Emerging Debt is One of the Last Fixed Income Categories that Provide a Compelling Upside

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"La deuda de empresas de mercados emergentes es una de las últimas categorías en renta fija que proporciona un gran potencial alcista"
CC-BY-SA-2.0, FlickrThomas Rutz, co-fund manager MainFirst Emerging Markets Corporate Bond Fund Balanced / Courtesy photo.. Emerging Debt is One of the Last Fixed Income Categories that Provide a Compelling Upside

Nowadays, in an environment of higher growth, inflation and growing prospects of rate hikes, getting returns on fixed income is not easy, but Thomas Rutz, co-manager of the MainFirst Emerging Markets Corporate Bond Fund Balanced, believes that emerging corporate debt could offer attractive returns this year. In this interview with Funds Society, the manager explains that he prefers to take long-term credit risk and reaffirms the attractiveness of companies in emerging countries, which have improved their fundamentals in recent years, adjusting to falling commodity prices  and their currencies, and gaining strength for upcoming episodes of volatility. According to the expert, Latin America, cyclical sectors and high yield are the segments to watch.

– Emerging debt is an asset that is increasingly driven by international managers. What are the main benefits of these types of assets right now?

The main benefits are that EM corporates, in particular the high yield segment, offer an excellent risk-adjusted return profile in an environment of slowly rising interest rates. They are one of the last fixed income categories that provide a compelling upside. In addition, an allocation to emerging markets corporate debt provides an attractive opportunity to add diversification, as they exhibit a different risk profile to developed markets and provide investors with the opportunity to capitalize upon the future growth of private sector companies.

We believe that emerging markets are in the process of a multi-year convergence towards the developed world and the credit spreads (risk-premium) will narrow driven by those dynamics. There are very good prospects for a solid performance in 2017 due to better fundamentals with overall growth increasing from 4% in 2016 to 4.5%.

– Are the valuations attractive? In which segment are they more attractive: public or corporate debt?

Overall, emerging markets economies have greatly benefited from macroeconomic stabilization, improved legal and regulatory framework and better corporate governance, and also continue to benefit from very attractive demographics, such as population growth and the emergence of a new middle class. This will continue to drive domestic demand and economic output.

Valuations are therefore highly attractive. We prefer EM corporates over EM sovereign investments, since corporate credit spreads offer a better risk-adjusted return profile. In addition, credit spreads are higher and their duration is on average lower than those of sovereign debt. They, thus, offer better protection in a rising interest rate environment.

– Will the commodity rebound last and drive emerging markets? Which commodities will profit and which will suffer?

The recovery of commodity prices provided a crucial fundamental support to many emerging market countries and corporates last year. At current price levels, many firms already profit from massively increased cash flows which are then used to further deleverage their balance sheets.

– Have emerging market companies improved their fundamentals in recent years? If so, in what sense and in which segments of the market?

Yes, they certainly have! Leverage levels in EM corporates have stabilized markedly. Most companies have adjusted to the higher dollar and the lower commodity prices. This provides the base for corporate balance sheets to be more resilient to further volatility in currencies and commodities and, therefore, default rates are likely to decline.

Especially in the energy and mining & metals sectors, the firms responded to the crisis with cost-cutting initiatives, severe capex cuts and asset sales.  The extent of these adjustments has differed by region and country. In Russia, the flexible FX regime has largely mitigated the effects of declining oil prices. In Latin America, we are also seeing good progress, with many corporates taking proactive steps to cut CAPEX and sell assets (e.g. Brazil’s Petrobras or Vale).

– Do you prefer interest rate risk or credit risk at present?  Do the Fed’s future policies play a role in this?

We prefer credit risk for the reason that through credit spread compression, a positive return can be achieved, even in an environment of rising interest rates. Therefore, we manage our funds with a focus on the credit spread performance. Their duration is either in line with or shorter than the benchmark.

– What potential influence may Fed policies have on emerging corporate debt? Will its impact be smaller or greater than that of public debt?

Since, due to such developments as stronger commodity prices and the corrected macroeconomic imbalances, the overall position of the emerging markets is much stronger than a few years ago, Fed policy is likely have a comparatively milder impact on emerging market debts.

Moreover, potential protectionist trade measures by Donald Trump should be manageable since they have mostly already been priced in. In other cases, many investors have used short-term kneejerk reactions and dislocations as excellent initial buying opportunities. The proposed infrastructure program is likely to have a positive effect on commodities and thereby provide further attractive investment opportunities.

In which markets do you currently see the highest number of opportunities and why? Can you give some examples of sectors and names?

We currently see a lot of potential in Latin America as it is still largely undervalued. We, therefore, maintain a 25% overweight in the Latin American region. and our portfolio is tilted to more cyclical sectors, such as industrials, infrastructure and commodities. We like names such as Brazil’s Petrobras (energy) and Gerdau (steel). The latter, for example generates 45% of its revenues in North America and 35% in Brazil and is therefore well positioned for Trump’s infrastructure push in the coming years.

– Is China still a major risk for the emerging markets, or less so than before?

We neither did nor do we see China as a major risk for the emerging markets. Still, as long as valuations remain very stretched we will continue to have a large China underweight vs. the benchmark (2% in our fund vs. 20% in the JP Morgan CEMBI).

– Active management is key to your investment style in the emerging markets. Why? Is it a market that requires active investment management?

Yes, emerging markets require active management. We actively search for relative value in undervalued companies in the whole fixed income universe by applying a bottom-up, 5-step decomposition of the credit spread approach. Fund managers have to face the fact that there will again be significant winners and losers. A very active and opportunistic investment style will therefore provide additional alpha for those who are willing to continuously search for new opportunities and are able to adjust their positions. Our active management allowed us to outperform the benchmark by 560 basis points in 2016. For 2017, we expect another good year for active managers.

– How is the structure of the portfolio of the MainFirst EM Corporate Bond Fund Balanced set up? Is it a concentrated or a broad portfolio? Why? How many positions does it hold?

The MainFirst Emerging Markets Corporate Bond Fund Balanced is a fairly balanced mix of investment grade and high yield corporate bonds. The approach is opportunistic and based on the convictions of our fund management team. In a way, we are “bond pickers” and the resulting portfolio is a collection of global “best of” titles. This is at all times accompanied by diversification across multiple axes (regions, countries, sectors, ratings, duration). Currently, the portfolio holds 107 positions in 37 countries.

– How are titles selected? What characteristics do the titles need to have to be included in your portfolio?

Every investment is subjected to a risk and opportunity analysis, assigned a credit spread target, and usually replaced with another security once the target is reached. This encourages an active, target-focused style of investing. Emerging markets are ideally suited to a relative investing style.

– What do you like most, IG or HY firms at the moment, and why?

We currently like HY firms most, as they provide a greater upside potential through credit spread compression. With real yields hovering at very low levels, credit spreads are one of the last remaining potential sources of performance gains. Instead of focusing on long duration, the emphasis in the current market environment is on a thorough analysis and a disciplined investment approach to deliver performance. In contrast to most developed market fixed income instruments, whose performance is generally highly correlated with underlying government bonds, in emerging market credit products positive returns can still be achieved in an environment of slowly rising interest rates.

– Can you say something about the expected returns for this asset in 2017?

It is always difficult to predict performance, as unforeseen developments may always affect markets. However, if the current market conditions hold and trends continue as expected, we assume that the portfolio should be able to deliver the average portfolio yield plus roughly 200 basis points, which should result in a high single digit or even double digit return for 2017. As of February 7, 2017, the year to date performance for the MainFirst Emerging Markets Corporate Bond Fund Balanced is already at 2.76%.

Western Asset Macro Opportunities Bond Fund is Available to Brazilian Investors through a Local Feeder Fund

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Western Asset Macro Opportunities Bond, una de las opciones que ofrece Legg Mason al inversor brasileño a través de un feeder fund
Pixabay CC0 Public DomainPhoto: Jorge Letelier, Regional Director for Legg Mason in South America, and Roberto Teperman, Head of Sales for Legg Mason in Brazil / Courtesy photo . Western Asset Macro Opportunities Bond Fund is Available to Brazilian Investors through a Local Feeder Fund

At the beginning of January of this year, Roberto Teperman was appointed Head of Sales for Legg Mason Global Asset Management in Brazil. Previously, Roberto, who has a track record of almost 20 years in the financial industry, worked for Western Asset Management for 12 years, a subsidiary of Legg Mason that specializes in global fixed income solutions.

Over a year now, Roberto Teperman, based in Sao Paulo, has worked alongside Jorge Letelier, Regional Director for Legg Mason in South America, based in Santiago, Chile, in the development of feeder funds, which are investment vehicles that allow local investors to access funds in the UCITS format, and are registered in either Dublin or Luxembourg.

In October 2015, Legg Mason launched its first feeder fund in Brazil, the Legg Mason Western Asset Macro Opportunities Bond fund, an ‘unconstrained’ fixed income strategy that invests in a combination of investment grade and high-yield debt securities and derivatives. While the original strategy, which was launched in November 2013, is registered in Dublin and managed by a team headed by Kenneth Leech, CIO at Western Asset, which manages over US$ 4 billion in assets, the feeder fund has approximately US$ 100 million in assets.

The launch of this feeder fund was carried out shortly after the establishment of Instructions number 554 and 555 of the Brazilian Securities and Exchange Commission, which modified the definition of qualified investor, thus opening the fund distribution business to the “mass affluent” client.
One of the main factors taken into account for the launch of the Western Asset Macro Opportunities’ feeder fund was its investment style, as it can invest up to 50% of the fund in high-yield debt and emerging markets as well as  have exposure to currencies.  Having the capacity to invest in futures, options, and other derivatives in order to actively manage the duration of the portfolio is a strategy that perfectly adapts to the preferences of the Brazilian investor.

“The Brazilian investor is accustomed to high interest rates on fixed income, which limits the options that can be offered to cover their investment needs. An alternative could be an equity fund, which generally offers near-double-digit yields, but they have higher volatility. However, fixed income funds with exposure to higher yielding securities seem like a better option,” says Roberto Teperman. “What we decided at that time was to review our product platform and look for the fund that best fits the needs of Brazilian clients. That’s how it was decided to distribute the Western Asset Macro Opportunities,” he adds.

The second feeder fund, the ClearBridge Global Equity fund, has been launched in Brazil to provide exposure to the MSCI World Index; the given client’s needs. These investment strategies are aimed at both institutional and retail clients, with the latter being private banking platforms, HNWI, and asset managers.

“We are working with clients and the sales team at Western Asset, who is an entity legally licensed as a Brazilian fund administrator, to open and create feeder funds that invest in offshore funds.  Currently, we are evaluating the possibility of launching new feeder funds for different strategies with other affiliates of Legg Mason. The launch of these two funds is just the beginning, we are likely to launch new feeder funds in Brazil soon,” continues Roberto.

Legg Mason has been present in Brazil since 2005, after acquiring Citigroup’s asset management business. By having a person with knowledge of the local players and language, based in Sao Paulo, and fully dedicated to funds distribution, the management company aims to reinforce its long-term commitment to the local market.

Chile, Peru and Uruguay

In Chile, Legg Mason has been present since 2006 and its Santiago office serves as a base from where to develop the business in Peru and Uruguay. Currently, talks are being held with institutional investors, private banks and family offices, so that feeder funds that give Chilean investors access to offshore products can soon be launched.

The latest tax amnesty programs that have taken place in Chile, Argentina, and more recently Peru, have changed the landscape of the local investment fund industry. In this regard, Legg Mason has adapted to the changes quickly.

“The fiscal amnesty in Argentina and the fact that some global players like Royal Bank of Canada and Merrill Lynch have left the region has caused the fragmentation of the offshore business in Uruguay. Due to the former, numerous independent financial advisors have established themselves as family offices so as to continue serving their clients,” says Jorge Letelier.

“Both in Argentina and Peru, investors are taking advantage of the benefits offered by their governments, to repatriate capital to their country of origin and to be able to invest, either in local bonds with high yields, or in local funds with tax incentives for them”.

At this very moment, Legg Mason is not considering the idea of having a sales manager in Buenos Aires, but it does follow the development of the local industry very closely. “For now, Chile will continue as the center of operations for the Southern Cone,” concludes Letelier.

Seeking for Alternative Ways to Diversify Your Income?

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¿Buscando caminos alternativos para diversificar la obtención de rentas? 
CC-BY-SA-2.0, FlickrPhoto: Tristán Schmurr. Seeking for Alternative Ways to Diversify Your Income?

2016 leaves behind much economic uncertainty, regional political tensions, an oil price roller-coaster, and monetary policies which would have been unthinkable in the past. Hence, calmness and patience were key virtues for ending the year with positive returns.

And, heading into 2017?

The Franklin Templeton Investments solution goes through three very flexible strategies, which are able to adapt to the environment as the year’s uncertainties –the Trump stimulus program, the presidential elections in France and Germany, and Brexit–unfold, and as monetary and fiscal policies gain clarity.

Franklin Strategic Income Fund

“In a world still hungry for yield, our view is that a number of fixed income sectors still represent potentially attractive income-generating opportunities, particularly on a risk-adjusted basis, despite recent volatility following the US elections,” explained Christopher Molumphy CIO at Franklin Templeton Fixed Income Group and Portfolio Manager at FTIF (Franklin Strategic Income Fund).

In the coming months, any gradual replacement of monetary stimulus with fiscal stimulus could also lead to periodic volatility. However, Franklin Templeton’s fixed income team believes that demand for income-producing securities has not diminished, and that such demand should provide support for income oriented funds. “We regard periodic volatility as a signal of healthy markets functioning normally,” explained the fund manager.
 

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The strategy which he heads focuses on obtaining a high level of current income, with capital appreciation over the long-term as a secondary objective, and opts for fixed income and variable rate debt, which includes emerging markets. The fund uses an active asset allocation process and, under normal market conditions, invests at least 65% of its assets in US and foreign debt securities.
 

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Diversification is achieved by seeking opportunities across the whole spectrum of investment grade and below investment grade bonds, while global bond and currency markets provide the potential for risk reduction through a combination of low-correlated sectors and strategies.

Global Multi-Asset Income Fund

The US firm’s other solution for the year is the Franklin Global Multi-Asset Income Fund, which aims to distribute a consistent level of income while maintaining potential for long-term capital appreciation. The fund aims to do this while maintaining strong downside protection and within a specified risk budget of half of the volatility of the global equity market.

Given that 46% of its assets are fixed-income, and of this, 86% are investment grade bonds, its profile is more conservative.

With a three star Morningstar rating, the fund’s Portfolio Manager, Matthias Hoppe, of Franklin Templeton Solutions, explained that “by following a sensible approach to portfolio construction and adopting a philosophy that attempts to ‘win by not losing’, we approaches 2017 optimistic about the opportunities the market offers to generate a good level of income on a risk adjusted basis.

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The fund, a pure multi-asset one, invests in equities, fixed income, and alternative assets such as REITs, commodities, infrastructures and other instruments. Its regional positioning currently prefers the United States, followed by global assets and Europe in third place.

Franklin Income Fund

Heavily weighted in U.S. assets, which represent almost 80% of the portfolio, Franklin Templeton’s latest solution for income diversification is the Franklin Income Fund.

“While the pace of economic growth may remain relatively subdued, we see reasons for optimism in US and global equity markets in 2017, even as investor uncertainties over commodity prices and upward-trending US interest rates will likely persist,” said Edward Perks, CIO at Franklin Templeton Equity and Portfolio Manager for the Franklin Income Fund.

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The strategy has an almost identical weight of equities than of fixed income. 46% compared to 42%, respectively. The third leg of this portfolio is the convertible bonds, which have a weight of 10%.

The main difference with the Franklin Global Multi-Asset Income Fund is that in this case most of the fixed income assets have a rating below investment grade.
 

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“We follow a flexible, value-oriented investment philosophy seeking income and long-term capital appreciation potential by investing in dividend-paying stocks, convertible securities and bonds,” Perks summed up .

The Franklin Income Fund team believes that as the year moves forward, a stronger US economy offers a positive dynamic for many other economies and markets, “allowing for a potential shift in equity market leadership from the United States to other parts of the world,” he concluded.

Vasiliki Pachatouridi: “ETFs Will Benefit From a More Diversified Client Base Thanks to the MiFID II Directive”

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Vasiliki Pachatouridi: “La dimensión futura de los ETFs se beneficiará de una base de clientes más diversificada gracias a la directiva MiFID II"
Vasiliki Pachatouridi, courtesy photo. Vasiliki Pachatouridi: “ETFs Will Benefit From a More Diversified Client Base Thanks to the MiFID II Directive”

According to a report by Greenwich Associates and commissioned by BlackRock under the heading “ETFs in the European Institutional Channel”, the volume of assets in exchange-traded fixed income funds worldwide could exceed $2 trillion in 2025. There are those who draw attention to the high volumes of investment that this vehicle is attracting, but for Vasiliki Pachatouridi, iShares Fixed Income Product Strategist at BlackRock, the growth of debt ETFs should be taken into account in relation to the size of the underlying fixed income market and the investment fund sector as a whole.

In an exclusive interview with Funds Society, Pachatouridi states that, in November 2016, fixed-income ETFs reached almost US $600 billion in managed assets worldwide, with US-based fixed-income listed funds leading the way with US $421 billion in assets under management, followed by those domiciled in Europe with US $139 billion. “While assets managed by fixed-income ETFs have more than tripled since 2009, they still make up a small part of the underlying bond market: in fact, it accounts for less than 1%,” she explains. In fact, Pachatouridi points out that, if broken down by segment, high-yield fixed income ETFs currently have the largest share of the underlying market for this type of bond, at 2.4%, followed by listed fixed income funds with investment grade rating, representing only 1.8% of the underlying bond market with this rating.

As a reason for this growth, it should be noted that, during the past two years 25% of institutional investors have started using ETFs to access fixed income markets, and everything points to the fact that this interest is increasing. In  her opinion, the main catalysts for this trend are, “the purchase of bonds by central banks, which are shifting investors to US corporate debt; secondly, the consequences of regulations in trading models that, in particular, have reduced the ability of banks to maintain risky assets and act as liquidity providers within the framework of the main trading model and, finally, the pursuit of profitability.”

Over 55% of investors use ETFs to rebalance their portfolios. In the current market context we witnessed a strong upturn in risk inclination in all segments of corporate debt, which translates into inflows into exchange-traded fixed income funds. “November was a record month for TIPS ETFs (US bonds protected against inflation), which raised $ 2.4 billion, as inflation outlooks rose in the face of signs of upward pressure on prices, and the translation into practice of monetary policies at the budgetary level. At the same time, investment in conventional US Treasury bond ETFs fell ($ 2 billion), on fears of the Fed’s rate hike in December, which finally came.

The end of fixed income investment?

On the Fed’s monetary policy, Pachatouridi comments that, “now that rates are rising, some investors talk about the end of investment in fixed income. This position assumes that investors are always looking for profitability. The reality is that investors have balanced their portfolios, therefore, the debate no longer focuses on the interest of incorporating fixed-income securities into the portfolios but, instead, on how they should be maintained. Within a context of rising interest rates, we could witness a new rotation towards safer assets and bonds,” she explains.

In her opinion, the rise in rates does not necessarily lead to the widening of corporate debt spreads. “For example, if rates rise because growth is really improving, corporate debt spreads could also be reduced as benefits outlook improves and the risk of default decreases. However, if rates rise because markets are concerned about rising inflation (in the absence of growth) or, worse, due to the persistently high level of sovereign risk, spreads are likely to widen as long as the rest of the variables remain intact.”

More Investors

One of the challenges facing the future is the expansion of the ETFs’ investor base, which is currently very small. In this regard, for Pachatouridi, the future dimension of these products will benefit from a more diversified client base thanks to the MiFID II directive. “Reporting requirements on trading and on post-trading transparency represent clear progress that will improve the perception of the liquidity of European-domiciled ETFs, as they will provide more visibility to transactions in non-organized (OTC) markets.” In her opinion, other key catalysts for the growth of this market could be the standardized calculation of risk and trading, the increase in the supply of securities in ETFs for loans, the development of ETF derivative instruments, as well as greater acceptance of these products as collateral in over-the-counter transactions.

Pachatouridi states that one of the main differences between Europe and the US in terms of trading in fixed income assets, is the lack of consistent and reliable data on that activity in the Old Continent, which is something that MiFID II also seeks to solve. “Since trading is not required to be reported, there is a tendency to underestimate trading volumes in the secondary market for exchange-traded fixed income funds. MiFID II will improve the perception of the liquidity of the ETFs domiciled in Europe, since they will provide visibility to operations in unorganized markets (OTC).”

The ECB will have 10% of corporate debt

As regards the ECB’s corporate debt buy-back program and its impact on the market, the expert points out that, assuming the program runs until March 2017 and that the ECB continues to acquire debt at a rate of approximately 250/280 million Euros per day, bonds in the hands of the institution will add up to between 70 and 78 billion Euros. The market volume of corporate debt (non-financial) in Euros in the Euro zone amounts to approximately 950 billion Euros, so the ECB would hold less than 10% of this figure. “Incidentally, the ECB’s activity has had a considerable impact on the current price fluctuations and liquidity of eligible bonds for the program. The willingness of intermediaries and their ability to generate two-way markets and, especially, to offer securities to clients to start short positions have been hampered,” she says.

In her opinion, ETFs also play a role in the fragmentation of the fixed income market: “Corporate debt takes the form of a multitude of different securities and only a small part of them are suitable for inclusion in the general indices” In this regard, Pachatouridi adds, “ETF trading provides insight into the future state of the bond market: it’s electronic, transparent, and low-cost in a standardized and diversified product.”

Amundi Will Reduce Positions In The US Market and Increase Its Weight in European and Emerging Markets

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2017 will, not in the least, be a quieter year than 2016, and from Amundi analysts point out three key issues to watch: the consequences of Donald Trump’s presidency in the US, the upcoming elections in Europe, and the negotiations over Brexit which, according to Philippe Ithurbide, Global Head of Analysis and Strategy in Amundi, are not priced into the markets. “The consequences for Europe and the United Kingdom will be greater than is believed, and the probability for the UK to get everything it wants is zero: you cannot have everything without paying a price for it.” The expert, who does not believe that the process will be canceled, or that it will be short, predicts long negotiations, lasting many years, which will lead to painful consequences for both the EU and the British. But, despite all of the above, his star commitment for this year is the European stock exchange.

In 2017, growth will not expand beyond 3% (with the exception of markets such as Brazil, Russia or the USA, which will increase their growth), due to the impetus of protectionism, the fall of global trade, and the weakness of the investments, and in which neither is inflation going to spiral (in more than 80 countries throughout the world, the expectations of inflation surpass reality, in some cases there are negative inflations and in Europe it has not arrived yet, he says), the expert explains that the fund management company plans to reduce positions in US stocks and bonds markets (in which they strongly positioned themselves months ago) and to allocate part of those investments to Europe (both stocks and credit) and also to the emerging world.

“In the United States, markets have risen greatly, but neither growth, nor inflation, nor the Fed justify those levels,” explains Ithurbide, who only expects two rate hikes in the US during the year. “After the election, the market became more expensive and we decided not to be short because the momentum was there, but now we can say that the US market is preparing a bubble,” he adds.

He says, however, “in European equities, valuations are more attractive, there is more potential for profit growth, and dividends are the highest in the developed world,” he adds. Which is something that Alexandre Drabowicz, global Co-Head of Equity in Amundi, confirms: “Unlike at other times when profit expectations were high, this year starts from a very low base so that there is room for surprises” , He says, and predicts improvements in sectors such as energy and banks. The management company does not think there will be a re-rating of the asset, but believes that the European stock exchange will be revalued due to the effect of profits, as the expert expects a growth of 10%, coupled with dividend yields of 4% that lead him to predict “very decent returns”.

The fund manager is also very positive with the Japanese stock exchange, which has been the best after the US elections, due to the effect of a low yen, and where he sees “tremendous opportunities from a stock picking point of view”, also in part because of the inflows that will come from pension fund investments and the return of foreign investors, net sellers of the asset last year, who could begin to return.

Emerging Markets: A constructive vision

Their vision is also very constructive in emerging equities, given the economic adjustment of recent years and improvements in current account balances, their attractive valuations (with a discount of 25% -30% in some markets), their cheap currencies (which will be another catalyst for profitability), and also by the low investor positions: “Many investors are underweight in this asset in their portfolios, but will have to reduce those positions: in 2016 they took a first step when entering into emerging debt, and if they go one step further and enter into emerging equities – even if only to place that underweight in a neutral position – they could strongly boost stock market returns. “

The management company is committed to markets with good stories of internal growth (more so than external, in a world that is decelerating globally) with emphasis on countries such as India (where, for example, they’re playing on banking history, since in the last 18 months more than 200,000 current accounts opened, and it is a market in which Pension funds are opening up their investments to the country’s stock), the Philippines, Russia or China. In Latin America, these stories are harder to find, because their economies are more closely tied to commodities, although Peru would be the country of choice. They are underweight in Brazil and, although they are reducing that position somewhat, they believe that it is difficult to be positive with the political problems facing the country. It would also be difficult to commit to markets like Turkey (where they have not invested for years), but the fund manager does support Mexico’s investment case: “There may be volatility, the peso may fall even further… but we will reassign positions gradually, it is a candidate for it,” he says.

Latin America… Debt is Best

In fact, rather than an attractive market from the point of view of equities, Latin America is so from the point of view of fixed income, according to Abbas Ameli-Renani, emerging markets’strategist. In contrast to their 2014-2016 commitment to Central and Eastern European markets (due to the ECB’s EQ benefits and low inflation; markets which he now considers as overvalued and risky if there is an inflationary rebound), their commitment when it comes to debt in local currency is now on Latin America. Thus, markets like Brazil are attractive, both when considering local currency debt and external debt in hard currency, along with other prominent markets such as Russia or Indonesia. He likes local debt because, in many markets (with some exceptions), inflation is lower than that forecast by central banks, which not only does not lead to rate increases, but which will cause them to be maintained or even for some authorities to adopt an accommodative bias, which is positive for local debt. The exception would be Mexico, but it is a market in which the fund manager is looking for buying opportunities, as the central bank is prepared to support the currency if necessary in the face of Trump’s threats. He does not see the same attraction in Turkey.

Nonetheless, Amundi’s strong conviction overweight is emerging market debt in hard currency, thanks to the improvement of fundamentals in those countries, and reminds us that it is an asset which offers the same return as global shares but with a quarter of its volatility.

Trump: A demon for emerging markets?

The fund manager, who believes that China may be a key risk for emerging markets, explains, however, that although the Trump effect may be seen as negative in these markets because of protectionist rhetoric and the implications of rate hikes by the Fed, it should, in fact, help the emerging world due to the implementation of US tax policy, and the country’s growth, which supports greater global growth. “Historically, when the United States has raised rates, the spreads of emerging countries have narrowed,” he points out. And if the Fed raises rates for the same reason, because there is growth, there is no impact either. “Trump will not necessarily be negative for emerging markets: only if there is a combination of strong protectionism, while at the same time the Fed raises rates very aggressively, will there be an impact, but it is unlikely that both events coincide” he added.
 

BECON Investment Management Partners with Cullen Funds in Latam

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BECON Investment Management alcanza un acuerdo de distribución con Cullen Funds para clientes latinoamericanos
Pixabay CC0 Public DomainPhoto: Camerage. BECON Investment Management Partners with Cullen Funds in Latam

BECON Investment Management, led by José Noguerol, Florencio Mas and Frederick Bates, has reached a partnership agreement with Cullen Funds. BECON is going to distribute all of Cullen’s strategies in the Latam region. 

The main focus will be on the Cullen US Enhanced Equity Income, Cullen Emerging Markets High Dividend and Cullen North American High Dividend funds.  All of these strategies have an income focus to their stock selection and Cullen feels the Latin American client and advisor will want to invest in other income producing options besides core fixed income. They believe that the US Enhanced Equity Income strategy is particularly interesting as it invests in value, dividend paying stocks and applies a selective covered call writing process to generate additional income.  “The yield the fund generates should be attractive to investors given it has been historically around 7%.” BECON states.

This is not the first time that Cullen taps the Latam market. The firm has been distributing their funds to Latin American clients for over five years through their own distribution efforts to advisors based in Miami, Texas, New York and California who work with Latin American clients.  Cullen have also marketed strategies in Uruguay and Chile over the past three years, traveling from the NY headquarters.  According to BECON Investment Management, “advisors really like the investment process and style Cullen employs but wanted more local support.” The relationship with Becon, which manages more than $300 million in investments from Latin American clients today, will now allow Cullen to focus on local support and expertise in the region.  

For BECON’s first partnership, the firm is planning on working with very few asset managers in order to provide a focused sales effort and be able to position multiple strategies through the distribution channels. They will also be hosting several events. The first multifirm event will take place on March 15th in Montevideo where 150 advisors will attend. the second event will take place on March 16th in Buenos Aires where 150 advisors will attend. Several more events will take place in Chile, Peru, Brazil and Colombia once more intermediary agreements are signed with the key brokers and banks in those countries.

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.