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Legg Mason: “There is a Greater Movement towards Global Diversification by Brazilian Investors”

During the ninth edition of the Annual Forum of Local and International Specialists for the Discussion of Economic Challenges in Brazil, which was held at the Unique Hotel in Sao Paulo on the 1^stof December, Western Asset, a subsidiary of Legg Mason received professionals of the investment world, with the objective of discussing the challenges Brazil faces in the short term.

Joe Sullivan, Legg Mason’s President and CEO welcomed attendees to the event. After his speech, Ken Leech, Chief Investment Officer for Western Asset, explained how the global scenario has been extremely benign for emerging markets in general, and for Brazil in particular, and what the chances are that this scenario will continue in 2018 .

Then, in a first panel, the government’s microeconomic reform agenda was analyzed as a catalyst for growth. Moderated by Paulo Clini, CIO for Western Asset Brazil, the debate was attended by Joao Manoel Pinho de Mello, Special Secretary of Microeconomic Policies of the Ministry of Finance, Walter Mendes, President of the Petros Foundation, and Marcelo Marangon, Executive Vice President of Citibank , who evaluated which are the most advanced microeconomic reforms to resume economic growth.

During the second panel, they examined how presidential elections will influence the agenda of fiscal reforms, analyzing the possibilities of achieving a fiscal balance in a turbulent political situation. On this occasion, the moderator was Adauto Lima, Chief Economist at Western Asset Brazil, and the panel counted with the contributions of Bernard Appy, Director of the Fiscal Citizenship Center, Caio Megale, Finance Secretary for the municipality of Sao Paulo, and Christopher Garman, Eurasian political consultant.

Strongly committed to Brazil.

The Brazilian economy has recently recovered from one of its worst crises in decades, and is finally returning to positive terrain. Interest rates remain at low levels, but investors worldwide have a strong interest in the yields offered by Brazilian debt.

“Interestingly, investors in Brazil think that their interest rates are at low levels due to their history, but when you think about the performance of the 10-year US Treasury bond, which is somewhat above 2%, in the German bond rate, which stands at 0.4% and the Japanese rate that is close to 0%, and you compare them with the interest rates in Brazil and the possibility that the currency will appreciate as the economy improves , you can get a very attractive return,” said Ken Leech during the press conference with journalists.

Meanwhile, Joe Sullivan added that they had increased exposure to Brazilian debt in all those portfolios in which the portfolio’s mandate allows it: “We have positions in Brazilian sovereign local debt and in certain Brazilian corporate bonds, usually denominated in dollars.”

Although the situation has improved in the Latin American giant, it’s still of vital importance that there is a fiscal reform in Brazil. “Our expectation is that some kind of fiscal reform will be approved, if not this year, the next, but we believe it will be enough to maintain support in favor of Brazilian debt securities. The Brazilian policy has turned towards a government more favorable to the markets, although the elections always introduce an element of uncertainty. We hope that this type of policy will continue, but we are prepared for what may come.”

Regarding how the normalizing process by central banks may affect emerging markets, Leech said that they hope that this time it will not be a problem: “If you think about the last three years, from 2013 to 2016, when the central banks were decreasing their interest rates, unlike in other periods, the rates in emerging markets rose, with a divergence of direction between the rates of developed countries and that of emerging countries. Our vision is that if the central banks begin to raise interest rates it will be because growth has improved and if this is true, then interest rates in emerging markets would not go down. With inflation so low, our vision is that interest rates are going to rise very slowly, so there should be no great impediment for emerging markets.”

The local investor’s appetite for diversification increases

Brazilian investors first became interested in international equities with exposure to currency. Many investors did not hedge currency because they really needed high volatility to compensate for the high rates that Brazil had until just a few years ago. In the last year, there has been an enormous success in hedged strategies because investors no longer need to have exposure to currency risk to find international investment alternatives that provide competitive returns when compared to the local interest rate level.

In any case, the demand from institutional and retail clients is different. The institutional client seeks long-term returns and is interested in variable income products that invest in infrastructure and global fixed income products, because they are a very powerful diversifying element as compared to local debt.

“Brazilian investors have the great advantage of having one of the highest interest rates in the world. So it’s not easy to find Brazilian investors wanting to invest outside of Brazil, where interest rates are much lower. But for the first time, Brazilian interest rates are at their minimum in decades, with inflation close to 3%. Many of their assets are invested in Brazil, but we have seen a growing interest in buying global returns. We believe there will be a greater movement towards global diversification on the part of Brazilian investors,” concluded Joe Sullivan.

“Markets Can Remain Irrational and Solvent for a Long Time. It ‘s Classical of the Herd Mentality”

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“Los mercados pueden permanecer irracionales y solventes por un largo tiempo. Es un clásico de la mentalidad de rebaño” — Wikimedia CommonsPhoto: Tim Paulson, Fixed Income Strategist at Lord Abbett and Justin Wells, Global Equity Strategist at Old Mutual Global Investors, discussion panel moderated by Gustavo Cano, Director of Product and Strategy for UHNW LatAm clients at BBVA Compass. “Markets Can Remain Irrational and Solvent for a Long Time. It ‘s Classical of the Herd Mentality”

In Miami, Martin Hofstadter, Offshore Business Director at Lord Abbett and Andrés Munho, Sales Manager for Latin America, Florida and Texas at Old Mutual Global Investors, welcomed US Offshore industry professionals to a lively panel on global macroeconomics. Moderated by Gustavo Cano, Director of Product and Strategy for UHNW LatAm clients at BBVA Compass, the event was attended by Tim Paulson, Fixed Income Strategist at Lord Abbett and Justin Wells, Global Equity Strategist at Old Mutual Global Investors.

Once the panel was over, the event was attended by Dr. Roberto Canessa, a renowned cardiologist and one of the sixteen survivors of the plane which crashed in the Andes in 1972.

The debate on the macroeconomic environment began by evaluating the performance of central banks, which continue to keep interest rates at low levels for a longer period of time. According to Justin Wells, it’s very complicated for the Fed to diverge radically with the rest of the main central banks, because this could cause strong volatility with respect to the rest of the currencies. In his view, central banks will maintain very benign levels of volatility despite an increase in geopolitical risks that is much greater in developed markets.

While Tim Paulson pointed to the great correlation between asset prices and balance sheet volumes of central banks. “We hope that as the Fed begins to unwind its balance sheet, the impact of its actions in the equity shares market will be reduced. We expect to see risk premiums begin to recover, at present, it’s clear that the European Central Bank’s and the Bank of Japan’s actions are surpassing the Fed’s normalization attempts, which are still very small reductions.”

Lord Abbett’s strategist argued that as long as the tremendous search for returns on revenue continues in the world, which results from the demographics of developed economies, we will continue to see low interest rates for some time. “If you compare returns on German sovereign debt with those of US debt, the latter are higher, but if you take into account the cost of currency hedging, both are more or less at the same level. US rates are at current levels due to the influence of the rate levels in Europe and Japan. And, all rates are moving together, affecting currencies. In this model, if the currency’s hedging goes up, the Fed’s rate goes along with this increase. There is massive global arbitration.”

According to Paulson, the market is expecting less aggressive behavior from the European Central Bank. “Just because they cut down from buying 60 billion to buying 30 billion, does not mean that at some point the market is going to decrease its purchase speed. In Europe, they are still trying to remain behind the Fed, but they continue to buy more than the market is able to digest. Everyone competes against everyone for profitability,” says Paulson.
As for the possibility of overheating the market, in which more and more investors are looking for the first indications that a correction may be taking place, Justin Wells said that there is strong speculation about a potential correction and about why is it’s different this time. “The relationships of conventional metrics with the correlation of the market are breaking down. There is a huge level of disruption in the economy, which is very interesting.”

Meanwhile, Tim Paulson, joked with the idea of ensuring a recession in the future. “While a possible recession may come in 6 months or in10 years, none of the market participants can say when. Economic data show that the chances of a recession in the next 6 or 12 months are lower than average. A recession is possible, but unlikely in the near future. The risk is that there is always going to be something that cannot be predicted, something that causes a recession. While it is unlikely that a recession will occur with a risk of restructuring and real loss of assets as a result of the behavior of central banks, it cannot be ruled out, as it can happen. At no time in history has it been so easy to access the capital markets. A rise in interest rates may put some pressure on the markets and bring them down, but we are far from a horrible decision being made by the Fed.”

Another issue that was mentioned during the debate was the US tax reform. According to Paulson, it’s not an issue that they are implicitly considering in their strategies and he does not believe that anyone in the market is doing it. “You cannot bet on the possible final result of the tax reform. All that can be done is watch which assets will be affected by the fiscal reforms, and if everyone is taking into account the same type of tax reform or that it will happen with the same probability. It is not a question that can be easily solved, but it is how you usually play this type of events; looking for differences in probabilities.”

The absence of volatility and complacency in the markets

On the absence of volatility in the markets, Paulson commented that after the global financial crisis many investors did not leave behind a psychology of pessimistic tendency and continued to bet on quality and defensive styles. “This defensive mentality is what has allowed very low or very benign levels of volatility. We continue to see frequent rotations that can be very destructive, by sector and style, we feel that perhaps they reflect in a more accurate way the real level of volatility, which measured in terms of conventional metrics is simply not reflecting what is actually happening.”

For Wells, another factor that is reducing volatility is the use of quantitative models, since the existence of a reversion to the average calibrates the behavior of real activity, both in the depth of the market and on the surface. “Spreads compression, high price-to-earnings ratios, all these indicators are changes that affect risk premiums, this is really what the actions of central banks has killed. The dynamics of the markets have changed, more than 1.2 trillion dollars have abandoned large cap equity strategies since 2007, and at the same time 1.4 trillion dollars have gone into passive investment and smart beta, a huge change in terms of the underlying dynamics of the market. You need to have a process that is dynamic and that responds to it, against the change in the rules.”

According to Paulson, in a period of low volatility with incredibly cheap access to capital, businesses and consumers start making bad decisions and do not feel the weight of these decisions until after a while. They become more complacent, and eventually the pressure in the system also becomes complacent. Historically, the longer it stays in these periods of low volatility, the more violent the rupture. “In a period in which stocks and bonds have very high valuations, investors are beginning to look for opportunities in alternative investment by increasing the risk of their portfolios. Something similar to what has happened in Europe in the last six or seven years. Bond yields have turned negative and investors continue to invest because they still need more profitability, it is not logical; it ‘s only working because all investors are taking the same position at the same time. Markets can remain irrational and solvent for a long time. It’s classical of the herd mentality that investors exhibit when they are not clear in which direction to invest.”.

Lack of inflation

According to Paulson, inflation will be affected by the structural trend in the long term. The labor market in the United States is very tight, being one of the reasons why inflation has picked up a bit, but somehow deflation is being imported from Europe and Japan, something that may be reversing many of the trends that are happening. “As long as inflation remains at low levels, I am confident that risk assets will perform well or at least central banks will maintain their accommodative policies. The issue that may introduce some disruption is that inflation starts to grow faster than central banks expect and they then have to change their reaction.”

For Justin Wells, this is one of the areas in which they are seeing a greater disconnect between the convection that has worked so far and has stopped working, the classic Phillips curve. “The massive disruption that the real economy is suffering at this moment, with its winners and losers, has caused huge deflation, we are not seeing wage growth as a result of the introduction of new disruptive technologies. Some workers will be replaced by automation or other forms of disruptive technologies, at an incredible rate of disruption; something which, from the point of view of the active manager, will create a large number of opportunities.”
To conclude, the asset managers commented that for the following 12 months they still expect to be closely watching the levels of support that the Fed provides to the market, the pressures that are being created in the system and how to navigate them.

Dr. Canessa’s participation

During his presentation, once the debate ended, Dr. Canessa reminded the audience that it is not necessary to wait for a plane crash to enjoy life: “Don’t look at the mountain, it can be very steep, just look at the next step that has to be taken, and if you feel disappointed look at what you have achieved up to that moment, you cannot wait until the helicopters arrive to save you, you have to continue walking.”

BlackRock to Acquire Citi’s Asset Management Business in Mexico

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BlackRock comprará el negocio de asset management de Citi en México — Wikimedia CommonsPhoto: Rafael Guajardo/ Pexels CC0. BlackRock to Acquire Citi's Asset Management Business in Mexico

BlackRock and Citibanamex, a subsidiary of Citigroup have announced a definitive agreement for BlackRock to acquire the asset management business of Citibanamex, subject to regulatory approvals and customary closing conditions.

BlackRock and Citibanamex will also enter into a distribution agreement upon the closing of the transaction, to offer BlackRock asset management products to Citibanamex clients in Mexico. Through its network of 1,500 branches in Mexico, Citibanamex provides wealth management products and services to more than 20 million clients.

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The transaction involves approximately US$31 billion in assets under management of Citibanamex, across local fixed income, equity and multi-asset products, primarily for retail clients. The transaction is part of Citi’s emphasis on expanding access to best-in-class investments products, rather than on manufacturing proprietary asset management products. BlackRock’s business in Mexico currently focuses mostly on institutional clients, offering international investment and risk management products and services across asset classes, strategies and geographies.

The agreement builds upon the long-standing relationship between BlackRock and Citi and brings together two leading firms to offer a wider range of products, enhanced technology and investment capabilities for clients. It is expected to close during the second half of 2018. The financial impact of the transaction is not expected to be material to Citigroup or BlackRock earnings. Terms were not disclosed.

Armando Senra, Head of Latin America and Iberia for BlackRock, said: “BlackRock’s ambition is to become a full solutions provider in key markets around the world. This transaction is a big step forward in that direction in Mexico. The acquisition of Citibanamex’s asset management capabilities combined with our global investment platform and technology create a stronger franchise that can deliver a more compelling set of investment solutions across client segments in Mexico.”

Jane Fraser, CEO of Latin America for Citi, said: “Our goal is to create a state-of-the-art bank in Mexico focused on delivering a richer, smarter, more intuitive experience to everyone who does business with Citibanamex. The agreement with BlackRock delivers on our commitment, offering clients leading asset management services, and provides BlackRock with access to our extensive network in Mexico. We are excited by the opportunities this transaction offers and look forward to working with BlackRock.”

Mark McCombe, Head of the Americas region for BlackRock, said: “BlackRock believes in the long-term growth potential of Mexico and is committed to continue growing our presence here. Combining BlackRock’s capabilities in product and technology with the distribution network of Citibanamex creates a stronger franchise that can do more for clients.”

Ernesto Torres Cantu, CEO of Citibanamex, said: “Our commitment is to deliver the best client experience by offering the best of Mexico, and bringing to them the best of the world. Our association with BlackRock does exactly that”.

Citi Institutional Clients Group advised Citi on this transaction.

EMD Should Shift From Being Beta To Alpha Driven

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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.

John Stopford (Investec): “The Market Does Not Believe the Fed, Thinking it’s The Boy Who Cried Wolf”

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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.

MFS: “The Market Forgets that When Credit Liquidity Dries Up, There Is No Turning Back”

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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”

WisdomTree Buys ETF Securities’ European Exchange-Traded Commodity, Currency and Short-and-Leveraged Business

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WisdomTree compra el negocio europeo de ETF Securities — 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.”

Venezuela On the Edge of a Cliff: Lets Be Cautious

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Venezuela al borde del abismo: es el momento de ser cautos — 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.

Afore Pensionissste Grants its First Investment Mandate to BlackRock

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Afore Pensionissste otorga a BlackRock su primer mandato de inversión — 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 BlackRock to 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.

BlackRock Launches New China A-Share Opportunities Fund

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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.”