Current markets present significant challenges, but investment professionals are convinced that there are many opportunities to be exploited: Emerging Markets (both fixed income and equities), Japanese Stock Market, High Yield, Global Fixed Income from a flexible perspective, and Convertible Bonds were some of the strategies presented by the fund management companies M&G Investments, Matthews Asia, RWC, Carmignac, Henderson Global Investors, and NN Investment Partners during the first day of the 2016 Fund Selector Summit, organized by Funds Society and Open Door Media, and held in Miami on April 28th and 29th .
The opportunity which emerging markets currently represent became apparent during the event. Regarding equities, John M. Malloy, Fund Manager at RWC, spoke of a positive environment due to attractive valuations, the strong growth in some markets, and some other matters which represent a great investment opportunity in certain securities. “Valuations are not like those of the late 90s or the year 2000, but markets are cheap. And the most interesting thing is that when profit begins to recover, they’ll become even more attractive,” said the fund manager. Growth will also support this statement: “We see emerging markets as a growth opportunity: although this has been questioned in recent years, countries like India, Pakistan, the Philippines and some Latin American markets will offer higher growth than in many parts of the developed world, and at some point, the markets will recognize it,” he added. He believes that these markets are in good shape overall, and there are positive signs such as export growth, which had been declining for some time but have since stabilized and begun to recover; and the expert is convinced that the figures will increasingly improve.
In addition, some of the factors which play in favor of some companies are automotive industry technology, the growth of infrastructure (strong in countries like India, Indonesia, and Brazil) or media and advertising (with companies that are not expensive, unlike in the developed markets). The team is currently optimistic, especially with Asia, which has very strong fundamentals and higher growth rates, but also speaks of turning points in Russia and Brazil: “Brazil faces major problems and a great recession but everything can change and the market may rebound faster than you can think… as was the case with Argentina: one year ago no one spoke of the country and in six months the markets’ mentality had totally changed,” he explains. Regarding interest rate hikes in the US, he believes there will be one or two more this year but will not be a big risk in an environment where the dollar is stable and will perhaps weaken (does not cover currency); and he is also more optimistic with data coming from China, because “the pressure has dropped.”
His emerging stock market strategy (which includes up to 20% in frontier markets and in the most liquid part, now 12%), combines a top-down and bottom-up approach. It is index-agnostic, and has a very high active share, over 90%, and materializes in 50-60 names, in a diversified portfolio which is very focused on growth (their companies have the potential to see their profits grow by more than 20%). It is also biased towards large and mid-caps. And they can boast of beating the market in difficult years. The company launched the fund in UCITS format in December and he thinks it can now generate much interest, and they also recently opened an office in Miami. In frontier markets, he points out Pakistan’s potential, for its demographics, its reforms, its political stability and Chinese and IMF investments, and also points out the existing opportunities within the banking sector.
But before investing in emerging market equities, many investors are beginning to increase their positions in emerging market fixed income, both in hard and local currency. Claudia Calich, Fund Manager of Emerging Markets Bond at M&G Investments, pointed out the opportunity presented by that asset and its good current entry point: currencies have depreciated a lot and are stabilizing, although still the levels are low and exporters will benefit; low raw material prices have stopped their collapse, although importers and consumers continue to benefit (also, beyond the winners and losers of cheap oil prices, she is positive in countries that have adapted to current levels of oil, such as Russia. She is not positive about Nigeria). She also believes that there are opportunities in the currency area, leading her to increase its exposure in the portfolio. In her opinion, Central America and the Caribbean are the most attractive markets in which to invest to benefit from the recovery in the US…. Moreover, growth is more visible and that can change the negative perception people have of emerging markets versus developed ones.
When it comes to risks, she believes these have diminished: and so, she is now less cautious with Brazil than she was a year ago. On oil prices, the situation has also changed in respect to early in the year; China’s rebalancing has improved, although there are still challenges ahead…With regard to countries that are suffering from exposure to China via exports, she points out the adjustments carried out in many of them, mainly from Latin America, for example with adjustments to their currencies. Regarding the Fed, there have also been changes from the initial perception of four rate hikes this year. She believes that there will be one or two rate hikes during the remainder of the year (in June or July, and at the end of the year): If the Fed is forced to make more rate increases, the losers would be countries with large financing needs, such as Brazil, Turkey, and South Africa, and the winners would be those exposed to its economy-because the Fed would raise rates for a good reason, such as Mexico, Central America and the Caribbean, or Eastern Europe. Due to that exposure to the US and its recovery, she is comfortable with countries like Honduras, Dominican Republic, El Salvador, or Guatemala. In general, by countries, the fund is heavily overweight in Bulgaria, Azerbaijan, Paraguay, Guatemala, and Romania versus underweight in Malaysia, Poland, Turkey, South Africa, or Colombia, with less attractive valuations which do not compensate for risk.
On valuations, she believes these to be similar to those faced in the debt crisis in Europe, far from the highs, and which, in some cases, compensate for the risk taken. The fund manager has reduced exposure to credit− the chances of defaults have increased and compensate less for the risks taken, while she believes that if the correct names are chosen, it is still interesting− and has increased investment in the area of government debt in the fund, which can invest in both corporate debt and public debt, in both hard currency or local currency −local currency exposure has risen recently−. The fund manager is positive with the attractive valuations overall, but is cautious with some, such as some Asian ones, and the fund’s exposure to currency is currently around 25% in aggregate terms. In relation to flows in emerging markets, she believes that we will not see as many outflows as in the past.
As regards fund management, she considers it essential to adopt a flexible and active style, which is capable of seizing opportunities wherever they may be found (in credit or public debt), and to find the best ideas, using both interest rates and currency exchange, as well as credit, as profit drivers.
Matthews Asia focused its presentation on Japanese equities: the management company has been investing in these assets since the mid 90s. The company tries to look at Japan as part of Asia, and they explain that Japanese companies are experiencing a lot of growth from other parts of Asia (e.g. the consumer and tourism sectors): with a long-term and growth approach, they try to find the best ideas in Japan, ranging from 50 to 70. “The economy presents many challenges in terms of growth, it’s not an attractive investment destination from that point of view, but there is great opportunity in Japanese companies,” says Kenichi Amaki, Fund Manager. “There are high quality growth companies and that’s why I invest there.”
The fund’s portfolio is focused on the best opportunities in the country: the fund manager looks for growth companies, understanding this concept in three ways: leading global companies such as Toyota; the “Asia growers” that capture the productivity growth and wealth in the rest of Asia −a game that, unlike in the past, can now be played and which has great potential−; and companies which are able to grow in the domestic Japanese market, capturing niches. The company focuses on growth companies in the country, all of them of great quality.
The expert also pointed out the onset of the country’s improved corporate governance, and the trend of returning cash to shareholders: “Changing corporate culture will take time, but it will improve; most companies already have payout ratios… and that’s one of the reasons to invest in the country,” he says.
Regarding the recent disappointment in the Bank of Japan’s monetary policy, the fund manager believes that the authority will wait to push its monetary policy to announce those measures together with other tax measures, “combining both will be a more powerful combination.” Market expectations have also risen and, he believes, the central bank awaits its opportunity when expectations are lower than they are now, in order to positively surprise the markets.
With regard to valuations, the fund manager stressed that Japan is the cheapest developed equity market. By sectors, he points out opportunities in healthcare and industrial, while he is underweight in consumer discretionary, materials, utilities and financial institutions (“there is much competition for loans, banks have no power to set prices,” says the fund manager, whose consumer discretionary underweight is due to the fact that the benchmark weight in the sector is concentrated in auto companies).
Fixed income opportunities
Keith Ney, Fixed Income Fund Manager at Carmignac Risk Managers and Fund Manager of the Carmignac Sécurité fund (which has never had a negative result in 27 years) spoke about the fixed income opportunity. During his presentation, he focused on the strategy of the Carmignac Global Bond fund, managed by Charles Zerah since February 2010. The fund has a flexible and opportunistic style with a focus on total return, seeking to beat the market with a strong focus on risk management and capital preservation. The asset manager has greatly increased its holdings of fixed income, which accounted for 23% of the portfolio in 2007, and now account for 60%. “The structure is very flexible and very quick to adapt to changing markets,” said the expert. Another of the fund’s key factors is a global universe, both as regards to geographies, as well as assets, which can take long and short positions (in duration, credit, currency… but the latter in a purely tactical way and for hedging purposes, as the fund is not a long-short). The fund’s duration can range from 4 to 10, so that they can benefit from rate increases. The idea is to exploit market inefficiencies to add value. The volatility is limited to 10%, and the fund has a negative correlation with other similar funds of its competitors.
Currently, in duration he has exposure to the US, Germany, Australia, and Switzerland and European peripheral debt in countries like Italy, Portugal, Bulgaria and Greece. However, he has slightly reduced his position in the United States because he advises that the market has perhaps underestimated future rate hikes in the country, but explains that the Fed is now more dependent on markets and global financial conditions than on economic data. In Europe, the activity of the ECB could be positive, although he believes that the corporate debt repurchase program will fail, to the extent that there are not enough debt securities to buy and the ECB will have to extend its purchases to the public debt of peripheral countries: hence its exposure to markets such as Italy.
In credit, positions are focused on sectors with very low prices, with an opportunistic view: the distressed raw materials segment− with many fallen angels− or CLOs. But the star position is on European banks, “still cheap and in deleveraging phase” and he points out the opportunity available in subordinated debt and CoCos, “a poorly understood asset which is a great opportunity from an opportunistic point of view.” In currencies, they currently have no great convictions: “We no longer hold the positive vision of the dollar which we had a few years ago,” says the manager. Carmignac will soon open an office with five people in Miami.
Henderson Global Investors also pointed out the opportunity in fixed income which High Yield credit represents from a global perspective: Kevin Loome, Head of US Credit, pointed out that High Yield spreads in the US do not signal a recession and that problems in the energy sector have been “contained”. “I do not think we’re close to the situation in 2008”, so the fundamentals are intact: “High Yield has been placed in a position which now represents an opportunity” in an environment of negative rates in many assets which increases appetite for this debt segment. “There may be a strong technical advantage in the coming years,” he adds. Finance companies have performed badly, he points out, and are disadvantaged by the policies of the Fed, but they don’t represent a large part of the high yield universe, he says.
On the asset side, he points out its higher returns overall, its shorter duration, and exposure to the upward rate cycle, low levels of default, a growing market in Europe and opportunities for stock pickers: “In my career I have never seen such great dispersion,” he explains, hence a good selection of credit can provide much value, which he applies to the Henderson Global High Yield Bond fund. In his opinion, the greatest opportunities are in High Yield and bank loans.
The fund manager also points out the importance of having a global High Yield strategy, and not just in the US, although it represents most of the market, and the management company has a bigger team in Europe and emerging markets than other companies. In fact, he sees opportunities in Europe for its better quality, less exposure to energy, and because the asset will benefit from the ECB’s policies in relation to the US market, where he is cautious. “We are now less US-centric because we see more opportunities in Europe,” he says.
With regard to defaults, they are low but they tend to rise especially in the US energy sector, in which Henderson is underweight.
Convertible bonds were also discussed at the event: Pierre Lepicard, of NN Investment Partners, brought the asset’s current status to the 2016 Fund Selector Summit. “The drought in Africa has consequences except for lions and crocodiles… that is what is currently happening in the markets: we live in a world with few returns and those who seek them have to leave their comfort zone, where they used to invest, and that is associated with risks.” For the expert, markets go through some fundamental changes: including that last year interest rates hit rock bottom, and that had consequences for investors.
“Convertibles are a way to take risk intelligently”, although it is important to choose a good fund manager. NN IP has the NN (L) Global Convertible fund to play the asset and obtain hedging in the bear markets while at the same time participating in bullish markets, focusing on selection from a thematic perspective approach, avoiding names which do not offer convexity, and the preservation of capital. Currently 95% of the portfolio is invested in 16 investment themes (especially “cloud computing”, health spending and the rebound in Europe) and 30 convertible bonds; the portfolio is neutral in credit risk and duration, and is slightly overweight to equity exposure (especially in the US and Europe).
The fund manager pointed out the benefits of convertible bonds from the point of view of diversification and talked about how well they have performed long term, both in markets where equities have had good results, and in those where they don’t. “These bonds will provide convexity, downside hedging, and diversification for both secure and risk assets,” he said.
Lepicard used a low profitability environment like Japan as a laboratory to see if this asset would work in a global environment of zero interest rates, like the current one … and it does work. In fact, in Japan, stocks are very volatile, bonds offer very low returns, and convertibles shine with good returns. And if rates rise, he says, the asset can provide good protection that can help both in a deflationary scenario as well as in another with rising interest rates.
“There are few assets that can work like that, offering profitability and diversification, reducing portfolio risk, while also providing hedging in an environment of rising rates”, he defended, and showed the advantages of portfolios which include convertible bonds versus those that do not.