Mirova: The Eight Sustainable Development Themes which They Pursue in their Responsible Investment Strategies

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At Mirova, the socially responsible investment arm of Natixis Global Asset Management, they firmly believe that the financial industry, and especially the investment industry, plays a significant role in solving the problems arising from the unsustainability of the current economic development model: climate change, the depletion of natural resources, the imbalance between growth and debt, and the decorrelation with the real economy, amongst others.

The philosophy applied by Mirova in its strategies is based on the conviction that the integration of sustainable development themes into investment decisions allows them to offer solutions in responsible investment. In order to identify the companies that manage future challenges effectively, Mirova experts have developed a unique approach to economic analysis based on eight sustainable development themes: energy, mobility, building and cities, resources, consumption, health, information, and communication technology.

The Energy Challenge

The main challenge for achieving a sustainable energy model is reducing dependence on fossil fuels while fostering access to energy for populations still relying on wood and coal combustion.“Coal has been losing ground to natural gas as a source of energy. Coal powered plants can easily be converted from coal to gas which, in addition to reducing carbon dioxide emissions, extends the life of the power plant and lowers the cost of operations,” says Kenneth Amand, Client Portfolio Manager at Mirova. “These are economic forces that will be hard to fight without substantial coal-power subsides for which there will be little public appetite.”

According to Armand, it would only be logical to expect the wealthier and larger nations globally to bear the biggest weight of building a low carbon economy, as besides being the biggest polluters, they already have the infrastructure in place to develop new energy resources and technology.

As regards the recent US withdrawal from the Paris Climate Agreement, at Mirova they believe that businesses looking to lower their carbon footprint will be at a short-term disadvantage competing with less scrupulous businesses willing to pollute despite climate change. “For the world, we believe that there are opportunities lost – discoveries and advances that could have come from the climate change leader it had in the US, one rich with intellectual and financial resources. Forcing an involvement in antiquated technologies such as coal or oil might adversely affect the US’s ability to remain a leader in the future low carbon world. While the US has good green technologies, such as Tesla and First Solar, it has relatively light regulations, especially on social issues. Europe, on the other hand, has strong regulations forcing most corporations to take Environmental, Social, and Governance criteria into account in all industries.

As for advances in renewable energy, Amand points out that, although the cost of windmills and solar panels continue to fall while their reliability continues to rise, the issue of energy storage remains to be solved. “Storage is critical for energy sources that are intermittent, like wind and sunshine. This demand for storage has fostered a frenzied research and development effort; we would be amazed if a solution were not found in the short term. Storage of energy needs to be portable and less than USD 150/kwh, a point at which gasoline will be rendered too expensive.”

Another branch of research focuses on tidal power and seeks mainly to increase its efficiency.In addition, there is another race focused on studying the products and materials used in industrial production as a means to cutting costs. “Tesla’s giga-factory is one effort. Trying to convince Bolivia to mine its lithium reserves is another.”

Solving the Mobility Issue

The increase in the population moving into the cities is making these crowded.There is scarcely enough capacity for this increase on most public transportation systems, let alone enough room for every inhabitant to drive and park their own vehicle. With this backdrop, electric, self-driving cars seem to offer the best solution for non-point pollution and transportation with start and end points as diverse and dynamic as the people they serve. “Every major automotive company and virtually every technology giant is, in one way or another, pursuing self-driving car technology. In fact some of the major automakers are preparing for this eventuality by stepping out of the race to the biggest,” Amand points out.

The Change in Homes

Most households around the world are preparing to improve their energy efficiency. Thermal insulation of a house provides sufficient energy savings to cover the cost of the renovation carried out in the house.Similarly, LED bulbs, lower power appliances, and smarter devices are making homes more energy efficient. As regards the issue of space, building upward is the best way to use limited city real estate and conserve energy.

Water Conservation and Optimization of its Consumption

Although two-thirds of the planet is occupied by water, very little can actually be used for human consumption and agriculture.Arabic nations spend a significant amount of their annual energy consumption desalinating ocean water for drinking and servicing their cities. “The US uses about 10% of its energy production replacing water spilt through leaky and old pipes. Mexico has determined that childhood obesity can be connected to soda consumption in lieu of clean drinking water. Today, a tax against sugary beverages is levied to pay for filtration systems to be put in state schools.” Amand points out.

The Paradox of Consumption

The number of people purchasing in large shopping centers is getting lower each year. However, consumption rates haven’t fallen. “They’ve migrated back to the catalog. However, that catalog is no longer the Sears and Roebucks book of the past, it’s Amazon.com, Etsy, ebay, and the websites of most designer labels. The smart companies have found ways to make their store fronts an extension of their digital catalog. From high-end designer clothes to basic electronics and food products, the world is seeking a balance between eRetail and storefront retail. Where will the balance land and who will be the winners?” wonders the team at Mirova.

Increased Expenditure on Health

Each year, a growing number of people reach retirement age, starting a new chapter in their lives, rich in social and cultural experiences.To maintain their quality of life, sometimes they simply require small adjustments, such as the need to correct eyesight, failing due to the passage of time.Nearly half of all people in retirement use some sort of corrective lens. “As people get older, diseases once rare and oft unheard of are becoming daily facts of life. Medicine has become both better at serving the masses, with quicker more efficient eye care, and better at serving individuals with devices uses to determine specific dosages for individuals are treatments based on a larger set of inputs.”

Information and Communication Technology

At present, the most relevant trend in information management is cloud migration, an environment in which software can be easily upgraded, enabling better control of cybersecurity problems and fraudulent practices such as phishing and spam. Other additional benefits include lowering the cost of energy and the cost of maintaining equipment. “Moore’s Law has come to an end, transistors will get no smaller and likewise computer processors, as we know them, won’t likely get any faster. As such, new ways will be discovered to reduce the time data are processed. Cloud computing helps here as well.”

Investment and Environmental, Social, and Governance Criteria

Finally, Amand reviews the current scenario of sustainable investment: “On the financial side, Europe is leading responsible investment but things are moving in the US as well. China has a strong industrial power and strong investment in green technologies but strong social risks. Implementing ESG factors is not something countries do, but rather something asset managers and corporate boards do. For asset managers, these factors can help the manager unearth advantages and disadvantages a particular business has, given real-world implications on its business. For corporations, ESG can be a guide to testing whether all aspects of their business are properly aligned with sustainable goals. However, some countries and securities administrations have set forth more robust disclosure policies, like the EU which has some of the strongest disclosure policies in the world.” Amand concludes.

Emerging Within the Emerging: The Potential of the Asian Frontier Markets, According to Allianz GI

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Emergentes dentro de emergentes: el potencial de los mercados frontera asiáticos, según Allianz GI
CC-BY-SA-2.0, FlickrDennis Lai, Senior Manager at Allianz GI. Courtesy Photo. Emerging Within the Emerging: The Potential of the Asian Frontier Markets, According to Allianz GI

One of the core messages from the Asia forum recently held in Berlin by Allianz Global Investors is that investing in the Asian continent goes far beyond China. Although the Asian giant offers investment opportunities that cannot be ignored, and has risen strongly in recent months in tune with other markets such as India, a market which asset manager Siddharth Johri spoke about, or Korea, all of them revalued by about 30% in the last twelve months, there are also others that offer great potential.

Therefore, beyond the more developed Asian countries, there are emerging countries within the continent, emerging within the emerging, or frontier markets. Dennis Lai, Senior Manager at Allianz GI, spoke about the opportunities in Asian frontier markets, growing markets with very favorable demographic characteristics, consumption opportunities, infrastructure, and GDP growth.

Without taking into account the beneficial effects generated by China (and other more developed Asian countries) on some of these markets, the boom in development and research policies, and the improvement in their fundamentals and credit quality from an investment point of view (which improves the perception of risk).
The Allianz GI strategy that invests in emerging and frontier Asian markets harnesses the potential of these markets and focuses on growth segments (such as consumption, services, technology, and infrastructures, which are less present in the indices but will be gaining traction) and avoids the traditional ones (utilities, financial, health…), in a strategy with conviction that selects between 60 and 80 names.

And it is also based on themes: for example, the asset manager likes the investment in automation theme, and the fact that Asia is a fundamental part of the supply chain for Western robotics firms; also the sale of automotive components to the OECD industry theme; or the aerospace theme, as the continent also provides components to large Western firms.

According to the asset manager, Pakistan, Vietnam or Sri Lanka are some of the next economies that will be among the fastest growing.

The Allianz GI strategy invests in names that also bring great diversification to the portfolios by their decorrelation with other Asian markets, since their fundamentals and their cycle are at a different, earlier stage, than that of other more developed Asian markets.

In addition, they are little-known markets and emerging outflows affect much less:

“We are positive in Asia and in the smaller markets, where we see very interesting opportunities,” remarked the asset manager.

Asia’s Potential

Stefan Scheurer, Asia Pacific Economist at the asset management firm, also pointed out during the event that Asia is not just China, but a vast continent stretching from Japan to Australia and including many, and varied, markets. Between them, the population is larger than that of Europe plus America together, with 4 billion people, 60% of the world’s population, and accounting for more than 35% of the world’s GDP… a trend which is rising, as by 2020 it could account for 42%.

In this context, China has become one of the major standard-bearers and advocates of globalization, and despite Trump and his protectionist attempts, experts estimate that international trade (intra regional and interregional) will continue to grow, driven by TPP (of which the United States is not a party).

According to the expert, the continent will continue to grow, driven by productivity and innovation in China’s or India’s case, with large amounts of patents; regarding the debt problem, he points out that there is potential to increase leverage, since it is a problem in China but not in other economies in the continent. In addition, the population and demographic profile is more favorable in countries such as India, Indonesia or the Philippines than in China, which leaves greater potential for growth in these economies. With all these factors, the expert predicts continued growth in Asia, above that of developed markets, and also driven by the continent’s status as a “relative winner of de-globalization”.

 

 

Interest Rates, Oil, and the Dollar: the Three Factors that Convert Emerging Debt Into an Investment Opportunity

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Tipos, petróleo y dólar: los tres factores que convierten la deuda emergente en una oportunidad de inversión
Federico García Zamora, Director of Emerging Markets at Standish (part of BNY Mellon) / Courtesy Photo. Interest Rates, Oil, and the Dollar: the Three Factors that Convert Emerging Debt Into an Investment Opportunity

In 2017 the return of investors towards emerging market debt after several years of inactivity has become evident. The drop in oil prices, lower growth in China, and political problems were behind this disillusionment, which this year has been almost completely wiped out.

The investment spirit in emerging debt “is blowing in the wind”, as Bob Dylan would say, however, any cautious analysis would lead us to consider whether this trend is sustainable in the medium term or if, on the contrary, it has an expiry date.

This is the first question we asked Federico García Zamora, Director of Emerging Markets at Standish, BNY Mellon, during this interview with Funds Society in Spain. His answer is clear: “The context has changed and will be maintained for at least the next 12 to 24 months due to three fundamental factors: interest rates, the oil price, and the Dollar.”

In his opinion, the Fed’s rate-hike strategy is already embedded in long-term bond prices. “It will not come as a surprise to anyone that interest rates continue rising and, therefore, it will be perfectly accepted,” says the expert.

As for the second fundamental factor, the price of oil and commodities in general, García Zamora explains how they are analyzing both from the production side (companies in the sector) and from the demand side. His forecast is that the price will be much more stable in the next 12 months, at around 40-60 dollars. “The price cannot rise again too far above 55 dollars because the supply of unconventional oil would rise a lot, while below 40 dollars, a lot of the supply would be destroyed,” he explains.

Despite admitting that for investment in emerging markets it would be better for the price of oil to rise, “stable oil is going to be very good without it having to rise. We will see good results with price stability,” he argues.

Good results that, in terms of profitability, translate into 7% -8% annual returns for emerging debt, “which is very attractive when compared to any other fixed income asset in which you can invest worldwide, if nothing changes regarding currency exchange rates.”

As a matter of fact, the third factor that supports this interest for emerging countries is the evolution of the Dollar and here the expert’s forecasts point to a fall of the dollar during the next two years. “This adds appeal to this asset class as opposed to a few years ago when the dollar kept rising,” he explains.

An upward trend that the expert explains as due to the rapid increase of interest rates while they were falling in the rest of the world, as a result of the European crisis, stimulus withdrawal by the Fed, the collapse of oil prices, and Donald Trump’s election. According to García Zamora, all these elements contributed to placing US currency at highest levels during the last five years, but now he is convinced that it will continue to be come down because “that’s how the Trump administration will solve the country’s high trade deficit. Depreciating the dollar has always been his intention, but it was easier to explain to the average American voter that he would solve the problem by raising customs fees.” His forecast is that the dollar will stand at 1.25 to1.30 Euros.

From Russia and Brazil to South Africa and Turkey

Asset allocation from a geographical point of view has varied in the last twelve months. During 2016, Russia and Brazil have been the darlings of the Standish emerging portfolio, in which Colombia has also had some weight, despite being slower in its recovery.

“Another country that we liked a lot is Argentina due to its change of government. Its crisis was self-inflicted with a government that shot itself in the foot as much as it could. With a much more reasonable policy and investment, the potential of the country has changed completely.” In this regard, Garcia Zamora says that they have already taken profits in Argentina and have rotated their portfolio towards other issuers like Mexico, South Africa and Turkey, which are “cheap.”

The investor’s main concern in emerging markets is volatility, which the expert puts between 8% and 12% depending on whether the investment is made in local currency, Euros or dollars. “It is true that these assets have gone up quite a bit, but if you are a long-term investor it remains attractive. The fall that some expect may not arrive and my recommendation is invest now and, if there is a fall, invest further,” he concludes.

World’s Largest Mutual Fund Company Expands Business Capabilities in Mexico

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Vanguard nombra a Juan Manuel Hernández director de operaciones en México
Wikimedia Commons. World’s Largest Mutual Fund Company Expands Business Capabilities in Mexico

Vanguard Investments Mexico announced that Juan Manuel Hernandez has been named the head of Vanguard’s business in Mexico as the company expands its efforts to meet local investors’ needs for low-cost and broadly diversified investment products.

Hernandez joins Vanguard from Blackrock Inc. Mexico, where he served as head of institutional sales. He also held the head of sales position for iShares Mexico.

“Vanguard has been serving investors in Mexico since 2009 from our headquarters in the US, and we believe regulatory, fee, legal, and capital market structures are moving in the right direction to enable Vanguard to expand in Mexico,” said Kathy Bock, head of Vanguard Americas. “We are delighted to have someone of Juan’s caliber to lead Vanguard’s work to further increase access to our products to investors in Mexico.”

“Many companies talk about their client focus but Vanguard actually lives and breathes it as a result of its mission to take a stand for all investors, treat them fairly, and give them the best chance at investment success. It has a global reputation for offering products solely designed to serve investors’ needs and goals. Vanguard’s desire to deepen its business is a huge win for Mexican investors and I’m honored to have this opportunity to be part of the effort,” Hernandez said.

Vanguard, the world’s largest mutual fund company and one of the world’s largest investment management companies, has gained a global reputation for doing what’s right for investors. “We do that by advocating for low-cost investment products and transparency in what investors are paying for their investments,” Bock said.

“Our views of investing are straightforward, easy to understand and designed for the long term. With more than 40 years of experience in successfully managing money for individuals and institutions, we have helped millions of investors meet their investment objectives around the world. Our goal is to do the same for more investors in Mexico.”

Vanguard, the world’s second-largest ETF provider, offers 65 Vanguard US-domiciled ETFs cross- listed on the International Quotation System (SIC) of the Bolsa Mexicana de Valores and 26 ETFs approved as eligible investments for Mexican Sociedades de Inversion Especializadas para el Retiro (SIEFOREs).

Vanguard has worked with The Compass Group as its distribution partner since 2009 in Mexico, Chile, Colombia, and Peru. “Compass is a critical partner in our success in Latin America. The Compass team has been invaluable in helping Vanguard enter Mexico and in serving investors there and elsewhere in Latin America,” Bock said. “Its local expertise in representing Vanguard’s mission has contributed greatly to our success in serving the pension systems and in participating in industry forums that have served to strengthen the capital markets and pension systems for investors.”
“We look forward to continuing our work with Vanguard to ensure that investors throughout Latin America have access to high-quality low-cost investment products,” said José Ignacio Armendáriz, Compass partner and country head of Mexico.
 

Finegan: “We Look for High Quality Companies in Emerging Markets at Reasonable Prices, that Makes Us Very Different from the Index”

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During the “Janus Henderson Knowledge Exchange”, the first Janus Henderson Investors event after completing its merger process, Glen Finegan, Head of the Emerging Markets Equity team, reminded attendees that a market index is not always the best option for finding investment opportunities and detailed the criteria they take into account when selecting and including a stock in the Henderson Gartmore Emerging Markets fund.

Based on the historical composition of the MSCI Emerging Markets index, he explained that in 1992 the index invested 30% in Mexico, around 20% in Malaysia and about 12% in Brazil. However, China and South Africa, two of the economies with the greatest potential at that time, lacked representation. “In the past, the index was a very poor guide on where to invest during the next 25 years. And, it is very likely, that currently it’s also a poor guide for knowing where to invest, so one wonders whether 25% should be allocated to China, as suggested by the index at present. That’s why we don’t take it into account when building the portfolio and we follow a bottom-up philosophy when selecting stocks,” said Finegan.

He also pointed out that the index also fails to both where people lives today and the expectations of population growth, a determining factor in creating opportunities in emerging markets: “In ten years, the population in Africa is likely to double and this is going to bring a series of very interesting changes, especially for those companies that are dedicated to the sale of detergents, or the ones that run a chain of supermarkets, as they will benefit from a fascinating trend in the long term. While the index focuses on identifying where companies with the largest stock market capitalization are, we are more interested in locating the secular trends that will determine the earnings and profits of companies in emerging markets.”

Finegan explained that an index does not correctly reflect the investment universe because it is only a list of large capitalization companies, something that in emerging markets is frequently linked to companies with state ownership and management, that do not necessarily take into account the interests of minority shareholders. Instead, he said, there are companies domiciled in the United Kingdom and the Netherlands that are not included in the emerging markets index, but which have a strong appeal due to their position in these markets. He cited PZ Cussoms, a company based in Manchester which produces soap and baby products, as an example. “Created in Sierra Leone 135 years ago, they have built an extensive detergent business in Africa, of baby care products in Indonesia, and more than half of their income comes from the emerging markets business.”

He also mentioned Unilever, a firm with a strong brand that currently obtains 60% of its profits from emerging markets, and which has a strong presence in India and Indonesia, Cairn Energy, an Edinburgh-based oil company that recently made an enormous discovery in Senegal and which has an excellent track record in emerging markets, and Heineken, Nigeria’s largest brewery and one of the largest in India and Latin America.

Henderson’s emerging markets’ equity team has spent years looking for investment opportunities among companies with good corporate governance practices, those that respect the interests of minority shareholders. During this time, they have built a list of approximately 350 companies with sufficient quality to invest in them, that any of these companies is finally included in the portfolio depends mainly on a good price, which is not necessarily cheap, but reasonable.

Another concern with emerging markets is that, normally, minority shareholders are not protected by the rule of law.“News headlines in recent years in China, Russia, Indonesia, Turkey and Brazil show that the companies linked to the governments of these emerging countries usually have an agenda which differs greatly from good corporate governance, very often including corruption schemes. That is why we try to find businesses managed by individuals or family groups that seek to manage their business in a sustainable way and are less likely to generate environmental or social problems,” added Finegan, for whom knowing who manages the business, and how their interests are aligned with those of the shareholders, is essential.

“We look for companies that have generated strong returns over the long term, with a strong financial track record, but we’re tremendously concerned about how these financial results have been achieved. Many companies in emerging markets have built their franchises taking excessive risks. However, we like those companies that have built their franchises over time in a slow and secure way, reinvesting their profits. The demographic trend pointing to a new emerging middle class will serve as a tailwind and competitive advantage for many companies, so it will not be necessary to take big risks. An example of this type of company is Shoprite, a leading supermarket chain based in South Africa, which has spent the last 20 years expanding into the rest of the African continent without a significant debt volume on the balance sheet, only reinvesting part of its cash flows in its expansion project. Building a powerful franchise that will continue to grow in the coming years.”

Although the fund is not labeled as the “Sustainability” type fund, it does tend to take environmental, social and governance (ESG) factors into account when determining the integrity of a company’s management team: “If the company’s control group has taken advantage of any of the other parties involved in the company, why would it be expected to treat minority shareholders differently? For example, the fact that, at present, a manufacturing company in China obtains good profit margins by not treating its waste does not mean that in the future it does not have to face the shutdown of its company, investing millions of dollars in remodeling its manufacturing plant, or having to pay a huge fine. All these possibilities result in bad news for the minority shareholder.”

In addition, Finegan stressed the importance of investing in solid franchises, since only these have a strong purchasing power. So, if inflation is high in the country in which they have presence, they are able to push through price increases.

“There is often talk of the large size of the technology sector in emerging markets, but we do not think so, because the vast majority of so-called technology companies in emerging markets are companies with a low technological component. For example, a Taiwanese company that claims to belong to the technology sector, but which actually builds keyboards for Apple. If Apple’s margins fell, they would stop producing their keyboards and would most likely shutdown. That is why we are looking for companies that have demonstrated that they can generate returns above inflation, counteracting the effects of the devaluation.”

To ascertain the quality of the management teams of the companies in which they invest, they study their behavior during past crises, which in emerging markets tend to be more frequent over time, especially in the case of Latin America. “Brazil has experienced several crises in recent years, specifically in 2009 and 2015; in order to know whether the people who run the company are as conservative as they claim to be, you just have to observe how they managed to navigate through these last episodes.”

Finally, on the financial fundamentals side, they look for companies with low debt levels, investing in indebted companies only when they are backed by a strong business group. In addition, they carefully examine the cash flows generated by the company, because in many cases, the company’s income statement is quite fictitious. “We prioritize the preservation of capital when investing in emerging markets. We try to find companies that manage their businesses with a contrary view, allocating capital at the right moments. An example of this would be the Chilean company Antofagasta, dedicated to copper extraction. Antofagasta usually maintains lower debt levels than its competitors, because they know that the only way to acquire good assets at a good price is to be able to buy when the rest of the competitors are forced to sell,” concluded Finegan.

Juan Francisco Fagotti and Valeria Catania Join BECON IM

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Juan Francisco Fagotti y Valeria Catania se unen a BECON IM
Juan Francisco Fagotti and Valeria Catania, courtesy photo. Juan Francisco Fagotti and Valeria Catania Join BECON IM

Third-party distributor BECON Investment Management adds two senior positions in a move to boost its presence among Latin America’s private banks, independent wealth managers, fund of funds, and family offices.

Juan Francisco Fagotti joined the firm as Senior International Sales Representative along with Valeria Catania in the role of Regional Office Manager. Fagotti’s educational background include a degree in accounting from the Universidad Catolica Argentina, and is currently completing a Masters in Finance at Universidad Torcuato Di Tella in Buenos Aires Argentina. Catania brings decades of experience in the financial sector having worked at firms such as Credit Suisse, Prudential Securities, Wachovia Securities, and Wells Fargo.

“We are very excited that Juan and Valeria have joined the team. BECON is experiencing rapid growth in the region so we expect to continue adding additional positions soon. We plan to double in size during the next 3 years by increasing headcount and offices strategically around the region. Latin America is large and clients expect high quality and consistent service. Adding key people, offices, and products is key to our strategy” says Florencio Mas, CFA who is Managing Director at BECON.

The firm plans to open additional offices in Santiago Chile and Miami in a move to take advantage of decades of client relationships in both North and Latin America. Frederick Bates, another BECON representative stated “It’s important to stay focused an ensure our clients’ needs come first and if that includes expansion then we will when the time is right. As a third party distributor we cater to the intermediaries we offer solutions to as well as the asset managers we represent. It is so important to ensure that the asset managers have confidence that BECON is extension of their firm and their products are top of mind every morning when we wake up. Our model is clear in that our true edge is 20 years of experience and relationships in the retail intermediary channel unlike other 3rd parties that primarily focus on pension funds. We also believe the less is more in terms of partnerships with asset managers because in order to represent their products well we can’t become a supermarket. We have space for one more asset manager and are in conversations with firms we believe compliments our current offerings”.

BECON went on to state that one of their true differentiators is the fact that their senior management is directly involved the servicing of client relationships. Also they are solely focused on third party distribution and have no intent to create their own asset manager, private bank, or multi-familiy office. The landscape for distributing cross border mutual funds in Latin America is getting competitive as firms flock to the region in search for growth opportunities beyond institutional channels such as pension funds.

BECON Investment Management is an exclusive 3rd party distributor. In 2017 they partnered with Schafer Cullen, a specialized high dividend value equity manager with $20 billion USD in assets under management. More recently BECON announced an addition partnership with Neuberger Berman, a global asset manager founded in 1939 with approximately $270 Billion in assets.

“The Long-Term Investment Opportunity in the Energy Sector in Brazil and Mexico is Enormous”

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"La oportunidad de inversión a largo plazo en el sector energético de Brasil y México es enorme”
Paul H. Rogers, courtesy photo. “The Long-Term Investment Opportunity in the Energy Sector in Brazil and Mexico is Enormous”

The improvement in economic fundamentals, in both emerging countries and companies, gives these countries the opportunity to grow faster than developed ones, and offer more returns for investors. That’s why they remain a long-term bet, despite the latest rally in their stock markets. This is maintained by Paul H. Rogers, Manager and Analyst of Lazard Asset Management, emerging stock market expert, in this interview with Funds Society, during which he discloses the main risks and opportunities for these markets.

How do you rate the current momentum for entering the emerging market?

Emerging markets have appreciated 20% during the year and we believe that thanks to the improvement of both, country and company fundamentals, they continue to be a good long term opportunity We see how companies’ balance sheets are stronger and the balances of the countries have also improved, leaving behind those bad years experienced between 2013 and 2015. This gives emerging markets the opportunity to grow faster than developed ones.

By price, where is it currently more attractive to invest?

We have to think in general terms. Our investment process is based on the selection of companies, not countries, but the relative valuations of emerging markets versus developed markets point to discounts of 13%, with equity returns of around 25%. That is, we believe that there is a possibility of obtaining higher returns than in the developed markets.

Where in Asia: do you see more opportunities?

We are currently underweight in China, while we are overweight in South Korea and Taiwan. Asia represents 72% of the benchmark and 75% of MSCI EM benefits. That is, it’s the bulk of the emerging market. Other smaller markets, such as Indonesia or the Philippines offer investment opportunities, although they have to be evaluated. company by company.

Is China a risk to be taken into account?

We believe that China’s risk is concentrated in its high debt levels. Its debt to GDP ratio stands at 250%, while growth has begun to slow down. Nonetheless, we believe that the country will be able to manage this risk during President Xi Jimping’s five-year term by carrying out serious structural reforms.

Latin America: Do you see opportunities in this region?

In Latin America we are currently slightly overweight in Mexico and Brazil, where we see good prospects for their companies. Thanks to the improvement of macro factors and the process of stabilizing the price of raw materials, we believe that Brazil can continue to grow, and that companies’ profits should improve. In fact, if we look at the macro factors, it seems more likely that companies generate profits at current prices. We believe that the long-term investment opportunity in the energy sector in Brazil and Mexico is enormous.

Brazil: Despite the recent corruption scandals, do you think that low prices and falls should be an incentive for investment?

It is a country that for many years has demonstrated its ability to overcome political difficulties. Brazil is very attractive at these levels, although Brazil should be approached as a long-term investment.

Which are Mexico’s strengths?

Mexico is going to benefit from the economic strengthening of the US, since many companies have exposure to the American market. Its situation in NAFTA is going to mature and I think it will reach a good agreement with the USA. Both economies are likely to negotiate and improve their relationships. In Mexico, the elections will be held in 2018 and a more populist candidate could be elected. Volatility will surround the electoral process over the next year.

If you had to choose companies from other more modest markets, which markets offer the best fundamentals and prices?

No, we generally do not see great opportunities in these smaller markets, although in Chile and Colombia we see an incredible opportunity for the banking sector to expand and increase its profits.

What will be the impact of higher interest rates by the Fed on Latin American stocks?

I think the US is going to carry out a gradual increase in rates, consistent with the economic growth of the country, which will keep the dollar stable and, therefore, stability within the currency market.

Will other Latin Central Banks follow the Fed’s path?

Each central bank is very independent in its monetary policy, depending on the inflationary situation of each country. In fact, Brazil has to continue to reduce its interest rates, while Mexico is in a cycle of rate hikes.

What are the main challenges and risks for the Latin American stock market during the coming months?

The most significant risks are political, for example, in Mexico, the next presidential elections, and Brazil is pending resolution of the corruption scandals and the final decision on President Temer’s future. These events will generate short-term volatility.

The currency risk: is it better to hedge against it or to assume it when investing in the Latin American stock market?

We take the currency risk into account when investing in a company, although we do not expressly hedge the portfolio. In addition, we have invested in a significant number of companies that generate income and profits in dollars, since they have a large part of their business in the US, and this helps us to somehow hedge against exposure to local currencies.

When investing in Latin American stock market… do you also invest in European or Spanish companies with exposure to LatAm?

Not at present. We have been invested in banks with Spanish holding company and local businesses, but we prefer to invest in companies with at least 50% of their assets or their income in emerging countries

Risk Taking will Require Active Management to Control the Periods of Volatility Which May Arise

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"Si no asumes riesgo, no tendrás retorno, pero eso requerirá de una gestión activa para controlar los periodos de volatilidad”
Neil Dwane, courtesy photo. Risk Taking will Require Active Management to Control the Periods of Volatility Which May Arise

For the second half of the year, with global growth dull, and interest rates staying low for longer, Beta returns will remain low and thus clients should remain confident that active management can deliver good returns that meet the needs for income and capital gain according to Neil Dwane, Global Strategist with Allianz Global Investors, in his latest interview with Funds Society.

What is your vision/forecast for the markets in the second half of the year? Will there be volatility or will calm predominate, as in these last months?

In general we see little upside in many asset classes after a strong H1. The US equity market is now expensively valued with little dividend support and is desperate for Trump tax reform and fiscal stimulus. Also, the US is seeing dull economic growth and faces a Federal Reserve intent on raising rates.

Asia offers more growth opportunities as India and Indonesia capitalise on their modernising new Governments whilst we expect China to be stable ahead of the Party Congress in November. Longer term, Asia offers the opportunity of 4bn new consumers for whom the “American Dream” is alive and well.

Europe looks attractively valued as the political risks following Brexit fade and the new positive momentum from Macron could energise the “journey to the United States of Europe” in 2018, though actual policies seem unclear as yet. With interest rates likely to stay very low, Euro investors face the continuing conundrum of holding return-free bonds or switching into equities which offer either an attractive dividend or good industry exposure to the world’s opportunities.

“If you take no risk, you will earn no return” remains our mantra and thus taking some risk will require active management to control the periods of volatility which may arise.

What will be the main sources of uncertainty?

For many global investors, the key generator of uncertainty remains the policy directions from President Trump who may yet become trade protectionist with Asia and NAFTA and may or may not actually achieve any tax reforms which can sustain the US economy.

Geopolitics in the Middle East and other areas related to the energy sector may also continue to unnerve investors as an oil supply shock is not priced into the current price of oil. Clearly this would hurt most oil importing economies and tax global activity.

More difficult to assess, is the troubling situation with North Korea where pressure from the US and China is not yet showing any substantial progress but which could be easily inflamed by a diplomatic mistake or misinterpretation.

At geopolitical level, the negotiations of the Brexit will begin … how do you foresee that they will develop and what impact will there be on the markets, especially in Europe? Will the UK shares and the pound be the only ones harmed?

Brexit presents a period of great uncertainty, made worse by the recent result of the June UK elections. We think it very unlikely that a deal can be negotiated by 2019 and transition arrangements will be necessary. All European companies will hope that economic and business sense prevails and that the broad regulatory and trade processes used today are maintained. The UK will endure a significant period of economic uncertainty and weakness now, which may weaken Sterling further, whilst the EU may make better progress as Macron rejuvenates policy.

Both the Euro and Sterling are undervalued against the US Dollar, and we would expect Euro to strengthen from here first and further.

Also at the geopolitical level, there will be elections in September in Germany. After what happened in Holland and France, could it be said that populism has been banished in Europe or do we still have to wait?

For now it would seem that populism has peaked after the Brexit vote. However, it should still be noted that anti-EU parties received 40% of votes in recent elections and possibly, even in France, only half the electorate voted for Macron. Shorter term, Italy becomes the last fault line of significant political risk for Europe as nearly 60% currently favour anti-EU parties but at least we have until May 2018 to assess progress further. Thus, populism may slumber and awaken in the next electoral cycle if Europe’s policies do not share its wealth, growth and opportunities better.

Do you see political risks in markets like Italy or even Spain?

Italy is of concern as above. Spain seems to us to offer little political risk to Europe given its short history as a democracy and the Catalan question may be addressed through further local economic empowerment in due course.

On monetary policies: Do you see a clear distinction between the US and Europe? What do you expect from the Fed?

Yes, we have entered a period of monetary policy divergence with the ECB remaining accommodative and the Fed now raising rates and considering how to reduce its balance sheet. Financial conditions in the US remain quite loose so we expect the Fed to continue to raise rates in H2. Global monetary accommodation is peaking and the consequences for many asset classes from QE will now beginning to manifest themselves, especially in the overvaluation of sovereign bonds.

When will the ECB act? In this sense, how can monetary policies impact global equity markets and investor flows?

We expect the ECB to finish tapering QE in 2018 and to then raise rates albeit slowly in 2019, dependent on the strength of the economy then. This should support the mid-cycle economic expansion we see today.

Regulation, such as MIFID II: impact on industry and markets

We expect MIFID 2 to offer better transparency and thus better investment solutions to clients as it will force all managers and distributors / advisers to explain what services they are providing to their clients and at what costs. This could be very disruptive. It will thus force new business models and new relationships to be forged with clients but it will change the current financial services landscape. Brexit too, will shake up the industry as it remains unclear if being equivalent will mean the same as it does now for many European banks and insurers.

At the market level … what assets do you see more opportunities for the second half of the year and why?

Taking risk to earn a return, and managing client nervousness to headline shocks and uncertainty, leaves us with high conviction over the “hunt for income” where clients can find attractive levels of yield from US High Yield and Emerging Market Debt as well as European equities. With global growth dull, interest rates staying low for longer, Beta returns will remain low and thus clients should remain confident that active management can deliver good returns that meet the needs for income and capital gain.

Seizing the Infrastructure Opportunity

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Bridges, roads, water systems…these are but a few examples of the infrastructure essential to keep the global economy moving forward. Infrastructure itself demands ongoing investment. In the developed world, the need is for improvement and new capacity; in emerging markets, urbanization and population growth are driving new spending. Indeed, global infrastructure projects are forecast to more than double by 2030.

Such a robust expected growth rate for infrastructure is certainly supported by the current environment. Not only does the need for more spending exist, but, according to Legg Mason, there’s heightened interest for more fiscal stimulus, especially in the developed world, to help boost a lackluster rate of economic growth. Monetary policy initiatives have largely supported the world economy since the financial crisis of 2008, but if fiscal policy begins to play a larger role then infrastructure could be a natural beneficiary.

Infrastructure in the US: The Trump factor

Increased infrastructure spending is certainly a priority for the new Trump Administration in the United States and it’s one of those rare issues that seem to have a lot of bipartisan support, increasing the likelihood that it actually happens. One of the world’s most important proponent of infrastructure investment right now can be seen in President Donald Trump’s well-publicized trillion-dollar spending objective, the details of which however, are not yet known. According to Richard Elmslie, co-CEO and Portfolio Manager at Legg Mason, “In general, what President Trump is really trying to do is, rather than to build a lot of new infrastructures, to rebuild those existing infrastructures that are in poor condition, and this is actually a proposal that carries fewer risks. His vision is exactly how we look at the infrastructure sector.”

Ajay Dayal, Investment Director at Legg Mason added that “when we find opportunities, we apply a highly-disciplined bottom-up process based on risk-adjusted returns; in fact, RARE is the acronym for Risk Adjusted Return on Equity. Opportunities can come from different factors: from profitability factors, political, or changes in the economic outlook,” explains Dayal. As an example, he recalled that just after the US elections, after Trump was elected, bond yields began to rise and many people began to flee from utilities, which the market sees as a proxy asset to public debt. “After a while, these companies became really inexpensive and from our perspective, when there is a generalized exit from this type of stocks, we must study the opportunities that have arisen there in terms of valuations,” he points out. But the question surrounding Trump is whether this is a time to invest in infrastructure because of the plan that could be implemented in the United States, or whether there is something else. Dayal is convinced that this opportunity, in which the private sector will play a very important role in the financing of projects, is going to spread to many more countries. “Trump’s agenda is incredible for attracting infrastructure investments to the United States, and it’s making people realize that the best way to create growth in a country’s economy is through spending in this area. But Trump’s plan is also going to make other developed and emerging countries take a look at it in terms of productivity.

The need for investment capital

While the public sector will remain a major source of financing, greater private sector participation is a must, given fiscal constraints and the sheer magnitude of the need. With greater involvement from the private capital markets the opportunities for investors should naturally increase as well. In fact, the demand for private-sector capital to make ambitious plans a reality creates opportunities for investors looking to participate in this growth, and to participate in the income opportunities which are a unique feature of this type of investment.

Recognizing the income opportunity

For investors, infrastructure offers a potential opportunity to address some of today’s challenges—like the need for competitive income. Indeed, the S&P Global Infrastructure Index, a key benchmark for the sector, sported a dividend yield of 3.75% as of 3/6/17 compared with 2.37% for the MSCI World equity index and just 1.68% for the Bloomberg Barclays Global Aggregate Bond Index.

In some cases infrastructure company revenues are regulated and often linked to inflation. This can provide for stable cash flows and serve as a potential hedge against inflation. Stable cash flows can allow for sustainable dividend payouts and may contribute to lower correlation and less volatility relative other major global asset classes, which can make it a worthy diversifier in a broader portfolio.

Behind the income from infrastructure investments

Infrastructure investments are uniquely appropriate for investors looking for secular growth in the longer term. The listed companies in these sectors can generate stable dividends and have the potential to generate returns at attractive valuation levels. But surprisingly, it’s the regulated nature of the infrastructure companies that accounts for the highly sought-after potential for stable income for those investors. The electricity, gas or transportation companies, and other key services for citizens such as water supply, airports, roads, hospitals or schools, — along with their associated distribution and maintenance operations – are almost all regulated by governments or agencies – and those regulations tend to focus on minimum and maximum profit margins, as well as on distributions from the income they generate. But that regulation doesn’t encompass the share prices for these companies, which can – and does – fluctuate, providing opportunities for value-minded and risk-averse investors such as the ones offered by RARE Infrastructure to generate attractive total return for its investors.

Koesterich: There are Very Few Bargains Across Major Asset Classes. In Order to Find Value, One Must Get More Creative

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Koesterich: "Hay muy pocas gangas en las principales clases de activos y para encontrar valor uno debe volverse más creativo"
Russ Koesterich. Koesterich: There are Very Few Bargains Across Major Asset Classes. In Order to Find Value, One Must Get More Creative

It’s been over a year since Russ Koesterich, Portofolio Manager of BlackRock‘s BGF Global Allocation Fund joined the Global Allocation team. In this interview he talks about his investment process, asset allocation, the market, reflation, factor investing, volatility, and the key economic data points that his team is monitoring.

Tell us about the work that you and the team have been doing to evolve the investment process.

Since the inception of the strategy in 1989, Global Allocation has been a story of evolution as the investment opportunity set has grown, technology has improved and team resources have expanded. We have continued that evolution and made some enhancements to the investment process which we believe harness the competitive advantages of the Global Allocation platform. These include: a greater dedication of risk budget to our higher conviction ideas from our bottom-up security selectors, position sizing by the portfolio managers and the adoption of more robust portfolio optimisation tools that allow us to better calibrate our top-down asset allocation decisions.

What has not changed about Global Allocation is our mission to deliver returns competitive with global stocks, over a full market cycle, at a lower level of volatility. We also remain keenly focused on managing risk, maintaining flexibility, and being value-oriented in our investment decisions. We do, however, expect recent enhancements to allow for more deliberate risk taking in the portfolio and believe that they provide a competitive advantage relative to other multi-asset funds given our focus on both bottom-up security selection and top-down asset allocation. While it is still early days since initiating these enhancements, we are encouraged by the improvement in relative performance and in particular would note the contributions to performance that we have seen from both security selection and asset allocation.

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You talk about the ability for Global Allocation to deliver a higher breadth investment solution at a time when there are few cheap traditional asset classes. What do you mean by that?

Higher breadth refers to a portfolio that is well diversified, with lots of relatively small, uncorrelated bets. Having the opportunity to work on the BGF Global Allocation Fund with its flexible mandate and a highly experienced, fundamentally driven, multi-asset investment team was very compelling to me. It is uncommon for multi-asset funds to have both bottom- up and top-down expertise within one captive team. This depth of expertise allows for multiple ways to generate alpha relative to a standard 60/40 benchmark and allows for more differentiation versus a portfolio of all ETFs.

Looking at valuations, the challenge for many investors is that broad betas are generally expensive. That is certainly the case in developed market government bonds and US equities. In fact, US equities and US bonds have never both been as expensive at the same time as they are today. In short, there are very few bargains when looking across at major asset classes. In order to find value, one has to look a little deeper, beneath the surface of the index, and get more creative in order to isolate opportunities.
 

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This is where we can build a portfolio of more bespoke ideas. This includes the work we are doing to focus more of our risk budget on the idiosyncratic ideas derived by our fundamental investors. In addition, we have capabilities to build customised baskets of securities that seek to capitalise on a particular theme that we feel strongly about, such as dividends in emerging markets or low-volatility stocks that possess less interest rate sensitivity. The fund’s ability to utilise derivatives such as options, also allows us to move opportunistically when we identify an attractive opportunity and build an asymmetric payout into the portfolio. This was on display last summer when we bought long-dated, out-of-the-money call options on US financial stocks shortly after the UK referendum. It is flexibility like this that allows for more varied ways to generate alpha at a time when broad betas have enjoyed a phenomenal market rally.

The ‘reflation rally’ that began in mid- 2016 stalled out in the first quarter of 2017. What do you think is driving this change in asset class performance and how has the fund performed as a result?

The exact cause of the change in asset class performance is tough to pinpoint, but it is likely to be a combination of investors adjusting their views on global growth in the short-term and asset price movements. On the latter point, the asset classes most likely to benefit from a period of reflation moved a good deal from the summer of 2016 as global growth expectations improved. In many respects, it is not unusual to see these market trends reverse, even if for only a brief period, as investors seek to rebalance their portfolios. Within the BGF Global Allocation Fund, we too made a number of rebalancing decisions in Q1 in response to this change in asset prices. These included: reducing the fund’s financials weighting; adding to US dollar (USD) duration as yields backed up; reducing the fund’s USD weighting and adding to gold-related securities. These rebalancing decisions, along with a few others, have allowed the Fund to maintain a strong start to the year despite shifts in asset class leadership.

What are the key economic data points that your team is monitoring and do you believe that the world economy has shifted into a higher-growth, higher-inflation regime? How is the portfolio positioned in light of this?

While there has undoubtedly been an improvement in the global economy since early 2016, the jury is still out on whether we have shifted into a higher-growth, higher-inflation regime. Like many investors, we are very focused on the divergence between the consumer and business survey data (i.e. soft data) and the transactional data such as GDP, retail sales and things like auto sales (i.e. hard data). In short, the global economy is not performing as well as the survey data would suggest. We have seen episodes like these in the post-financial crisis era, whereby risk assets have appreciated given expectations for monetary and/or fiscal stimulus; when those expectations prove to be too optimistic or when the stimulus starts to fade, risk assets can become vulnerable to the downside. In the near-term, we need to see firmer evidence, especially in the US, that confidence is translating into activity.

Therefore, I would characterise the portfolio as still constructive on the economic outlook over the intermediate term and as a result, still constructive on equities, especially in Japan and Europe vis-à-vis the US. We have, however, made a number of small adjustments to the fund’s sector positioning, fixed income duration, gold exposure and currency positioning as potential hedges in the event that global growth expectations start to deteriorate more rapidly.

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Equity market volatility is at a historical low despite policy uncertainty and geopolitical risks increasing. How do you guard against the possibility of increases in market volatility while still pursuing your high conviction views?

This is the essence of portfolio construction and something that I think we do well and that we have been able to evolve over the past year. The possibility that equity market volatility could increase should not prevent us from pursuing our higher conviction views. Rather, it should cause us to think about what we want to own in conjunction with those higher conviction ideas in order to effectively manage our risk, both in absolute and relative terms. Unfortunately, what we see from many end investors over time is a tendency to construct a portfolio based purely on their best ideas without any thoughtful consideration to correlations and how things interrelate. The risk is that the investor ends up with a portfolio of correlated ideas at the wrong time in a market cycle.

We have the ability to look at the fund through multiple prisms, which allows us to understand not only sector or regional exposures, but also something like our factor exposures. To what extent are we more exposed to quality or momentum and how can we manage that if we believe volatility could spike? We can also look at recent asset class correlations and then change our correlation assumptions in order to stress test the portfolio under a different market regime. To what extent is gold helping to diversify equity risk today versus previous years? The answers to these questions can provide us with important insights so that we persist with our high conviction ideas, remain well diversified in the event of a change in volatility and seek to deliver a return that is competitive with global stocks over a full market cycle at a lower level of volatility.
 

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