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Dubreuil: “The ECB Should Lag the Fed in Hiking Interest Rates by at Least Another Year”

Dubreuil: “El BCE se retrasará al menos un año con respecto a la Fed en comenzar su ciclo de subida de tipos” — Photo: Pascal Dubreuil, Portfolio Manager, at H2O Asset Management, an affiliate of Natixis Global Asset Management / Courtesy. Dubreuil: “The ECB Should Lag the Fed in Hiking Interest Rates by at Least Another Year”

Almost two years ago, after a long career in the asset management industry, Pascal Dubreuil joined the global fixed income and currency team, as Portfolio Manager, at H2O Asset Management, an affiliate of Natixis Global Asset Management, which specializes in Global macro management and alternative strategies of fixed income.

Since then, Dubreuil has been the main investment decision maker of the H2O Multi Aggregate fund, a flexible global fixed income fund actively embracing all debt and currency markets. It can invest globally, with a high degree of granularity, in the widest possible set of liquid fixed income securities ranging from all the investment grade securities featuring in its benchmark, the Bloomberg Barclays Global Aggregate index (BBGA), to high yield securities, issued both by governments and corporations. The currency exposure of the fund is also actively managed according to directional and relative value strategies designed to optimally translate their macroeconomic scenario into global asset allocation.

The Base Scenario in Macroeconomic Terms

According to Dubreuil, the business cycle of developed countries has further to go, as private leverage is not extended enough yet. “Within this group, the US is leading the Eurozone by one to two years, while the UK is beginning to feel the economic cost of Brexit. In contrast with most developed countries, growth in emerging countries is structurally impaired. Commodity producers (most of Latin America and the Middle East) have barely recovered from their recession and are pulled down by bloated balance sheets inherited from the past,” he said.

Furthermore, he believes that growth of manufacturing exporters, mostly from the Asian region, has fared better, but it has over-extended through an increasing and unsustainable leverage. “Growth in emerging countries is either poor in quantity or in quality. Like in the late 90s, the global business cycle is not synchronized across regions. To express these macroeconomic views in H2O Multi Aggregate, we inter alia use currencies, e.g. implementing a long USD position versus a short exposure to Asian and commodity currencies like AUD and NZD.”

Dubreuil maintains that, the excess leverage of manufactured products’ exporting countries has resulted in core inflation in the US becoming the other main macro risk. “The tightness of the US labor market should increase further as the business cycle continues. Pressure on wages and inflation should eventually recover from the recent soft patch. When it does, dollar funding would get tighter which would present a key challenge to de facto dollar-zone countries, some of which also exhibit excessive leverage (e.g. China, Northern Asia, Canada, and Australia). Fixed income markets would not perform well in this rising US core inflation scenario, but the extent depends on how prepared investors are for a rising yield environment.”

How is the portfolio positioned?

The H2O Multi Aggregate strategy’s investment process is designed to implement relative value strategies across the main Sovereign Developed debt markets in order to benefit from rising divergences in monetary policies. “We also slice and dice the H2O Multi Aggregate’s benchmark, the BBGA, and implement strategies aiming at exploiting its strengths and weaknesses. To benefit from the normalization of interest rates initiated by the Fed, we underweight the duration of the fund in the US compared to the benchmark, with a particular emphasis on the 5-year segment of the US curve, as we expect the US interest curve to continue to flatten between the 5-year and 30-year pillars,” Dubreuil commented.

He also believes that the valuation of government bonds issued by European peripheral countries compelling: “The core and the periphery are converging economically; political risk is receding, while the ECB should lag the Fed in hiking interest rates by at least another year.”

Moreover, valuations of Emerging Debt Markets are less attractive since the sharp rally they have experienced since early 2016. “China’s cyclical recovery is likely to fade out, leading to headwinds for commodities, which are key for Emerging Markets. Therefore, we have a selective allocation, focused on core value trades like Mexican local sovereign bonds, offering a high yield and a clear disinflation path ahead. We also see opportunities in frontier markets like Iraq and Zambia, both benefiting from their carry and IMF’s involvement that anchors both policies and investors’ expectations.”

As regards corporate credit exposure, the team at H20 favors subordinated bonds from European financials and non-financial issuers exhibiting strong fundamentals. “They still offer attractive credit spreads and benefit from strong technical factors as the volume of new issuance of the credit markets we favor, is expected to remain moderate in the coming months.”

To conclude, Dubreuil sums-up H2O Multi Aggregate’s directional strategies by asset class, “The fund is underweighted in duration and overweighted in credit versus the benchmark, and long USD versus other currencies. The main relative value strategies as far as rates, currencies, and credit are concerned, are respectively: underweight in US duration versus the EMU duration; long MXN vs. Asian currencies; overweight European credit vs. US credit.

WisdomTree Investments’ Steinberg Wants to Triple Their Mexican AUM With a New Launch

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Steinberg de WisdomTree Investments: "Vamos a entre duplicar y triplicar los activos en México" — Foto cedidaPhoto: BMV. WisdomTree Investments' Steinberg Wants to Triple Their Mexican AUM With a New Launch

As part of WisdomTree‘s 7th anniversary in Mexico, and the launch of its first ETF designed exclusively for Mexican investors, Jonathan Steinberg, CEO of WisdomTree, Jose Ignacio Armendariz, partner and CEO of Compass Group Mexico, in partnership with WisdomTree, and Ivan Ramil, Director of Institutional Clients at Compass Group Mexico, spoke with Funds Society about their expectations and plans for the Mexican ETF market, which Steinberg says is “growing rapidly” and is key to expanding their presence in Latin America.

WisdomTree currently has approximately 45.1 billion dollars in assets under management (AUM) worldwide, of which 650 million come from the nearly 40 funds available in the Mexican market. With the launch of their newest ETF, the WisdomTree Global ex-Mexico Equity (XMX), the manager expects to double and maybe triple its AUM in Mexico. “This is the first time we have created a specific fund for the Mexican market. I hope it’s the biggest fund in Mexico… We have been very successful with funds with exposure to Europe and Japan but I feel this will be bigger than all of them combined,” said Steinberg. Armendariz mentioned that the index that the ETF replicates was created with the Afores (Mexican pension funds) investment regime in mind, in order not to exclude them, but that, in addition to the Afores, it is also directed to other institutional and retail investors. “It is an ETF with great liquidity, low commission and that provides exposure to the world in a single instrument” he mentions. Ramil added that they are “very excited about the product. We just finished a roadshow and feel it will be a great product for the Mexican market.”

The XMX, which is traded on the Mexcan Stock Exchange’s Global Market platform (SIC), replicates a market capitalization weighted index covering 90% of the elegible shares in the global market, excluding Mexico, and that meet the eligibility requirements of The CONSAR (Afore’s regulator). The Index is calculated in US dollars, capturing 23 developed markets and 21 emerging markets, with more than 50% exposure to the United States. The most overweight sectors of the fund are financial, IT and discretionary consumption. The ETF is rebalanced every October, and includes minimum requirements for market capitalization and liquidity. It also sets sectoral limits to increase diversification.

MFS: Why is Reconsidering Active Management Now More Important than Ever?

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How much does active management contribute as compared to passive management? With this question, Michael Roberge, CEO, President and CIO of MFS Investment Management opened his presentation at the 2017 MFS Annual Global Analyst and Portfolio Manager Forum, which took place in Boston in mid-May.

According to Roberge, some of their larger and more sophisticated clients, including those who manage sovereign wealth funds and pension plans, are increasing their positions in actively managed funds, contrary to what the average retail client is doing. During his talk, he explained the main reasons why clients should, according to MFS, consider active management in this environment, compared to investing passively.

The Short-Term Mentality of the Bulk of the Market

In the period immediately following Donald Trump’s election in November last year, the market rose between 6% and 7%. For Roberge, even more noteworthy than this rally, was the massive turnaround from the more defensive and higher-quality sectors to much more cyclical sectors, with the expectation that the new administration would reduce taxes and that the regulatory burden would be lower. Likewise, any increase in economic growth was traded: the price of deep cyclical stocks soared and consumer staples companies suffered a fall in prices. This was caused in part by investors who pursued these sectors out of fear of falling behind the benchmark in terms of performance. In a clear example of how the short-term mentality dominates the behavior of the markets, more than five months after Trump’s takeover, a new rotation in the opposite direction was happening. Investors have begun to perceive that it will be difficult for Trump to get approval for significant spending on infrastructure, and that he lacks support for much of his election promises.

According to Michael Roberge, this was clearly reflected in the deep cyclical sectors: US Steel’s stock price, which was US$ 21 per share pre-election, doubled to US$ 42 per share, only to returning a few months later to US$ 21. Meanwhile, MFS ‘strategy was to sell cyclical stocks and buy defensive stocks. The asset manager’s teams look for returns with horizons of three-to-five years, identifying long-term opportunities. This is where the firm thinks it has the greatest opportunity to add alpha to a portfolio.

Higher Volatility

Another factor playing in favor of active management is the minimum volatility period experienced in the last decades. This is largely a consequence of the accommodative policies of central banks.

The European Central Bank, as well as the Bank of England and the Bank of Japan continue with quantitative easing programs; and while the Fed appears to be at the beginning of a rate-hiking cycle, Roberge argued that when inflation is considered, the real interest rate of Federal Funds is negative, which is especially stimulating for an economy growing at around 2%, with the potential to grow at 4%. In the CEO’s opinion, it could be said that all central banks globally, continue to inject liquidity into the system, which not only keeps interest rates low, but also suppresses market volatility.

MFS claims that, in the next ten years, a low growth scenario will persist globally. There is a problem of over-indebtedness and an aging global population in the major developed economies which will cause the world economy to remain below its potential.

For Roberge, the only way to achieve greater growth in real terms would be by fostering an increase in the labor force, something which new immigration policy trends are slowing, or increasing productivity. This last variable is the one that can best be implemented by governments worldwide.

“The global economic environment is still more deflationary than inflationary. In Japan, they have been trying to generate inflation for over 30 years, something that is also beginning to happen in the United States. The latest inflation data (with respect to the previous year) have been downward, even only taking into account the underlying inflation. It could be said that there is an inflation problem at the global level,” said Roberge.

Given these factors, MFS believes that investors can expect a world with lower economic growth, in which there will be greater volatility, as economies will face greater challenges. “There will be new episodes of uncertainty in Europe: Greece will reappear in news headlines due to debt renegotiation, and Italy will hold general elections in May 2018. And finally, the moment central banks begin to remove excess liquidity from markets, higher levels of volatility will be created, which, when added all up, represents a huge opportunity for active management as compared to passive,” he added.

For Roberge, this does not mean that a portion of the portfolio shouldn’t be invested in passive management vehicles, but how much is being spent on active management should be reconsidered.

A Disruptive Environment

According to MFS, another one of the fundamental keys that indicate that it will not be enough to buy the index to achieve the investment objectives is disruption. A large number of industries are going through a disruptive period: “The most obvious example is the retail sector where Amazon is crashing its competitors in the traditional retail segment. More and more sectors are undergoing a period of transformation: Airbnb, for example, has led to a similar change in the leisure industry, Uber has broken into the taxi industry, robo-advisors and smart beta ETFs have hit the financial industry. All of these examples, which highlight the complexity of the environment, make passive management less attractive.”

Now More than Ever, Investors need Active Management

Continuing with the discussion, Roberge highlights two reasons why investors should consider positioning themselves in actively managed vehicles: return and risk management. In relation to the return of the markets in the next ten years, the asset management company expects a global equity return of around 4.3%. This figure is considerably lower than historical returns, especially since starting valuations are very high, meaning most of the opportunities are already priced into the current market prices.

Meanwhile, the expected return for the same term in global investment grade fixed income is roughly 3%. Historically, rates are at very low levels, leaving very little room for capital appreciation gains, and leaving only the coupon search and the spreads on corporate debt as the main source of return for this asset class. Therefore, according to MFS, the average investor who invests in a balanced portfolio could achieve an estimated annual return of close to 4% over the next decade.

These returns make it extremely difficult for the bulk of investors to achieve their retirement goals. Therefore, they will need an additional source of return to achieve their goals, something that can only be achieved through active management and alpha generation,” Roberge said.

In this regard, the alpha in portfolios becomes a more important element than ever. According to MFS projections, for US large cap equities, the contribution of active management in terms of excess return on the index will increase from the 17% registered historically (2% over 10.1%), to 42% (2% over 2.8%). While in fixed income, active management’s contribution will increase from 12% (1% over 7.5%) to 24% (1% over 3.1%).

However, investors have recently stopped believing that there is alpha opportunity and lean instead passive management, seeking only lower commissions, regardless of net returns. In ten years, these investors will be very disappointed if indeed the MFS forecasts are met and their index returns are limited to below the 4% offered by the market, regardless of how low the fees charged by passive vehicles may be. For all of the above, Roberge encourages reconsidering active management as the main way to reach long term investment objectives.

Swanson: “Fundamentals Are Starting to Whip in and Valuations Are Very High”

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The extent of the current geopolitical situation worries investors who focus their discussion between continuing to bet on risky assets or moving toward “haven” assets. Where should investors put their money? During his presentation at the 2017 MFS Annual Global Analyst and Portfolio Manager Forum,James Swanson, Chief Investment Strategist at MFS Investment Management, reviewed what’s happened during the last cycle to determine where the global markets are now, and how investors should position themselves.

The Starting Point

After the market collapse in 2008, when US equity indices fell nearly 50%, the financial press maintained that investment in US stocks was not going to pay off, as GDP growth over the past eight years was well below the 3.5% at which it used to grow. However, Swanson argued that the measure that should really have been taken into account is the generation of free cash flow by companies. In the United States, this metric grew dramatically, reaching levels not previously observed.

Several factors enabled this development, one of the main being globalization. With the onset of the crisis, the American working class was forced to sell its work at a low price, so the companies had an extremely cheap labor force. Likewise, the reduction of interest rates carried out by the Federal Reserve allowed a considerable reduction of the cost of capital. In addition, the use of new technologies allowed the transformation of assets at a lower cost. These elements had repercussions in better ratios, better margins, and finally greater free cash flows.

And where is the cycle now?

Comparing levels of confidence indicators, the so-called “soft data” encompassing various investor sentiment surveys, with data on housing, industry, labor and consumption, known as “hard data”, one can observe a great divergence between both. The fundamentals of the economy lie far below the euphoric feeling that investors are showing, something Swanson says had not been seen before in several cycles. The next question to ask is how these two tendencies will converge.

To clarify this point, Swanson showed the evolution of performance in terms of real cash flow in the US equity market, or what is the same, if one invests a dollar in the S&P 500 index, how much cash flow is obtained after discounting inflation. In the long term, the real cash flow is around 2.6%. During the last recession, this measure fell sharply, but in the next two years it experienced a spectacular recovery, and now, while we are in the last stage of the cycle it has reverted to its long-term average. This, suggests that fundamentals are starting to whip in at the same time market valuations are extremely high.

Even though there is a notion of reflation in the environment, Swanson pointed out that core inflation in Europe, the United Kingdom or the United States is far from the 2% level that central banks would like to see. Another disconnect between perception and reality, in the MFS strategist’s opinion, the massive underlying reflation which sentiment is indicating is not happening.

Clouds on the Investor’s Horizon

One of the first concerns that investors should bear in mind is the growth of consumer income in real terms. Swanson has observed that wage in the last cycle has been somewhat subdued in the United States, Europe and the United Kingdom. He pointed out that it would probably be a residual component of the last recession and the demography of these countries. “Globally, we are going through a particular moment in time, in which baby boomers are retiring from the workforce and are being replaced by a generation with lower wage levels. Incomes in real terms are lower and this is going to have a direct effect on spending.”

The second cloud on the horizon is the economic situation in China. Just a year ago, China’s credit system was expanding, with lower interest rates and greater liquidity. But now the situation is different, government spending has fallen, consumption taxes have risen, housing purchase credit has been tightened and the Shibor rate, the Shanghai interbank rate, is starting to rise. “Every time they have made this kind of movement within the investment cycle, putting the brake on their economy, the consequences have been suffered globally. China is the largest marginal commodity consumer, and commodities play a key role in global inflation levels. At present, we can appreciate a weakening of the price of commodities. However, China has not entered into recession, nor is in the process of doing so, but will see a slowdown in consumption and spending because the monetary impulse is decreasing. This will have repercussions on exports from the United States and particularly from Germany,” Swanson said.

The third cloud that investors should not lose sight of is the production, consumption and the point of the economic cycle in which the United States is currently in. Industrial production, as measured by the ISM Manufacturing PMI index, tends to follow the movement of the money supply. In general terms, a pattern can be observed in which, whenever there is greater liquidity in the system, manufacturing production accelerates and expands. Currently, the real money supply is slowing its growth, showing an anticipated signal that production will also fall. So the bet on reflation may not be sustainable over time. Sales of new residential homes and automobiles are slowing, as are sales of consumer products. Therefore, Swanson invites all those investors who are thinking of increasing their position in risk assets to match the current valuations with the risk of going through a small pullback during the summer or with the risk of entering during the latest phase of the cycle: “We are reaching the eighth-year of the cycle, while the longest cycle ever recorded was 10 years. If you compare the economic situation of the United States with that of a patient who goes to the doctor, we would be talking about a 78 year old person, who could have died a couple of years ago, but is still enjoying relatively good health,” he argued.

Some of the signals that indicate an advanced moment in the cycle are already showing: euphoria replacing fundamentals, a squeeze in margins, and a slowdown in consumer spending. However, what is even more worrying for Swanson is that companies are not reinvesting in their own businesses. According to the MFS strategist, the historical evidence is very clear: companies that can reinvest their capital and obtain a return which is higher than that on their capital, over the long term, their stocks have often outpaced the market. However, companies in the United States, which find themselves with massive amounts of cash flow, decide to repurchase their own stocks or increase their dividends.

The Promises of the Trump Administration

Finally, new accusations of obstruction of justice faced by the US president could have serious consequences, increasing uncertainty and instability in the markets. In any case, if the difficulties faced by the new administration can be solved, infrastructure spending would not be sufficient to compensate for the lack of private sector momentum, and the effects would be lengthened over time. Likewise, the contributions of the promised fiscal reform are not expected to be as relevant as those achieved in the Reagan era. This is, because the baby boomer generation is leaving the workforce and there will no longer be the positive impact of the incorporation of women into the working world in the 1980s. In addition, the proposed tax cuts will affect only roughly 20% of the US population, typically wealthiest individuals, who have a much lower propensity to consume than the working class, and which therefore, will not be a significant stimulus. In summary, according to MFS it is difficult for the US expansionary cycle to go on for much longer and current market valuations are very high.

Investec Invites Robert O’Neill, the Soldier Who Shot Bin Laden, to Its Inspirational Event for Financial Advisors

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Investec invita a Robert O’Neill, el soldado que disparó a Bin Laden, a su evento para asesores financieros — Photos: Robert O'Neill, former Navy SEAL, at the Investec Inspirational Event / Courtesy photo. Investec Invites Robert O'Neill, the Soldier Who Shot Bin Laden, to Its Inspirational Event for Financial Advisors

Investec Asset Management has many reasons to celebrate. Last month, one of its flagship strategies, the Investec Global Franchise fund, celebrated its tenth anniversary with an excellent performance history, exceeding the MSCI All Companies World Index by 2.9% annually over the last 10 years. Added to this success, is the asset management firm’s extraordinary track record in Miami; and in appreciation, the company will try to hold an annual inspirational event for financial industry professionals.

The first “Investec Inspirational Event” took place in Miami last Thursday, June 15^th featuring Robert O’Neill, the Navy SEAL soldier who shot and killed Bin Laden in May 2011. O’Neill, with over 400 missions, 52 medals and 17 years of service in the US military, shared his experiences, and the lessons arising thereof that can be applied in daily life, with a hundred financial advisors.

During his speech, he pointed out the strenuous selection process that he had to overcome to become part of the Navy SEALs: “It is an intensive training, very hard, in which it is very easy to quit, and which even encourages quitting, because there is the option to resign at any time. The army is always trying to increase the number of soldiers entering the Navy SEALs admission tests, but regardless of how many people enroll for this process, 85% don’t make it through.”

According to O’Neill, the main reason why the system works is obviously that each of the instructors is a Navy SEAL and has undergone the same training, which he describes as “not impossible, but very hard, followed by something even more difficult, which is immediately followed by something even harder, day after day, for 8 months.” However, he doesn’t recommend facing a challenge with that mentality, as the key to achieving a long-term goal is to focus on little victories. So, for months, he followed the advice of his first instructor: “Just think of waking up in time, making the bed properly, brushing your teeth and being on time for the 5 am training; afterwards, just worry about getting to breakfast, after that about making it to lunch time, and then about making it to dinner. After dinner, just worry about getting to a perfectly made bed. If the bed is made the right way, no matter how bad the day was, you will only think of the next day. And when you think of quitting, something that will pass through your head, think, ‘I will not abandon now, I will quit tomorrow’. All I am asking you is to do one thing, no matter what, never quit and you will be fine.”

Another important lesson that the Navy SEALs learn by simulating different extreme situations, is that panic will not help them, so they train in keeping calm by negative reinforcement. “All the stress we experience in life is in our head, it is self-induced. It’s a choice we make; it’s a burden we choose to carry. In combat, bravery is not the absence of fear, it is the ability to recognize fear, put it aside, and act. No one has ever achieved anything positive by panicking. Fear is natural, it makes you think with greater clarity, but there is a line that should not be crossed, because panic is contagious. Portray calm, and calm will be contagious.”

Once he became part of this elite army corps, he was deployed to several worldwide destinations until the September 11^th attacks in New York. Then everything changed. He decided to enroll in a special unit within the Navy SEALs, where he would have to spend another 9 months in exhaustive training, this time competing against other seasoned Navy SEALs, knowing that 50% of the participants don’t succeed.

Then the secret missions, the truly dangerous ones, began; those in which he went from being a soldier to not existing, and to having to communicate with his children using fake e-mail addresses when entering combat.
At that level, O’Neill points out the need to move from taught tactics to invented tactics, to being creative, to anticpating what the opponent is doing. It is at that moment that the usefulness of micromanagement is questioned, since each member of the team must know how to perform their task. This is achieved by training, adjusting tactics, and learning the best way to communicate effectively.

The Mission that Ended Osama Bin Laden’s Life

The mission was carried out by an incredible intelligence team, led by four women, who after years of searching managed to locate Bin Laden in Pakistan. O’Neill reveals that President Obama was not convinced that this was Bin Laden’s whereabouts, and that the mission was initially set up to check that information and return.

One of the most stressful moments of this operation was the 90-minute flight from the base in Afghanistan to bin Laden’s hideout, during which they could have been hit at any moment for invading the country’s airspace. “Ninety minutes during which your head doesn’t stop thinking: ‘everything can explode now’. Worrying about things you can’t control only adds to pressure. So what do you do? At that point, I started counting from 0 to 1,000 and then in the reverse, from 1,000 to 0, to keep my head free from distractions, speeding up the counting or slowing it down, in order to just not think.

Once they arrived at the destination, one of the helicopters fell without casualties, and the rest of the soldiers entered the house identified as Bin Laden’s hideout. He was able to witness the first steps of the operation from the front line, the rest of the team dispersed to check the rooms. On the last set of stairs, he sensed a movement behind a curtain which he thought could be Osama Bin Laden’s last protective barrier, expecting to find suicide bombers in explosive vests. “At that moment I remember thinking that it was not a matter of bravery, but the tiredness of constantly thinking that I could explode at any moment. I moved the curtain, and there I found him. In front of me was Osama Bin Laden, as tall as I expected, a little thinner, with a somewhat grayer beard.”
O’Neill fired twice and felt paralyzed for a few seconds, and then more officers entered the room, asking if he was okay. Then O’Neill asked what the next step was, to which they responded “to go through the computer systems, we have rehearsed it a thousand times”.

On the return flight, another tense ninety minutes during which no one speaks until their arrival in Afghanistan, at which point the pilot jokes that it is probably the only time they will celebrate being in this country.

To conclude, O’Neill’s suggestion to his audience was: “The next time you feel overwhelmed by the stress at work, when nothing is working out as it should, or when you are at home and feel like the ceiling is falling on your head, breathe deeply and think of all those people who are fighting, defending and preserving freedom. Push yourself forward, never quit, and you will be fine.”

Why, According to Aberdeen AM, Diversification is the Key to Creating Robust Multi-Asset Portfolios in the Long Term

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Por qué la diversificación es la clave para crear carteras multiactivo robustas a largo plazo, según Aberdeen AM — Foto cedidaSimon Fox, courtesy photo. Why, According to Aberdeen AM, Diversification is the Key to Creating Robust Multi-Asset Portfolios in the Long Term

For many years now, asset managers have been responding to financial challenges through multi-asset strategies that seek to adapt to different market contexts, and they always seek the most appropriate sources of profitability and protection for portfolios. But the current environment is different from the past, and the challenges it poses are more acute, so it’s necessary to seek more creative solutions and go beyond traditional portfolios – which move within a framework composed of 60% fixed income and 40% equities. For Simon Fox, Senior Investment Specialist at Aberdeen Asset Management, these strategies “will no longer serve to build robust portfolios in the future,” he explained in a recent interview with Funds Society.

The motives? Investors will not only have to face a much more volatile environment, (marked by short-term problems such as Brexit, and long-term, with structural problems for growth such as demography, adjustment in China or de-globalization) but will also be faced with the fact that traditional assets, such as fixed income and equities, will offer much lower returns than in the past, within a framework of lower global growth. “Investors will have to face strong short-term volatility, but there are also structural hurdles: stock markets will no longer provide returns as high as at other times in history, and bonds, which have also provided strong returns in portfolios in the last decades, have much lower yields,” he explains. And in many cases, the latter do not even offer protection. In conclusion, with the traditional mix between equities and fixed income, future returns will be reduced inexorably.

In order to deal with this situation there is no other option than to look for creative solutions. Some opt for more active management that regulates the exposure to equity and debt based on the market situation, that is, they choose to do market timing. For Fox, this solution is very difficult, because “the markets are very difficult to predict.” On the other hand, there are also professionals who, in order to navigate this environment, are opting for strategies based on the use of derivatives to boost returns and increase hedging, but which may be more complex to implement and highly dependent on the capabilities of asset managers and the success of their bets. Faced with these alternatives, Fox has no doubts and opts for diversification.

Therefore, the search for opportunities in new market segments, and research into new assets capable of enriching portfolios, is AberdeenAM’s commitment to its multi-asset flagship strategies (one focused on growth, Aberdeen Global-Multi Asset Growth Fund, and another in dividends, Aberdeen Global-Multi Asset Income Fund). The portfolios, which were traditionally positioned one-third in equities, another third in fixed income and the remaining third in diversifying assets, have evolved over time to a situation which, since the end of 2014, is much more diversified and with alternatives to those assets in which the asset managers do not see value.

For example, there is no exposure to public debt or investment-grade credit, because asset managers believe that they currently offer neither return nor hedging. Instead, these assets have been replaced by other segments of the universe of fixed income with more possibilities (emerging market debt, asset backed securities, loans, high yield…) and also with real assets. Therefore, segments such as private equity, real estate, and especially infrastructures, have gained strong positions in the portfolio, in an environment where traditional assets yield less, including equities, with positions of around 25%.

In total, the portfolios have hundreds of positions, implemented, in the case of equities. from a quantitative perspective and focused on low volatility. And it has been shown that the most diversified portfolios can provide value: they offer greater protection in case of problems and, as a result, better results than their comparable ones.

Long Term Vision

The idea of building these portfolios is not based on market timing or short-term analysis: According to Fox, their construction is based on a long-term global vision (5-10 years) carried out by a group of analysts who make forecasts with this horizon, and with whom the multi-asset management team works very closely within the management company. Therefore, the positions do not change overnight depending on the markets, but they work to find diversifying solutions that bring added value.

For example, the vision is that inflation will end up rising, but it will not do so abruptly in the coming months: hence the inclusion in the portfolio of assets such as floating rate bonds and, above all, the infrastructures to play this story of price hikes – while eliminating the risk of duration by renouncing to public debt in the portfolios.

New Assets

Creativity is key in this context, and at Aberdeen AM they point out some of the latest additions and newest strategies, or the assets with the biggest appeal to offer returns. “There are now many more opportunities than in the past,” Fox says, and that leads us to talk about not multi-assets, but multi-multi assets.

As examples in this regard, Fox points out the bonds in India with high investment grade calification (which can offer annual returns above 7% and is a market that benefits from the improvement in fundamentals – in fact, the asset management company has a fund focused on this asset-), or access to equity through a smart beta perspective (focusing on low volatility or earning income, something they apply to funds). The alternative spectrum also opens up new opportunities, such as aircraft leasing (which can offer returns of close to 10%),insurance-linked securities, or royalties on health companies, options which are available to the asset management company thanks to its global character and its size. At the moment, they do not use ETFs, although they could do so.

All of this, at a time when the traditional barriers to diversification (such as transparency, illiquidity, regulation, commissions…) are dissolving, therefore “currently, diversification is easier thanks to the size and globality gained by asset managers and by the greater exposure and access to different assets,” explains Fox.

Solutions for Retirement

These types of solutions are suitable for retirement because they offer a low risk profile and provide benefits of diversification, returns and profitability, so that demand is very strong in both Europe and Latin America, as well as in the US offshore market.

Henderson Global Growth: A ‘Growth’ Equity Strategy that Selects Stocks from a ‘Value’ Perspective

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The Henderson Global Growth strategy essentially seeks to analyze the underlying business of the companies in which it invests, with a strong focus on those companies that grow in the long term. A global equity portfolio of growth style, but which selects its stocks from a ‘value’ perspective. Two of the four managers that make up the investment team explain its characteristics in detail.

The Management Team

For Ian Warmerdam, Portfolio Manager and Director of the Henderson Global Growth strategy at Janus Henderson Investors, it is imperative to have the best talent in managing a global equity fund. And, that can only be achieved by creating the best conditions to attract and retain talent, with a boutique management culture and entrepreneurial spirit.

That is why he believes that, in a small team of managers, it’s easier to see the results of each manager’s individual contributions: “If you are a good manager or a good analyst and you have confidence in your capabilities, why would you want to be just another cog in the machine in a large management team when you could see the direct result, in terms of risks and rewards, of your investment decisions?”

He also does not expect his team to grow in the short term. Composed of 4 highly motivated and autonomous managers: Ronan Kelleher, Gordon Mackay, Steve Weeple and Ian Warmerdam himself, they all have over 16 years experience in the investment industry and at least 7 years within global equity management. A team that, before joining Global Equities, had already worked together at some point during each of their careers, and which shares investment ideas with the Global Emerging Market Equities team, led by Glen Finegan.

According to figures at the end of March of this year, in total, they manage about 1.5192 billion dollars in assets, with its flagship strategy being the Henderson Global Growth, which, seven years after its launch, manages 604.5 million dollars.

Investment Philosophy

As for the investment philosophy followed by his team, Warmerdam points out that the strategy follows a bottom-up approach: “We spend very little time thinking about geopolitical factors. We believe that the vast majority of companies we value have intrinsic value in their own right. External factors are actually a distraction, when the market moves it creates opportunities, but it is really the business analysis that allows us to invest in the long term.”

Janus Henderson’s team likes to think that when you invest in a company you do it in perpetuity; that kind of mentality helps to focus on stocks with high quality at the franchise and managerial levels, two variables that allow the stock to accumulate value in the long term. “We carry out a strict valuation process, Henderson Global Growth is a growth strategy, but we like to think that we are value investors. We never build the portfolio based on an index, under any circumstances. The core of our investment process is very simple, companies change, industries change, but the important thing is to focus on weighting risks and opportunities. But the financial industry likes to complicate it; the key is not to be distracted by new theories and by terminology.”

Warmerdam admits that it is extremely difficult not to be distracted in a world inundated with news 24 hours a day, macroeconomic and political events broadcast as sensationalist press, and real-time information on stocks and markets. “Following the markets in real time is a huge distraction, which can play tricks on our human emotions when it comes to investing, fear and greed. We look for some kind of gratification that confirms our decisions in the feedback that the market seems to provide, and that is a very dangerous thing to do. Financial markets are the only market in the world that people tend to flee from when there are rebates, this shows how little logic they have.”

What Type of Stocks Make Up the Portfolio?

The fund includes quality stocks that continue to grow over the long term with attractive valuations. When they look for new investment ideas for the fund’s portfolio, they pose six questions grouped into three themes: strength of franchisee, financial fundamentals and management team. In order to include a stock on the follow-up list, and from there to the final portfolio, they must be able to successfully address these questions.

Gordon Mackay comments that the first question asked is whether the company participates in an attractive final market. What they are looking for with this question is to identify markets in which companies continue to grow and where participants can obtain attractive economic returns. Markets with a clear structural growth trend in which, from the consumer’s perspective, the final product is very difficult to differentiate in any significant way. The second question is whether the company has a competitive advantage that is sustainable over time. With this question they seek to determine who the competitors are and how the company is positioned in relation to them.

In terms of financial fundamentals, they look at the quality of earnings, which is usually determined by a strong cash flow component and by high levels of cash flow conversion capability for long-term shareholder returns. Generally, it’s those companies that are able to generate high yield on their own resources (return on equity), which are able to reinvest in their businesses and to keep growing.

“We look for businesses that are able to withstand a downturn in the business cycle. We try to find out how resilient the underlying business itself is, and how strong its balance sheet is; and whether the company has been managed in a conservative way from a financial perspective,” says Mackay. “From the standpoint of portfolio positions, we tend to find fewer companies in the financial sector that are able to meet these criteria.”

For managers of the Henderson Global Growth strategy it’s very important to know the senior management team that manages the company. We are looking for high quality leadership that has been able to allocate its capital historically and which demonstrates ethical practices and good corporate governance. The final question is whether the company’s management team is able to act in the interest of minority shareholders. “We like to see that there is a high level of alignment between the shareholders and the management team. What we prefer is that there are executives who own the same shares that we do in the company, instead of only benefiting from stock options, because when they are part of the shareholder group, they tend to be more conservative in their actions.”

Once a company meets these six requirements, they can potentially be included on a watch list, which typically contains between 80 and 120 securities. That any of these stocks make it into the final portfolio depends on the level of valuation and the analysis of expectations. The Henderson Global Growth portfolio is a high conviction portfolio, which concentrates on between 45 and 60 securities. “When we add a new company to our strategy, we use weights of 1.5% or 3%. When we do not get it right in the valuation of fundamentals, or when the stock is overvalued, it is sold. Each of the portfolio managers has his own inventory of investment ideas, we do not try to cover the entire market,” adds Mackay.

What Trends does the Strategy Follow?

It is a portfolio composed exclusively of long positions, which does not use derivatives to try to improve the performance obtained. In addition, it seeks to focus on positions with growth in the long run, following a series of trends that the management team has identified as secular trends that are still below their intrinsic value. Thus, Mackay comments that, although these trends are not necessarily “undiscovered”, they will represent a significant change over the next five and ten years: the transformation of the internet, innovation in the field of health care, improvement in energy efficiency, consumption growth in emerging countries, and digital payment.

“A clear example of the trend of digital payment is Mastercard. A stock which could be perceived as expensive in terms of multiple P/E with respect to next year, but which, if evaluated over a five-year horizon, can be seen as attractive growth,” Warmerdam concludes.

The Importance of Tactical Management: How to Benefit From Market Volatility Episodes

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In today’s environment, multi-asset strategies remain an indispensable tool for gaining flexibility and diversification. But what elements make it possible to differentiate a multi-asset strategy from its competitors? Cristophe Machu, from the Multi Asset and Convertibles’ team of investment specialists at M&G Investments, explains in detail the approach used by the M&G Dynamic Allocation and the M&G Prudent Allocation strategies, which seek to convert market overreactions into a source of returns for the investor.

Both funds use an approach composed of three different pillars: strategic valuation, tactical valuation and portfolio construction. During the first block, strategic valuation, the management team examines and compares the valuations of the different asset classes in which the strategy invests – equities, fixed income, and currencies – with their fundamentals, to ensure the correct allocation of assets, which will be the portfolio’s main source of alpha. In the second block, tactical allocation, the management team seeks to exploit the opportunities that are generated in terms of volatility from changes in investor sentiment. According to M&G, on average, 18% of market volatility is the result of an excess of optimism or pessimism in investor sentiment, something that affects valuations, but not fundamentals. Finally, in portfolio construction, they focus on finding sources of decorrelation between the different assets. According to M&G, the correlations are not static, which is why they must perform a qualitative analysis over quantitative analysis, in order to understand the degree of correlation that future portfolio assets can reach.

Why is Strategic Valuation the Starting Point?

Returning to the first pillar, Cristophe points out that valuation is a good indicator of future returns, as it allows us to know what returns are expected of an asset and how it is being perceived by investors in the market. In equities, in both the United States and Europe, the current level of the forward P/E multiples can show the expected average yield over five years. Therefore, if you buy shares with multiples between 8 and 10 times, in five years you could realize an annualized yield of 20%. However, if you pay too much for an asset, with multiples between 24 and 26 times, the investor would almost certainly incur a loss.

A second issue that M&G evaluates, in order to try to take advantage of the opportunities it generates in the medium term, is the evolution of market volatility. In this respect, the managers of the multi-asset strategies would try to detect “episodes”, or moments in which quotes for the assets don’t correspond with their fundamentals to add risk to the portfolio. This alternative investment approach, with some contrarian vocation, tries to play tactically with asset allocation, increasing equity exposure when the market is over selling its positions for no apparent good reason. The strategies that follow this approach are called “Episode strategy”.

A good example of this approach is the returns obtained by the M&G Dynamic Allocation fund, which invests around 40% in US equities, compared to the performance of the S&P500 index and to a multi-asset portfolio that starts from the same allocation in US stocks, but that uses stop-loss mechanisms whenever the market experiences a fall, progressively reducing its exposure to risky assets with each decline. Over a period of 20 years, the returns of the M&G strategy would have been substantially higher than those of the market and of the strategy using stop-loss mechanisms, exceeding them by 60% and 108%, respectively.

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Why is it Pointless to Try to Predict the Future?

2016 was a year full of political events, during which the difficulty of guessing when making predictions became quite clear. Many investors were surprised by the vote in favor of Brexit and by Donald Trump’s election as president of the United States. For Cristophe, the most surprising thing about that whole case is that, even knowing the final result, it is still possible to err when reading the expected market reaction. Some market experts anticipated that a Trump victory could mean a precipitous decline in the markets and the beginning of a recession. Far from these predictions, in the weeks following the November election, so-called safe haven assets, gold and Treasury bonds at 10 and 30 years yielded negative returns, while the S&P 500 index performed positively. That is why, in terms of tactical management, none of the asset managers at M&G tries to make predictions, but rather, to benefit from the volatility that different episodes or market events can create.
In this regard, the VIX volatility index could serve as an entry indicator into the equity market, because according to the M&G investment specialist, after a peak of volatility in the VIX, the S&P500 usually experiences a rally in the following years, showing adequate moments for the incorporation of greater exposure to risky assets in the strategies.

Cristophe also points to the purchase by the M&G Dynamic Allocation fund of European, US, British, and Japanese stocks during the months of January and February 2016 as an example of a response to a market “episode”, to then undo these tactical positions in March. Months later, after Brexit, the fund took advantage of the attractive valuations of the banking sector and of certain regions to increase its exposure to these assets. It then sold those positions as soon as the market moved sideways in September of the same year.

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The Importance of Correlations Between Assets
At M&G, they argue that the correlation between equities and fixed income is dynamic and depends on the bond yield. If the bond yields are quite high, close to 10% or higher, there is usually a good source of bond and equity decorrelation. On the other hand, if the bond yields are much lower, below 5%, the ratio between the two assets is positive. This means that, at present, adding fixed income is not as attractive as equities, neither from a valuation point of view nor as a source of decorrelationas compared to equities, therefore, at M&G they do not believe that investing in a traditional multi-asset fund is the right solution for the client

Where is the Value?

Both the M&G Dynamic Allocation fund and the M&G Prudent Allocation fund can take short positions in equities and fixed income. In response to the cycle of interest rate hikes by the Fed, the fund positions itself with a negative duration.
The bond market is in an anomalous situation, where yields remain extremely low in both the United States and the United Kingdom, as well as in Europe and Japan. Taking inflation into account, these bonds have a negative yield, implying that an investor is willing to lose money in the medium term by investing in this type of assets. That is why the fund seeks to generate profitability by positioning itself short in relation to the debt of these countries.

Furthermore, at M&G they believe that, in US corporate credit, specifically in the BBB-rated universe, there may be value, as well as in some emerging markets, such as Brazil, Colombia and Mexico, which offer attractive spreads with respect to US Treasury bonds.

In equities, price is determined by the product of corporate profits and market valuations in terms of P/E multiples. In this regard, at M&G they strive to find sectors or geographical areas that can offer an increase in terms of corporate profits or whose valuations have potential for appreciation. Emerging markets and European equities would have these characteristics, and they hold long positions in both markets. While in the United States, although corporate profits are high, valuations are at their highest, so they hold long positions in some sectors with attractive valuations such as banking, technology, biotechnology, and oil, but for the first time in the fund’s history, they hold a net short position in US equities.

Finally, in the area of foreign exchange, M&G’s multi-asset fund managers prefer emerging market currencies for two reasons: the attractive valuation level of the Turkish Lira, the Russian Ruble, the Mexican Peso and the Brazilian Real, and the carry that these currencies represent against the dollar.

Sara Shores: Over the Long Run I Love All My Children and Factors Equally but Over the Short Run One Might be Having a Better Day

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Smart Beta is a growing strategy that according to Sara Shores, CFA, Global Head of Smart Beta at BlackRock, has captured investor’s attention and interest for three main reasons: returns, diversification and fees. In an interview with Funds Society, she also explains how they do factor investing, a strategy that accounts for over 170 billion of their assets under management and expects double digit growth.

Shores explains that the main reason for the strategy’s popularity is that the return environment has been getting more and more challenging with equity returns in the 5% range, as expected by BlackRock’s capital markets assumptions for the next five years which “is not enough for most investors to meet their retirement goals.” So by focusing on factors, the broad, historically persistent drivers of return, and doing so with Smart Beta vehicles, one has the potential of incremental returns, with a significant lower fee than traditional active management.

Regarding diversification, which has been proven elusive via traditional allocations, she mentions that most the factors they look at in equities are also present in fixed income, currencies, commodities “and that then opens up a whole new range of diversification because momentum in equity is not particularly correlated with momentum in commodities or currencies, so by investing across asset classes we can really take full advantage of the opportunity set for factor investing.” So despite having equity factor investing as the largest Smart Beta asset class and continue to “see a tremendous growth in equities there are great opportunities in other asset classes.”

The BlackRock executive believes that there are five persistently rewarding factors in equity markets are: Value, Quality, Size, Low Vol, and Momentum and while “over the long run I love all my children equally and I love all my factors equally but over the short run your son or your daughter might be having a better day, and it is the same for factors, so one of the things the team has been working on is to see what factors are better poised based on the current market.” They are overweight in US equity markets with Momentum, and just recently moved to an overweight in minimum volatility given US growth is strong but grow at a modestly slower pace than in recent months, which could translate into investor caution.

About their operation, she mentions that at BlackRock they want to marry quantitative research with a really strong economic understanding on what drives markets and what drives risk and return. “Humans are made better by data, data is made better by humans, we like data and models but we also want to rely on our intuition. Our philosophy on factor investing is to always start with the economic grounding of asking why, what is the economic justification that suggest a factor will continue to earn a return in the future and only with that economic just we go and look at the date to see if it actually works over time over a wide range of assets and geographies, so we want to inject the human judgment as well.”

With over 170 billion in AUM for their factor-based strategies, both the index driven smart beta strategies and the non index ‘enhanced’ factor strategies, they are always mindful of liquidity and capacity to make sure that any of their strategies don’t move the market in an unexpected way. Most of their assets are in their smart beta ETF type strategies, whose markets are so large and liquid that liquidity is generally not a problem. However, in their enhanced strategies, where they have 12.5 billion in AUM they are “very mindful of liquidity, our strategies are not of a size were we are worried of moving markets yet, but we do think of how big can we be, we manage that by making sure we don’t have too much risk deployed in any individual factor/instrument to make sure we can trade the portfolio with a reasonable liquidity should something change unexpectedly. So we keep a very watchful eye on that capacity question.” She concludes.

Pioneer Investments: “Earnings Growth Will Be the Dominant Driver of Returns for European Equities”

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Pioneer Investments: “En renta variable europea la clave ahora es estar atentos a los beneficios empresariales ya que si crecen, las bolsas continuarán subiendo” — Fiona English, courtesy photo. Pioneer Investments: “Earnings Growth Will Be the Dominant Driver of Returns for European Equities"

The arrival of capital flows into European equities coincided with the reduction of political risk in the Old Continent after the first round of French presidential elections. But with the German and Italian elections on the horizon, the question is whether the fundamentals will continue to support the upturn. Fiona English, client portfolio manager at Pioneer Investments, talks with Funds Society about het outlook for European Equities.

Europe has received a big amount of inflows in the last quarter, but is it sustainable? Are the fundamentals supporting this performance?

Indeed flows coincided with the reduction in political risk following Round 1 of the French presidential Election as investors believe the chances of fragmentation within the Eurozone has subsided. That said, in reality there are 4 main drivers of European Equities which combined suggest that the performance of the European market can continue– 1) better economic growth, 2) better earnings growth 3) reduced political risk and 4)flows into the asset class

We are experiencing quite synchronized global growth at this moment and with 50% of earnings for European companies lying outside the Eurozone, this clearly provides a support to earnings potential for European companies. Within this, European GDP Growth is likely to strengthen this year with our Economists forecasting 1.8% for FY 2017. The key here is for companies to translate the more supportive economic backdrop into earnings growth and we are witnessing signs of this. In Q1 on aggregate, 46% of companies beat consensus estimates by 5% or more, while just 22% missed, pointing to the strongest quarter since the Q2 2007.

This and the reduction in political risk within the Eurozone has given investors the confidence they needed to return to the asset class with 18bn of inflows in the last 2 months alone.

In our view, for the market trajectory to be sustainable – we need to see confirmation of earnings growth continuing as we move through Q2 and Q3 this year.

Have investors lost the train in European equities after the rally seen in April and May?

While the rally was swift, we still believe there is more to go if earnings growth proves sustainable. The asset class remains underowned with many international investors now beginning to consider European equities “investable” again.

In fact despite the rally, European Equities have seen a slight reversal of this trend since mid-May with the market moving sidewards at best and underperforming the US market. There is probably an element of seasonality at play and the market is likely seeking another catalyst to move higher from here. We believe this will come in the form of a confirmation of further earnings growth. Any further weakness may provide a good buying opportunity as we move into the second half of the year.

Where are you finding the most attractive opportunities and what areas are you avoiding?

Given we believe that earnings growth will be the dominant driver of returns from here and in line with our investment process, we believe the most consistent way to generate performance will be through good stock selection. We do not believe that earnings growth will happen across the market as a whole but rather you must look for the companies which have a strategic competitive advantage and the ability to capitalize on better economic trends and convert it into better earnings growth. In this environment, stock selection will be key to performance.

How have you positioned your portfolio to take advantage from the rally?

We have looked to keep quite balanced portfolios not favouring any one area of the market but looking for idiosyncratic/stock stories which we believe have the potential to deliver medium term outperformance. For example, most of our portfolios are overweight Industrials at this moment due to the number of individual compelling investment cases we find there. The sector offers a number of different business models which will benefit from the more positive macroeconomic tone but also strong companies which have a strategic advantage that allows them to translate this into earnings growth. Finally valuation is clearly always important and we look to seek the correct entry point which should allow us upside potential from a valuation standpoint.

Is it the right moment to invest in more risky assets within equity or should we be more cautious?

The key for the equity market is to see greater earnings growth – if this happens we believe the market can move higher.

Do small-caps look attractive versus large-caps?

We see opportunities in all areas of the market. Finding value should be less focused on market capitalization but more on individual companies and their ability to deliver.