As we approach the middle of the year, with sluggish stockmarket returns so far in 2018, Investec believes that it makes sense to assess where we are with regard to the investment case for European equities. In their opinion, a volatile year so far for European equities hasn’t put a stop to the region’s fundamental equity drivers and each of the 4Factors on which they analyze stocks are showing encouraging signs for the region: earnings growth, fundamentally sound profitability, attractive valuation and technical momentum.
“Despite this recent moderation, we believe the current environment still offers plenty of scope to continue the strategy that has served our investors so well in recent years: finding areas of the market where earnings recovery is evidenced but not yet priced in.” Says Ken Hsia, Portfolio Manager, Investec European Equity Fund.
Looking at their 4Factors, Investec continues to see plenty of attractive opportunities in Europe. “Our experience on the ground shows that Europe’s earnings recovery is still very much under way. Analyst consensus still expects 8% EPS growth for 2018 and 2019 in Europe. Return on equity continues to improve with several drivers playing their part –revenue growth, margin expansion, financial deleveraging/share buybacks and some tax cuts. As some parts of the world are already seeing margins peak, this would indicate that Europe’s current business cycle still has room to run.”
Besides, they believe that Europe’s monetary policy will deliver a similar situation to the US, where the pace of recovery has been more gradual over a longer period of time than previous cycles. “As we are less than two years into the most recent uptrend– compared with over four years for the US – we believe there is room for European corporate revenues to recover further.”
In their opinion, the key risks are around global geopolitics. The Brexit negotiations continue to drive uncertainty for UK businesses and individuals – but that hasn’t stopped UK companies from investing for growth.
The ongoing talk of a global trade war also loomed large over the market, especially in the commodities sector. “However, as bottom-up stock-pickers, we will approach this on a company-by-company basis. This holds true for both the direct impact of the trade tensions, as well as indirect effects, such as decreases in commodity or metal prices if tariffs tilt supplies towards Europe”.
Their process is also showing positive improvements on the strategy front, where they focus in on companies that can generate shareholder wealth above and beyond the cost of invested capital. “As it currently stands, European companies have been delivering improving returns on equity, due in part to the improving revenue trends and the resulting operational leverage. All the while, improved capital discipline and cost cutting exercises undertaken during the previous earnings downturn are also starting to bear fruit.”
Looking at sectors, they believe the materials one is benefiting from higher commodities prices, as well as a newfound capital discipline. Meanwhile in financials – more specifically banks – they currently see good opportunities to invest “in a sector that is starting to recover from a decade of structural regulatory and economic headwinds. With the uncertainty around Basel IV regulation now resolved, banks have the possibility to use the excess capital sitting on their balance sheets to lend, creating additional revenues that can further fuel returns.” They also like the recent Strategy improvement in the UK food retail and are currently seeing some weakness in telecoms,healthcare and retail, which Investec believes are all at the low end of their historical profitability ranges.
As ever with equities, positive earnings momentum and solid profitability don’t necessarily guarantee returns as this often increases the risk of overpaying. However, Investec believes that although we have seen European equities trade more richly over the last 18 months, European equities do not look overvalued and technicals are showing no cause for concern.
“In summary, we continue to be constructive on European equities due to our investment thesis: that earnings and returns are benefiting from the economic recovery and the recent round of self-help measures undertaken by companies. Meanwhile, valuations do not reflect the full extent of the earnings recovery. Downside risks are common to equities, but we remain focused on the upside potential, especially if European banks are able to show lending growth.” Hsia concludes.
Erick Muller, Head of Strategy at Muzinich. The Time for Global Desynchronization in Monetary Policy, Taxation and Growth has Arrived
Much has been said about the unique phenomenon of global synchronized growth, the unanimity of a lax monetary policy, and the objective of having common fiscal policies by geographical regions. But what if all this had come to an end?
According to Erick Muller, Head of Strategy at Muzinich, an asset management company specializing in corporate fixed-income or credit, this may be the next market reality. Muller believes that a new macroeconomic environment is emerging in which the European and North American economy begin to take different paths. “2017 marked a new turning point since the great financial crisis as it brought about a scenario characterized by synchronized growth between emerging and developed countries, a stronger banking sector, very positive and growing corporate results, and a lower unemployment rate. Since then three things have changed: monetary policies, fiscal policies and the pace of global growth,” says Muller.
In Muller’s opinion, these three trends are the ones that are breaking the great synchronization that we had until now. Analyzing each one of them, Muller firstly points out the fiscal policy undertaken by the US and its announcement of tax cuts. In this regard, he stressed that these measures are not succeeding in making the US economy any more efficient; however, it could cause an increase in the budget instead.
“Donald Trump’s decision to redesign trade policy in order to benefit the US, could produce a certain shock in the market or short-term uncertainty in the business sector,” Muller points out, and points to protectionist policies as the clear difference with other economies. In this regard, he acknowledges that growth has slowed down, especially in developed countries, but it isn’t alarming because global and fundamental indicators are positive.
Finally, Muller refers to the fact that this desynchronization is more evident when it comes to talking about the monetary policies of central banks. “Inflation is not rising at the rate expected by central banks, which has a clear effect on the rate hikes they plan to make. The Fed has already started more firmly along this rate hike path, while the ECB is delaying the rate hike and lengthening the cuts to its asset purchasing program,” explained Muller.
Opportunities on the horizon
In this context of “desynchronization”, he sees investment opportunities in corporate bonds, mainly denominated in Euros. “We are convinced that the focus is on short duration and on being very selective, we believe that floating bonds, syndicated loans and private debt are interesting, although the latter has less liquidity,” says Muller, who explains that they have seen a growing interest in private debt by institutional investors.
When talking about geographical areas, Muller admits that they prefer Europe over the US. “It’s true that US high-yield can offer somewhat higher interest, but the currency exchange hurts it,” he concludes. In terms of emerging markets, he points out their attractive yields, especially in short durations.
Finally, Muller points to flexible strategies as the type of strategy that best adapts to an environment like the current one; In this regard, he also acknowledges that strategies of short durations and absolute return are among the most demanded, especially by conservative profiles. Instead, institutional investors have become more sophisticated, he added.
To the left Vladimir Colas, Member of Ardian’s Executive Committee and Co-Head of Ardian USA. To the right Nicolás Gazitua Senior Investor Relations Manager for Ardian . In a context of high demand, Ardian has confidence in Latin America
After the announcement of the opening of their first office in Latin America in Chile, Funds Society had the occasion to discuss the details of Ardian’s strategy in the region during an exclusive interview with Vladimir Colas, Member of Ardian’s Executive Committee and Co-Head of Ardian USA, and Nicolás Gazitua, leader of Chilean office and currently Senior Investor Relations Manager for Ardian in New York.
The election of Chile as the first country to establish is not only because of the stable economic and political environment but also because of the continued interest of the investors and clients in the country. “The growing demand of our LPs (pension funds, insurance companies, and family offices) in the region, particularly in Chile, Colombia Peru, has been the main reason for us to choose Santiago. Additionally, though our focus is to build stronger relationships with investors in these countries, we have seen significant interest from Brazil and Mexico to diversify their holdings outside of Latin America. We will be looking to fulfill that demand as well”, explain Gazitua.
When asked if the approval of the new investment act that expands alternative assets for pension funds has been a key drive in their decision, Gazitua states: “The internal decision was taken before the new regulation was approved. That being said, there is no doubt that the new regulation is a great push”
Ardian has since 2015 a distribution agreement with Volcom capital. In regards to the consequences that the new office might have in their relationship with the distributor, Colas explains: “We are extremely satisfied with our relationship with Volcom. The opening of Santiago will not change our agreement, it will strengthen and enlarge our collaboration”
Direct investment in Infrastructure
The immediate objective of the Chilean office, that will be led by Nicolás Gazitua, is to support the investor and LP relations across the region. Their view is that, due to both the improvement of foreign investment and the domestic economies, interest in infrastructure investment will increase, and as such, in the medium term, they are considering the possibility of managing direct investment from the Santiago office enlarging the team with the resources and expertise required.
Vladimir Colas explains: “our added valued lays in sharing with our investors and LPs, information, knowledge and strategies. We want to be close to the interests that our LPs and clients have in the region.”
Ardian is an approved asset manager for private equity and infrastructure assets by the Chilean risk rating commission (CCR), which makes them potentially eligible within the investment universe of the Chilean pension funds. Ardian is the sole foreign asset manager approved by the CCR for the infrastructure segment.
Interest in the Private debt segment
Gazitua stated that in the short term they will seek of authorization for the Private debt segment. Regarding the Real Estate segment, Gazitua adds “the requirements needed to gain the approval are demanding and we are considering asking for it once we are ready to meet them”. Colas adds that they have recently closed a fund that invest in European Real Estate assets with investor from the region, stating that there is evidence of real interest for this asset class.
Both executives end the interview by pointing out their competitive advantages versus local companies that already established in the local markets. Colas states: “We are a global and multilocal company, offering a wide variety of products (fund of funds, direct investments, infrastructure, private debt) with a significant expertise and business knowledge. We accompany our clients in their decision making process sharing our knowledge, experience and information of the different sectors.”
Gazitua adds: “Our main differentiating service is the possibility to offer our clients customized investment programs. Some investors are looking for a private equity solution where, rather than committing to a particular fund, they can invest in a number of fund and strategies combined over several years—and we have the ability to provide that solution.”
Over the last two decades the ASI Infrastructure Platform has only ever invested in social and economic infrastructure projects. From their London and Edinburgh offices, in UK, they invested in government concessions, called Public Private Partnerships, which offer investors attractive risk-adjusted returns with a low correlation to economic cycles and other asset classes.
The Infrastructure Investment Team built a successful franchise that was then exported to Europe, opening offices in Paris and Madrid to cover all the Euro zone. Later, the team decided to expand to Asia, installing an office in Sydney, from where they invest in Australia, New Zealand and United States in funds that are targeted at US and Australian dollars. Last year, they decided to tap into the Andean region and the Latin American market, launching a fund targeting Social and Economic infrastructure projects in the Andean region.
According to Gershon Cohen, Global Head of Infrastructure Funds, his team tend to work closely with global contractors and operators in infrastructure, organizations that they consider their industrial partners, some of them are renown companies like the Spanish construction company Grupo Ferrovial or the French firm Bouygues, who specializes in developing, building and operating infrastructure projects around the world.
“We work with our industrial partners in bidding for concessions and the opportunity to invest in infrastructure through these concessions. We are backed by some of the worlds’ leading investors in infrastructure. Investors that, for the last 20 years, have pioneered in infrastructure investments, like the large Dutch sovereign wealth fund, as well as the South Korean and some of the Chinese funds, and some of the very large private equity groups, like Partners Group. These groups have supported us on our journey”, said Mr. Cohen.
“When we invest in infrastructure and concessions, we are always looking for a degree of political, fiscal and economic stability, as well as legal certainty. All these characteristics are relative, because they have a different mix and degree depending on which part of the world you are investing. However, we try to marry the opportunity to invest with the needs of our investors and with a degree of stability. In that sense, UK and US are a very stable place, Europe is fairly stable and Australia a very good place to invest. But, we also look for governments that are wanting to bring forward a large pipeline of investment opportunities, and right now, one of the best places that has all these ingredients is the Andean region in Latin America. Argentina and Brazil also present many opportunities, but currently Chile, Colombia, Mexico, Peru and Uruguay offer more economic and political stability, in our view. Especially now that Colombia has just became a member of the OECD and Peru is on its journey to become a member of this organization”, he added.
The Latin American footprint
The Infrastructure Investment Team always thinks on a long term basis, elucidating which economies will look more stable from a political perspective and which ones will want to bring forward infrastructure projects to support their growth. In the specific case of Latin America, they invest in infrastructure projects that build roads, rails, schools, hospitals or water treatment plants. Even today, a high proportion of the population in Peru does not have access to clean drinking water, therefore, there is a big need to invest in projects that can treat water and convert it into potable water. Health, education and transportation are big issues as well.
“We are genuinely the only social infrastructure fund focused on the Andean region. There is no other competitor that are active and have offices on the ground or have capital dedicated to the region. Many of our peers are investing from their global vehicles, flying in and out, but giving the institutional way into our commitment to the region for a very long time, we have invested in developing a partnership with people on the ground, to gain a first movement advantage in the region, because we are honestly excited about building a team in Latin America”, said Ivan Wong, Deputy Head of Primary and Secondary Funds’ Investments and Asset Management at Aberdeen Standard Investments.
A couple of years ago, the ASI Infrastructure team team formed a strategic partnership with a Colombian based organization, a boutique advisory company – LQA Funds SAS that has a long track record in raising capital for infrastructure projects with both the government and the private sector; and was looking to become more of a fund manager. Last year, they launched a first fund of 250 million dollars that are hoping to invest over the next 3 to 4 years, in about 10 to 12 projects in Chile, Colombia, Mexico, Peru and Uruguay.
“We team up with our industrial partners to bid for contracts. Hopefully, if we are successful and the investors supporting us are pleased with the results, maybe in 2 or 3 year-time, we would do another fund, and maybe after that, another one. That is our strategy: to create a long-term presence in Latin America’s infrastructure environment. Later, on, we could bring up alternative or private equity strategies.
In mature economies, infrastructure has become so well understood that there is an oversupply of capital and less supply of projects, causing returns to decrease. However, the slightly more emerging economies -with relative political and economic stability- offer a similar risk profile and infrastructure projects yield mid-teens returns. If we stayed in Europe now, we will not be able to achieve that type of returns. That is why we are making a strong commitment to the region, we have an office in Colombia with seven people from the strategic partner, some more people will join our local partner from our teams in Madrid and Australia”, explained Mr. Cohen.
“As we become more familiar and successful within the region, and there is more economic stability in other parts of Latin America, we could look to broaden our scope to Argentina or Brazil, but we are very cautious. For 20 years, we have been gradually growing our platform and it makes sense to be cautious when you are entering in a new part of the world. We often say we are not very exciting, but in a world of volatility, long-term institutional investors are delighted to trust their pension funds money to us, because we have a very long term outlook and a track record that supports this”, added Mr. Wong.
The challenges of the region
Latin America’s economies are not simple, Colombia has just finished a long-term conflict and they still have some issues pending and Peru is going through a change of president, which is normally not easy. But, because ASI Infrastructure Team has presence on the ground, they can explain their investors in a transparent manner the complexities of the region. “Latin America’s investors are predominantly American leading investors that have already been invested in the region for many decades, so they actually appreciate the understanding that we have gained, and they recognize the challenges of the region. Nowadays, the US has more economic ties with Latin America than ever before, mainly due to political and macroeconomic issues. It is being an interest journey for us. We are delighted to be doing what we are doing and it is going very well”, concluded Mr. Cohen.
Nick Timberlake, courtesy photo. "A Stronger Dollar Should Benefit the Emerging Markets Export Engine and Their Liquidity Should Be Less Vulnerable Than in the Past"
Despite the challenges in the form of monetary tightening in the United States or geopolitical factors, emerging market equities this year have everything to gain. The reason? Levers such as valuations, earnings growth expectations and the confidence of investors. This is what Nick Timberlake, responsible for Global Emerging Equities of HSBC Global Asset Management, states in this interview with Funds Society.
Is the global synchronized growth scenario in danger? If this is the case, how could this impact the emerging world?
Global growth remains strong, though there has been a slight loss in momentum recently. Emerging Markets continue to be the key driver of global growth, and we expect them to contribute about 70% to total GDP growth in 2018. Many Emerging Markets remain in a “Goldilocks” environment of strong growth and low inflation. Some countries have scope for monetary easing, while some countries are taking advantage of growth acceleration to implement long-term economic reforms. Different inflation levels across countries is leading to policy divergence. This can affect relative interest rates and currency strength, particularly resulting in higher US interest rates and a stronger USD.
What will be the impact in emerging markets of a higher inflation, a cycle of rate hikes in the developed world, and a potential greater strength of the dollar?
Inflation remains relatively low in most Emerging countries, despite cyclical inflation in the US. A stronger USD should benefit the Emerging Markets export engine. Emerging country liquidity should be less vulnerable to a stronger USD than in the past, given that governments have reduced the proportion of short-term USD debt and improved their current account deficits. This makes the country’s liquidity position less sensitive to foreign exchange movements. Many emerging countries have improved their fiscal positions, and increased macro credibility provides them a degree of monetary policy flexibility if needed. Certainly countries with a twin deficit are likely to be more sensitive than others.
Nonetheless, many experts are positive regarding emerging countries fundamentals, do you agree and why?
We are also positive on the fundamentals of Emerging countries. Fiscal budgets are better managed. For example, Russia has reduced the “oil breakeven” of its budget to reduce its sensitivity to fluctuations in oil prices. Monetary policy is more credible. A lower inflation environment in Brazil has allowed its Central Bank to implement aggressive monetary easing. Government reforms continue to strengthen the foundations for long-term economic growth. For example, Brazil is reducing its fiscal deficit through economic and anti-corruption reforms, while Mexico has a broad, long-term reform programme including energy, labour, and education. China is reducing capacity at state-owned enterprises and deleveraging.
Do the stock markets of emerging countries have potential to grow in 2018? At what pace or at what levels?
It is difficult to specify how the equity market will move, but, from my experience, this is the type of environment that should be positive for Emerging Markets equities and for active managers specifically.
Earnings drive equity markets. What is important for investors is that strong economic growth is translating into corporate earnings growth. Earnings growth expectations remain in double digits for 2018 and 2019, across most sectors and a majority of countries, though earnings revisions have moderated from a high level.
Valuations look attractive relative to profitability, though valuations are not as cheap as they were at the beginning of last year given the strong equity market returns. Emerging Markets equities offer a similar return on equity compared to Developed Markets equities while trading at a lower price-to-book valuation.
Investor sentiment has been positive. We have seen strong flows into the asset class over the past two years, yet global equity investors remain underweight Emerging Markets.
What is the biggest strength of emerging markets equities this year? The attractive valuations, corporate results outlook ….?
The biggest strength for Emerging Markets equities this year is that all the drivers we just discussed are present at the same time. We believe this combination of factors creates a positive and attractive environment for Emerging Markets equities.
What could be the impact of Fed’s rate hikes on the equities of the emerging world?
Investors should expect cyclical inflation at this point in the economic cycle. The current pace of Fed rate hikes has been well-flagged and has been priced in by the market. We are monitoring how high capacity utilisation, potential trade tariffs, and deficit spending could lead to higher prices and could cause the Fed to raise rates faster than expected. A much faster pace of rate hikes could lead to more volatility in equity markets in general, not specifically to Emerging Markets.
Currently, the volatility is stronger… Is this going to be the case in the stock markets of emerging countries. Which are the potential consequences?
Volatility in Emerging Market equities reached the lowest point in a decade in January 2018 and has been near pre-financial crisis levels, so a pick-up in volatility was expected and has not come as a surprise to us. There are any number of reasons why uncertainty increases or investors begin to have differing views of the future. Inflation, trade tariffs, and geopolitical tensions are the first examples that come to mind. As active managers, we need to monitor these issues and incorporate our perspective into our stock selection and portfolio construction. I should note that higher volatility can be advantageous, as it can create investment opportunities where we see our fundamental outlook has been mispriced by the market.
Which are the more attractive markets? (Africa, Latin America, Eastern Europe, Asia …)
Our region and country positioning is driven by our stock selection. This allows our portfolio positioning to be guided towards the areas of the market with greater opportunity. On a regional basis, we are overweight Eastern Europe and underweight Asia and Latin America.
On a country basis, we are most overweight Russia, given a stable macroeconomic backdrop, accelerating growth, and attractive valuations.
Regarding Latin America: with which markets are you more positive and why?
We are less positive on Latin America relative to other parts of Emerging Markets. On a country basis, we are somewhat neutral in Brazil, and we are underweight Mexico, Chile, and Peru. Mexico valuations are high relative to other Emerging Markets, and there is election uncertainty. Chile has fundamentally attractive companies but valuations are again high. Peru has a limited universe, and valuations are not attractive.
The situation in Argentina is complex following the support requested to the IMF … are you positive on that country?
Our Frontier Markets has exposure to Argentina. The country has been implementing structural reforms that we feel should support long-term growth. Any IMF support would help to reinforce that path. Our Global Emerging Markets fund currently does not have a position in Argentina.
Foto cedidaNicolás Gazitua. Ardian Opens an Office in Chile
Ardian, a private investment house with over 71 billion dollars in assets managed or advised, announced the opening of an office in Santiago, Chile. The new office, serving Ardian’s growing base of investors and investments in Latin America (LatAm), demonstrates Ardian’s long-term commitment to both Chile and the LatAm region. This will be Ardian’s 14th office in its global network.
Ardian will work closely with its LPs – pension funds, insurance companies and family offices — to share knowledge and strengthen relationships. Currently, Ardian’s LatAm investor base, mainly within Chile, Colombia and Peru, has leveraged a diversified range of strategies on Ardian’s platform including Private Equity Secondaries, European Direct Buyouts, Infrastructure Secondaries, European Real Estate and Global Co-Investments. Ardian sees continued investor demand in the region, as well as particular interest from LPs within Brazil and Mexico, which are looking to diversify their holdings outside of LatAm.
In addition, Ardian has become increasingly active since it first entered the region in 2010 after it began acquiring LatAm businesses as build-ups for European portfolio companies. Over the last eight years, Ardian has supported portfolio companies acquiring nine LatAm build-ups with specific exposure to Brazil, Mexico, Chile and Ecuador.
In 2016, Ardian Infrastructure made its first LatAm direct investment when it acquired an 81 percent stake in Solarpack, which manages solar PV plants in Chile and Peru. It will continue to target mid-market essential infrastructure assets in the energy and transport sectors to provide Ardian’s global investor base with increased opportunities to invest in high-quality LatAm infrastructure assets.
Nicolas Gazitua will lead the new Chilean office supported by a dedicated team based in Santiago in coordination with the NYC office co-headed by Mark Benedetti and Vladimir Colas. Ardian will continue to build out the Chilean team and provide additional resources over the coming years.
Benoît Verbrugghe, Member of the Executive Committee, Head of Ardian US said: “The Latin American region is very important to Ardian and this office will allow us to focus on building closer relationships with our LPs and other institutional investors in the region. Our growing international footprint highlights our commitment to a truly global, multi-local approach. We prioritize the deep knowledge and relationships that can only come from an on-the-ground perspective, allowing us to understand the needs of our investors and portfolio companies on a granular level.”
“Furthermore, the Chilean office is an important step forward in our continued efforts to provide our global investor base with opportunities in high quality LatAm investments and superior returns. We will also use the office to source secondary deals from potential LatAm sellers” concluded Verbrugghe.
Wikimedia CommonsJenny Johnson, presidenta y COO de Franklin Templeton Investments . Franklin Templeton Prepares to Position its ETF Platform in all Distribution Channels in Mexico
During her last visit to Mexico, Jennifer M. Johnson, President and COO of Franklin Templeton Investments, pointed out that country’s importance for her company, stating that, regardless of the outcome of the elections, “We are very optimistic about the possibilities of the local market.”
Its most recent bet, the entry into the ETFs’ market, presents an unparalleled opportunity in Mexico: “Mexico is very interesting since ETFs are bigger than mutual funds, I think it is the only market where that happens”, commented Johnson, who, through Franklin Templeton has a line of ETFs that includes passive and Smart Beta strategies. “Mexico is a great opportunity for the Franklin ETFs platform. They are great for all markets, pension funds, institutional funds, retail clients, and we are going to look to position them in all distribution channels,” she added. Meanwhile, Hugo Petricioli, the company’s Regional Director for Mexico and Central America, mentioned that he has seen a strong appetite for ETFs from all of his clients.
Regarding the recent change in regulation, which will allow Afores to invest in international mutual funds, Johnson commented: “We believe that open architecture is the best thing for the client” adding that it is a natural progression to first invest in the local market and then turn around to see what’s on offer abroad, “also, when there is greater uncertainty within a country [such as the one generated before the presidential elections and the NAFTA renegotiations], investors like to hedge themselves by venturing into other geographies.” She also mentioned that at Franklin Templeton they have “great portfolio managers both locally and abroad, and so we see this opening as an interesting opportunity”.
About the renegotiation of the North American Free Trade Agreement, Johnson commented that it may take a little longer to reach its culmination but that in general, President Trump likes to use social networks to provoke, but he is practical when it comes to executing, “so we believe that in the end it will be something sensible which will not be very disruptive.”
Despite the above, and according to Luis Gonzali CFA, Portfolio Manager, the team at Franklin Templeton is cautious in its positioning, seeking to hedge against a global rise in inflation. In addition, and according to Ramsé Gutiérrez CFA,Vice-president of the Fixed Income team in Mexico, the company is also looking, as long as the mandate allows, to reduce the duration of debt portfolios, “since the premium’s time value is currently almost nil.”
Aitor Jauregui, courtesy photo. Aitor Jauregui (BlackRock): "Growing Demand in Europe and Sustainable Investment will Make the ETF Market Grow Over the Next Few Years"
The ETF business continues to increase after three years of record growth figures. For Aitor Jauregui, Head of Business Development for BlackRock in Iberia, the outlook is much better in the long term: “With an average annual growth of 19% over the past few years, at BlackRock, we expect that in 2023 the ETF industry will reach 12 trillion dollars and 25 trillion dollars by 2030.”
These positive forecasts are also positive for the ETFs market in Europe which, according to Jauregui, will be “one of the main drivers of the investment fund business during the coming years”. According to this executive, and as shown by the Greenwich Associates European ETF Study commissioned by BlackRock, European institutional investors will have a prominent role in this growth, as the average of their allocation to exchange-traded funds increased by 10.3% of its total assets in 2017, from 7.7% in 2016.
“European institutional investors are adjusting their portfolios to a more volatile environment, given the return of volatility to the market and the end of stimuli from central banks. In this context, European institutional investors have found in the ETFs an investment vehicle that adapts to their needs,” says Jauregui before delving into this survey’s data, which was compiled from the responses of 125 investors, mainly pension funds, asset management companies, and insurance companies.
The survey shows the trends that make the ETF business set a positive trend in Europe. First of all, there has been an increase in the use of smart beta ETFs, which, at present 50% of respondents admit to using. Secondly, there is a greater demand for ETFs by multi-asset funds: In fact, 79% of asset managers admit to using them, as well as their intention to increase their use during the next year.
Finally, the survey shows two further trends: The use of fixed-income ETFs is a source of growth in the ETFs universe, and socially responsible investment (SRI) has a leverage effect on this business. Regarding the latter, it is worth noting that 50% of the respondents admit having invested part of their assets following sustainable investment criteria.
The attractiveness of ETFs
For Jauregui, these four trends are, “sources of forward ETFs market growth.” And they will be a driver because European institutional investors appreciate the value that this vehicle brings to their portfolio. For example, according to the aforementioned survey, ETFs are used to substitute direct investments, such as bonds, shares or derivatives. The survey shows that 50% of respondents say they use ETFs to substitute derivatives, compared to the 30% who acknowledged doing so last year.
In this regard, Jauregui points out that, regardless of the economic environment, investors value the characteristics they offer positively. “In Europe, in particular, I believe that the implementation of MiFID II makes institutional investors appreciate transparency, cost, and operational simplicity more. This is also going to be an argument that will sustain its growth in the coming years,” he says.
Speaking in terms of strategies, the ETFs that arouse most interest among European institutional investors are those of minimum volatility, dividends, factors and, finally, multifactor strategies.
Finally, should we carry out this same analytic exercise by asset allocation, the survey would show that fixed income is the type of asset where ETFs are most likely to grow. “In the case of equity ETFs, 86% of respondents admit to using them and 43% expect to increase their use throughout 2018. In fixed income, 65% expect to invest in this type of ETF as compared to the 48%registered last survey. Once again, the main criteria of European institutional investors when deciding on their use are: their liquidity, their cost, their performance and, finally, the choice and composition of the index they follow.
Debates within the Sector
In the midst of the strong development that this market is experiencing, the sector faces two debates: Possible overheating in the ETFs market and the argument between active management and passive management. In both cases, Jauregui has a solid position that he defends coherently. “It‘s clear that the weight of the ETFs in the market as a whole, and the assets that are there, is too small a part for their behavior to affect the progress of the underlying markets,” he said in relation to the first debate.
Regarding the second debate, Jauregui argues that the approach of two different types of confronting management does not make any sense. “I think that every investment decision is an active decision, even when a manager chooses to use an indexed vehicle in his portfolio. At BlackRock we believe that we have to think about indexed management as one more element when managing our clients’ capital and offering investment solutions,” he points out.
And while the sector continues debating this, BlackRock has advanced over all its competitors and has become the leading provider of the European market in terms of ETFs. According to the survey, 91% indicates iShares as its main provider.
In this regard, the asset manager believes they are on the right track. “We will continue working on new launches, while always being very selective about the solutions we provide in the market and betting on the indexes without leverage and without using derivatives. Likewise, we will focus on smart beta and factors ETFs. There is a general interest on the investors‘part, but we believe that managers of multi-active strategies are very interesting potential investors. In the long term, we will also focus on the trends we see, such as fixed-income ETFs and socially responsible investment,” concludes Jauregui
This year, Morgan Stanley Investment Management is celebrating the 20th anniversary of the Growth Team. The team’s strategies emphasize long-term concentration of capital in what the team believes to be high quality companies with sustainable competitive advantages and an attractive free cash flow profile: MSIF Growth Portfolio, MSIF Advantage Portfolio and MSIF Global Advantage Portfolio.
To commemorate this milestone, Morgan Stanley’s distribution team for the Latin American and US Offshore business, led by Carlos Andrade, invited more than 80 investment professionals, including fund selectors, portfolio managers, CIOs and top producing offshore financial advisors, to the EAST Hotelin Miami to participate in a discussion about disruption and permanence and how both concepts are incorporated into portfolios. Leading the debate, three members of the Growth Team: Stan DeLaney, Managing Director and disruptive change researcher, Armistead Nash, Managing Director and an investor on the team, and Mary Sue Marshall, Managing Director and portfolio specialist; who shared their views on secular trends and big changes coming from disruption on technology and disruption in business models.
The disruption landscapes
According to the Growth Team, disruptive changes play a very important role in their research process. As long-term investors, they focus on companies they believe to have a sustainable competitive advantage. To separate the wheat from the chaff, they need to have a good handle on the competitive environment that these companies face and the tech disruptive forces that may impact them over time.
From their experience, they state that disruption almost always fits into one of two types of paradigms: bottom-up disruption or top-down disruption. The first one, would represent those products or services that are not that good, but are so much cheaper than anything else in the market. Over time, people adopt them, the products or services improve, and the adjustable markets expands. The second type, a top-down disruption, would consist of those products or services that have a premium performance and price comparing to existing offer in the markets. As the technology improves, their cost declines and their markets expand.
“Back in 2004, we started working on the digitalization of advertising. At that time, executive directors and media had already realized that online advertising was a completely different animal, mainly because of its measurability. Our hypothesis was that, over time, companies will eventually migrate their ads from traditional media into internet. Fourteen years ago, 20% of the media time was spent on the internet, but only 4% of the advertising dollars were spent there. The relationship between advertising dollars and GDP has always being about 2% to 3%, and we do not think that will change. Today over 35% of advertising dollars are spent online, being online roughly internet and mobile, and over 50% are media that have transferred to online”, said Stan DeLaney.
Optimizing for the minimal disruption risk
Additionally, Armistead Nash believes that it is necessary that investors have a view on disruption and the competitive landscape the companies they invest in are facing. Especially nowadays, in a world where disruption is happening faster than ever before, driven by several different forces.
“One important factor of disruption is certainly the internet software space. The price of computing power has come down significantly with the advent of large cloud infrastructure players. Small businesses now have the capacity to outlay less capital investment upfront for their technology infrastructure. They can just rely on the computing power provided by these large cloud infrastructure players, and consequently, there are more start-ups coming to the internet and software space. We also feel that, with the advent of the internet and global funds, companies can have a broad distribution and approach to services like never before at a much lower cost. All these factors are driving an accelerated pace of innovation and change and starting out some new competition. It is precisely in this environment when it is more important to have a handle on the competitive landscape and to have a view out for the next three to five years, to invest in those companies that are exposed to minimal disruption risk”.
Considering its relation to disruptive change, Nash differentiates four groups of stocks: “First, we try to invest in companies that offer a product or service with very few or no substitutes. Second, we invest in companies that have an innovative culture, that despite incurring into failures, continue to invest a significant amount of capital back into new product launches. The third type of stock that we include in our portfolios are those that have the willingness to alter their product or business model based on the consumer preferences or the market demand. And, finally, the fourth type of company we invest in, are those companies that are not over-earning or over-charging relatively to the value that they provide to customers, avoiding creating an environment in which other enterprises can generate disruption in terms of pricing.
At a portfolio level, we intend to mitigate the impact of disruptive change from a risk manager perspective. First and foremost, we make sure we are using conservative assumptions in our financial projections for the companies that we invest in. Next, we avoid those businesses in which we do not have an edge on or we do not feel we have a competitive advantage”, he explained.
Pixabay CC0 Public DomainSean Taylor, courtesy photo. Latin America Has Higher Earnings Expectations than Other EM, but Significant More Political Risk
Funds Society had the occasion to, from Santiago de Chile, interview Sean Taylor, Chief Investment Officer for Asia Pacific at DWS, and discuss with him his market view on the Asia Pacific region for 2018. Taylor, who joined DWS in 2013 with 21 years’ experience in the Industry, manages two flagship DWS products: DWS Investor Emerging market fund and DWS Top Asian fund. He is also responsible for the EM equity platform.
Positive view on global economy but need to be selective in sector and stocks
DWS outlook is positive on the global economy but recently they have observed an increase in uncertainty due to the US trade policy, Italy’s new government’s anti-EU rhetoric and select Emerging Market currency weaknesses. Taylor states that: “All three aspects require close monitoring. While an outcome is difficult to predict, our base case assumes no escalation of these issues and an eventual positive resolution triggering a sentiment relieve.”
Taylor also thinks that assets prices have already rallied and DWS is recommending their clients to be more selective in sectors and stocks: “Even under these positive scenarios, investors have to be more selective on duration and seek diversification.”
Same happens in the EM context, where Taylor recommends that: “it is not just buying EM, is being more selective particularly on the credit side and the sovereign side” and adds: “Current account deficit EM countries and those with high US debt levels are being impacted through their domestic currencies and/or foreign reserves, although rising US rates have been well flagged.” According to Taylor, if easing financial conditions tighten more sharply than expected, EM debt could become under pressure. DWS expects 2 further 25bps hikes by the Fed by the end of the year with the US 10yr yields of 3.25% by March 2019.
Regarding credit, they are expecting positive returns although not as high as in the recent years. They recommend a multicredit strategy to blend in some of that risk in.
On equities they are positive, US equities are expensive but still have upside: “it is really going to be based in earnings and earnings this year will be quite positive.” The rest of the international markets are looking cheaper, as they are not reflecting this economic growth.
Emerging markets: Expecting rewards after years of growth negative policies
When questioned about their preferences in terms of markets from a macro perspective, Taylor stated that beginning 2017 DWS was overweight in EM and continue to do so structurally: “There have been changes happening in those markets that we consider very positive. From a Macro perspective we see high potential in GDP growth versus previous years because we will start to see the positive impact of the new policies of new leaders in Asia. The new leaders in Asia came all about at the same time with a new mandate: to widen the economy. To achieve this they had to change the model: China had to stop corruption, India had to reduce burocracy and so did the Philippines and Indonesia. These changes implied being growth negative for the first 5 years but now they are able to collect the positive effect.
Also from a monetary point of view, Asia had a tight monetary policy and was dampening growth when the rest of the world had QE. Now as QE comes out we think Asia continues to be driven by its owns dynamic in economic terms. “
Taylor also thinks that EM and Asia are in a better position to adjust to changes in US and Chinese policy and adds, “Investing in EM has therefore been selective, avoiding those most vulnerable economies with deteriorating current account deficits and uncertain politics (Indonesia, Argentina, Philippines, Turkey, Malaysia) and under pressure to raise rates (Indonesia, Philippines) as well as those under potential trade/sanctions (Mexico, Russia) – however we have taken advantage of the rise in commodities, energy and oil prices where we have been sectorally overweight.”
Latam higher earnings growth than EM area but significant political risk
Turning into the Latin American region, although it has been underweight in DWS portfolios for several years, they have started to increase their exposure recently. Even if political risk is on top of the table, DWS has a forecast of 25% estimated growth earnings versus 18% for the EM market area as a whole.
Going into more detail on the political risk, Taylor mentioned that the difficulty about the Brazilian election is the wide variety of candidates and possible scenarios. Therefore, there is a lot of event risk going forward. But to his view, Brazil is already factoring the worst case scenario:” From a fundamental point of view, Brazil went through 4 years of deep recession and although last year President Temer was beginning to put some reforms in there were also down because of the political situation. The Brazilian team is not factoring any positive news until the election. Brazil has the highest tax to GDP ratio of any large EM but has the lowest investment rate/GDP of 14% and the growth model relays on current account deficit. They need a strong president to implement the necessary reforms and leads Brazil to a cycle of economic growth. On the bottom up side they are expecting good earnings coming through.”
Commodities and Growing demand in China
DWS is expecting to see steady commodity prices going forward supported by growing demand in China. China’s growth for the following 5 years will be driven by : “the “One Belt one Road project” and growth in Chinese domestic economy. China is going to change from investment led growth to domestic lead growth so it will evolve into better consumption. In addition, the increase of the quality of life of the average Chinese will lead to the next phase of urbanization that will imply taking the next 100 million people from Central China to Western China into more urban areas. All these factors will enhance the demand for commodities”
Hong Kong versus Chinese domestic stocks
Taylor is an expert in Chinese and Hong Kong markets and as such he highlights the need to differentiate between forces driving Hong Kong markets and Chinese stocks. Taylor explains that; “the HK index, the Hang Seng, has relatively little to do with China as it is really based in domestic HK. Its sectors are: HK property, HK or international banks with HSBC and utilities and all those are quite interest rate sensitive so that puts as off. Utilities, we are underweight because the prices are capped by the government and if the funding costs increase their margins are going to be reduced and it is relatively expensive. The only area where we see some upside is consumer as consumption is picking up.”
He further states that on the other side, the China indexes traded in HK, the H Share index, which is effectively Chinese SOE (state owned enterprisers) listed in HK many years ago to improve Chinese corporate governance is 30% cheaper than the A share (Shanghai) index: “We have now a 25/28% arbitrage between H share and A share. The H share 3 years ago was 60% cheaper than the A share in China is now 30% cheaper”. This fact together with “Asian are buying Asian” and are demanding better balance sheet management, support his view that “ the earnings profile of what I call, MSCI China H Share, which does not include Hang Seng- domestics HK stocks- is much greater that the earnings of HK companies.”
In addition, as per recent announcements that could also boost Chinese equities, Taylor mentioned the Chinese Depository receipts. Although details are yet to come, the Chinese depository receipts will allow companies like the tech and the internet companies in the US to trade onshore in the Chinese market.
Chinese Bond Connect
Following on with his positive view on China, Taylor also comments on the Chinese Bond Connect project. It will allow foreign investors to be able to access the second largest bond market in the world:“ given our view in sovereign, where we are not seeing much yield globally, Chinese sovereign and corporate offer some good yields. That will mean that China will go into some of the big bond indexes and that will naturally put a one-of flow of bonds in there, but what it really means is that international investors can´t ignore China”
View on the generally accepted Chinese risks
The two biggest risk of China according to the majority of investors is that China´s got too much debt and too much leverage. To Taylor the two are different. The government debt to GDP, which is increasing every day, will be eased by foreign investors being able to access the Chinese bond market (Chinese Bond connect) as the government will be able to issue more, diversify and lower the risk premium of the Chinese economy . “Our view is that the debt problem is a balance sheet problem not a solvency problem and China owns effectively both sides of the balance sheet, so the only problem that can really put China into trouble is China itself.”
In his opinion, the biggest short term risk China is exposed to is the leverage in the financial system and particularly wealth management products. A lot of the smaller banks don’t have enough deposits, so they go to the overnight market and that causes spikes. Nonetheless, to Taylor the decision taken by the Chinese central bank has been very sensible: “what has happened in the last year is that PBOC has been very clever, it has kept policy rates very low, only raising 5 bps when the fed rose, but its kept 7 days rate quite tight, so it’s been squeezing liquidity out of the market, it´s been making the system safer. And that is also why we can assign a higher PE to China.”
EM Currencies outlook
For Taylor recent months have been complicated for emerging market currencies due to a stronger US dolar. That being said, most of the currencies are behaving as expected with current account surplus economies and better politics outperforming those with more difficult current accounts and uncertain politics. They consider Turkey and Argentina isolated incidents.
“In Asia, India has not done too well given the rise of commodities and oil prices, whilst Malaysia’s new government has caused some political uncertainty which is seen in the ringgit – however higher oil for Malaysia will help bolster their current account. For China the renminbi has strengthened since the beginning of the year while the Korean won has mostly been stable during the latest geopolitical tensions. Russia however has seen a depreciation in its currency post sanctions,” explains Taylor.
Strategies applied to the DWS Emerging and Asian funds
DWS Investor Emerging market and DWS Top Asian fund are both managed similarly combing country selection with stock selection. Their philosophy is one of a global perspective with local knowledge. They have localized teams all across the regions that provide a very good perspective of what is going on the ground: “3 years ago their strategy was defensive, which meant buying growth companies, buying quality. Now the strategy is more balanced. Last year they were really overweight in the technology areas, in South Korea and Taiwan while this year they are underweight because prices have already reflected the upside value. For 2018 they are focused more into consumer, financial, and cyclicals sectors. We have a very good risk adjusted return and very fundamentally driven, very disciplined process.”
2019 Outlook
As a final conclusion, Taylor states that their 2018 outlook for Asia and the emerging markets is positive: “We don’t see it being the same return as last year but we are confident for another 10% upside from here.” When asked about their expectations for 2019, he stated that next year earnings will be lower than 2018 but still positive at 14%. ”In 2019 we would expect to get full return as we would have gone through the rate cycle, would be a bit clearer on trade, hopefully more clear on sanctions and people would truly realize that our top down story of that growth continuing, plus the bottom up story of earning picking up structurally as well as cyclically, plus Asia buying Asia will give good support for the market.”
