CC-BY-SA-2.0, FlickrPhoto: Lucas Hayas. Fading Fears, Growing Risk Appetite?
For months, the marketplace has feared a US recession, driven by a sluggish global economy, the collapse in energy prices causing a marked decline in capital spending in several key market sectors and tightening financial conditions. Those concerns have begun to ease in recent weeks. We’ve seen a modicum of stability return to oil prices, pressure on high-yield credit markets has lessened and volatility has declined. While US economic growth is far from robust, it has held onto its post-crisis average of about 2%.
Given how much fear has become imbedded in market expectations in recent months, these modest signs of improvement could help rejuvenate the market’s appetite for riskier assets going forward. Even with sluggish growth late in 2015 and a plunging oil price, once you strip out the energy sector, profit margins actually expanded in the fourth quarter. As input costs such as the price of energy and other raw materials fall and if interest rates stay low, profit margins for many businesses will likely expand. It won’t take much to move the dial on profits for companies in the consumer discretionary staples sector, as well as those in tech and telecom, assuming they get a little bit of a lift to the top line. The consensus this year is for profit growth of 2%–3%. A modest uptick in sales could see that expand up to 6%, in my view.
Buying power being unleashed?
Where will that uptick in sales come from? The buying power of the US consumer, boosted by a moderate increase in wages as well as falling gasoline prices, lower home heating and cooling costs and declining apparel prices. For some months now, those savings have been stashed away. But history tells us that when consumers feel confident that price declines (e.g., energy) are here to stay, they tend to spend more. We’re seeing glimmers of hope that consumers are beginning to reallocate some of these savings to more consumption, which is likely to modestly spur manufacturing and the service side of economy.
We’re also seeing other signs of a turnaround. Container shipments and truck shipments are up. Some air freight indicators are beginning to rise. Spending in the technology and telecom sectors of the S&P 500 have begun to improve. Taken together, all of these developments point to a potential improvement in final demand.
It looks as though the US economy won’t disintegrate into recession any time soon but will more likely maintain the slow-growth pattern of the past several years. Against this backdrop, the Federal Reserve will probably see little danger of falling behind the inflation curve, so interest rate hikes should be gradual. It’s an environment where investors, depending on their age and risk tolerance, may want to consider adding to their portfolios some of the riskier assets on offer in the marketplace.
James Swanson is the chief investment strategist of MFS Investment Management.
CC-BY-SA-2.0, FlickrPhoto: Michael Davis-Burchat. Don't Let the Name Fool You
For the past several months now, I have been on an extended research trip for the express purpose of taking a close look into China’s domestic A-share market. While many investment professionals typically rely on screening functions to select potential portfolio holdings in specific sectors, when it comes to mainland China’s domestic-listed, A-share companies, you will want to proceed with caution.
In recent years, many Chinese companies, and especially A-share listed firms, have been using their capital—either with cash or with shares—to make acquisitions. Some firms are expanding their operations within specific value chains (either upstream or downstream), some are adding more products or service offerings and some are even entering entirely different sectors from where they began. In a few extreme cases, firms have transformed themselves by divesting their original businesses and re-emerged in a new industry. In the interim, they may even continue to maintain their old firm name before revisions reflect their new business models.
I’ve recently met with several firms that have made acquisitions within the past two years. Through my discussions with management teams, I gained insight into the motivations that have driven recent acquisitions. Due to the economic slowdown, firms that have been operating in traditional industries, such as the property and manufacturing sectors, are facing some difficulty. So expanding into more value-added areas in related industries is an attractive move. Alternatively, major shareholders or management teams may decide to strategically pivot and enter new areas in order to tap other growth drivers or convert the company entirely. Due to the lack of relevant talent and the time it takes to develop expertise organically in new areas, a firm in this situation may also opt to purchase a strong existing player in the new sector.
This kind of diversification and business transformation makes sense. As in many cases, firms can either leverage current resources to create synergy with the new businesses, or if they venture into an area they are not familiar with, they can pay a reasonable price for a leader with a good track record and then allow the acquired management team to retain a partial stake. If these firms don’t change, they may not survive by merely adhering to their old business strategies. In other words, they have little choice but to adapt.
On the other hand, there are also firms that make acquisitions in “hot” areas such as information technology, health care and media. Acquisitions are sometimes made simply for the sake of having exposure to such industries despite a lack of any concrete plans for development in the sector. A company may also make so many acquisitions in a single year that integration becomes problematic. In nearly all cases, there are profit guarantee clauses embedded in the acquisitions, and if the acquired firms are unable to meet targets, there are penalties imposed.
Though many firms have thus far delivered on profit guarantee clauses, there is still no guarantee that all profit targets will be met at the end of the contract term. Meanwhile, in cases where profit targets are not met, the acquirer must then write down assets.
As long-term investors, our job is to identify those firms with solid management teams who have clear objectives for acquisitions to provide new growth areas for themselves and to avoid those that pursue “hot” concepts to support their stock prices in the short term. As Chinese investors become more mature, they will eventually reward only firms that achieve long-term earnings growth from such acquisitions.
Photo: Proclos . Bill Gross: "Investors Cannot Make Money When Money Yields Nothing"
In his latest monthly outlook, Bill Gross mentions that negative interest rates are real but investors seem to think that they have a Zeno like quality that will allow them to make money, otherwise why would a private investor buy a security at minus basis points and lock in a guaranteed loss? The bond guru states that “zero and negative interest rates break down capitalistic business models related to banking, insurance, pension funds, and ultimately small savers. And although under current conditions “they can’t earn anything! … many of them are using a bit of Zeno’s paradox to convince themselves that they will never reach the loss-certain finish line at maturity.” But as Gross mentions, some investor has to cross the finish/maturity line even if yields are suppressed perpetually, which means that the “market” will actually lose money.
And this applies to high yield bonds and even stocks. “All financial assets are ultimately priced based upon the short term interest rate, which means that if an OBL investor loses money, then a stock investor will earn much, much less than historically assumed or perhaps might even lose money herself.” The reality, according to Gross, is that Central banks are running out of time. Their polices consisting of QE’s and negative/artificially low interest rates must successfully reflate global economies or else markets, and the capitalistic business models based upon them and priced for them, will begin to go south.
According to him, during 2017, the U.S. needs to grow 4-5%, the Euroland 2-3%, Japan 1-2%, and China 5-6% so that central banks can normalize rates or “capital gains and the expectations for future gains will become Giant Pandas – very rare and sort of inefficient at reproduction… Investors cannot make money when money yields nothing.” He concludes.
You can read the full letter in the following link.
CC-BY-SA-2.0, Flickr. Are Investors Too Complacent About US Inflation?
Low inflation has been an unwelcome thorn in the side of the US Federal Reserve (Fed) and remains the most elusive piece of the Fed’s interest rate puzzle. The decision to raise interest rates in December was predicated on consistent growth in the US jobs market and an assumption that this would eventually feed through to higher inflation. However, the sluggish outlook for inflation has been a key reason why the market’s expectations for further interest rate hikes this year have been delayed. But inflation has recently shown signs of stirring again, with the Fed’s core measure of inflation increasing by 1.7% over the year, a level close to its target of 2%. This has surprised investors and puts into question the consensus view that inflation is likely to remain below the Fed’s target for an extended period. As commodity prices potentially form a base we pose the question: ‘Are investors too complacent about US inflation?’
When looking at the key factors that drive US inflation, we can see that external inputs (mainly the oil price and the US dollar) have had a significantly negative impact on inflation readings over the past 18-24 months (see Figure 1). This does not come as much of a surprise, as within that time frame we have seen the price of Brent crude oil fall from circa US$100 per barrel in mid-2014 to US$40 per barrel currently, and the US dollar has appreciated strongly versus most major currencies. What is of greater interest is the extent to which these transient factors have been implicitly priced into future estimates for inflation, and that the more persistent drivers of inflation — which have been operating in a more normal fashion — have been largely overlooked.
The Federal Reserve Bank of St. Louis recently attempted to quantify the mispricing of inflation expectations by extracting the implied expectations of future oil prices from the breakeven expectations of inflation rates. Assuming that the non-energy elements of the CPI basket are at historically normal levels, inflation expectations are so low that they imply the oil price would reach zero by 2019 – a wholly unrealistic assumption in itself. This exercise illustrates that if the core elements of the CPI basket remain robust, energy prices have to remain at very low levels going forward for inflation to meet current expectations. If the logic of this analysis is reversed and we take a view that energy prices do stabilise, or even rise in line with the forward curve, it raises a more pertinent point; that the market is expecting almost non-existent rates of non-energy CPI over the next year. Providing the US economy does not fall into recession, it is hard to believe that these expectations will materialise.
Clearly the case for higher headline inflation rates is dependent on the path that oil prices will take over the next year. While the oil price is likely to be volatile in the near term, we think that highlighting a range of plausible scenarios can be helpful in understanding the potential range of inflation outcomes. We model five potential scenarios that range from oil prices testing the lows and rebounding to reaching the market consensus of US$60 per barrel by the end of the year.
Taking this one step further we calculate the year-on-year contributions using these oil price estimates, energy weightings and the historical elasticity between energy CPI and the oil price. We can see from Figure 2 that the strong negative contribution of energy to CPI ties in with the steep drop in oil prices we witnessed at the end of 2014 and beginning of 2015. This negative effect diminished as oil prices stabilised and started to recover. We can see that by the end of 2016 energy prices are likely to positively contribute the CPI, even in the more conservative scenarios.
While the central case is that inflation rates remain well contained, it is naïve to ignore the potential risk that the market could be surprised by higher inflation rates. Our nowcasting models suggest inflation and wages will be firm going forward and our commodity team believes that robust oil demand and a material decline in oil supply will provide support to the oil price. If there is a more sustained oil price recovery, consistent with our commodity team’s forecast of approximately US$60 per barrel, there is a meaningful risk that inflation could even overshoot to the upside. This is a tail risk that neither the bond, currency or equity markets are prepared for.
Philip Saunders is Co-Head of Multi-assets at Investec.
Robert Hackney, Senior MD, First Eagle Investment Management, which advises the First Eagle Amundi International Fund - Courtesy photo. Making More, by Losing Less: Amundi First Eagle’s Pure Value Strategy
Robert Hackney is Senior Managing Director for First Eagle Investment Management, which advises the First Eagle Amundi International Fund, a fund that has been in operation for the past 20 years, and boasts a volume of assets under management of 6,45 billion dollars. We have had the opportunity to talk to him about the fund and its investment philosophy.
This fund is presented with the slogan “Making more, by losing less”, but what is really the philosophy of your strategy?
The manager explains that at First Eagle they follow Ben Graham’s – the father of Value Investing- investment philosophy, as set out in his book “The Intelligent Investor”. He believes that “Investors should look for opportunities to grow their wealth, but above all to preserve it. If an investor is comfortable investing in a company whose intrinsic value is higher than its stock market listing, you can be sure he is minimizing the risk of capital loss. “
Quoting Ben Graham, Hackney refers to the “margin of safety” concept: “there must be a difference between the intrinsic value of a stock and its market price, and when there is a significant discount in relation to the intrinsic value, it’s the time to buy.” Hackney believes that “investment should be approached by analyzing the fundamental value of a company, its ability to generate cash flow, so we can get to identify companies that are overvalued in order to move away from them,” this is when the motto “making more, by losing less” acquires its full meaning: “When the bubbles of overvalued stock burst is when our fund earns more“, because it loses less than the indices, in which the items with more weight tend to belong to overvalued popular companies.
“The only way to buy at a cheap price is by investing in companies which are not very popular.” Graham believes we can find value in undesired and unwanted companies, as could currently be the case with the energy industry, unattractive to most managers, “but which are, nevertheless, the ones we have added to our portfolio during the last six months”.
In short, the philosophy of the fund is to select companies for their intrinsic value and fundamentals, thus avoiding large unrecoverable losses.
What is the current level of cash in the strategy? And six months ago? What has changed? And gold?
“We use liquidity as a residual item while waiting to find good opportunities, preserving purchasing power, in order to have the opportunity to buy when we really think we should do it. When the market is cheap, we have little liquidity in the portfolios, and vice versa. We currently have 15% in cash, this item has historically been 10%, and the time it has been at its highest, during the second quarter in 2014, it reached 27%”
“With respect to gold, we have been buying for a year and a half, and the idea is to always maintain a 10% weight in our portfolio, which is what we have now, and we use it as a potential hedge against market decline and possible financial hardship and policies. During the period 2008-2011 the value of gold increased much faster than the value of shares, and as a result had to sell gold so as not to exceed 10%. In 2012 the value of gold began to fall and that of shares began to rise, therefore, we had to start buying to maintain that percentage.”
As Hackney points out, gold plays no role in the global economy. It has no industrial use and is either intrinsically worthless or intrinsically priceless, depending upon the state of affairs in the world. Humans have used it as currency and throughout history it has been the mirror of the world of finance and the barometer of investor confidence. In 1999, with an almost perfect global economic situation, gold traded at $ 300 an ounce, in 2016 it trades at $ 1,200, reaching $ 1,800 an ounce during the most tumultuous time globally.
The portfolio is constructed searching for balance and protection among the various items in the portfolios, thus minimizing risk exposure.
Are there good buying opportunities during a market correction? Where? Which sectors?
“Yes, there are good opportunities to be found within the energy sector and oil companies, some examples are Suncor Energy and Imperial Oil, Ltd., both Canadian companies, or Phillips 66. These are companies with healthy balance sheets that have little debt and which will survive. We need energy and oil, and if our investment horizon is long term, we can safely keep these companies in the portfolio,” says Hackney.
The expert finds other opportunities in markets such as Hong Kong, in which “real estate companies have great potential, as a result of fears and the collapse of the Chinese market are shifting activity and development to the Hong Kong market.” Finally, Hackney adds that the strategy is very interested in holding companies such as Jardine Matheson, Investor AB or Pargesa. “Generally they tend to be family-controlled companies that have a philosophy that fits perfectly with ours.”
One of the sectors which is not usual for this strategy is the banking sector. “We don’t have any European banks, since they are heavily indebted and it’s difficult to independently assess their assets. We do have a couple of U.S. banks in the portfolio, one is U.S. Bancorp and the other is BB&T. “
We have probably gone through a long period in which the “growth” stocks have behaved better than the “value” stocks. What has to happen for the market to be based on the fundamentals again?
“When the market is bullish and growing rapidly, we think it’s time to take positions in cash and gold, thus being below market. But we know that those periods are not eternal and that they often end up falling sharply, and that’s when we’ll return to buy,” said Hackney. “Humans react to fear and markets are a great school of the irrational, and can remain irrational for longer than we can remain solvent. For example, one may think Amazon is overvalued but you never know when, or if, the correction will come. For that reason we do not put ourselves short.”
How do you see current valuations?
“Currently in certain parts of the market there are companies with very attractive valuations such as in some parts of the global real estate sector; or companies with some exposure to the oil industry but which are not producers of the commodity, but have very attractive prices and they are what we are looking to buy,” says the manager. “The valuations we don’t like very much are in the social media or new tech sectors, because they are no longer adjusted in price and do not interest us.”
Do you think the proliferation of generic and factor based ETFs affect your investment style?
“In the short term, the proliferation of ETFs that replicate indices have dramatically increased market volatility, the spread is wider and the prices do not conform to reality, but the long-term effect is positive for selective managers who know what to buy, allowing them to acquire companies with artificially low values.” Hackney points out that they are really two completely opposite styles. “Our philosophy is that if you want to beat the market, it is impossible to achieve it by following the index, you must stop staring at the screen and look for the intrinsic value of the companies.”
CC-BY-SA-2.0, FlickrPhoto: Amaradestiempo en Pixabay. Mexican Pension Funds Made a 516 Million Dollar Profit in 2015
The 11 Mexican public retirement funds managers, also known as Afores had commision based revenues of 26,817 million pesos in 2015, which is equivalent to $1,554.61 million (considering 17.25 pesos per dollar, the rate at the end of 2015). According to official figures published on regulator’s website, consar.gob.mx, this amount represents 1.06% of the resources administered at year end, reflecting growth of 5.2% in 2015, slightly higher than the previous year’s 4.7%.
Meanwhile, net income of the 11 Afores stood at 8,898 million pesos or $516 million with a negative growth of -2% (in pesos) over the previous year. Interestingly, in 2014 the growth in this category was 13%, which shows how complicated was the year that just ended; because while in 2014 the peso-denominated assets grew 15.7%, in 2015 growth was of only 7.1%. Assets under management of Afores ended the year at 148,300 million dollars. It is important to highlight that current comparisons are made in pesos, as these companies produce pesos, and given that the currency depreciation of 17% in 2015 distorts the figures if looked at in dollars.
The afore business requires economies of scale. They need a significant investment in systems to handle a large number of customers (53.6 million workers) and thus must be efficient in their operation; as well as having the ability to bring new customers and retain affiliated workers. Regardless of size, all are interested in having more customers, however the incentive is greater for small and medium ones.
Breaking up the fee income, 40% corresponds to operating costs; 26% to membership and transfer costs; 17% is administrative overhead; 7% cash operating costs of operating personnel and service workers; 4% regulatory costs; and 3% cash operating costs for investment and risk management.
One point that the CONSAR has done much emphasis on recently, refers to expenditure by the Afores for membership and transfer which has gone from 31% of fee’s income in 2014 to 26% in 2015. Afore Pensionissste with a 13% expenditure is the afore with the lowest cost of membership and transfer; however it is important to mention that is also the afore with the lowest number of promoters. Afore XXI Banorte, Banamex and Coppel spent 21% of their fee’s income in promotion; while Profuturo spent 34%, Invercap 42% and MetLife 48%.
For the 11 Afores on the market the main challenge is to grow their income at a larger rate than the drop in commissions every year. During 2015 only 6 Afores succeeded in doing so.
CC-BY-SA-2.0, FlickrPhoto: Roberta Schonborg. Scared of Defaults? Don’t Worry, There’s a Bright Side
It’s hard to talk about high-yield bonds today without addressing defaults. So here’s our take on the matter: Default rates will rise over the next few years. But don’t fret: returns are likely to rise, too.
Defaults have been below average for years, so an increase shouldn’t come as a huge surprise. High-yield bonds have always been riskier than other types of bonds. And it’s not uncommon for some issuers to default as the credit cycle winds down and borrowing costs rise.
But a higher average default rate doesn’t mean returns have to suffer—provided you’ve been selective about your exposures. Over the past two decades, jumps in the average default rate have usually been followed by big increases in returns (Display).
The reason is tied partly to investor psychology. Defaults usually aren’t spread evenly across the high-yield market, which includes many different regions and sectors. Nonetheless, investors tend to respond to a rise or an expected rise in defaults by punishing the whole high-yield market.
The result: plenty of sound credits trading at very attractive valuations. For example, a large share of defaults in 2001 and 2002 were telecom companies that had borrowed heavily but ran into trouble when the dot-com bubble burst. That led to selling across the US high-yield market. But investors who bought bonds in nontelecom sectors in the years after 2002 did well. In 2003, US high-yield returns soared to 29%.
Beyond Energy, Values Look Compelling
We think something similar is going on now, with energy, metals and mining companies standing in for telecoms. With the price of oil near multidecade lows, we expect these types of companies to account for a large share of defaults over the coming years.
Many investors have reacted to recent volatility as they did in 2002—by bailing out of the market altogether. As a result, some non–energy sector bonds now offer higher yields than they have in years.
That’s important, because starting yield—now above 8% on average—is one of the best predictors of what investors can expect to earn over the next five years. In 2009, high-yield defaults hit a record high—but so did high-yield returns. At one point that year, the average yield on the Barclays US Corporate High Yield Index exceeded 20%.
Even so, investors can’t afford to be cavalier about the market and its risks. It’s critically important to be selective, even among higher-quality bonds. That’s especially true in US high yield, which is in the later stages of the credit cycle, and Asian high yield, which is already in contraction. A global, multi-sector approach makes sense, since different regions and sectors are at different stages of the cycle.
But we think it would be a mistake to abandon high yield altogether. The biggest risk today isn’t a rise in defaults—it’s pulling out of the market prematurely and missing the opportunity to buy before it rebounds.
Gershon M. Distenfeld is director high yield at AB.
CC-BY-SA-2.0, FlickrPhoto: Rede Brasil Actual. For Brazil, No Glimmers of Light Yet
With so many headlines recently over politics and economics in Brazil, Eaton Vance wants to provide an update on recent events and the market volatility that has followed.
Over the past two years, Brazil’s economy has suffered from a terms-of-trade shock as well as simultaneous fiscal and political crises. These shocks have led to seven straight quarters of economic contraction (the longest recession since at least the Great Depression era of the 1930s) and multiple credit rating downgrades, leaving Brazil’s sovereign credit rating back in “junk” territory by all of the major ratings agencies.
With the exception of large currency depreciation, says Matt Hildebrandt, Global Credit Strategist at Eaton Vance, Brazil’s progress adjusting to these shocks has been limited. Fiscal deficits have grown larger and public debt levels higher with no sign of debt sustainability in sight. To make matters worse, President Dilma is currently defending herself in congressional impeachment hearings while former President Lula and the heads of both of the lower and upper houses of Congress have been implicated for corruption from testimony received from the ongoing Operation Carwash investigations.
According to the expert, Brazilian assets have rallied the last few weeks, as the market has interpreted negative news related to President Dilma as positive for the country. The thinking is as follows: Dilma’s removal may ease the political gridlock currently paralyzing the policy process, which would allow the government to develop and implement a plan that puts the country’s debt trajectory on a sustainable path and that improves the economy’s competitiveness. Such thinking may prove correct in the long run, but impeachment will likely be a messy process and even if Dilma is removed, the political establishment will still be plagued by unscrupulous personalities, vested interests and party factions. The path to debt sustainability and greater economic competiveness will be a long one.
From a long-run perspective, Eaton Vance thinks Brazilian assets offer a lot of attractive opportunities. But, the recent market rally has priced in the best possible near-term outcome even though the outlook is fluid and uncertain.
“Expect more market volatility in Brazil in the months to come until the government, regardless of who is running it, is able to articulate and implement a more coherent policy path forward. Only at that point will we be able to say that there is some light emerging at the end of the tunnel”, concludes Hildebrandt.
CC-BY-SA-2.0, FlickrPhoto: Michael J. Kelly, CFA, global head of multi-asset at PineBridge Investments. PineBridge: “Asset Allocation Is The Biggest Decision In Every Portfolio”
As volatility increases throughout global markets and returns lower, investors are facing a turning point. Michael J. Kelly, CFA, global head of multi-asset at PineBridge Investments, explains why asset allocation -along with a dynamic approach- is more important than ever.
What is going on in markets now?
Today’s volatility is the result of forces that have been building for a while. For many years, the global savings rate was relatively stable. Then, just before the global financial crisis, it stepped up. We saw extreme caution from businesses, central banks, and investors. Far fewer people and institutions were investing.
This was one of the biggest ever tailwinds for financial assets. Too much money was chasing too few opportunities. Meanwhile, central banks were growing their balance sheets relative to global economic growth. So they’ve been adding liquidity on top of naturally formed liquidity – another huge tailwind for financial assets.
This caused a global liquidity surge, which caused many investors to lean on growth assets, weighing down prospective returns. However, this challenging market environment also created opportunity for investors who can selectively identify attractive insights and dynamically shift their investment mix.
Now is a good time for investors to start thinking ahead and realizing that the next several years won’t be easy. Unlike during the crisis, which was extremely painful but ended relatively quickly, this will be a slow drip. Expect more risk and not enough return to meet investors’ expectations. And the answer is not diversification alone, but optimal allocation across the investment universe while expressing convictions.
This brings me to asset allocation. This is the biggest decision in every portfolio. It’s not a new concept, but many investors still don’t pay it enough attention.
And that has been fine so far – investors have been playing it safe with few consequences – but the time is coming when markets will reach an inflection point, and investors will need to use asset allocation to help them navigate a world of much lower returns but continued high expectations.
What’s the danger for investors in playing it safe?
We’re entering a period of slowly rising interest rates, and it’s been a while since markets have had to deal with that. For a long time, we’ve been in markets dominated by falling interest rates. You can play it safe without much of a penalty in that world. In periods of disinflation, the correlation between capital conservation assets and growth assets becomes negative. The effectiveness of one to hedge the other goes up. So playing it safe has worked really well as rates have dropped.
But what happens when rates are no longer falling? They’re either flat or rising. While play-it-safe investing lowers the risk, it carries quite a penalty in returns. When inflation and rates are flat and rising, that negative correlation actually becomes positive. We have already started to see this, for instance, in the fourth quarter of 2015, as the market anticipated higher rates by the US Federal Reserve. The effectiveness of those two to balance each other out goes down while the cost goes up, since the differential of returns is much higher.
How can investors best position their portfolios in this environment?
We do see some opportunities, but to explain, let’s go back to the idea of diversification. If you own a little bit of everything in a market capitalization sense, that means you own the slope of our Capital Market Line (CML). The CML is our firm’s five-year forward-looking view into risk and return across the asset class spectrum. Right now we consider its slope to be disappointingly positive.
But there is a silver lining: The dispersion of dots around the line has widened over time, and it’s the widest we’ve seen since we began constructing the CML. This means that the upcoming period will have more winners and more losers. So for investors, it’s a matter of picking more of the winners and avoiding the losers – which, of course, is not as easy as it sounds.
How do you do that?
With more opportunistic investing along with an intermediate-term perspective. You need to be much more opportunistic if you’re going to deliver an outcome over a three-, five-, seven-, or 10-year horizon.
In a world of policy-distorted markets that have created this massive tailwind, we think it’s relatively easy as the environment unwinds to avoid the asset classes that have been helped the most, those that might have the biggest tailwind.
How do you and your team approach asset allocation?
Our approach focuses on growth assets – trying to get growth-asset-like returns with 60% or less of the risk that normally accompanies them. We think the only way to do this is to be much more opportunistic in moving between markets and between growth assets, shifting between growth and capital conservation when necessary. That shift, in fact, can sometimes be as dynamic as a rotation, which we witnessed in the financial crisis.
So I believe in a balance of approaches. But there’s going to be really no alternative in a lower return world with flat or rising rates to being more opportunistic in the growth assets that you pursue. We expect this to lead to investors’ “scavenging” for alpha, which presents its own challenges. The market has grown in terms of people looking for alpha within infrastructure, within stocks, within bonds. Before the crisis, looking for alpha between asset classes was basically talked about and not employed. How are investors gearing up to do that? The answer is not just getting more alpha out of security selection, but finding better, more efficient ways to allocate assets that provide a more consistent alpha source.
Opportunistic investments are providing the unexploited source of alpha to fill in the gap between market returns and investors’ expectations. In the current environment, everyone’s investing in more assets, in more areas of the world. So to get us to those windows of opportunity, we need to move more toward seeking returns through asset allocation.
This information is for educational purposes only and is not intended to serve as investment advice. This is not an offer to sell or solicitation of an offer to purchase any investment product or security. Any opinions provided should not be relied upon for investment decisions. Any opinions, projections, forecasts and forward-looking statements are speculative in nature; valid only as of the date hereof and are subject to change. PineBridge Investments is not soliciting or recommending any action based on this information.
CC-BY-SA-2.0, FlickrPhoto: Aristipo Crónica Popular. Oil: Up, Up And...?
The New Year began in disastrous fashion for the oil market with Brent crude touching 12 year lows in January, which followed a year to forget in 2015. Confidence in the prospects for the oil price seemed irreversibly low when the decision to lift Iranian sanctions was announced and Chinese economic growth statistics continued to paint a rather bleak picture for global growth. However, oil has undergone a swift and material recovery since bottoming out on 18 January. The bounce in sentiment has not been exclusive to oil, with iron ore, copper and coal also experiencing a surge in their respective prices. The key question from here remains: is the rise in oil sustainable, or is it little more than a short squeeze which lacks any fundamental basis?
As outlined in our ‘Multi-Asset Brief’ in January, we believed the tide was beginning to turn in oil and that Brent crude touching a low of US$27.88 per barrel in January was not justified. Since that paper’s release we have witnessed a few interesting developments, not least of which has been a tentative agreement between Saudi Arabia and Russia over a planned production cap. While the deal itself was viewed as having little impact on supply over the short term, as it was predicated on other key producers (including Iran) also capping production, it was symbolic that a deal by a Saudi-led Opec is still possible in the current environment. The oil cartel had previously refrained from limiting supply, despite the weak market conditions, preferring to keep the market oversupplied to implicitly drive out incumbent shale producers.
The much publicised end to Iranian sanctions finally came on 16 January when a nuclear deal was struck between Iran and six of the world’s western powers. There was little doubt within the market that the easing of Iranian sanctions would cause a significant uptick in oil supply, although the jury is still out on how much and how quickly Iran can increase its production to anything that resembled its pre-sanction high. Since the sanctions were lifted, the increase in Iranian output has significantly undershot consensus market expectations, driven by ageing infrastructure and lack of investment, which has reduced its capacity to increase production for the time being. The oil market has also benefited from a drop in oil production in Iraq and Nigeria, with the former experiencing the largest decline due to a stoppage in flow along a pipeline carrying oil across the Kurdish border.
In a phenomenon which began in October 2014, the US oil rig count has continued to transition lower, falling approximately 72% from its peak. At the same time, global oil capital expenditure (capex) has also decreased, with Simmons forecasting it to fall approximately 50% in 2016 which followed a similar reduction in 2015. While the fall in rig count and capex has been swift and material, the drop in US oil production has been modest in comparison, although we began to see consistent declines being recorded in February. We believe the market over anticipated the speed at which production would decline in response to the falling capex, which exacerbated the downward pressure on oil prices, as production remained stubbornly high. Nonetheless, our view is for US production to follow a similar path to the fall in rig counts for the remainder of the year and into 2017, as we believe shale producers will be reluctant to increase drilling spending with prices below their respective marginal costs of production.
A looming factor that has the potential to jeopardise the recent rally in the oil market is the historically high level of oil inventories. The above-trend level of inventories has been caused by two main factors:
Oil supply strongly exceeding oil demand
A steep forward curve which acts as a strong incentive to build inventories. However, recently we have seen the forward curve flatten, thus minimising the incentive to build inventories as the premium received from doing so is comparatively less. A flattening forward curve, as oil inventories are high, in the short term should see new supply come online, which theoretically threatens an already oversupplied market. While we are obviously cognisant of this risk, we believe consistently falling inventories will be supportive of a more stable oil market.
We held the view earlier in the year that an oil price at sub US$28 per barrel was not sustainable over the longer term and not in line with fundamentals. The recent recovery has been swifter than even our expectations. In light of the current uncertainty in the market, we believe the path over the short term for oil will be volatile, particularly as the threat of inventories swamping the market is very real. However, over the longer term, we are more constructive on both the stability of the market and its eventual price, as falling capital expenditure and rig counts begin to have a more pronounced impact. Similarly, the tentative agreement by Opec members to freeze production, while complex and contingent on a number of factors, is still a potential positive for controlling supply over the longer term. As for the positioning of our portfolios, we are conscious of the short-term risks that lie ahead, although we do believe there are genuine factors which are now supportive of a higher oil price.
Philip Saunders is co-Head of Multi-Asset at Investec.
