Photo: Phil Whitehouse. Are Portfolio Decisions Feeding Volatility?
Markets had been unusually calm, until risk surged in late August. Bigger portfolio shifts when volatility is rising may be magnifying the spikes, making markets harder to navigate. AB thinks the answer is focusing on more than risk.
It’s true that volatility has moderated a bit but is still higher than it was before August, and policy makers have taken note of these sudden shifts in risk. In fact, it was one of the reasons why the US Federal Reserve decided to hold off on raising interest rates in September, point out Brian T. Brugman, portfolio manager of Multi-Asset at AB, and Martin Atkin, Head of US Client Solutions at AllianceBernstein Multi-Asset Solutions Group. To avoid being whipsawed, recommended, investors should take a holistic view of their portfolios. The focus should be on more than risk signals—return signals matter, too.
Reactions to Market Volatility Amplify It
“Our research indicates that risk factors—and oversimplified asset-allocation decisions based largely on volatility measures—can create a painful cycle. The very trigger that prompts an allocation shift away from equities is itself influenced by the resulting sale. And volatility begins to feed on itself”, said Brugman and Atkin.
There’s evidence that more managers are making decisions based largely on changes in market volatility. The firm looked at allocation changes over time, based on the implied equity exposure across different mutual fund categories, examining both high-risk and low-risk environments. Brugman and Atkin found that reductions in equity exposure have become noticeably larger since the Global Financial Crisis of 2008.
In fact, the downward shifts for tactical allocation strategies have almost doubled in size. It’s not surprising that tactical strategies make adjustments, but the bigger moves today are notable, explain the experts. Even world allocation strategies, which largely left their equity allocations alone pre-crisis, have begun to make significant equity reductions.
“Our analysis also suggests that portfolio shifts aren’t just bigger than before, but they’re also happening faster when volatility rises. This helps make volatility spikes more pronounced. The August episode confirmed this: selling pressure due to a collective decision to de-risk likely made the first few days more severe. Before August 24, when risk was below average, the group of strategies we isolated for this analysis had an average overweight to equity of 9%.Shortly after the spike in risk they were significantly underweight, averaging 15% less equity exposure than is typical”, point out.
One likely reason for the rush for the exits is that many risk-managed strategies exclusively use volatility gauges as a simplified trigger for making allocation changes. Because this systematic approach is so common, it creates significant selling momentum in equities when risk starts to rise and the signal turns red. This risk “tunnel vision” can lead to even sharper moves in the very metrics used to determine portfolio positioning.
Brugman and Atkin don’t think these type of asset-allocation triggers are robust enough. It’s important to determine if a sudden change in the risk environment is temporary or long-lasting. That knowledge can make a portfolio manager less likely to make the classic mistake: trend-following and selling into distress at a market trough.
A Holistic Process Must Integrate More than Risk Signals
One way to tackle this problem is to include both expected risk and expected return across asset classes in quantitative analysis. It’s also important not to leave fundamental judgement behind, and to consider how technical factors in the market impact the asset allocation equation.
All things considered, AB thinks it makes sense to be modestly underweight equities in the current environment. Volatility is above average, but we think the initial spike may have been exacerbated by indiscriminate selling from risk-managed strategies. Stalling growth in emerging markets and falling commodity demand may not be as much of a spillover risk for developed economies as some investors may think.
“In turbulent times like these, the ability to be dynamic in shifting equity beta can be very helpful. And volatility is a valuable signal that helps inform that decision. The key is to make sure that the trigger for shifting beta isn’t overly sensitive to changes in volatility alone”, concluded.
Christine Johnson, Head of Fixed Income - See photos. Old Mutual GI Provides Answers in Boston for 2016, a Year Full of Uncertainties About "What the World holds in Store for Fund Managers"
Old Mutual Global Investors recently held its annual client’s conference at the Taj Boston Hotel. The meeting was attended by more than 60 clients from around the world who were able to hear about the management ideas, which the company is developing for each of its different strategies.
During the first session, five of the top OMGI fund managers from London, Hong Kong, and Edinburgh, explained their views on the market’s most important current issues. Therefore, the rate hike by the Fed and its impact on assets, volatility, problems in China, the profitability of global fixed income, and energy prices were some of the issues on the table in the first panel.
“We met here in Boston a year ago to discuss how we saw the end of the year and what are our prospects were for 2015. Today, we can say that the predictions we made then have been met only in part, and that in 2016 we are going to continue to see a high level of uncertainty as to what the world holds in store for asset managers,” said Chris Stapleton, head of distribution for the Americas Offshore market.
Christine Johnson, Head of Fixed Income, Josh Crabb, Head of Asian Equities, Ross Oxley, Head of Absolute Return strategies, Justin Wells, Global Equities Investment Director, and Lee Freeman-Shor, fund manager and author of the book “The Art of Execution: How the world’s best investors get it wrong and still make millions in the markets”, reviewed the movements carried out in their portfolios in order to adapt the portfolio to the current environment.
“Each team and each strategy has its own vision, and I think this is the key to our success, and reflects the talents of our portfolio managers. If you follow the path marked by a CIO it would be much more difficult to reach the levels of profitability that our funds currently offer,” explained Allan MacLeod, Head of International Distribution.
ConsulTree opening in Argentina - Courtesy Photo. ConsulTree Celebrates the Opening of a New Office in Argentina
ConsulTree International, a Leadership and Talent Development consulting founded in United States announced the opening of a new office in Argentina as the most recent expansion of ConsulTree International’s presence in Latin America.
The launch ceremony was held two weeks ago at the exclusive Palacio Duhau in Buenos Aires, with a Cocktail reception attended by a selected group of human resources professionals.
The local partners, Eduardo Cappello -managing director for the new office, with over 17 years in the business- and Paula Valente -Senior Consultant and Partner, Human Resources & Talent Development Specialist, with over 15 years of experience in leadership roles-, joined Luisa Guzman, CEO of ConsulTree International, who spoke about the New Global Trends in Development.
The opening of the Argentina office comes in response to proven demand from the existing client base comprised of multinationals based in South Florida for extended service in the region. “We are excited to lead the expansion of ConsulTree through a local presence in Argentina” said Luisa Guzman.
Guzman, with over 20 years of experience in Management Consulting, Human Resources, Organizational Development, Talent Acquisition and Leadership Development, is the founder of ConsulTree whose headquarters is in Miami and is present in Peru, Chile, Honduras, United Kingdom and Spain.
CC-BY-SA-2.0, FlickrPhoto: Portobay Hotels. Advisors More Likely to Join Existing RIA Firm Than Start Their Own Firm
The latest research from global analytics firm Cerulli Associates finds that advisors are more likely to join an existing registered investment advisor (RIA) firm, rather than start their own independent firm.
“Many advisors are daunted by the task of forging their own path and the accompanying headaches,” states Bing Waldert, director at Cerulli. “Advisors considering the RIA channel are increasingly looking to join existing firms that can provide them with not only the necessary operational infrastructure, but also a sense of community.”
Cerulli’s fourth quarter 2015 issue of The Cerulli Edge-Advisor Edition explores recruiting and retention, looking closely at the factors influencing advisors to switch firms, and the demand for support and flexibility in terms of how the advisors choose to conduct business.
“A variety of platforms and support organizations have emerged to provide advisors with different ways to run their practices,” Waldert explains. “The rise of the Subaggregator is happening for two reasons. The first, as has been noted, is providing an option for advisors interested in the independent business model, but without the skills or desire to operate their own business. The second and unique reason for the rise of these firms centers on the culture and community of being part of a smaller organization.”
“Cerulli is naming this class of firms the Subaggregators because their business model in many cases escapes traditional definitions of broker/dealers (B/Ds), RIAs, or office of supervisory jurisdiction (OSJs). They use the platform of a larger firm, such as a B/D or custodian, that more frequently works directly with advisors,” Waldert continues. “These firms support multiple advisory practices, with advisors operating autonomously, often across multiple geographies. They have professional leadership in place. Perhaps most importantly, the advisor’s primary relationship is with the Subaggregator rather than the B/D, custodian, or platform. Advisors are recognizing this evolution and believe the rise of Subaggregators is the next generation of financial firms.”
CC-BY-SA-2.0, FlickrPhoto: Skyseeker. China Explained
The Chinese economy is in a transition phase as it works through the competing needs of growth, reform and deleveraging. Many of the country’s engines of growth are not firing as strongly; the export sector has been losing competitiveness for a number of years under the influence of rising wages and a strong currency. Meanwhile, investment expenditure is being held back by growing local government debt burdens and Communist Party officials scared to act because of the anti-corruption crackdown.
As a consequence, economic growth is being dragged southward. Concerned that growth is too weak, the government has announced that it will increase fiscal expenditure to boost activity levels.
But none of this is new to us − what is new are signs of change in the reform agenda. In 2013, the relatively new President Xi embraced market forces with welcomed initiatives such as the Hong Kong-Shanghai Stock Connect, which facilitates cross-border share trading, and promoting development of a bond market to reduce the reliance on banks for financing.
However, weakness over recent months in the stock and foreign exchange markets have been met by government intervention, aimed at supporting markets with measures including compelling brokers to buy stocks and prohibiting major shareholders from reducing their holdings. There has also been indirect intervention, for example imposing additional reserve requirements for banks when hedging renminbi for clients, with the aim of reducing speculation in the currency−essentially a mild form of capital control.
Policy pro-reform, action anti-reform
In theory, the reform agenda continues, but in practice the government’s actions are reflecting the Communist Party’s unwillingness to give up control, by exercising considerable financial muscle to influence the market forces it should be embracing. This is an important change and warrants close monitoring as it impacts the attractiveness of China to foreign investors.
Currency weakness is a new phenomenon
The liberalisation of the foreign exchange mechanism in China, with the aim getting the renminbi accepted into the International Monetary Fund’s Special Drawing Rights (reserve currencies basket) is subjecting the currency to market forces. Early indications are that the government will utilise its vast foreign currency reserves to support the renminbi. However, as a consequence, this will cause a contraction in domestic money supply, which may undermine efforts to boost the economy with fiscal stimulus. It may also provide a window that encourages rich Chinese to take money out of China. These reasons strengthen the argument for a weaker renminbi.
Foreign investors have been used to a relatively strong Chinese currency. The renminbi was pegged to the US dollar from 1994 to 2005 and has appreciated in recent years − so currency weakness is a new headwind for overseas investors.
Summary
These developments mean it will be imperative to monitor government actions as much as policy rhetoric, while investors will be dealing with a new dynamic of a weaker Chinese currency. In the meantime, as China’s economy muddles along we believe the best approach is to continue investing in the strongest, best managed, cash generative businesses that stand to benefit as China’s economy transforms. One positive from this point of view is that owing to the macroeconomic pessimism, many of these companies are currently trading on attractive valuations and we will continue to seek to take advantage of this on behalf of investors.
Charlie Awdry is China portfolio manager at Henderson.
Photo: Jonathan Sage is the lead portfolio manager on the funds. MFS Launches Two Equity Income Funds
MFS launches two equity income funds: MFS Meridian Funds U.S. Equity Income and MFS Meridian Funds Global Equity Income.
Both funds seek total return through a combination of current income and capital appreciation. They follow a disciplined, repeatable process that utilises the full capabilities of MFS’ integrated global research platform, which includes fundamental equity and quantitative analysis. This approach is called MFS Blended Research.
The funds are available to investors through the Luxembourg-domiciled MFS Meridian Funds range. Jonathan Sage is the lead portfolio manager on the funds and is a member of the team that has been implementing the Blended Research investment process since 2001.
Thomas Angermann. Courtesy photo. "We Definitely See More Opportunities in European Equities and Particularly in Small and Mid Caps than Three Months Ago"
Thomas Angermann is a member of the Specialist Equities Team at UBS Global AM, based in Zurich. Specifically he is responsible for the management of a number of Pan European small and midcap mandates. In this interview with Funds Society, he explains why the growth potential currently offered by Small Caps is higher than the one that can be found for Large Caps.
Do you think the current momentum is good for European Equities? Has the equity valuation improved after the market correction in August?
After the recent market correction the valuation for European equities looks interesting now. We definitely see more opportunities in European equities and particularly in Small and Mid caps than three months ago. We think the current correction is healthy as the market is pricing out the too high growth expectations.
Which will be the key factors for the revaluation? Which factor will have a greater importance: Profits, QE support or other macro factors?
Three main drivers should be mentioned. First, the potential earnings growth for the next year as well as the current expectations about this growth potential. Second factor, the Chinese economy, it seems we see first signs of stabilization, however we are still waiting for robust evidence on this. The adjustment from the pure investment driven economy of the past to a more balanced consumer driven economy of the future will take years. That will also create a lot of opportunities. The third factor is monetary policy by the central banks. We think they will stay accommodative but we do not count on any additional measures yet.
In general, what are the risks of short/medium tern correction in European stocks markets? In particular for Small Caps?
As before, three main risk drivers should be highlighted. The first risk we face are Emerging market turbulences. Specifically how the Emerging markets growth pattern will behave in the upcoming months and the level of volatility of EM currencies. We should keep an eye on how this will impact European export driven economies. The second driver is the behavior of the European consumer and to what extent it will remain supportive. A third risk factor would be given by central banks. However, as previously mentioned, we do not expect any upcoming change in their policies and it seems a first interest rate hike by the Fed is desired by the markets.
What extra value are Small Caps going to add vs. Large/Midcaps? Can Small Caps offer greater potential opportunities?
First of all the growth potential currently offered by Small Caps are higher than the one that can be found for Large Caps. Additionally Small Caps offer M&A opportunities, as in the current low growth environment larger companies might add growth by buying smaller companies. We expect that the M&A activity will increase, founding its main targets in the Small Caps universe rather than in the Large Cap world. A second factor is the daily volatility. Surprisingly during last months the volatility registered for Small Caps has often been lower than the one for Large Caps. However we will need further evidence of this pattern.
Is the SC sector affected anyway by general elections (such as the Spanish ones)?
Regarding elections, Small Caps sector is as much affected as the Large Caps sector is. We do not expect any remarkable long term impact coming from the Spanish political situation. However there might be short term effects.
Do you think that volatility will increase in the upcoming months? In this sense, which would be the consequences of a volatility increase regarding your investment style?
Since volatility has already been increased since end of last year with additional acceleration during August and September we do not expect further significant increases under current market conditions. However, in the case of a “Black-Swan-Event” (occurrence of something important which was not expected) we will see an further increase. Nevertheless we would not change our investment style and we would stick to our stock picking approach but would have an even closer look at our risk systems.
Photo: KMR Photography. Equity Income: Why Big Is Not Necessarily Best When it Comes to Dividend Yield
The Henderson Horizon Euroland Fund utilises a proprietary analytical screening tool to identify stocks that are being incorrectly priced and offer value in the market. This is a model that fund manager Nick Sheridan has been developing since he first started running money in the late 1980s. The model is based around four key metrics: ‘Dividends; Earnings; Net Asset Value; and Value of Growth’, with the portfolio constructed from those stocks that offer the most overall value. This article looks at the ‘Earnings’ pillar in more detail.
“Higher corporate earnings has been the missing piece of the puzzle for European equities, but this seems to have finally started to come through, with most companies at least in line with estimates during the latest earnings season. Loose monetary policy and quantitative easing (QE) have helped, as has the currency advantage provided by a weaker euro” points out Sheridan.
Furthermore, while the negative effects of falling energy costs are well known, for many companies (and particularly those involved in travel, transportation and retail, plus energy-intensive industries) lower energy costs provide a significant boost to net earnings, freeing up money to spend on expansion and employment. Indirectly, with consumers benefiting from what is effectively a tax cut, companies can also profit from a consequent boost to consumer spending, explain the portfolio manager.
But Sheridan warns that any assessment of earnings should be viewed with an element of caution, and as just one metric to assess the investment potential of a stock. While a company may offer a sustained level of earnings, this may already be reflected in its price, with the risk being that an investor may be forced to pay a premium for the stock.
Companies in the portfolio are likely to be durable, well-established names with experience of trading through varied economic and business conditions. This should help to make the fund’s earnings profile more robust. RELX, Bayer and ASM International are a few examples from the current portfolio.
Brazil has been facing the perfect storm since the re-election of Dilma Rousseff in October 2014 and asset prices in Latin America’s largest country have collapsed. Credit default swaps on Brazil 5-year sovereign debt in US dollar and hard-currency corporate bond spreads widened to as much as 545 bps and 938 bps respectively, as at the end of September 2015, which is higher than during the 2008/09 global financial crisis and the highest since Brazil’s 2002 crisis. The adequate level of foreign exchange reserves – one of the few positives for the country – did not prevent S&P from downgrading Brazil’s sovereign rating to junk last month, which was inevitable given the weak macroeconomic and political environment.
Against this backdrop, many bond investors are looking at Brazilian assets in the same way they opportunistically eyed Russia at the beginning of this year. Russia, which was downgraded to junk by both S&P and Moody’s respectively in January and February of this year, has generated one of the best returns year to date in the emerging market debt universe. Russian hard-currency corporate bond spreads have tightened by more than 30% (or 273bps) year to date despite the ongoing economic sanctions from Western countries, low oil prices and weak Ruble and Russia 5YR CDS has rallied 32% (180bps) year-to-date to 370 bps as at 9th October 2015.
When looking at corporate bonds as per the above graph, Brazil’s recent widening in spreads with a peak after the September sovereign downgrade to junk shows some similarities to what Russia experienced earlier this year in January/February when a number of Russian corporate issuers became fallen angels to speculative grade. While they never recovered their investment grade ratings, Russian corporate bonds then outperformed the rest of emerging markets. Will Brazilian corporate bonds follow the same path in the short term? This is unlikely as Brazil is not Russia.
First, the macro picture is very different. Although both economies have plunged into recession this year, it was the result of external factors for Russia while Brazil is arguably facing more domestic headwinds than external threats. The Russian economy has been hard hit by the international sanctions and low oil prices. For Brazil, political issues (an out-of-favour President and the massive Petrobras corruption scandal) are arguably at least as detrimental to investor sentiment as low commodity prices are to its negative terms of trade.
Second, Russian issuers have shown incredibly resilient credit fundamentals in the current economic environment. The weak Ruble has been helping exporters (oil & gas, metals & mining, chemicals) to improve their competitiveness as their costs are in local currency and their revenues are in US dollars. Facing a virtually closed primary market over the past 12 months, Russian issuers have also shown strong discipline in keeping leverage down and maintaining adequate cash levels in order to meet debt maturities. Finally, the scarcity of bonds has been helpful from a market technicals point of view. In Brazil, this is quite the opposite. Many issuers have significant external debt on their balance sheet and the weakening Real has materially increased debt levels in US dollars and interest expenses for domestic players with no hedging in place. Leverage is on the rise as both debt levels increase and earnings reduce on the back of the recession in Brazil and weak commodity prices. In addition, the “Lava Jato” (Car Wash) corruption scandal is likely to remain an overhang on almost all corporate debt issuers in the country.
In this context, we expect default rates to increase in Brazil. Unlike Russia, which has been broadly a macro call in the first 9 months of this year, credit differentiation in Brazil will be critical and bond returns uneven. There is no doubt that some opportunities for decent returns have emerged among unduly punished bonds, but Brazilian corporate bonds as a whole are unlikely to generate such strong returns in the short term as those seen in Russian credit so far in 2015.
Photo: Michael Kooiman. Hedge Funds Bleeding Slowly versus Market Hemorrhage
The Lyxor Hedge Fund Index was down -1.4% in September. 3 out of 11 Lyxor Indices ended the month in positive territory. The Lyxor CTA Long Term Index (+4.0%), the Lyxor CTA ShortTerm Index (+2.3%), and the Lyxor L/S Equity Market Neutral Index (+0.4%) were the best performers.
In contrast with the sell-off by last fall, the current recovery process is proving more laborious. Continued soft macro releases, several micro turbulences (VW, GLEN, the US Healthcare) and signs that the Fed might be more concerned about global growth, drove markets to re-test the end-of-August lows. L/S Equity Long bias funds and Event Driven funds were yet again the main victims. Conversely, CTAs, Global Macro and L/S Equity funds with lower or variable bias, successfully navigated these challenging times.
“Quantitative easing combined with tighter regulation is growingly questioned. The former is boosting re-leveraging, the latter is trapping liquidity within banks. Both are increasing market risks. With few obvious growth gears in sight, we expect moderate and riskier asset returns.” says Jean-Baptiste Berthon, senior cross asset strategist at Lyxor AM.
Pressure remained on the L/S Equity Long bias funds. They continued to underperform, with broad markets bleeding back to the end-of-August lows. Their drawback accelerated by month-end on the healthcare sector’s debacle. They held their largest allocation in the non-cyclical consumers sectors (which includes healthcare stocks). The H. Clinton’s tweet, tackling drug prices hikes at one specialty-drug company, resulted in a sudden re-assessment of the whole sector’s revenues and M&A prospects. Indeed, these drug pricing anomalies reflect a broader transformation of the healthcare space since 2014. Since then, waves of Biotech and Generic companies’ acquisitions granted Pharma with much greater pricing power. The current correction might be bringing back M&A premiums and fundamental forecasts to a more sustainable profitability regime.
In contrast, Variable bias funds continued to successfully navigate a challenging space, in Europe especially. They finished the month only slightly down. They adequately not re-weighted yet their net exposure. Instead they actively traded around positions.
Market Neutral funds managed to weather the mid-month Fed sector repositioning. They also benefitted from wider quantitative factors differentiation, with Momentum outperforming Value. The short-term backdrop for the strategy remains riskier, less likely to profit from a potential rebound, and threatened by higher rotation risk, in the healthcare sector in particular.
Event Driven funds were again and by far, the main losers. Bargain hunting in the most beaten down securities allowed Event Driven to start the month on the right foot. However the valuation recovery didn’t last, caught up by the post-FOMC uncertainty. The losses accelerated in the last two weeks. In tandem with L/S Equity funds, they got hit by the healthcare meltdown. Strongly allocated through Merger arbitrage and special situation, the sector severely hit the whole Event Driven space. Valleant, Baxter, Allegan, Perrigo were amongst the largest return detractors.
L/S Credit Arbitrage funds’ returns were in line with the global index. The perception of risk remained elevated, factored in widening HY spreads, in the US especially. Lyxor L/S Credit funds remained reasonably conservative. There was volatility in cross credit Fixed-income arbitrage ahead of the Fed FOMC: this sub-strategy slightly underperformed.
CTAs, stars of the month. After being initially hit on their short energy exposures, CTAs then hoarded gains from their long bond exposures. With limited or negative exposures to equities, they dodged most of the market turmoil. They recorded small losses in FX and agricultural.
The sell-off since the end of August combined fundamental and technical drivers. CTAs’ involvement in the debacle was recently debated. Lyxor observes that Long term models cut their equity allocation to a conservative net exposure of 25% before the sell-off. During the sell-off, they further cut their equity exposure to around 5-10%: not a key factor in the selling pressure. During the sell-off, most Short term models further cut their about-zero net exposure down to -25%. The ST models move was more aggressive. But they manage a tiny portion of total CTAs’ AuM (less than 15% of the around $300bn CTAs’ total assets). The firm therefore see little evidence that CTAs were a substantial culprit for the equity sell-off.
By focusing on FX and rates, Global Macro dodged most of the September equity volatility. With limited exposure to commodities and shrinking allocation to equities (from 15 to less than 10% in net exposure), Global Macro dodged most of the September volatility. The bulk of their directional exposure was in the FX space. Their long in USD vs. EUR, GBP and CAD, produced marginally positive returns. Their market timing on rates added gains. They rapidly rotated their bond exposures back to the US, as it became probable that the Fed’s normalization process would be postponed.
