CC-BY-SA-2.0, FlickrPhoto: masaru minoya. Can Japanese Stocks Rise Again?
With Japan now one of the worst performing equity markets this year, BlackRock’s Global Chief Investment Strategist Richard Turnill provides an updated outlook for stocks in the Land of the Rising Sun.
According to the specialist, Japanese companies’ inflation expectations have been steadily declining in recent quarters, amid an appreciating yen. Bank of Japan (BoJ) stimulus efforts this year – including an expanded quantitative easing (QE) program and a shift into negative interest rate territory– have failed to stem the yen’s rise and boost inflation expectations.
In his opinion, deflationary pressures have weakened market confidence in the central bank, and hurt Japanese stocks. Japanese equities experienced record outflows in April, according to BlackRock research based on exchange traded fund (ETF) flows, and Japan is now among the worst-performing equity markets this year in local currency terms, with the TOPIX index down more than 13% year to date, according to Bloomberg data.
Turnill believes that there are reasons to like Japan over the longer term, even as a strong yen contributes to Japanese corporate earnings downgrades. The “short Japan” trade looks increasingly crowded, Japanese stocks appear cheap (around 13x forward earnings) relative to their own history and to other markets, and Japanese corporate balance sheets in aggregate have low financing risk, BlackRock analysis suggests.
“We still hold a neutral view of the market, however. We believe monetary policy, the first arrow of Prime Minister Shinzo Abe’s “three-arrow” economic plan, isn’t enough to boost the local economy and market. The BoJ still has ammunition left to raise inflation expectations, including increased equity purchases, despite last week’s inaction. But we would need to see additional easing coupled with advances toward achieving Abe’s second and third arrows, for us to adopt a more bullish view of Japan. In the near term, we are awaiting credible fiscal stimulus aimed at paving the way for structural reforms. Over the longer term, we want to see tangible progress in labor reform and in cutting red tape for local businesses.” He concludes.
CC-BY-SA-2.0, FlickrPhoto: James Halliday. Roboadvisors Present Concerns when it Comes to Mis-Selling and Data Protection
Of the growing number of fintech innovations, robo-advisors will have the greatest impact on the financial services industry in the short- (one year) and medium-term (five years), according to a member survey by CFA Institute, the global association of investment professionals. An overwhelming majority of respondents, 70 per cent, consider that mass affluent investors will be positively affected by automated financial advice tools in the form of reduced costs, improved access to advice, and improved product choices.
The Fintech Survey, which measured the opinions of CFA Institute members globally, found it unlikely that automated financial tools will replace engagement with human advisors for institutional investors and ultra-high net worth individuals. The implication is that the tailored nature of financial advice to these market segments is not as easily amenable to standardized automation tools typically provided by robo-advisors. These groups of investors, with large portfolios and potentially diverse and complex investment needs, are likely to continue to favour personalised, human advice.
Respondents are most divided about the impact of financial advice tools on market fraud/miss selling and on the quality of service, with a roughly even split between respondents who believe that the growing prevalence of financial advice tools will exacerbate or diminish market fraud and miss selling. However, investment professionals made it clear that flaws in automated financial advice algorithms could be the biggest risk introduced by robo-advisors (46 percent of respondents, a plurality), followed by mis-selling (30 percent) and data protection concerns (12 percent).
Blockchain Technology
Additionally, the survey addressed the impact of blockchain technology, the distributed ledger that underpins virtual currencies, and which is being explored by financial services firms. The survey revealed that members thought that clearing and settlement, alternative currencies, and commercial banking are the top three areas which will likely be impacted the most by blockchain technology.
Commenting on the survey, Svi Rosov, CFA, analyst at CFA Institute, said: “FinTech is attracting increasing attention from consumers, investors, the investment management industry and regulators across the globe. Our survey confirms the intuition that rapid technological innovation has the potential to shape and even disrupt the asset management industry, but also reveals that investment professionals are not yet convinced that investors will be made unambiguously better-off.”
. The 'Funds Society Fund Selector Summit' Won Silver in the British Media Awards
The ‘Funds Society Fund Selector Summit’, produced by Open Door Media Publishing Ltd, picked up the Silver Award in the ‘Event of the Year’ category in the British Media Awards which took place in London on May 4th.
The event serves fund selectors in the US offshore market and is a joint-venture between Funds Society, the Miami-based publisher of the eponymous website and publication, and Open Door Media Publishing Ltd, the award-winning publisher of ‘Investment Europe’ and ‘International Investment’.
Nick Rapley, CEO of Open Door Media Publishing Ltd, commented: ‘We are extremely proud to receive this recognition for one of our premier events. The ‘Funds Society Fund Selector Summit’ is a fantastic event and the result of a unique collaboration between two leading financial media companies. We look forward to building on this success and to producing more conferences with Funds Society in the future.’
Alicia Jimenez, partner and founder of Funds Society, added: ‘.This event is the result of a joint effort between Open Door Media’s fantastic expertise as an event organizer for the asset management business and Funds Society’s deep knowledge of the Americas region. A combination that will hopefuly bear more fruits in the future. We are extremely greatful for this recognition’.
The latest ‘Funds Society Fund Selector Summit’ took place at the Ritz Carlton, Key Biscayne, Miami, on the 28th & 29th April 2016. Coverage of the event can be found at both www.investmenteurope.net and www.fundssociety.com
CC-BY-SA-2.0, FlickrPhoto: Mohmed Althani. Emerging Markets, Japan and Fixed Income: The Favorites on the First Day of the Miami Fund Selector Summit
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.
Japanese equities
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
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.
CC-BY-SA-2.0, FlickrPhoto: Jacinta Lluch. Durable Source of Alpha Generation: Invert the Pyramid
Many a market practitioner has been humbled in recent years trying to project the direction of US interest rates. Professional forecasters, futures markets, and even the Federal Reserve have all consistently gotten their interest rate calls wrong over the last half-decade. At MFS, explains Bill Adams, MFS Chief Investment Officer, Global Fixed Income at the firm, “we devote a great deal of fundamental analysis to forecasting rates, duration and the shape of the yield curve, and those elements make up an important part of our alpha generation toolkit”. However, given the extraordinarily difficult and unusual market environment of recent years, the firm recognizes there is an unusually low probability of getting one’s rate call correct, and an even lower probability of getting it right consistently. That is simply not a reliable or durable source of alpha generation within a well-managed fixed income portfolio.
In our view, says Adams, consistent alpha generation depends on actively managing multiple sources of risk. “We view the portfolio construction process a bit like an inverted pyramid. At the bottom of the pyramid are the factors hardest to consistently anticipate—rates, duration, and curve positioning. Next come currencies, another piece of the portfolio notoriously difficult to forecast. Against the present market backdrop, unduly influenced by global central bankers, these are the lowest conviction pieces of our alpha pyramid”, points out the CIO.
In the current environment, MFS believes that it can add more durable and sustainable alpha by engaging in a thorough process of analyzing and underwriting both corporate and sovereign credit. So security selection and sector and regional allocations are areas we approach with the greatest conviction. While you cannot generate excess returns without taking risks, we believe it is critical to take risks that are appropriate.
“Allocating assets to multiple regions is an alpha source we embrace”, explains Adams in the MFS blog. “Bringing together securities from multiple regions and reducing home country bias in a fixed income portfolio helps improve risk adjusted returns, in our view. It is also important to look beyond absolute levels of return and focus on relative return opportunities. In isolation, a 10-year US Treasury bond yielding 1.80% is not all that attractive. But compared to a Japanese 10-year JGB with a negative yield or a German 10-year bund with a yield not far north of zero, the value of the US security becomes clearer”.
As we move up the inverted alpha pyramid, the conviction grows. Moreover, MFS prefers underwriting individual credits by leveraging our global research platform to trying to make a significant call on the direction of 10-year Treasury yields. That research capability allows the firm to better manage risk. This is where MFS place its greatest conviction, with a deep understanding of both sovereign and company credit fundamentals. “Our global research platform leverages not only fixed income analysts, but equity and quantitative analysts as well, who provide a deeper understanding of individual corporate credits. To truly understand credit fundamentals, an investor must assemble a complete view of a company’s capital structure”, says Adams.
In the unusual global economic and interest rate environment that exists today, MFS believes fundamental, country-by-country and company-by-company analysis is a much more durable and sustainable alpha source than interest rates bets.
Photo: Michael Maeder. Columbia Threadneedle Investments Appoints Sales Director In Zurich
Columbia Threadneedle Investments, announces the appointment of Michael Maeder as Sales Director Financial Institutions with immediate effect. Michael is based in Zürich with direct report to Christian Trixl, who heads up Columbia Threadneedle Investments in Switzerland.
In his role, Michael Maeder is responsible for broadening and deepening relations with financial institutions with a focus on private banks, cantonal banks, independent asset managers and family offices in the German speaking regions of Switzerland and in Liechtenstein.
Michael joins from NN Investment Partners where he had been business development manager since 2009, covering a similar clientele in the same region. He started his career at UBS Investment Bank in 2006 in Zürich. He holds an MBA from International University of Monaco.
Christian Trixl, Head of Swiss Distribution at Columbia Threadneedle Investments, commented: “I am delighted to welcome Michael to our team. Michael’s experience in the Swiss market will help to expand our presence and client relations with financial institutions in Switzerland and Liechtenstein as we strive to offer them the successful investment solutions and products that they demand”.
CC-BY-SA-2.0, FlickrBrice Perin, fund manager at Generali Investments, in charge of GIS Absolute Return Convertible Bond Fund. Courtesy photo.. “A Flexible Absolute Return Approach Enhances the Convertible Bonds’ Convex Profile”
Brice Perin, fund manager at Generali Investments, in charge of GIS Absolute Return Convertible Bond Fund, explains in this interview with Funds Society why it is worthy to use an absolute return strategy in convertible bonds.
What do convertible bonds bring in an environment like the current one?
At Generali Investments we believe that convertible bonds feature an attractive asymmetry between credit and equities, especially in a volatile, uncertain market.
The securities’ hybrid profile automatically adapts to market movements in order to capture on average 2/3 of the market’s upside and limit to 1/3 of the drawdown. In fact, in falling stock markets, the securities automatically lower their equity sensitivity, therefore getting closer to the bond floor.
In addition, we are convinced that introducing a flexible absolute return approach enhances this embedded convex profile, therefore further limiting drawdowns and aiming to capture the market’s upside.
One of the key needs today is true diversification and decorrelation with other asset classes: can your fund accomplish this challenge?
Yes. In fact, convertible bonds combine various alpha drivers such as equities, bonds, credit, implied volatility, ratchet/prospectus clause, and benefit from different market cycles. These components do not always move together at the same time: depending on the market cycle, some would generate alpha while others could underperform and undermine performance. To optimize the different parameters, we have the ability to hedge partially or totally the unwanted parameters, in order to focus on the ones we would like to isolate and benefit from.
How is the absolute return strategy obtained with convertibles?
An absolute return investment approach applied to convertible bonds fund allows us to add arbitrage techniques in a transparent, rigorous and risk-managed UCITS structure. The GIS Absolute Return Convertible Bond fund aims at generating alpha through from both outright «credit» and «equity» exposure offered by our convertible bonds’ long positions and via hedging strategies (which isolate specific alpha creating components) – whether it is a macro hedge, overlay or a micro hedge at the security level. Moreover, those techniques aim to improve the convexity of convertible portfolios and the downside protection offered. Put simply, the concept is based on isolating and exploiting a desired parameter, for example isolating an attractive prospectus (“ratchet”) clause – while limiting or removing the unwanted underlying equity exposure.
What are your objectives in terms of returns and volatility?
Our strategy has an absolute return objective of achieving consistent performance across the market cycle, with a target volatility of 6-7%.
What strategies are applied in convertible bonds in general and specifically in your fund ? Arbitrage strategies, volatility … How do they work ?
Besides the standard outright exposure that convertible bond funds offer (mainly directional exposure on underlying equity and credit), implementing an absolute return philosophy within this asset class allows us to introduce some additional arbitrage and hedge strategies.
The latter consist of hedging partially or totally some of the risks, in order to focus only on some of the convertible bond parameters. As an example, we can hedge the underlying equity risk in order to isolate and implement volatility or prospectus strategies.
When implementing a volatility strategy we aim to benefit from the favorable changes in the implied volatility of a convertible bond, or from the favorable change of the spread between CB implied volatility and realized of the underlying equity. By re-adjusting our underlying equity hedges, we “capture” underlying equities’ volatilities.
Whilst, when investing and isolating the prospectus clause, we aim to benefit from, for example, some issuance premium compensation provided in the case of a takeover (that could be undermined by equity performance if un-hedged). Lastly, we can also decide to adjust the fund’s global sensitivities to equity or credit markets via overlay index positions to limit market drawdowns.
Is it easier to achieve absolute returns with convertibles than with other asset classes? Or more difficult? Why?
The current tumultuous market conditions and uncertainties make it challenging to achieve absolute returns across all asset classes. The heightened volatility and the frequent periods of strong underperformance in global markets (November 2015 to February 2016) enhance the importance of adopting a flexible and benchmark agnostic investment approach.
As mentioned before, convertible bonds carry a hybrid and asymmetric profile which adapts naturally to market movements. In fact the equity exposure (sensitivity or delta) moves in line with the equity markets therefore moving converts closer to their bond floor in periods of sell-off or to more equity-like profiles during market upsides and rebounds. From this perspective we consider convertible bonds have self-adjusting features.
In addition, convertible bonds associate other components such as volatility and prospectus (ratchet) clauses. Being able to isolate these, in order to hedge or invest in each component, allows us to identify the sources of alpha and eliminate partially or completely the underperforming components.
For all of the above arguments we believe that the asset class gives more leeway and opportunities to achieve total returns over the market cycle.
When did the strategy was launched and how it has worked in bullish and bearish periods ?
The fund was launched early 2004 as an outright convertible bond strategy; therefore it has a long track record of over 12 years. In 2015 we thought of revamping the investment approach in order to be able to benefit from more sources of alpha and better navigate across all market cycles. From September 2015 we introduced some hedging and overlay strategies with an unconstrained and flexible investment philosophy. In 2015 the fund posted an absolute performance net of fees of 5.82% for a realized volatility of 5.12%.
Since last September we have experienced some extremely distressed market conditions, with some of the main underlying equity markets losing more than 20% at some point between November and February.
Nonetheless the fund outperformed the convertible and equity markets, as well as the peer group. In fact the fund has realized positive absolute performances since the reshuffle, thanks to an active delta management (mainly via futures and a few contract for difference single name positions) and a rigorous liquidity and credit analysis resulting in a cash portfolio of majorly mainly robust credit names.
Lastly, we have implemented an active risk process and improved our downside risk management, both at the front office and risk management level. Such a process consists of definition of maximum acceptable loss, de-risking mechanisms (implemented with various levels of escalations triggers) and re-risking (activated by loss recovery).
Can the current actions of the ECB help your strategy and fund ?
We believe that the latest ECB intervention will impact the European markets positively. On the credit side it will support valuations within the investment grade space and in certain riskier credit sectors. On the equity side we believe that market volatility could temporarily ease which would also impact on the underlying.
All in all, while we do not think that the recent ECB actions will have a direct impact on convertible bonds, we nonetheless believe that in the short run it will positively benefit the underlying asset classes (i.e. credit and equity), as was the case in the past weeks. This shall also benefit our convertible bond strategies both outright and absolute return. Having said that, should volatility surge again, our absolute return strategy should fully benefit from it.
CC-BY-SA-2.0, FlickrPhoto: Thomson Reuters. Seilern Investment Management Won Four New Awards
Seilern Investment Management have recently been acknowledged throughout Europe in the Lipper Awards, for the long-term performance of our funds. On 19th April in London, they announced the final round of UK and Pan-European awards, bringing the total to 14 awards in 2016.
Over the past weeks Seilern Investment Management have won awards for Best Equity Group (Small Company) in Switzerland, Germany, Austria, UK, and Europe and Stryx World Growth has won for Best 5 Year Performance in Switzerland, Germany, Austria, France, UK, and Europe.
“These awards are a testament to the commitment the team has in seeking out companies that demonstrate only the very highest prospects for long-term growth and reflect our consistency in generating returns for our investors. While we are gratified to be recognised, above all, we are pleased that we continue to deliver for our clients”, said Raphael Pitoun, Chief Investment Officer.
Capital Strategies Partners has an strategic agreement to cover Spain, Italy, Switzerland and LatAm market for Seilern Investment Management.
CC-BY-SA-2.0, FlickrPhoto: Balint Földesi. Serial Inverters, the US Treasury 's New Target
The US Treasury Department has taken new steps to further curtail a popular type of corporate transaction in which a US company merges with a foreign counterpart, then moves abroad to lower its tax bill. The strategy known as corporate inversions technically involves having the foreign company, based in a country with lower tax rates, buy the US company’s assets. Ireland, with its highly competitive 12.5% corporate tax rate, has been a popular place to incorporate, Eric McLaughlin, Investment Specialist at BNPP IP.
The new rules, announced in conjunction with the Internal Revenue Service, take particular aim at foreign companies that have completed multiple deals with US companies in a short period, what the regulator calls “serial inverters.”
The two main points Eric McLaughlin, Investment Specialist at BNPP IP, presents are the implementation of a three-year look-back period for US-based mergers and acquisitions (M&A) and earnings stripping:
Three-year look-back period. This relates to how the Treasury is going to enforce ownership fractions for inversions. If the shareholders of a foreign acquirer own more than 20%, but less than 40% of the combined entity, and the foreign acquirer conducts substantial business activities in the foreign jurisdiction, the inversion technically works. If the shareholders of the foreign acquirer own more than 40% of the combined entity, the inversion works and most of the negative consequences are avoided. The new rules go further, effectively counting domestic acquisitions by an inverted acquirer in the last three years as impermissible. If the value of those previous acquisitions is disregarded, the foreign acquirer becomes smaller and subject to more stringent inversion rules.
A tactic known as ‘earnings stripping’ involves the US subsidiary borrowing from the parent company and using the interest payments on the loans to offset earnings — a cost that is not reflected on financial statements, but which lowers the tax bill. The new rules classify this intra-company transaction as if it were stock-based instead of debt, eliminating the interest deduction for the US subsidiary. This change applies not just to inversions, but to any foreign company that has acquired a US entity and used this technique to lower taxes.
Implications of the new steps to curb corporate inversions
“We thought the Treasury had deployed the full extent of its regulatory power in two previous inversion updates. The rules recently announced by the Treasury, however, were seen as much more aggressive and expansive and sent shock waves up and down Wall Street,” says McLaughlin. The most immediate reaction was the news that Pfizer plans to abandon its USD 152 billion merger with Allergan – the largest deal yet aimed at helping a US company shed its US corporate citizenship for a lower tax bill. Pfizer executives have made no secret of their belief that renouncing its corporate citizenship and lowering its overall tax bill was their duty as stewards to shareholders.
Yet even by the Treasury’s own admission, the latest rules will not be enough to completely halt the flow of companies seeking to renounce their US citizenship. There is even a question as to whether the Treasury has overstepped its authority. Such a move would be possible only with an overhaul of the tax rules by Congress, which few believe will happen soon. The current political climate also complicates the matter. Corporate tax policy may be a key issue in the fall presidential elections as Democrats have moved to toughen legislation, while Republicans look to lower corporate tax rates.
It remains to be seen what effect the new rules have on the broader equity market. While inversions have not played a dominating role in the mergers and acquisitions, (40 companies have struck inversion deals over the past five years, according to data from Dealogic), this does put additional pressure on investment banks. Meanwhile, in filing a lawsuit to block the Halliburton-Baker Hughes merger, the Obama administration has demonstrated its increasing willingness to challenge giant takeovers, reflecting a belief that the corporate world goes too far in its pursuit of megamergers.
Finally, the tax rate risk facing certain companies just got pulled forward. “The good news is that the anti-earnings stripping rules grandfather all instruments prior to April 4 and appear limited to foreign parents. The bad news is that we expect tax rate creep for US companies headquartered abroad and that these companies have lost their tax advantaged acquirer status. It also makes us wonder if this is the first step towards tighter tax regulatory frameworks globally.” He concludes.
CC-BY-SA-2.0, FlickrPhoto: Brian Jeffery Beggerly. High Yield in the Crosshairs
Investing in high yield bonds is not for the faint of heart. That said, the risks associated with below-investment-grade bonds are frequently overstated and couched in hyperbole, believes David P. Cole, CFA, Fixed Income Portfolio Manager at MFS.
Late last year, investors beat a thunderous exit from high yield bonds, which in turn reverberated through financial markets as analysts pondered the implication of deteriorating credit markets on the US economy. More recently, investors have made a U-turn, and high yield has witnessed inflows again and spreads have tightened. Talk of a US recession has similarly subsided.
According to the expert, high yield bonds are subject to a cyclicality that mirrors the economic cycle — and default risk is an important factor in total investment returns. If one understands the cyclical backdrop of the high yield asset class and adopts an investment approach that involves prudent security selection, particularly in the lower-credit-quality segment of the market, high yield bonds can make a compelling addition to a well-diversified portfolio.
“The asset class has historically delivered a risk-return profile somewhere between higher-quality fixed income and equities, and has exhibited characteristics of both markets over full market cycles. In the period from 1988 to 2015, the Barclays U.S. High Yield Corporate Bond Index delivered a compounded annualized total return of 8.1% — more than the 6.6% return of the Barclays U.S. Aggregate Bond Index but less than the 10.3% return of the S&P 500 Index”, points out.
High yield bonds can offer diversification against interest rate and equity risk. With relatively low interest-rate sensitivity compared with other fixed income asset classes, the US high-yield market may offer a buffer against a rise in interest rates.
Prudent security selection in the lower-quality segment
Volatility in the lowest-rated high yield bonds can be significant. For this reason, it’s important to focus on differentiation in return and risk characteristics by credit quality, as the returns of the lower-quality segment of the market can vary quite meaningful from that of the overall high yield market.
Historically, highlights Cole, investors have not been adequately compensated for a strategic allocation to lower-quality segments of the high yield market, as the perceived carry advantage is often offset by capital losses due to defaults. Compared to the higher-quality portions of the high yield market, the lowest-rated high yield securities (CCCs) have produced lower compounded returns given the variance drain — losses incurred from heightened volatility because of the wealth erosion caused by downdrafts in security prices — associated with their significantly higher return volatility.
“While lower compounded returns argue against a strategic overweight to CCCs, this market segment also displays a greater dispersion of returns than those in the higher-rated BB or B portions of the market. This suggests potential opportunities to add value by selectively investing in CCC securities, especially on the heels of a significant selloff, when credit spreads have widened substantially”, explains the MFS portfolio manager.
Consequently, says Cole, a tactical allocation to the lower-quality segment of the high yield market can be appropriate when one is being sufficiently compensated for taking on the additional price risk. In the current environment, for instance, energy and mining companies may become attractive. However, investments in these lower-rated securities must be carefully weighed against the overall risk profile of the portfolio, as they can be both distressed and highly illiquid.
“December’s headline-driven selloff in high yield, prompted by a small handful of high yield strategies that ran into trouble with overweight positions in commodity sectors and CCC-rated securities, provided a stark reminder of just how important it is to manage credit risk in high yield”, concludes.
For MFS, the high yield market provides an opportunity for investors to gain exposure to the credit market with an asset class that provides diversification and an attractive return profile over time. Investing in this market also requires prudence, an eye for identifying inflection points, and favoring certain names — such as those on the higher-quality tier of the credit quality spectrum — to deliver attractive risk-adjusted returns.
