastructure we have taken a couple of new positions recent months – adding Bilfinger Berger Global Infrastructure (BBGI) and International Public Partnerships limited (INPP). Both INPP and BBGI provide exposure to a large portfolio of Public Private Partnerships/Private Finance Initiative projects across the UK, continental Europe, Canada, Australia and the USA. These provide attractive, government-backed and largely inflation-linked long-term cash flows.
Within our special opportunities sleeve we have also made a new allocation BioPharma Credit. This holding provides exposure to a diversified portfolio of debt backed by the assets or royalties of biotechnology firms. Benefitting from the premium associated with specialist lending, Pharmakon Advisors are targeting an 8-9%pa return from a portfolio offering significantly different return drivers to other exposures in our Funds.
Pixabay CC0 Public DomainCarlos Noriega and Agustín Carstens at AforeMX. Carstens Says Mexican Pension Funds Could Learn From Behavioral Economics
Celebrating the 20th anniversary of the Mexican Pension funds, the Afores, Mexican financial authorities, OECD and IDB representatives along with international experts, specialists, academics and investors met in Mexico City for the Second Afores National Convention and the 15th FIAP international seminar.
In the event, Carlos Ramírez Fuentes, president of the Mexican Pension system regulator, Consar, said that this year has been of significant capital gains and a good level of collection, but that the discussion on commissions for 2018 is expected to be “complicated”. The participants also recognized that the contribution rate of Mexican workers is one of the lowest in the OECD.
In his speech, the Bank of Mexico’s Governor, Agustín Carstens, commented on “the virtuous circle that is produced thanks to the synergies that have been generated by the reform of the pension system and the autonomy of the Bank of Mexico, with its consequent impact on the savings in our country,” but he noted that the system faces enormous challenges that must be addressed in a coordinated manner. “The current pension system has a low coverage, to the first quarter of 2016 the contributors to social security in Mexico represented only 27% of the population of working age, which places our country below countries like Chile ( 40%), Costa Rica (41), Panama (47) and Uruguay (65),” he said.
Robert Kapito, president of BlackRock, said that Latin America offers investment opportunities because it has a large percentage of workers compared to the general population, but stresses the need to improve its performance and savings capacity, following the example of emerging Asia. In his opinion, this can be achieved through an improvement in financial education, an increase in women in the workforce, adjustments to policies and regulations, as well as an evolution of investment solutions. “Definitely if people in Latin America know more about their finances and their future financial needs, that would help economic growth,” he said.
Meanwhile, Guillermo Arthur, president of FIAP, warned that short-term solutions should not be sought in Mexico, since doing so could lead the country to face a crisis like the one currently experienced in Chile. While the Undersecretary of finance SHCP, Vanessa Rubio, said that “we must think of an increase to mandatory contributions, in voluntary contributions, in the possibility of giving incentives for this, and in perhaps gradually increasing the retirement age. ” However, Carstens stressed that “while establishing an increase in mandatory contributions could be reasonable, (…) this measure alone could generate incentives that would favor informal employment”, proposing the use of schemes such as 2017 Nobel Prize winner, Richard Thaler’s nudges, to automatically enroll workers in voluntary savings schemes. The central banker concluded that although there are still important challenges, he is convinced that “with the will and commitment of the institutions, the authorities and the employer and union sector, the necessary measures will be implemented for the benefit of the workers and the country as a whole. “
CC-BY-SA-2.0, FlickrPhoto: Eric Golub
. Why We Are In The Silver Era For Hedge Fund Strategies
Three years ago K2 Advisors, part of Franklin Templeton Investments, launched its first UCITS Liquid Alternatives fund, the Franklin K2 Alternatives Strategies Fund. At the time, some would have argued that the macroeconomic conditions were not favorable for certain hedge-fund strategies. While they haven’t for a number of years, but now this may be changing.
Monetary policy looks to be shifting in some countries, currencies are becoming more volatile and geopolitical risks have intensified of late.
“We think these fundamental elements could drive alpha opportunities for skilled hedge fund managers to capture. Many think that hedge-fund strategies are super-charged and high-octane. We would argue hedge-fund strategies are actually meant to be dull, with low volatility. But hedge-fund strategies can also provide diversification and long-term capital growth potential.” Says Brooks Ritchey, Senior Managing Director, Head of Portfolio Construction, K2 Advisors.
His team believes that low interest rates are often an overlooked factor in regard to hedge-fund strategy performance. Now, as US interest rates are making slow but steady strides upward from historic lows, they think certain hedge-fund strategies may be finding new opportunities to show their mettle.
“If the US Federal Reserve (Fed) continues to raise interest rates this year and next, we think it could cultivate an environment for certain hedge-fund strategies’ to flourish. Rising interest rates have historically been associated with lower cross asset correlations, creating more alpha opportunities for hedge funds,” adds Ritchey.
Additionally, K2 Advisors reminds us that rising interest rates have typically led to future periods of above average alpha, as represented by the Hedge Fund Research Index Fund Weighted Composite Index (HFRIFWI).
The illustration below shows a positive correlation between alpha and interest rates. The average level of alpha rose to the highest level at 14.07% during the measured period, where the US 10-year Treasury yield stood at 7.05%. Based on what we’ve seen in the past, they think hedge-fund managers could have the opportunity to capture that alpha, or outperformance, as US interest rates continue to rise.
For Ritchey, global geopolitical risk is another element that should drive a change in the landscape for hedge-fund strategies. On the back of recent geopolitical tensions, major currency spreads have widened, and historically wider spreads have benefitted hedged strategies’ alpha. “This is particularly noticeable within the Group of Seven (G7) economies, since they coordinate and attempt to manage major exchange rates in a way that leaves their currencies closely linked. As a result, we might not yet be in the golden era for hedge-fund strategies—the most-ideal environment for managers to capture alpha—but we could be approaching the silver era, where favourable opportunities are starting to appear.” He notes.
Allocating Toward Market Themes
Not all hedge strategies will fair equally as conditions change. K2 Advisors expects that the event-driven hedge-fund space, for example, may face headwinds as central banks globally begin to normalize interest rates. Event-driven hedge funds often seek to profit from merger-and-acquisition (M&A) corporate activity, which, in their opinion, could be diminished as interest rates rise. Global macro strategies, however, may benefit from rising rates. The global- macro space has seen an increase in trading volume over the last two months, and the firm anticipates this trend will continue.
“We’ve seen evidence that the current market landscape could become a nurturing environment for certain hedge-fund strategies, but we’re only just at the beginning and believe more opportunities could crop up during this silver era.” He concludes.
