Participant Capital, a Miami-based private equity real estate investment firm, founded by Royal Palm Companies, a developer with more than 40-years of success, has announced today the promotion of Claudio Izquierdo to Chief Operating Officer. With Claudio’s years of experience in international investment and business development, the company is strongly aimed to elevate its global expansion.
Claudio Izquierdo has a long history of working with institutional investors and ultra-high net worth individuals throughout Latin America. His successful career includes impressive achievements at some of the world’s most prestigious investment banks such as Morgan Stanley where he rose to the position of Vice President. He also served as a Senior Vice President of Investments at UBS and a Senior Financial Advisor at HSBC.
“Claudio is an exceptional professional with international business acumen and deep expertise. He is managing over 30 distributors and building partnerships with key financial institutions across the globe,” comments Daniel Kodsi, Participant Capital CEO. “We are proud to have him on our team!”
Prior to joining Participant Capital, Claudio enjoyed a successful career as an entrepreneur having established a number of international export and trading businesses. He has a degree in finance from Florida International University. He is a frequent contributor to a variety of trade and business publications and a sought-after speaker and expert authority on international investment and management products.
“I am happy to oversee how fast Participant Capital is growing,’’ says Claudio. “Thanks to the dedication of our team, we are creating long-lasting value for our clients and providing direct access to world-class real estate projects from the ground-up at the developer’s cost basis.”
Pixabay CC0 Public DomainFoto: PxHere CC0. La "manipulación de divisas" de China: ¿una señal de pánico o un plan astuto?
Over the past several months, there has been hype about the prospect of the Chinese renminbi (RMB) weakening past 7 per U.S. dollar, despite no evidence that 7 is a magical number. China’s central bank, People’s Bank of China (PBOC), had denied that it was focused on defending 7, and the IMF said it wasn’t significant. So when the RMB finally broke 7, the media treated it as a dramatic event, but I believe, this will soon pass.
It is likely that the timing of the move was deliberate, following President Trump’s latest round of tariffs last week.
A sign of panic?
In a Monday morning tweet, President Trump responded to a depreciating Chinese renminbi by stating, “It’s called ‘currency manipulation.’ ”
The decision to tag China as a currency manipulator was either a sign of panic, or a cunning plan. Or a bit of both.
My interpretation of yesterday’s tweet is that the president still wants to sign a trade deal with Chinese President Xi, because Trump recognizes that a deal is better than no deal for his re-election prospects.
No deal would mean continued taxes on Chinese goods, paid for by American families. (And the next round of tariffs would fall largely on consumer goods, which had previously been spared because of the direct impact on voters.) No deal would mean a continued Chinese boycott of American soybeans, which is contributing to harsh conditions for farmers in politically important states. No deal would mean continued economic uncertainty, which is leading to weaker corporate capex and worries about a recession. Moreover, the prospect of no deal, and an escalation of the tariff dispute into a full-blown trade war, has had a clear, negative impact on investor sentiment.
I believe Trump wants a deal, but is struggling to find a way to close the deal.
Given that the currency manipulator label carries no concrete consequences, Xi is unlikely to feel more pressure to sign a deal that he believes is disadvantageous. He may see the accusation as a sign of panic. I believe the timing of latest currency move was a short-term political signal by Xi.
Xi is unlikely to resort to a significant devaluation to respond to Trump, in my view. The tariffs are having little direct impact on China’s economy (net exports were less than 1% of China’s GDP last year, and only 20% of total exports went to the U.S.), and Xi has far better tools to deal with the more significant indirect impact: weak confidence by manufacturers, who have slowed output and deferred investment. Further, China’s consumer story—the largest part of its economy—remains pretty healthy, as does employment and wage growth, so there is no reason for Xi to panic.
A cunning plan?
In the past, Treasury Secretary Steven Mnuchin ignored the president’s calls to tag China as a currency manipulator. And when the law required a formal ruling on the question, Mnuchin—following in the footsteps of many Democratic and Republican predecessors—declared that China was not a manipulator.
His last finding was just a few months ago, on May 28, when Mnuchin informed Congress that China did not meet the criteria for being designated as a currency manipulator under either the 1988 or 2015 legislation.
Yesterday, however, just several hours after Trump’s tweet, Mnuchin issued a press release designating China as a currency manipulator under the 1988 legislation. “In recent days, China has taken concrete steps to devalue its currency…to gain an unfair competitive advantage in international trade,” according to the press statement.
What changed between May 28 and Monday that led Mnuchin to reverse course?
During that period, the RMB depreciated by all of 0.4% against the dollar. Was that enough to justify a change in policy? Was that sufficient to provide, as the Treasury press release claimed, “an unfair competitive advantage in international trade.”
The timing of Xi’s decision to relax his central bank’s interventions that had for many months prevented market forces from pushing the RMB below 7 was clearly politically motivated, in response to Trump’s August 1 announcement of additional taxes on Chinese goods. But this market pressure itself was the result of uncertainty created by the Trump tariffs, and Xi’s action was modest: The PBOC lowered its target rate for the currency by only 0.3%, although market forces pushed it down further.
Here’s another way to look at it: between Trump’s August 1 announcement of additional taxes and Monday’s currency manipulation decision, the RMB depreciated 0.3% against the dollar.
Yet another perspective: over the course of 2019, the RMB is behaving as it has in recent years, with its direction vs. the dollar determined by the strength or weakness of the dollar. Year to date, the RMB is down 1.5% vs. the dollar, while the U.S. Dollar Index (DXY) is up 1.5%.
(China has in fact been manipulating its currency to stop market forces from weakening it even more. The Trump administration wants them to stop? And on Tuesday, China’s central bank guided the exchange rate a bit higher, consistent with its statement that they are “not carrying out competitive devaluation.”)
It is fair to conclude that little has changed since the Treasury’s May 28 decision that China did not meet the legislative criteria for currency manipulation.
So, did Mnuchin change course yesterday simply due to pressure from his boss?
Or, was it part of a cunning plan?
Yesterday’s press release says, “As a result of this determination, Secretary Mnuchin will engage with the International Monetary Fund to eliminate the unfair competitive advantage created by China’s latest actions.” Well, we know that the IMF believes the RMB is roughly fairly valued, so this is unlikely to worry Xi.
Did Mnuchin decide that designating China as a manipulator might calm the president without blowing up the trade talks, because there are no consequences to the designation? Mnuchin may have decided that this course of action would lead Trump to give U.S. Trade Representative Robert Lighthizer and him more time to negotiate with their Chinese counterparts, in an effort to reach the deal that Trump knows he needs, but doesn’t know how to achieve.
If they are given room to negotiate, I think a deal can be reached by the end of the year, as I believe that Xi continues to want to reach a deal. While tariffs are not a huge problem, as China is no longer an export-led economy, failure to conclude a deal would open up the risk that a full-blown trade war leads to restrictions on China’s access to American tech, everything from semiconductors to research collaboration. That would be a setback to China’s economic growth, which Xi wants to avoid.
Column by Matthews Asia, written by Andy Rothman, Investment Strategist
CC-BY-SA-2.0, FlickrFoto cedida. Marcus Evans prepara su próximo Latin Private Wealth Management Summit
The Latin Private Wealth Management Summit is a two day event offering Latin America’s leading advisers of single and multi family offices, wealthy private investors, international fund managers and asset managers a devoted environment for unparalleled business and networking opportunities in a stimulating environment.
For two days between October 3rd and 4th, senior investment executives responsible for fund management and asset allocation decisions of Family Offices including: Presidents, Founders, CEOs, Managing Directors, CIOs, will meet in Panama City for an extensive program organized by marcus evans.
Foto cedidaGonzalo Binello. Schroders nombra a Gonzalo Binello director para Latinoamérica
Schroders is announcing today that Gonzalo Binello has been appointed Head of Latin America. His appointment will bring a dedicated, regional-specific emphasis on our development in Latin America, a key strategic growth area for the firm. Gonzalo will also retain his role and responsibilities as Head of Offshore Intermediary Sales.
Gonzalo joined Schroders in 2003 and was most recently the Head of Intermediary Offshore Sales, based in Miami. He has extensive experience and knowledge of the Latin American market, having been Head of Distribution for Latin America and Central America at Schroders from 2009 to 2013.
Gonzalo will report in to John Troiano, Global Head of Distribution at Schroders.
As part of these changes and our focus on Latin America, Pablo Albina will also become Head of Investments for Latin America and continue with his role as Country Head of Argentina. Pablo will work in partnership with Gonzalo to develop and implement our strategy for the region, focusing on building our local investment teams and enhancing our product suite. In this role, he will report to Karl Dasher, Co-Head of Fixed Income and CEO North America.
The new appointment of Gonzalo, together with Pablo, will secure the ongoing prosperity and growth in the Latin America region.
John Troiano, Global Head of Distribution, Schroders commented:
“Schroders has established itself as a growing force in the Latin American market. Furthermore, the region has become a key strategic growth area for the firm and we are experiencing significant client demand for our investment expertise across the continent. We are confident that Gonzalo’s appointment will support the continued growth of our business across Latin America.”
Gonzalo Binello, Head of Latin America, Schroders, said:
“Schroders’ profile in Latin America among investors continues to grow. I am excited to bring my regional experience of the market to this new role and help build on the substantial foundations that Schroders already has in place.
“The investment needs of investors across the continent are diverse. I am determined to ensure that Schroders’ business continues to evolve to meet the complex challenges that both existing and prospective clients face.”
After years of growing older, the ranks of advisers and RIA firm leaders are getting younger. New FA Insight benchmarking research from TD Ameritrade Institutional finds the leadership of registered investment advisor firms is passing the torch from the Baby Boomer to Gen X and investing to sustain their firms’ strong performance well into the future.
The report found that the advisory community as a whole is getting younger, reversing a graying trend that had many advisors worried about the sustainability of the industry. With a median age of 49 years – three years younger than in 2015 — six out of 10 firms have at least one owner who expects to stay at the helm for at least another 12 years, according to The 2019 FA Insight Study of Advisory Firms: People and Pay.
The median age of firm associates, overall, dropped to 42 from 44 in 2015, while the median age of lead advisors is now 46 years, down from 50. The study also found that the number of owners who are 40 years of age or younger equals the number of firm owners who are over 60.
“As the next generation of RIA leaders comes to the forefront, they’re investing in their firms with a long time horizon,” said Vanessa Oligino, Director of Business Performance Solutions at TD Ameritrade Institutional. “We expect to see different approaches to industry challenges – whether they be staffing and compensation, growth and organizational design, or technology and innovation.”
Firm owners remain characteristically confident about continuing growth in 2019. They’re investing in senior-level experience, with lead advisor compensation up by 12 percent over the last two years, in an effort to secure seasoned talent that can help supercharge growth and navigate tomorrow’s challenges.
The report found that, although 2018 ended with the major stock indexes posting their worst yearly performances since the 2008 global financial crisis, choppy markets did not quell firm owners’ optimism, even as growth in assets under management (AUM) slowed.
The median revenue growth rate for firms was 14 percent in 2018, up slightly from 2017, while the median client growth rate of 7.4 percent was little changed. The rate of growth for AUM dropped to 5.9 percent.
Today’s Advisory Firms: Growing and Profitable
Firms continued on their growth trajectory in 2018, thanks to efficient operations management and the increase in productivity from associates in revenue-generating roles.
At 21 percent, a typical firm’s operating profit margin last year rose by more than a percentage point from 2017, and overhead expenses as a share of revenue fell slightly in 2018. This translated to rising income for firm owners, whose median total income rose 3.6 percent in 2018 to $633,000, the highest since 2014, or 55 cents for every dollar or firm revenue.
Despite market declines at the end of 2018, firm financial performance was also strong compared to the average of the previous five years. The rate of revenue growth increased to 14 percent, versus 12 percent, while operating profit margin increased from 20 percent to 21 percent. Revenues generated by revenue-generating roles were up 14 percent to $547,000 in 2018, while annual revenues per full-time equivalent (FTE) were up 13 percent over a two-year period.
Wanted: Seasoned Help
Advisory firms anticipate doubling their hiring rate in 2019 compared to 2018, with 61 percent making at least one hire last year. The largest firms plan to increase headcount by 10 to 12 percent, bringing on board seven FTEs.
Senior revenue generators and advisory firm staff, who have a proven ability to navigate market volatility and ease client concerns, have seen compensation rise over the last two years, whereas compensation for less experienced revenue generators has fallen. The compensation of associate advisors, who are now generally younger and have less experience than in prior years, has gone down by 8.5 percent and operations manager compensation rose during this period by 8 percent during this period.
The quest for experience may also help explain why firms continue to recruit lateral hires from inside the industry. RIAs tend to hire predominately from other independent RIAs for revenue roles, though they may also consider recruiting from other financial services firms and wirehouses.
Only 4 percent of firms are hiring recent college graduates for revenue-generating roles. A slightly higher amount, 6 percent, are hiring professionals from outside of the financial services industry.
People costs represent 77 percent of a typical firms expenses and 59 percent of total revenues. For every dollar spent on cash compensation, firms spend an additional 14 cents, on average, on retirement programs, medical benefits, training and payroll taxes.
“Independent advisory firms are laser-focused on growth and profitability, keeping expenses in line, while generating healthy returns across market cycles,” said Oligino. “Entrepreneurial and optimistic, successful owners are making investments they believe will benefit their firm in the long-run.”
Click here to read the executive summary of The 2019 FA Insight Study of Advisory Firms: People and Pay.
CC-BY-SA-2.0, FlickrFoto: FIBA. FIBA y FELABAN preparan su CLAB 2019, enfocado en FinTech
Fintech revolution and regulation, digital transformation, blockchain, payment innovation, cybersecurity, the future of customer experience, financial inclusion and AI are some of the themes to be discussed at the 19th CLAB Financial Technology and Innovation Conference.
Between September 4-7, over 1,000 people from over 35 countries and representing more than 200 financial institutions will gather in Hollywood, Florida for three days of networking and lectures.
Organized by the Florida International Bankers Association (FIBA) and the Federación Latinoamericana de Bancos (FELABAN), CLAB will discuss the most relevant trends and technologies impacting the financial institutions in the region.
At today’s meeting the Governing Council of the European Central Bank (ECB) decided that the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25% and -0.40% respectively.
According to a press release, “the Governing Council expects the key ECB interest rates to remain at their present or lower levels at least through the first half of 2020, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to its aim over the medium term”.
However, on his opening statement, Draghi made it clear that loose policy is here to stay: “An ample degree of monetary accommodation is still necessary”.
The Governing Council also underlined “the need for a highly accommodative stance of monetary policy for a prolonged period of time, as inflation rates, both realised and projected, have been persistently below levels that are in line with its aim. Accordingly, if the medium-term inflation outlook continues to fall short of its aim, the Governing Council is determined to act, in line with its commitment to symmetry in the inflation aim. It therefore stands ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner”.
In this context, the Governing Council has tasked the relevant Eurosystem Committees with examining options, including ways to reinforce its forward guidance on policy rates, mitigating measures, such as the design of a tiered system for reserve remuneration, and options for the size and composition of potential new net asset purchases.
Aneeka Gupta, from WisdomTree said: “The ECB remains stubbornly stoic, falling short of market expectations. It has decided to leave the deposit rate unchanged at -0.40% but sets up the stage for a rate cut ahead at its meeting in September… European financials reacted positively to the possibility of tiering by the ECB. The markets were expecting to receive more stimulus at this meeting after the release of the weaker manufacturing PMI and IFO data from Europe and Germany respectively at the start of the week. The German bund yield fell to a record low of -41bps as the ECB opens up the option of further QE.”
Also today, the Governing Council of the ECB adopted an opinion on the recommendation from the Council of the European Union on the appointment of the future ECB President. It read: “The Governing Council has no objection to the proposed candidate, Christine Lagarde, who is a person of recognised standing and professional experience in monetary or banking matters.”
During the celebration of the Fidelity International’s annual Media Forum in London, Anne Richards, CEO of the firm, shared her view on the challenges that the asset management industry will have to face in the next decade.
According to Richards, global regulations on pension funds and other long-term saving vehicles are directing the mass affluent investors to own public listed securities. Meanwhile, the amount of capital that has been allocated to private markets has increased and the returns in the private markets have been persistently higher than in the public listed markets.
“The number of public listed companies is falling around the world. Companies are increasingly looking to private markets to raise capital. Last year in the US, more money was raised in the private markets than it did in public listed markets. When I was the rookie on the desk, one of my tasks was to manually check the price of each holding that we owned across the business. The total number of listed companies that I had to check was 967 stocks. Today, the equivalent number is more than a third lower. On one hand, the regulators are pushing the mass affluent investors into funds that are typically concentrated in daily listed stocks, which is a market that is currently narrowing, and on the other hand, the asset management industry knows that the returns are higher in the private market. I think this is a deeply uncomfortable juxtaposition to have,” explained Richards.
“The main benefit of democratization of capital was to allow people without a lot of money to get some access to capital markets. The shift that the asset management industry is seeing now will exclude a lot of investors from obtaining attractive capital returns. The returns in private markets are being only directed to those who have the capacity to get exposure to that type of capital, categorized as professional investors. This may cause eventually an inequality issue, which is the heart of much of the unrest and political divergences that the world is facing right now. We have to come together as industry and think about ways of making sure that we can continue to offer a whole range of investment opportunities, regardless of the investment amount”, she added.
A shift towards more returns for society
Speaking about the responsibility that the asset management industry has over society, Richards mentioned the need to take into consideration not only the financial returns, but the long-term impact that every business has in the society.
“When you look after other people’s money, like the asset management industry does, you end up with an above average share of voice by collecting a lot of individual voices. Our business could make a meaningful difference on encouraging companies not take advantage of the work force or the environment, and to do things that are good for the broader society. Financials returns are important, but not enough. We need to think about the long-term impact of investments. This is important to us because our clients and employees are also asking for a responsible way of investment,” she said.
A family business
The fact that Fidelity Investments and Fidelity International are a family started business -the Johnson family owns a large part of the business, although there are other many shareholders and employees that are owners as well- makes the dynamic of the business very different.
“This characteristic gives Fidelity International a long multi-generational view. The mindset is not about maximizing the value of what we are doing today. Instead, the mindset is how you can build something better to handle it to the next generation, and that’s very special. It is a very refreshing mindset. In a listed company business, the decisions of the management are sometimes affected by the demands that the market imposes on the business and the volatility that can come from the pressure on quarterly earnings.
This is not to say that it does not matter to us running an efficient organization and taking care of the business that we inherited from the previous generation. But we do have an ability to take a through-cycle view of what we want to do and how we want to invest,” she stated. Fidelity International has two distinctively separated business. Firstly, the investment management part of the business, where the firm engages directly with institutional clients, wholesale clients, private banks or larger financial institutions. And secondly, the platform business that can be used to help advisers to manage their part of the business.
“The dynamics of these two areas of the business are quite different. This gives us a good window on the landscape in the outside world and on what is wanting from us. This full capacity is very powerful and few of our competitors have it”, she mentioned.
Geographical spread
China is a massive market and opportunity. Population in China is aging and has more disposable income than the previous generations. Regulators and policy makers are starting to build the infrastructure to provide to each individual person the ability to have some sort of control over their financial future, as it has already happened in other countries around the world. China is about to build the first pillar to their pension system, but they still not have a third pillar of voluntary savings.
“As for now, we have been in investing in China over 20 years and we have been competing in the ground field around 14 years. In order to build up our capabilities in China, we have been a lot more patient than our competitors. Partly, because we have always felt we needed to be in control of culture, and partly because of the investment environment that our teams are operating in. In 2017, we had the opportunity to obtain a wholly owned investment license in China, which only allows to do business with high net worth individuals, not with the mass affluent market,” she explained.
Other strategic areas
Historically, Fidelity International tended to be known for its expertise and capabilities in both equities and fixed income. However, since the number of public listed companies is falling in many developed markets, Fidelity International considers very important to start building a broadest range of capabilities in the less liquid space of the investment universe. In that regard, the firm recently hired Andrew McCaffery, who will fill the newly created position of Chief Investment Officer for alternative assets.
“We want to build out our capabilities across the alternative investment space so that we can continue to offer innovative themes to our customer base as it evolves. So, it does not mean in anyway, that we are trenching our former heritage or our market expertise, particularly in the equity market and increasingly in the fixed income market, but that we need to enhance the offer the whole spectrum of capabilities”, she concluded.
Foto: Fed CC0. Los mercados ya han anticipado un recorte en julio
Stocks rallied to all-time highs in June bolstered by hopes for progress in the global trade wars and in anticipation of a potential reduction in the Fed’s policy interest rate. At the June meeting, the FOMC signaled that it was prepared to cut rates this year stating that uncertainties have increased and “the Committee will closely monitor the implications of the incoming information…and will act as appropriate to sustain the expansion.” Global markets seem to have priced in a July cut.
Stocks finished June with the best gain for that month since 1955 to close an outstanding quarter and the best first half gain since 1997. Financial markets are now discounting a positive outcome of the trade talks between President Trump and Chinese President Xi Jinping at the G20 summit in Japan, which started on June 29.
On the deal front, a surge of M&A transactions and IPOs put the U.S. way ahead of Europe and Asia for the first half. The booming U.S stock market and relatively strong economy provided a solid backdrop for deal making activity. Activists lit the fuse in many cases as buy side catalysts versus their typical role of demanding that sellers get higher prices from acquirers. Antitrust push back created formidable obstacles to some deals such as Sprint Corp. / T Mobile and Spark Therapeutics / Roche.
Announced first half U.S. deal values jumped twenty percent from a year ago to a record $1.1 trillion, the first time to reach that level during those six months.
Prominent proposed U.S. mega deals – those over $10 billion – included the $121 billion merger of United Technologies’ aerospace division with defense contractor Raytheon, U.S. drug maker AbbVie’s $63 billion bid to acquire peer Allergan Plc and Occidental Petroleum’ $38 billion deal to buy Anadarko Petroleum.
We expect M&A activity to pick up for small and mid-sized companies during the second half of the year as strategic and private equity buyers take a closer look at the intrinsic values versus the market prices of these companies.
Column by Gabelli Funds, written by Michael Gabelli
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Disclaimer:
The information and any opinions have been obtained from or are based on sources believed to be reliable but accuracy cannot be guaranteed. No responsibility can be accepted for any consequential loss arising from the use of this information. The information is expressed at its date and is issued only to and directed only at those individuals who are permitted to receive such information in accordance with the applicable statutes. In some countries the distribution of this publication may be restricted. It is your responsibility to find out what those restrictions are and observe them.
Some of the statements in this presentation may contain or be based on forward looking statements, forecasts, estimates, projections, targets, or prognosis (“forward looking statements”), which reflect the manager’s current view of future events, economic developments and financial performance. Such forward looking statements are typically indicated by the use of words which express an estimate, expectation, belief, target or forecast. Such forward looking statements are based on an assessment of historical economic data, on the experience and current plans of the investment manager and/or certain advisors of the manager, and on the indicated sources. These forward looking statements contain no representation or warranty of whatever kind that such future events will occur or that they will occur as described herein, or that such results will be achieved by the fund or the investments of the fund, as the occurrence of these events and the results of the fund are subject to various risks and uncertainties. The actual portfolio, and thus results, of the fund may differ substantially from those assumed in the forward looking statements. The manager and its affiliates will not undertake to update or review the forward looking statements contained in this presentation, whether as result of new information or any future event or otherwise.
The current US equity market cycle is the longest bullish market on record, with 9 and a half years of history, with a small correction in the fourth quarter of last year, but already back on track in the first semester of the year. In terms of compounded wealth, is the second highest market cycle on record, with a compounded return over 330%. According to Vishal Hindocha, Director of the Investment Solutions Group at MFS Investment Management, this is an enormous volume of return that probably will not be seen again going forward.
Valuations in equity market are telling investors that we are about to enter to a more recessionary environment. Observing the forward annualized returns based on historical Shiller P/E ratios for the S&P 500 Index for one, three, five and ten years, it could be stated that valuation will play a key role in future equity returns.
“When the Shiller P/E ratio is less than 10, equity markets are cheap, and returns are pretty strong. But, when the Shiller P/E ratio is in a range greater than 40, then the forward annualized returns in equity markets are bearish from that point onward, particularly in in the five and ten-years return. Just think about the compounded impact of that in the client’s portfolios. The current Shiller P/E for the S&P 500 is around 32,5x. We are currently in the 30 to 40 times range, if the history is sort of guiding us, the 5 or 10-years returns expectations on equity are not looking attractive from this point onward,” explained Hindocha.
Valuations in bonds are also not promising. In bond markets, current yield to worst tends to be a good predictor of what returns should investors expect over the next five years. A starting yield to worst a little bit lower than 2% communicates that investors should expect a subsequent 5-year annualized return between 2% and 4% above the mentioned yield, which again is lower than expected returns in previous periods in history.
“Returns expectations of the most major asset classes are going to be lower going forward. In MFS IM, we think that alpha is going to need to play a much more important role in investors’ portfolios from today onward. The 100 or 200 bps that you can get from alpha are going to be disproportionally more valuable to investors than they have ever been in the past,” he added.
Leverage in the system
Ten years after the global financial crisis and the level of corporate indebtedness is in fact higher than the pre-crisis levels. The net debt to EBITDA ratios of the MSCI World Index, the MSCI AC World Index and the S&P 500 are well above the 1.6 x level of 2008.
“Leverage itself is not necessary a bad thing. But what it means is that investors need to be extremely careful about what they own. These higher levels of leverage can turn a good business into a stressed business very quickly. That’s the reason why selectivity is going to be much more important in the future. If the default cycle changes, leverage its going to hurt lower quality companies. The same trend repeats itself at the government level. Global government debt to GDP ratio is also generally higher than at the pre-crisis levels. Debt levels are continuing to climb again, and this fact, combined with a decline in the quality of the global corporate index and a decline in the liquidity, is embedding more risk into the system,” said Hindocha.
What can investors do in this environment?
In the last three decades, investing has become an increasingly complex puzzle. According to a model developed by Callan Associates in the US, 30 years ago, in 1989, to earn a 7.5% expected return, investors needed a portfolio that could be 75% invested in cash and 25% in US fixed income, only supporting a risk level of 3.1%.
15 years later, in 2004, to earn the same 7.5% expected return, investors needed to increase the complexity of the risk budget introducing new asset classes: 26% in large caps US equity, 6% in small caps, 18% in non-US equity and 50% in US fixed income, would nearly triple the portfolio volatility to 8.9%.
Fast forwarding to 2019, the pie chart is a lot of more complicated, the expected returns are the same, but now the risk level is six times higher than 30 years ago. Investors are now required to invest 96% of the portfolio in growth assets (34% large cap US equity, 8% small-mid caps, 24% non-US equity, 14% real estate and 16% private equity) and 4% in US fixed income to obtain a 7,5% expected return with a level of volatility of 18%.
“Investors, trustees and advisors are now beginning to question whether the amount of complexity added to the portfolios over the last 15 years has been paying off or if it has only increased the risk,” he argued.
Does diversification work?
In addition, there are clear evidences that diversification is not working as it used to. The paper “When diversification fails”, published by Sebastien Page and Robert A. Panariello in the Financial Analyst Journal in the third quarter of 2018, concludes that diversification seems to disappear when investors need it most. The paper distinguishes between the left tail scenario, where equity is performing extremely bad, and the right tail scenario, where equity is performing extremely well.
On the left tail, the correlation between equity and the major types of asset classes increase over 50%. The benefits of diversification, which are really resting on low correlation between the asset classes, disappear when investors really need them. If equities are performing negatively, all the other asset classes are also falling at the same time.
On the contrary, on the right tail, when equities are performing extremely well, suddenly, diversification works perfectly well. When investors would want unification, correlations remain below the 50% and, in some asset classes, it even becomes negative.
“Diversification is an important part of the tool kit. We just need to recognize the role that it plays and the types of market environments in which it may be more appropriate. Diversification should change the shape of the distribution, it should help on left tail environments, and potentially hold the portfolio a bit on the right tail environments.
Meanwhile, active management, if done correctly, can provide better than average outcomes. It can even change the skew of the return’s distribution. Investors should start viewing good quality active management as a good diversifying asset.
“Active management seems to be providing the trait that investors are expecting from alternative investments. It seems to be protecting investors when markets are down and to being able to keep up when equity markets are going upwards. The active management skill, particularly countercyclical skill, is probably the best diversifying asset that investors can buy today. We as active managers can play a powerful role to help protect client capital when they need it the most”, he concluded.
