Pioneer Investments: “In 2017, Europe will Experience the Highest Profit Growth that it has Seen in Recent Years”

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Pioneer Investments: “Europa registrará en 2017 un crecimiento de beneficios superior al que se ha visto durante los últimos años”
Photo: Fiona English, Client Portfolio Manager at Pioneer Investments. Pioneer Investments: “In 2017, Europe will Experience the Highest Profit Growth that it has Seen in Recent Years”

Clearly, 2016 has been a transition year for European equities. A true roller-coaster with dizzying news and an unexpected end to market rebounds due to President Trump’s arrival to the White House as US President. The recovery of investor confidence with which we have started the year will give way to multiple uncertainties and geopolitical risks.

According to Fiona English, Client Portfolio Manager of Pioneer Investments with responsibility for European Equity, markets have long been waiting for a tipping point in Europe’s growth and profits. During the last 3 to 4 years, however, we have been disappointed again and again. This year will be different.

“Although political risk has increased, it is likely that growth will finally pick up in 2017, and I believe we will also see an increase in corporate profits for European companies. In addition, consumption is accelerating and figures in many other areas of the economy have proven to be resilient. Even “after the referendum in Italy the European market rebounded 5% with some indices returning close to 10%”, explains the fund manager.

Another argument in favor of European equities for 2017 is that, as a result of the political risks facing Europe, the authorities of the Old Continent have changed their position and are starting to now be more in favor of measures that stimulate growth as opposed to the prevailing austerity of recent years. And this, as has happened in the United States, is good for the stock markets, explains Fiona English.

Positive returns

In addition, European companies have a large global exposure. At least 50% of revenue comes from outside Europe and for Pioneer this means that once global growth improves, European companies should improve their results as well. It is a positive scenario that makes us modestly optimistic about what European equities can do this year. Looking ahead, I think this year the European stock markets are going to experience improvement in their dynamics and will generate positive returns,” says English.

For Pioneer Investments’ Client Portfolio Manager, that conviction does not mean that everything is going to be a bed of roses. The political risks facing Europe are many and are not about to disappear, which will mean that “the stock markets will experience periods of volatility and sales waves at certain times.” For example, after the rebound of the last quarter, as a result of the Trump effect, it is likely that “the stock markets will go through a period of consolidation during the next 3 or 4 weeks. Investors will want to reap profits in the short term.”

Correction could occur due to some of the geopolitical events that we have in sight for the next few months, or perhaps to some other event overlooked by the market (for example, China hasn’t caused any turmoil for a while now). These declines may be definitely good entry points into the market. The Pioneer fund manager also mentioned the generalized outflow of bond market investors, which will basically could result in an inflow into equities – providing support to the asset class

Growth or Value, what will win this year?

“We’ve had 6 or 7 years in which growth strategies have done better than the market in general, especially since GDP growth in Europe was so weak that for a portfolio to do well, it had to be in areas of the market where there was profit visibility. Emerging markets was one of those areas, and the United States was another,” said English.

What we have begun to see over the past 6 months, however, is a rotation as valuations in those markets have fallen, and secondly, inflation expectations have rebounded. In this respect, the Pioneer fund manager believes that, indeed, the value segments of the market are starting to look more attractive.

“What we, at Pioneer, don’t believe is that this should be an exclusion scenario of the type ‘either growth or value’. No, we believe that we must opt for both, quality securities within the market, and for stocks with good fundamentals. The best example of this is the financial sector. It should do well this year, but that does not mean we’re going to opt for any security within this sector. We have to include in the portfolio those entities that are going to endure the political and regulatory challenges looming on the horizon,” she concluded.

In short, a balanced portfolio with both management styles is what will help investors to sail through the numerous rough patches that are anticipated along the way.

Morrell: “There is an Increased Probability of a More Procyclical Fiscal Policy in The Developed Economies”

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“Aumenta la probabilidad de una política fiscal más procíclica en las economías desarrolladas y las políticas reflacionistas podrían beneficiar a las socimis”
CC-BY-SA-2.0, FlickrGuy Morrell, Head of Real Estate Investment at HSBC Global Asset Management. Courtesy Photo . Morrell: "There is an Increased Probability of a More Procyclical Fiscal Policy in The Developed Economies"

In this interview with Funds Society, Guy Morrell, Head of Real Estate Investment at HSBC Global Asset Management, maintains that real estate shares have the potential to generate acceptable risk-adjusted returns, though lower than in the past. Therefore, dividend growth is a great support factor to beat public debt. And they also offer the potential benefit of portfolio diversification. Currently, his favorite markets are USA. and Australia.

Which is currently more attractive: investing in real estate directly, or through stocks linked to the assets?

Our strategy is to invest in real estate through listed real estate stocks rather than directly in buildings, for various reasons. First, we require a high level of liquidity for our strategy that is not available when investing in buildings, as buying and selling takes time. On the other hand, real estate sector shares offer a much higher level of liquidity. Secondly, building a portfolio of properties globally requires a lot of capital. A common characteristic of offices, retail premises, or good quality industrial properties is their large sizes. It is difficult to efficiently diversify the specific risk of construction. On the other hand, investment in real estate stocks exposes companies with large portfolios, which helps to overcome some of the portfolio-building challenges associated with direct investment. Finally, investing in physical buildings requires specialized and local experience in key markets around the world. When investing in real estate stock, we are investing in specialized management teams.

Therefore, for our particular needs, investment through real estate stocks offers significant advantages as compared to direct investment. This does not mean that investment in buildings is inappropriate for some strategies. Large investors who can allocate large sums of money to acquire properties globally, and who do not need liquidity, may find that investing in buildings is an appropriate way to access this kind of asset. The key is to ensure that the way to access this asset class is consistent with the objectives and investment requirements of the clients.

How can you manage and control the risk of equity-linked volatility in a fund like the HSBC Global Real Estate Equity?

Real estate stocks are more volatile than direct properties, although this is due in part to the infrequency with which property valuations are made, which tend to be based on historical evidence. That said, there are certain features of our strategy that are worth highlighting. First, we have a preference for stocks that generate a high level of recurring income. Therefore, we avoid companies that generate most of their returns purely through development activity, which tends to be very cyclical. In addition, we have a preference for companies that have low levels of debt, since excessive leverage can exaggerate market cycles. Finally, we seek to bias the portfolio towards markets that we believe offer acceptable returns over the long term. While we cannot avoid the volatility associated with real estate stocks in general, our strategy seeks to benefit from the characteristics of the long-term performance of the property that produces the income, but in liquid form

Which do you consider to be currently the main attractions when facing equities linked to real estate?

Real estate stocks have the potential to generate acceptable risk-adjusted returns. They provide a dividend yield that has historically been higher than that of other stocks. And there is the prospect of dividend growth, since rental income generated by real estate stocks responds to the economies on which they are based. There is also the potential benefit of diversification because real estate stocks are not perfectly correlated with other long-term asset classes. In the short term (for example, for some months), there is a reasonably high correlation between stocks of real estate companies and other types of stock. However, as the period over which stocks are held increases, the correlation between real estate stocks and other types of stocks tends to decline. Similarly, in very short-term periods, there tends to be a weak correlation between real estate stocks and the underlying physical property. But as the period over which the stocks are held expands, the correlation between the real estate stocks and the underlying physical goods market strengthens.

And what are the main risks this year?

Potential risks take various forms, including uncertainty about the prospects of the global economy, the effectiveness of economic policy and political developments, including the rise of populism. From time to time, these could lead to periods of episodic volatility. However, we remain reasonably positive with our prospects. Regarding major economies, global cyclical activity has increased since mid-2016. While growth is likely to remain mediocre as compared to historical levels, there is reasonably resilient growth in the US, acceleration of the dynamics in the Euro zone and an improvement in activity in parts of Asia. It also seems that we are entering a period in which global fiscal and monetary policies are more coordinated. Interest rates are likely to remain relatively low (compared to the average levels of the last 30-40 years), even allowing for some increases in certain economies.

Can a U.S. interest rate increase affect the asset?

The effect of interest rates increases on asset prices depends on the underlying reasons and the magnitude of the increases. If they occur due to stronger economic growth and are gradual, then we believe that this would be a reasonably positive environment for REITs. Investors are likely to have already taken into account a modest increase in interest rates, and an improvement in the economic environment could be expected to lead to an increase in rents and to the net operating income of the REITs. However, if interest rates rise unexpectedly, or if the increases are in response to high inflation but weak growth (a stagflation scenario), then REIT prices may be adversely affected. Taken together, we believe that the first scenario is the most likely – when the incremental interest rate increases occur due to improved fundamentals – rather than to stagflation.

And political risks: elections in Europe, Trump in the US…?

Political risks could lead to periods of asset price volatility. While increasing populism may remain a concern for some time, it also increases the likelihood of a more procyclical fiscal policy in developed economies. This could lead to more constructive reflationary policies, in contrast to the more deflationary stance of recent years. Such an environment could, in the long run, benefit REITs by increasing their net operating income. And from a global perspective, rather than one that maintains a national or regional focus, this means that our strategy has an element of geographic diversification.

You invest globally: in what regions do you currently see greater opportunities for your fund?

We believe that certain markets in the United States offer risk-adjusted returns that are reasonably attractive due to a positive economic outlook combined with favorable competitive bidding. Within the Asia Pacific region, Australia is our preferred market.

Within Real Estate, in what sectors do you see the greatest appeal?

While our preferred sectors vary geographically, we have a general preference for the retail and logistics sector over the office market. In the United States, where there is a higher level of sectoral specialization than in other markets, we also see value in the self-storage and residential sectors.

What returns can be expected from these investments in stocks related to real estate?

We expect lower absolute returns on Real Estate sector stocks as compared to historical long-term averages. However, based on our estimates of future dividend growth, we believe that global real estate stocks are reasonably priced to offer acceptable long-term returns as compared to core government bonds.

Paul Brain: “If Trump Focuses On Infrastructure Spending, There Will Be A Rally In Emerging Market Bonds, But If There Are Trade Barriers We Will See Massive Sales”

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Paul Brain: “Si Trump se centra en el gasto en infraestructuras, habrá rally en deuda emergente pero si hay barreras comerciales veremos ventas masivas”
Pixabay CC0 Public DomainPaul Brain, Head of Fixed Income at Newton, part of BNY Mellon. Courtesy Photo. Paul Brain: "If Trump Focuses On Infrastructure Spending, There Will Be A Rally In Emerging Market Bonds, But If There Are Trade Barriers We Will See Massive Sales"

The shift from monetary to fiscal policies could boost inflation in those markets with higher growth and excess capacity…. and that will have an impact on the financial markets. For Paul Brain, Head of fixed-income at Newton, part of BNY Mellon, long-term public debt will be adversely affected, especially in the US, while credit could hold better if there is growth. As he explained during an interview with Funds Society, the Trump effect has unleashed expectations of growth and inflation, so Fed rate hikes are expected, but will be lower than expected while the ECB will continue with its expansionary policy… even though the IRR of peripheral debt could continue to rise. As for emerging debt, it all depends on whether spending on infrastructure, or trade barriers for developing markets, dominate Trump’s policies.

Are Donald Trump, and the economic outlook that revolves around him, unleashing a return of inflation?

There is a major change taking place globally and Trump’s ideas fit into this new context. We have passed the stage where we only had monetary expansion to support growth, and now governments are focusing on fiscal stimulus measures. In some economies, this change could trigger a rebound in inflation expectations, if interpreted as an additional boost factor. However, the inflationary impact will be lower in those economies that still have slow growth and overcapacity. In addition, many governments may not have the authority to quickly approve sweeping measures unless another crisis occurs.

How will these changes affect inflation in fixed income markets?

Going from relying solely on an expansive monetary policy (which is positive for fixed income) to a combination of monetary policy and fiscal stimulus will adversely affect bonds with longer maturities, as expectations for greater support from central banks are reduced. We have been informing about this change since the summer. However, the initial reaction could lead to further correction if the authorities succeed in launching serious fiscal stimulus programs. The US bond market is the most vulnerable because its central bank has already begun the process of monetary restraint. Credit markets could perform better because of improved growth prospects, and hence, improved corporate profits, but emerging market countries that have issued US dollar-denominated debt will see the cost of that debt rise.

Will investors commit to risky assets or will they opt for safe haven assets in the face of uncertainty?

Risky assets (emerging market debt and currencies) could stabilize if fiscal stimulus measures do have positive effects on economic growth, especially those that were most affected by the collapse of commodity prices. The stock markets appear to be anticipating good news from Trump’s plans and ignoring the negative comments about trade, etc. In our opinion, the demand for safe haven assets will increase as markets shift their focus to other political events, such as the various electoral processes that will take place in Europe next year.

What are the forecasts for the Fed’s performance in this environment?

With rising wages and the prospect of fiscal stimulus measures, the Fed is mandated to raise interest rates in December and present its rate hike forecasts for 2017. We are concerned about the length of the economic cycle for the United States since, beyond the stability of consumption, we began to see investment deceleration. We have left cheap money behind; and the spike in corporate leverage that has occurred during the past two years, along with higher costs (rising wages and appreciation of the dollar), will stifle profits and slow the economy down. So if fiscal stimuli are not enough (because they are downsized while being passed in Congress, are poorly designed or slow to implement), the US economy could slow its growth and then the Fed will stop raising its rates. In short, in the short term the market will price-in a higher official interest rate, but we continue to believe that the maximum that rates will reach will be lower than what the market expects.”

How will this lead the ECB and European debt?

Any factor driving global growth should be positive for an open economy like the European one, but protectionist discourse (both Trump and Brexit-related) and uncertainty over the growing popularity of anti-European parties will constrain growth. Therefore, we believe that the ECB will maintain its monetary policy expansion and that the IRR of European core debt will continue at low levels. On the contrary, the IRR of the peripheral bonds could continue to increase in the short term.

And emerging debt?

If Trump focuses on infrastructure spending, there will be a rally in emerging market bonds, but if there are trade barriers we will see massive sales

Will inflation-linked bonds, floating rate bonds and such instruments gain appeal?

We currently like bonds linked to US inflation and variable rate bonds because we think the potential rebound in inflation and the possibility of the Fed taking a tougher stance is being underestimated. It is possible that at the beginning of next year we rotate to other segments of fixed income if Trump’s policies disappoint.

What is your Outlook on the Dollar?

The dollar is backed by both the US interest rates hike expectations, and rising political uncertainty in Europe. As in the case of bonds, this situation could quickly change once the market’s “infatuation” with Trump is over.

EDRAM Defies Consensus Placing Venezuela, Ukraine, and Turkey as The Ones with the Most Potential in Emerging Debt

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EDRAM desafía el consenso y ve en Venezuela, Ucrania y Turquía las historias con más potencial en deuda emergente
Pixabay CC0 Public DomainJean-Jacques Durand, courtesy photo. EDRAM Defies Consensus Placing Venezuela, Ukraine, and Turkey as The Ones with the Most Potential in Emerging Debt

When it comes to identifying investment opportunities for next year, at Edmond de Rothschild AM they try to see the glass half full. But when it comes to investing in emerging markets, says Jean-Jacques Durand, Emerging Market Hard Currency Bond Manager, the investment is binary: it’s either all or nothing, “either you see the glass completely full or completely empty.” It is true that feelings are often extreme in these markets and there are always difficult periods but, in exchange, the manager reminds us, the exciting thing is that there are always interesting stories in emerging markets. “We have an opportunistic investment philosophy focused on where there are good stories. Even if the asset is not liked in general, there are always stories with good potential,” argued the manager, during a presentation with clients in Madrid.

Speaking of these interesting stories in emerging debt, Durand never disappoints with his anti-consensus positions. In the current context, and in analyzing the risk-adjusted returns, the manager points out that in recent years it has been the high-yield debt that has behaved better, because the higher spreads absorb the risks. In this sense, their proposals are very heterodox and they focus in countries like Venezuela, Ukraine and Turkey. He plays very interesting stories in the fund that he manages.

“Venezuela is in a transition situation comparable to that of Argentina a few years ago, when the country was debating between a political model that was coming to an end to give way to something new. It is a more dramatic case but the comparison makes sense,” explains the fund manager. In his view, there is an asymmetry in the short-term risk and long-term prospects of a country that has the resources to pay its debt (although there is some restructuring along the way). That is why currently it is one of the most attractive investment cases, he says, despite political problems, and lower oil prices. “The probability of seeing a new country in a few years is almost certain,” he says.

With regards to Ukraine, he also points to its transition since the war, with a diversified economy (agriculture, industry and technology) that also has the support of the West due to its strategic importance. In addition, he sees less risk of interference from Russia than two years ago.

In Turkey’s case he also differs widely from other fund managers. In his opinion, the discounted market as response to political problems is an overreaction: “There have never been defaults on their debt, the payment culture is very strong in Turkey, unlike countries like Russia” and also adds its low debt- to-GDP ratio. Despite the political problems, it is interesting, he says.

Brazil is also an attractive case, although fundamentally it has been the story of 2016: “Every year there is a good story, and there are usually very few, and this year it has been Brazil,” with a story of political and economic transition which has encouraged them to take positions in Petrobras. He believes that there is still potential for future reforms.

Technical and fundamental support

In emerging debt, says the fund manager, one of the keys are the flows, and explains that this market has changed a lot in recent years and, unlike decades ago, now has the support of the institutional investor. “In 2016 there has been a return of flows after two years of outflows following the taper tantrum of 2013, which partly explains the rebound,” he says. But although not all investors return, the key segment that does guarantees support for the asset: “Emerging debt accounts for 12% of global debt and the institutional investor, who was not there 20 years ago, now invests 3% to 4% of his portfolio. That demand will remain and will support emerging long-term debt,” he says.

The fund manager acknowledges that flows are increasingly important in a less liquid environment, partly because investors have to focus their capital on certain assets and this accentuates the lower liquidity and greater volatility in emerging debt. For the expert, the asset compensates for the risks taken in the long term and advocates a strategy with a broad horizon, as it is “dangerous and costly” to have a short-term strategy in these markets.” In addition, the current attractive valuations give room for that potential in the medium and long term.

Do Not Fear the Fed

But it’s not only technical factors that support the asset: in terms of fundamentals, these markets are stronger today than in the past, as they have higher currency reserves, a lower debt-to-GDP ratio than developed countries, and more debt in local currency than in dollars. For the fund manager, if they have already adapted to difficult situations such as the fall in commodities, they are prepared to face the risk of US rate hikes.

Three-quarters of the time US rates are negatively correlated to emerging market debt spreads, i.e., the behavior is positive because growth is priced-in. Only when there have been surprises has the asset fallen,” explains the manager. Neither have interest rate hikes been a bad sign for commodities, so the Fed should not be feared, he says.

China: The Number 1 Risk

The major risk, which could be systemic, is, in his view, China: “It is the number 1 risk for emerging markets and we must use hedging because the readjustment in their economy will not be smooth, it is unlikely,” he says; which is why he is hedged with CDS.

EDRAM 2017 Asset Allocation in the Developed World

In the presentation in Madrid, Benjamin Melman, Head of Asset Allocation and Sovereign Debt for the management company, spoke of the preference, for 2017,for European assets, and also – but to a lesser degree – US assets (particularly cyclical sectors with a focus on banks and the health sector); in fixed income, although the vision is negative, they’re committed to bonds linked to inflation in Europe, high-yield in the Old Continent, investment grade credit in the US, and, above all, European subordinated financial bonds, his favorite debt asset for next year.

Allianz GI: “Value no Longer Looks Cheap Relative to Growth”

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Allianz GI: “El value ya no parece barato en comparación con el growth; puede que ya hayamos pasado lo peor en términos de rotación”
Matthias Born, courtesy photo. Allianz GI: “Value no Longer Looks Cheap Relative to Growth"

Matthias Born, Investment Style Co-Leader Growth and Senior Portfolio Manager European Equities, Allianz Global Investors, says value no longer looks cheap relative to growth. He states in his interview with Funds Society, that the latest value rally has lasted 7 months already, which makes it easier for stock pickers like them.

El experto defiende que ahora es el momento de la economía y los ingresos, y el mercado tiene altas expectativas, por lo que el estilo growth podría hacerlo muy bien a partir de ahora. Así, con más margen para la recuperación económica y una recuperación de la inflación global, cree que los beneficios repuntarán y favorecerán a sus estrategias.

The great rotation that favors cyclicals against defensive players seems to be positive for the value strategies. Can it also favor growth strategies or is it a risk to them? Will the growth strategy continue working well in this environment?

Growth style portfolios are not per se defensive. Our portfolio for example is highly exposed to technology stocks, Industrials and consumer cyclicals. The value style is more tilted to financials and commodities among cyclicals. The latest value rally was mainly driven by a mean reversion into stocks, which underperformed for a long period of time, like banks.

Is this turn sustainable?

Usually these kind of sharp style rallies last for a couple of quarters, we are now into 7 months already. The extent of the rally is usually quite huge in the first 100-150 days. After that we usually see a stabilizing trend and we see again bigger performance dispersion across styles, which makes it easier for stock pickers like us.

Improving cyclical data, rising bond yields (caused by an increase in inflation expectations) particularly in the US, and a recovery in commodity prices contributed to the second sharpest rotation of the past decade. This resulted in European value outperforming growth by c. 16% since August and outperforming high quality by 25% over the same time period. Also cyclicals, and especially low quality ones, have seen the steepest rally since 2009. It is now showtime for the economy and earnings, the market has high expectations.

Seen the great rotation mentioned … How are you adapting your European equity portfolios?

Turnover during the year 2016 was, as ever, typically low ranging between 18% and 21%, reinforcing the team’s 3-5 year+ investment time horizon.  The bulk of our trading activity occurred in H2, as we sought to benefit long term from some of the inefficiencies created by political volatility, and the sharp underperformance of growth/ quality. In the year 2016 we have reduced our high weighting towards consumer staples and picked up some high quality names, that were derated after the Brexit vote, like Ryanair.

What sectors / values can benefit from these trends?

We focus on single stocks and believe that our holdings should deliver strongly on earnings growth this year. After the rotation in markets there is also an opportunity for reratings on some of our holdings, which were punished too harsh.

In an environment of higher rates in the future, the profits of companies are reduced and growth strategy will lose appeal, according to some experts. Do you agree or disagree with that idea? Is it increasing the types a threat for these strategies?

It is however, evident that on most valuation measure value no longer looks cheap relative to growth. The magnitude, and length of the current value rally at c. 16% since August (150 days), looks comparable to the previous value rallies of March 2009 and July 2012, reinforcing the view that the worst may hopefully be behind us in terms of rotation.

Will the ECB’s policies continue supporting European equities this year?

I believe earnings growth is important for equities to perform. The ECB induced multiple expansion of European equity markets has already stopped in 2015. Sectors, which are seen by the market as bond proxies like consumer staples have experienced a multiple expansion in the first half of 2016.

Encouragingly many of the issues that have held back European earnings (weak emerging market growth, deflationary pressures, and the commodity slump) in recent years are fading, and will likely benefit from strong base effects in the coming months. The effects of this are beginning to be seen as evidenced by the strong Q3 reporting season, and upward earnings revisions trend. Europe appears to be syncing with a global macro upturn, driven by the US, as Europe’s open economy and strong export links with the US leave it especially sensitive to global growth. While the Eurozone is unlikely to match US growth in absolute terms, the low base of Eurozone ensures the delta is important. With further room for the economic recovery and a pickup in global inflation, European company profits might now finally see the long-awaited turn in 2017. It will though be necessary to closely follow the impact of a potential de-globalization policy agenda.

About political risk in Europe… how can it affect your portfolios this year? What are the main risks?

Despite politics becoming increasingly unpredictable, the one guarantee of 2017 is that politics will again dominate the headlines. During the year we have French, German and Dutch elections, combined with the ongoing Brexit negotiations. While the importance of these should not be understated, 2016 has taught us that investors are becoming conditioned to such political shocks, and the equity market volatility generated by each of the three “black swan” events, was both less and shorter in nature than most investors anticipated. Indeed despite all these issues, economic data was remarkably resilient through 2016, with Eurozone PMI’s largely flat through the year.

Robeco: “The Dollar Will Remain Strong as a Result of the Political Situation Facing Europe”

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Robeco: "El dólar se mantendrá fuerte como consecuencia de la situación política que atravesará Europa”
León Cornelissen, Chief economist at Robeco. Courtesy Photo. Robeco: "The Dollar Will Remain Strong as a Result of the Political Situation Facing Europe"

As the saying goes: when the US sneezes, the rest of the world catches a cold. But that does not mean that the rest of the world doesn’t already have problems and opportunities of its own in a global context where the geopolitical situation affects markets more than ever before. For Leon Cornelissen, Chief Economist at Robeco, elections in Europe, Chinese development, and the debt super-cycle the market is currently undergoing, mark his vision for the coming years.

The biggest surprise of the New Year was not the fact that Trump’s behavior turned out to be as erratic as he displayed during the election campaign, but that the market rose in response to expectations of new fiscal measures and better corporate profits. However, for Cornelissen, Trump is not the only risk which the US represents, the high debt of US companies is also another one. Despite the risks, the firm is betting on the dollar in the long term, as, according to Cornelissen, “it will remain strong as a result of the political situation Europe faces.”

But he warns that any forecast will depend on the gradual development of policies made by the new tenant of the White House. “As long as his decisions do not directly impact or undermine underlying growth and profits, the stock market will ignore him” says Robeco’s Chief Economist, who believes that it is logical to think that, until we arrive at that scenario, economic growth and profits will continue to rise. Despite this reasoning, Robeco is cautious and maintains a neutral view on high-yield bonds and is underweight in sovereign debt.

The Old Continent

For Cornelissen, Europe is not doing so bad. In fact, its growth in 2016 surpassed that of the United States by 0.1%. Although, as a consequence, inflationary pressures have increased, Robeco explains. This is due in part to political pressures within the Euro zone and also to the fact that the ECB remains reluctant to open the debate on raising interest rates.

The political landscape will capture the most attention in 2017. The French presidential elections have been affected because the center-right candidate will probably be forced to withdraw due to allegations of corruption. The fact that in Italy the former Prime Minister is pushing for new elections, and that Greece is increasingly under pressure by the lack of agreement between the IMF and Germany to activate the third Greek bailout, completes the scenario.

Within this horizon there are other upcoming elections to take into account. “The elections in the Netherlands, Germany, and probably in Italy, are also worrisome to the markets, especially in the Italian case where growth prospects are not so good, which affects its risk premium,” said Cornelissen. Also, the economist has drawn attention to the consequences of the Brexit, which, in his opinion, will end up damaging the British economy. “In short, Europe is more important to the United Kingdom than the United Kingdom is to Europe,” he said in terms of the British trade balance.

According to Cornelissen, amidst this European context, Spain can benefit. “Investors are choosing the Spanish bond against the Italian or the French,” he said, referring to the good prospects for the country given that the growth of its GDP is the highest. “The stability achieved in Spain and the situation in France are two aspects that favor it,” he points out.

The weight of debt

Another key factor for Cornelissen is the level of global debt, which reached record highs in absolute terms and in relation to GDP. “Increasing debt is not a problem as long as there is growth, but it will be counterproductive if growth starts to fall. Keep in mind that, while the value of assets may fluctuate, debt is fixed, ” he says.

In this regard, for him, it is clear that debt has many positive aspects, “for example, it fuels growth or business investment,” but warns in this respect of some future problem areas such as China, US companies and loans to public administrations.

As regards to (o regarding, no se puede as regards) possible investment opportunities, Cornelissen points to emerging economies. Among them are the Latin American countries that, in his opinion, “are doing well compared to the last five years and remain attractive.” He is optimistic about the options in these markets, but warns that, in the short term, they will also suffer the effect of the policies implemented by President Donald Trump, which in particular will affect countries like Brazil or Mexico.

BlackRock: “Thematic ETFs Allow The Fund Manager To Engage In a Different, And Forward-Looking Narrative With The Client”

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BlackRock: “Los ETFs temáticos son productos fáciles de entender que permiten al gestor tener una narrativa distinta, de futuro, con el cliente”
CC-BY-SA-2.0, FlickrAitor Jauregui, Head of Business Development for Spain, Portugal & Andorra at BlackRock / Courtesy Photo. BlackRock: “Thematic ETFs Allow The Fund Manager To Engage In a Different, And Forward-Looking Narrative With The Client”

The use of ETFs has evolved a lot in recent years, not only because of the number of products, but also because of the different uses already given to those products by investors. An example of this is the tactical movement of investors following Donald Trump’s victory in the November presidential election in the United States. “Following Trump’s speech, the market began to accept that there could be opportunities in equities, and began to produce sales in the long stretches of the yield curve. One way for the long-term investor to adjust his losses was by selling long-term bonds and buying ETFs with durations of 1.5”, explains Aitor Jauregui, Head of Business Development for Spain, Portugal, and Andorra at BlackRock, in an exclusive interview with Funds Society.

At BlackRock, they are convinced that this greater diversity and extension in its use is key for its growth in Europe, despite the six-year gap in the sector with respect to its US counterpart; and points out such positive aspects as its contribution to liquidity: “At a time when, as a consequence of financial regulation, it’s not as simple for market makers to provide liquidity to the fixed income market, the ETF goes on to play a role which it did not have before,” he explains.

Another growth driver for the ETF industry will be MiFID II, in view of “the clear trend to package investment solutions and offer clients model portfolios where management fees are kept low.”

Their good behavior in times of stress is another argument in favor of their future development. “The investor resorts to them in times of market stress because of their excellent behavior. For example, following the referendum in the United Kingdom, ETF trading reached $ 5 billion and after Trump’s victory it reached $ 3.15 billion. This far exceeds what is traded daily.”

Their growth, however, may seem excessive. But for Jauregui it is not, since “of the 3.4 trillion dollars in these investment vehicles, only 600 billion are in fixed income, 0.6% of total debt issued in capital markets. When it comes to high-yield, only 3% of the bonds asset class is traded through ETF.” That is, there is still great potential for growth ahead.

Growing competition

Within the framework of this growth, and in a context in which increasingly more fund management companies offer exchange-traded funds, at BlackRock they take competition in the universe of indexed funds and ETFs in their stride, although they are quiet clear as to its added value. “It is understandable that there is competition, it’s good and it’s healthy. However, this is a business where scale is important, having efficient and liquid vehicles is usually closely related to the assets of the funds; having many small ETFs is not always the best solution for the investor,” says Jauregui.

Five megatrends to capture future growth

And in this environment of increasing competition, BlackRock continues to focus on innovation, with the aim of delivering value to its clients. An example of this are their thematic investment ETFs, which invest in megatrends. Megatrends in the investment world are transforming forces that have the power to change the global economy and business, and to influence investment decisions. In its latest report, BlackRock identifies five key megatrends that relate to four investment themes: aging demographics, healthcare innovation, digitalization and automation, and robotics. That is why, since last September, there are four ETFs in the market that, in collaboration with iSTOXX and FactSet, seek to capture growth in these megatrends.

“We believe that it fits in well in client portfolios and demand has been growing on the part of SICAVS managers and thematic fund managers,” explains Jauregui.

The iShares Ageing Population UCITS ETF (Aged) focuses on the aging of the population, and invests in companies that offer from health services for the elderly to cruises. As Jauregui points out, “by 2030 more than 13% of the population will be over 65, and there are sectors and companies that will benefit from it.”

Meanwhile, the index replicating the iShares Healthcare Innovation UCITS ETF (Heal) fund has exposure to very specific segments within the industry such as healthcare treatments, patient care, or diagnostic tools.

In terms of digitalization, the iShares Automation & Robotics UCITS ETF (Rbot) focuses on companies of both cybersecurity and financial technology or payment processing. “Investment in financial technology has gone from $ 1.8 billion in 2010 to $ 19 billion in 2015 and this is going to continue to grow,” says the expert.

Finally, the iShares Digitalisation UCITS ETF (Dgtl), which has attracted the most investment flows since its launch, invests in innovative companies in production robotics under the premise that “up to 45% of global labor activity can be automated.”

The four ETFs are physically replicated, that is, they acquire the securities of the underlying index and, to avoid concentration of risk, each index consists of a minimum of 80 components. For Jauregui this type of investment is clearly “strategic because we are talking about trends that are going to have greater relevance starting from 2020 or 2030. They are easy to understand products that allow the fund manager to engage in a different, and forward-looking narrative with the client.”

Passive… and active management, in megatrends

A strategy that BlackRock does not want to approach from passive management alone, but which can also extend to active management. “What has started from passive management will most likely develop into the active management business, it’s not exclusive, although investing in these megatrends through ETFs is very efficient for the investor,” the expert points out.
 

“Emerging Currencies Could Fall Further, But We Are Already At A Point Where Benefits Derived From The Latest Depreciations Can Already Be Seen”

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“Las divisas emergentes podrían caer más, pero ya estamos en un punto en el que se pueden ver beneficios derivados de las últimas depreciaciones"
Foto cedidaMatthew Michael, Emerging Market Debt & Commodities Product Director at Schroders. Courtesy Photo. “Emerging Currencies Could Fall Further, But We Are Already At A Point Where Benefits Derived From The Latest Depreciations Can Already Be Seen”

Uncertainties in the United States about Trump’s upcoming policies, developments in inflation, Fed rate hikes, and the strength of the dollar, as well as investors’ continued negative sentiment toward emerging markets are all reasons why Schroders’ managers are still cautious and hold defensive positions regarding these assets. But, as there are very positive factors within these markets, at the management company they are convinced that their positions will become much bolder over the next year … especially in emerging debt in local currency, and always very selectively.

In an interview with Funds Society, Matthew Michael, Emerging Market Debt & Commodities Product Director at Schroders was constructive with emerging debt where, in his opinion, the bottom line is the fundamentals. “We are constructive with the fundamentals of emerging debt, but not in all countries. In some markets, crises have brought opportunities,” he explains, referring to markets where political changes open up opportunities (such as India, Indonesia, Argentina, Brazil or South Africa). Thus, government change and the establishment of reformist policies are one of the aspects of improvement.

Secondly, currencies have fallen sharply and allowed many markets to adjust their current accounts: “Currencies have fallen 40% in four years. It is true that there is risk of further falls but we are already at a point where we can see benefits derived from the last depreciations,” in markets such as Indonesia or Brazil, he explains. In some of them you can get a carry of 3% to 4% as a result of selling dollars and buying emerging currencies… hence his commitment to debt in local currency. “External sovereign debt is not as attractive because it is linked to US Treasury bonds, which could fall if interest rates rise,” he adds.

The third factor in favor are the valuations, which are at levels even down to 2003 in countries like South Africa – with yields of 7.5%. “There are some markets that have never been so cheap,” he says. Markets like India, Brazil or Russia offer carrys of between 5% and 10%, he adds. “Profitability is above the historical average,” he explains.

Selection: the key

However, it’s not all rosy, and selection is the key: “In some countries, investors are underestimating the risks. Indonesia and Turkey are at the same level of profitability but the first country has a pro-growth agenda and has no debt problems, while the second is of international concern,” he warns.

In order to select the positions of the Emerging Markets Debt Absolute Return Fund, a fund with a philosophy of absolute return that is generating a lot of interest among investors, fund managers focus on the fundamentals, as well as a risk note given to each market, and also in technical aspects and sentiment. Factors that make him positive towards markets like Brazil, but as yet they do not advise investing in Mexico (where the technical factors are not supportive).

And the timing is key, argues the expert: “We reached the US elections with very defensive positions on the behavior of commodities, the strength of the dollar, and the market consensus on Trump’s defeat, factors that led to reduce risk”. But now, facing the end of this year and 2017, he explains that the time will be ripe to invest again, thanks to the attractive yields offered by emerging debt and the attractive fundamentals. “It’s a matter of timing; if we enter too soon we will suffer,” he explains. Hence his positive outlook regarding the asset but his current caution (at the end of October the fund had 36% in liquidity) and the premise of being very selective.

Better LatAm than Asia

Currently, the aforementioned fund’s portfolio favors the Latin American region, with about 40% exposure. “Until a few years ago, we had no exposure to the continent in our portfolio. Currently, we are defensive, but by the end of October the exposure was around 40%,” explains Matthews. The reason? Reformist agendas seen in markets such as Argentina or Colombia, as well as the recovery of commodities (which benefits these markets, along with others such as Chile or Peru). In addition, if Trump pushes the issue of oil and gas again, it could be positive for countries in the region, the most sensitive to these issues.
On the other hand, Asia only weighed just over 9%, less than the emerging Europe (at 13%): “A few years ago, Asia was the region that weighed 40%. Today we like markets like Indonesia, the Philippines or India, where returns are high, but China has yet to implement a major reform, and it still remains to see what its model will be,” explains the expert.

A very expensive dollar

On the dangers of a strong dollar for the asset, emerging local currency debt (in which it invests 56.7% of the fund, with only 7% being in external debt), he admits that it will not help. “There are great opportunities for emerging currencies but buying should still be tactical, for example, in markets sensitive to bullish commodity developments, such as South Africa,” he says. Still, his view is that the dollar is too expensive, at levels of the 1990s.

“The Main Risks For 2017 Concern Trump’s Economic Program And Its Implications On Growth, Inflation And The Fed”

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"Los principales riesgos para 2017 conciernen al programa económico de Trump y sus implicaciones sobre el crecimiento, la inflación y la Fed"
Christophe Morel, Chief Economist at Groupama AM. Courtesy Photo. "The Main Risks For 2017 Concern Trump’s Economic Program And Its Implications On Growth, Inflation And The Fed"

Trump and oil prices – with their effects on inflation – will be two important benchmarks for markets throughout this year. Christophe Morel, Chief Economist at Groupama AM, explains in this interview with Funds Society that if oil crosses the $ 60 barrier, inflation would skyrocket and that would have key effects on fixed income and equity markets.

What are the major risks in 2017?

The main risks or uncertainties for 2017 concern Donald Trump’s economic program and its possible implications for growth prospects, inflation, and the Fed’s reaction. Obviously, anything that is likely to change the expected pace of monetary adjustment affects available liquidity and hence the evolution of financial markets.

The other big risk is the price of oil. It is expected that the oil market will rebalance in the spring of 2017, in line with a Brent price of around $ 45 to $ 55, depending on the correct implementation of the agreements on the reduction of production, and the hypothesis that US producers are not too motivated to restart production. In any case, a barrel of oil crossing the $ 60 barrier (WTI reference) would push European inflation towards 2% in 2017 and US inflation to 3%. Obviously, breaking that barrier could influence investors’ perceptions of inflation and would undoubtedly be a market mover in fixed income markets and risky assets.

In Europe, the elections, the negotiations on Brexit, and the treatment of bad loans in bank balance sheets are factors to be taken into account. It should be borne in mind that business trends surveys announce a significant improvement in employment in 2017, which could help contain the populist threats in France, Italy, and Germany.

Why is Trump the main risk?

As yet, there is not enough visibility on his protectionist orientation, or his program of economic support. At this stage, we can only observe the appointments, which suggest that Trump will preside over the US as if it were a company. Without visibility on the protectionist orientation, however, it is difficult to imagine a generalized increase in tariffs, which would affect the competitiveness of American companies and their profitability. A simple questioning of the Trans-Pacific Partnership Agreement would reconcile his campaign promises without this being a cost to businesses, as this agreement has not had sufficient time to be put into practice.

With regard to his growth support program, we must once again distinguish between the “candidate” and the “president”. The launch of the program would potentially be a significant support for growth, which we estimate to be around 0.5% of GDP per year. But, we should put this into perspective. First, the plan faces political constraints on funding, as many Republican members of Congress do not agree with tax cuts without a parallel reduction in public spending. Thus, we should not overestimate the “multiplier” effects on growth that are always lower in growth periods (as compared to recession periods), and when infrastructure spending is financed by the private sector. Evidently, a very expansive policy could lead the Fed to an upward revision of  its perceived productivity growth, and therefore, also of growth potential and, ultimately, its estimate of neutral rates (of 0.3% according to an average scenario).

How will the transition to fiscal policies be?

In many countries, fiscal policy is clearly increasingly accommodative: in Japan, with a policy of public works and increased military spending, in the Euro zone with less fiscal orthodoxy by the European Commission, and obviously in the United States. And this would not be possible without the unconventional monetary policy that reduces the cost of public debt, makes the debt path more sustainable, and liberates “fiscal pockets.” For example, we have estimated that the ECB’s asset procurement policy allowed France to create budgetary margins of 0.1% of GDP in 2015, 0.3% in 2016, and 0.5% in 2017 Therefore, the decline in debt services helps to revitalize the primary deficits.

Will there be tapering by the ECB, or will we see a disconnection between US and European monetary policies?

The ECB’s asset purchases policy supports growth in Europe: we have estimated that QE would improve growth by almost 0.5% in two years. Therefore, since there is a profit, at least in theory, we believe that the ECB will do everything possible to maintain its policies and to not undertake any risks with recovery, ensuring as low rates as possible, whenever possible. The ECB’s monetary policy surprised investors with the use of unconventional instruments. It should still surprise by the more sustainable use of what is expected of QE Therefore, we believe it is too early to consider “tapering,” especially since core inflation is not expected to touch the “comfort” zone of 1.5% -2% before the end of 2018.

How many rate hikes will the Fed make and what will their impact be?

The Fed’s monetary policy scenario continues to depend on Trump’s economic announcements. Pending future announcements, a number of principles should always guide the Fed’s decisions: At least at the beginning, it should not accelerate the pace of rate hikes in order not to cause a rise in the dollar and in rates long-term that would lead to a restriction on financial conditions likely to weigh on growth. This should be supported by a governance that would be relatively less aggressive in 2017 than in 2016 (the most aggressive members in 2016 will not participate in the FOMC in 2017). In total, we anticipate two additional interest rate hikes in 2017, knowing that the risk is slightly upward if the hypothesis of a more expansive fiscal policy is effectively confirmed.

What are your expectations for emerging markets?

We should not put all emerging countries in the same basket. On the one hand, there are exporting countries in Asia (Hong Kong, Singapore, Taiwan…) that will benefit from the positive dynamics of international trade and of a still favorable economic situation in China. On the other hand, there is a synchronization of the specific risks that penalize some large emerging countries, in particular Turkey and especially Brazil, which is undoubtedly the “weak link” of the emerging zone. For investors, the emerging asset class is often the subject of a global and undifferentiated investment; this synchronization of specific risks is likely to weigh on the assets class as a whole.

Michael Zelouf: “We Have A Strong Conviction That The Interest Rate Curve Will Normalize

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Michael Zelouf: “Tenemos una fuerte convicción en que la curva de tipos se normalizará”
Foto cedidaMichael Zelouf, Business Director for EMEA at Western Asset Management. / Courtsey Photo. Michael Zelouf: "We Have A Strong Conviction That The Interest Rate Curve Will Normalize

Michael Zelouf, Business Director for the EMEA region at Western Asset, Legg Mason‘s global fixed income subsidiary, believes one must separate the US debt market outlook from the one for the debt market in general. In an exclusive interview with Funds Society, he explains that in the US, the uncertainty surrounding Donald Trump’s economic policies could increase market volatility, but the truth is that, after the December rate hike, “the market has already largely factored in the likelihood that the Fed will adopt a more aggressive stance this year.”

In this regard, Zelouf says: “Markets move very fast and, as fixed-income investors, we must rely on the slope of the forward rates curve to determine whether yields are going to go up or down. In the short end of the curve, everything depends on the Fed, and we cannot forecast it, so we will not take too much risk in this segment because the Fed could adopt a more aggressive stance. “

The normalization of the rate curve is, therefore, the most probable scenario and the one most expected by the expert. “If the Fed, at this late stage of the cycle in which rates are usually rising, is normalizing its monetary policy – and we believe it is doing so – the 10 to 30 year rate curve should normalize . We firmly believe that, in relative terms, returns at 10 to 30 years will be reduced,” says Zelouf.

Another issue, he points out, is whatever happens in Germany and Japan with the Bank of Japan’s objective of keeping the ten-year bond yield at 0, and in Germany below 0.5%. In his opinion, “this is a strong attraction for Japanese and German investors, who opt for the US bond. It makes a lot of sense, and not because US long-term debt is better, but rather for the relative value it offers over Japanese and German debt. “

Corporate bonds: telecommunications and the US financial sector

Regarding corporate bonds, Zelouf points out the telecommunications, energy, and financial sectors which could register 2% differentials against US public debt. “We have companies like Verizon, which in addition to being global has a dominant position in the US market and has a quarterly turnover of $ 4 billion,” he explains.

As a specialist in the Legg Mason Western Asset Macro Opportunities Bond Fund, it’s in the US financial sector where he sees the greatest potential, with long-term credit growth and interest rate outlooks that will increase its profits. “The combination of these two aspects implies that the return on assets will be positive.” In European banking, its exposure focuses on the big names: Bank of Scotland, HSBC, Credit Suisse, Standard Chartered…, with reduced exposure to the Spanish banks BBVA and Santander.

Zelouf believes that, currently, cyclical companies’ credit has reasonable appeal, and points out other names such as Exxon Mobile or AB InBev. “We invest in companies with a long-term strategy, organic growth, an adequate degree of leverage and where we know the management well and this is going in the right direction.” The main sector that they avoid in USA is that of health, since “it is difficult to know what will happen with Obama Care, and there is uncertainty regarding its income…”

Regarding high yield, he reveals that one of the peculiarities of the current credit cycle is its long duration, which facilitates refinancing of debt. “Currently, 63% of the debt in the high yield market will not be refinanced before 2019, they will do so between that year and 2021,” he points out. A circumstance to which we must add the economic growth of the last few years; which has been sufficient to generate income to cover the debt and interests of this type of companies.

In our opinion, in the second quarter of this year, we’ll see a rebound in defaults, which are starting to remit gradually. Therefore, we believe that the overall level of defaults in the high-yield segment, including energy stocks, which represent about 15% of the universe, began to decline thanks to the recovery of oil prices and the fact that many oil companies have not incurred in default since they have been able to refinance their lines of credit, etc., which means that the risk of default is beginning to dissipate. It has not disappeared altogether, but it is beginning to shrink.”

In any case, Zelouf admits that his exposure to the energy and commodities sector was relatively low in high yield, at 1.5%, and is mainly concentrated in companies with investment grade.

Selective in emerging markets

In emerging markets, the main criteria used to identify assets are “reasonable valuations” and the search for short-term debt in dollars. “We also look at the strength of the institutions of each country. That’s why we did not invest in Venezuela and that’s why we did invest in Argentina after its change of government.” From a tactical point of view, there are two factors they watch out for: interest rates and oil and commodity prices.

The first presents a negative scenario for those countries with a high level of debt in dollars. The second is positive for some and negative for others. Following OPEC’s announcement of a cut in production and an oil price forecast of $ 60 / barrel, Zelouf said that importing countries such as South Africa, Turkey or India would not benefit from this, which would require them to be very selective. “We are positive in some and negative in others.” Finally, structural reforms must also be taken into account in the long term, which is why they are committed to Mexico and India, which are countries that have implemented positive structural reforms. “In emerging markets you have to be selective, you have to talk to politicians, even if they sometimes they also make mistakes.”