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Prepared for Professional Clients only
2015
conference
round-up
BNY Mellon
investment
conference
2015
conference
round-up
H
eld at the Rosewood Hotel, London, the BNY Mellon
Investment Conference 2015 showcased the investment
expertise of our boutiques from around the world. Our fund
managers presented on a range of investment disciplines
in both main platform and boardroom sessions. We were
joined by exceptional external speakers. Lord Mark MallochBrown, former Chief of Staff of the United Nations, discussed
geopolitical risk and our Election Discussion featured Paddy
Ashdown, Alistair Darling and Lord Daniel Finkelstein, with
questions posed by Newsnight’s Emily Maitlis.
2
BNY Mellon Investment Conference 2015
contents
4
18
INVESTMENT PANEL DEBATE
22
BIG RISK FLASH POINTS FOR
THE REST OF 2015
STRATEGIES FOR A
CHALLENGING INVESTMENT
ENVIRONMENT
Lord Mark Malloch-Brown.
Paul Flood, Newton
EMBRACING UNCERTAINTY
Abdallah Nauphal, Insight
6
8
THE NEED FOR SELECTIVITY IN
EMERGING MARKETS
24
Alexander Kozhemiakin, Standish
Rob Marshall-Lee, Newton
10
HIGHER PAY PACKETS SHOW US
RECOVERY IS REAL
David Daglio, The Boston
Company
12
INVESTING IN DISTORTED
MARKETS
Iain Stewart, Newton
14
CAPTURING A BROAD
OPPORTUNITY SET
Steve Waddington, Insight
16
17
26
SEARCHING FOR YIELD IN
EUROPEAN FIXED INCOME IN AN
ENVIRONMENT OF NEGATIVE
GOVERNMENT YIELDS
ACROSS THE EMD UNIVERSE
Colm McDonagh, Insight
27
PROTECTING PORTFOLIOS FROM
‘RISK-ON’ REVERSAL
James Harries, Newton
28
HIGH YIELD: AN EVOLVING
ASSET CLASS
Paul Hatfield, Alcentra
29
UK INNOVATION ALIVE AND
KICKING
Emma Mogford and Paul
Stephany, Newton
EUROPEAN DISTRESSED DEBT
ATTRACTS RENEWED FOCUS
James Gereghty, Siguler Guff
AN IMPROVING PICTURE FOR
EMERGING MARKET DEBT
30
MORE MONEY, MORE PROBLEMS
Raman Srivastava, Standish
31
ABOUT BNY MELLON
Henning Lenz, Meriten
3
Embracing
uncertainty
T
he need for tailored solutions and greater
certainty of outcomes is the future for
asset management, according to Insight CEO
Abdallah Nauphal.
The re-regulation of banks has
caused collateral damage to the asset
management industry. More onerous
capital requirements on banks have
led to a change in their models and
consequently the type of business
they conduct, notably with respect to
market making. This has led to a dearth
of secondary market liquidity in certain
assets, such as bonds. Nauphal says.
“Regulation adds complexity and cost to
everything we do. Restricted secondary
market activity affects how we trade,
how often and how certain issues fit into
portfolios.”
Abdallah Nauphal
CEO, Insight
4
This is not wholly a negative, he notes,
pointing out the asset management
industry is presented with opportunities
to potentially disintermediate banks with
respect to corporate lending and in other
areas such as trade finance. Nauphal
points out assets under management by
the industry will soon surpass the total
assets under the control of banks, which
in turn may result in even more scrutiny
by regulators.
“Is ‘too big to fail’ an issue in asset
management?” asks Nauphal.
“Regulators are certainly asking the
question. We will need to educate them
that it’s not our capital we invest, it’s our
clients’. We are agents and do not pose
the same systemic risks as a bank acting
as a principal. If we can educate them
now, then we can hopefully influence the
shape of new measures that are likely to
be introduced.”
While noting regulation may be the
first tectonic shift shaking the asset
management industry, Nauphal argues
that perhaps more important still is
the change in investors’ needs. Due to
demographics and ageing populations
in the developed world, there is a shift
underway towards investment
decumulation.
One consequence is that investors want
greater certainty of outcomes, especially
as they bear a growing portion of their
own retirement burden and risk via
defined contribution schemes. “All of this
means there will be increased demand
BNY Mellon Investment Conference 2015
for tailored investments and certainty of
outcomes. Generic products are dying –
the future is about the individual investor,
not the average one,” says Nauphal.
Big data - the proliferation of available
information - is another trend affecting
asset management, although Nauphal
is slightly more sceptical than many
with respect to the way it is changing the
industry. Although he believes data could
affect the way in which groups profile
clients, making it easier to tailor products
better to individual needs, he questions
whether it can enable better investment
decisions. Any information advantage a
manager finds, is unlikely to last long, he
adds.
Central banks and their unprecedented
intervention in markets have removed
information content from prices. “Any
investment model based on the past 30
years of economic/central bank data
will not work going forward. It’s a whole
new paradigm.” Traditional portfolio
construction methodologies, such as the
efficient frontier, do not work. “We cannot
forecast, with any degree of certainty,
likely returns, volatility or correlations
within and between asset classes. As
such, mean variance optimisation may be
an exercise in compounding errors.”
Although some may say this is a natural
part of the risk of investing, Nauphal says
there is a big difference between risk and
uncertainty. Risk can be measured and
explained by probability and statistics, he
explains. On the other hand, uncertainty
refers to non-measurable, unpredictable
outcomes.
Central banks are buying more
government bonds than are being issued
and it is not just a European problem.
If you add in Bank of Japan, US and UK
quantitative easing programmes then
there is a net withdrawal of debt taking
place globally, he says. At the same time,
more than half the world’s sovereign
bond markets are yielding less than 1%.
“This is heavily distorting the market.
Excessive valuations and bubbles are
now the other side of the policy coin.”
As an industry, Nauphal says, we’ve
been pretending to know answers to
questions that are unknowable. “We
react to uncertainty the same way we do
to pain – we avoid and try and pretend it
doesn’t exist.” Nauphal advocates asset
managers need to start introducing the
concept of uncertainty and take account
of it in their investment processes. “At
least recognise uncertainty exists – this
would help us try to re-gain the trust of
investors,” he concludes.
The uncertainty of what all of this means
and its likely impact on investments
should not be overlooked, he says.
5
A
perplexed, inward looking
US has become becalmed
on the international stage by
gridlock between a late secondterm President Obama and a
Republican Party majority in both
the Congress and Senate, says
Lord Mark Malloch-Brown.
Lord Mark Malloch-Brown,
Former deputy secretary general and
chief of staff of the United Nations
The former chief of staff at the UN says the result
of such paralysis is a country that does not know
if it wants to intervene internationally again and
consequently is in danger of dropping off diplomats’
speed dial altogether. This means regional players
are more important today than they have been
in the past. The US is preoccupied with its own
problems so it looks to regions like Asia to be an
inconsistent friend at a time when China is growing
in power, he adds.
Malloch-Brown continues that while all of Obama’s
successors are keen to reboot and promise a more
assertive US, American support for its former
role as global policeman is at an all-time low.
Meanwhile, risks abound on a global scale and have
the potential to filter through to capital markets. So
what are his big five risk flashpoints to watch out
for in the remainder of 2015?
6
BNY Mellon Investment Conference 2015
Big risk flash points
for the rest of 2015
1 A wider conflagration
in the Middle East
Gone are the ‘glory days’ of just trying to
fix the Israel/Palestine issue. Yet again
troops are on the move in the Middle
East with Saudi Arabia’s announced
intervention in Yemen which may prove
a more difficult situation to extricate
themselves from than their last such
action in Bahrain .
At the same time Islamic State (IS)
infects wider Shia-Sunni relations, and
countries from Lebanon and Jordan to
Turkey and Saudi Arabia come under
internal stress as well as crisis in
their international alliances. There is
a re-ordering of state loyalties at play
because of this inter-Muslim conflict.
The intelligence community estimates
at least 1,000 new fighters are being
recruited a month for ISIS from Europe
and beyond. The hope then becomes can
we kill them faster than they can recruit?
That is a terrible political and human
calculus. It also poses further questions
over whether airborne responses alone
without any effort on the ground can
have serious unintended consequences.
2 Unsettled relations in
China’s Asian backyard
Asia too has started to look troubled, as
there have been extreme increases in
military spending in the region. In 2013
most of the world’s spending on defence
went down, while only Russia and Asia
went up. There was a 62% increase in
Asian spending, which stemmed from
China increasing its spending and others
reacting to it. China has increased its
defence spending by some 120% over
the past decade and is set to increase by
12% this year. At the same time slowing
growth and the corruption crackdown
in China give a real sense that there are
choppy waters ahead for its domestic
market.
3 Renewed crisis
in Europe
5 Humbling of
the BRICs
There is the question of how the EU
and eurozone can hold up to different
economic variations in the north and
south of the continent. The Germancentred manufacturing hub of Northern
Europe continues to show strength,
while the Southern half of the continent
is struggling with structural deficits
that are hard to contain with a currency
valued at the same level as Germany’s.
While India and China still have good
growth stories to tell, Brazil and Russia
have fallen way off form. In Brazil
the political movement demanding
President Dilma Rousseff’s resignation
or impeachment is gathering strength.
The core of the move against her is
the scandal around Petrobras and
massive corruption payments that have
surrounded it.
It is hard to believe the Greece scenario
will have a happy ending: Greek
unemployment and living standards are
such that it seems there is little choice
but for Greece to fall out of the euro.
If a Grexit occurs, combined with the
real possibility of a referendum on UK
membership of the EU, there could be a
real knock-on effect with referendums to
follow in other countries.
The falling oil and commodity prices are
in many ways linked to the slowdown in
China and this is helping to create the
perfect storm of political, business and
economic crisis in Brazil. The ‘R’ from
BRICs is not doing much better as oil and
gas makes up 60% of Russia’s exports
and commodities make up the bulk of the
rest.
4 Russian aggression
For the first time in a generation here
in wider Europe one neighbour has
invaded the other: Russia into Ukraine.
The respect for sovereignty and borders
is under threat as Russia destabilises
a neighbour because of the political
direction it was taking. All this against a
backdrop where Russia is rearming and
the rest of Europe is struggling to bring
its military spend back up to even 2% of
GDP, the NATO commitment, because the
level of will and ability is not present.
However, the next acronym outside
of BRIC is MINT (Mexico, Indonesia,
Nigeria and Turkey). Could these be the
next poster boys of emerging markets?
Nigeria depends more on oil exports
than Russia but so far it seems to have
managed to rebalance its economy
somewhat and now earnings from oil is
a much smaller percentage of its GDP. Its
politics, however, are fragile. But then the
same could be said for the other three
members of this grouping.
Yet, however popular Putin is in Russia,
and he is very popular, there is an
emerging middle class in the country
that finds itself barred by his behaviour
from being part of a wider community in
Europe.
7
The need
for selectivity
in emerging
markets
A
rising tide used to lift
all boats in emerging
markets but Newton’s
emerging market growth
manager Rob Marshall-Lee
discusses why he now
believes investors need
to be more selective and
active within these regions.
Rob Marshall-Lee
Emerging market
growth manager
8
BNY Mellon Investment Conference 2015
Recent headwinds in emerging markets
certainly do not mean the regions are
void of value and opportunity, argues
investment leader of Newton’s emerging
market team, Rob Marshall-Lee. While
he admits the slowdown in China and the
volatility of some currencies creates a
challenging backdrop, he remains bullish
on long-term investments prospects.
In fact, he notes, after recent sell-offs
in some countries, valuations look
increasingly attractive right now.
But more important than that, MarshallLee says, is that the fundamental
investment story behind emerging
market equities is still intact. His universe
contains a number of high growth
economies experiencing productivity
growth and featuring the potential
for high earnings growth. Amongst
their attractive characteristics, many
emerging markets countries have
superior demographic profiles, he notes,
adding many also have much less debt
than the developed world and stronger
government finances.
Of particular positive note, given Newton’s
thematic approach, is the population
dynamics of emerging economies,
he comments. Marshall-Lee believes
working age population growth is the
biggest driver to GDP growth and the
former is something prevalent across
emerging markets, although not uniformly
so. Citing the Philippines as a case in
point, Marshall-Lee notes that according
to UN estimates from 2011-2036, the
country’s working age will experience
more than 50% growth. This compares to
estimates for countries like China, Korea
and Thailand where the working age
population growth is forecast to shrink.
Many economies, again like the
Philippines, are also more advanced with
respect to the deleveraging process,
having already completed a similar task
post the 1997 Asian crisis. “Many are now
in quite rude health and while valuations
may reflect that to a degree, if there is a
good decade of growth ahead of you, it
may be worth paying up a bit for it.”
Such is the case for Marshall-Lee with
respect to India, which he favours.
He says valuations have risen on the
back of more buoyant expectations and
as such, there may soon be a technical
correction in Indian equities. However, he
remains sanguine about such a forecast
as he says he is less exposed to the
cyclical companies that have seen rapid
multiple expansion, perhaps ahead of, or
unaccompanied by fundamental earnings
growth. Instead he has a preference for
more staid companies with steadier, but
crucially, compounding earnings. He also
thinks any correction would likely be
short lived. “I believe India will be the best
equity market in the world over the next
five years.”
Still, as recent history has shown,
emerging markets are not without their
risks, he says, pointing out this is a
strong rationale for active management
of emerging market funds. The index,
by its nature, tends to reflect historic
profitability, not future opportunity –
which is where we focus.
Newton’s theme of state intervention
is one to which Marshall-Lee pays
close attention and he points out he
has only 1.5% of his fund in stateowned enterprises. “Some 75% of
the Chinese equity index and 55% of
the Russian equity index by weight is
owned by the government,” he points
out. When questioned as to whether
or not that means large voids in his
sector allocations Marshall-Lee agrees,
but notes he is happy to be under or
even zero-weighted to such industries.
“Sectors with higher state ownership
include the energy sector at 65%, utilities
at 59%, telcos at 42% and financials at
40%; IT, consumer, and healthcare sectors
are relatively free from state ownership.”
More concerned with absolute risks than
relative index ones, Marshall-Lee says
avoiding state-owned companies doesn’t
leave him bereft of ideas in such diverse
markets. “I still think there is a strong
consumer story in emerging markets.”
9
Higher pay packets show
US recovery is real
Sign-up bonuses for truck drivers in Detroit, Michigan, of
between US$10,000 and US$20,000, alongside an increase
in people quitting their jobs, show the trickle-down effect of
the US recovery, according to The Boston Company’s
David A. Daglio, CFA.
Daglio, senior managing director
and lead portfolio manager of the
US Opportunities Fund, notes that
Federal Reserve Chair Janet Yellen pays
close attention to the Employment
Cost Index, or ECI, which tracks wage
growth. According to the most recent
data from the US Labour Department,
compensation costs rose 2.2% over the
12-month period ended December 2014,
but Daglio notes that this reading is not
illustrative of the larger picture. Instead,
he watches the National Federation of
Independent Business’s Small Business
Optimism Index, which surveys the
intentions of smaller businesses in
relation to worker compensation over the
next six months. This metric, says Daglio,
indicates that the ECI could be poised to
rise more than 3% in the coming months.
right candidates and are offering more to
try and attract them,” he explains. “When
we talk to trucking companies, they
say the same thing: Their number one
problem is finding attractive candidates.
Even in lower-skilled jobs, like massmerchandise retail, some of the largest
US employers are raising wages.”
“Why do you think small business owners
are preparing to give wage increases? Is
it because they are philanthropic? No, it
is because they are struggling to find the
Daglio says softer data in the US
Northeast have started to spark worries
that the US economy is nearing its
plateau.
David Daglio
Senior managing
director and lead
portfolio manager
“Employment Cost Index – December 2014,” Bureau of Labor Statistics, U.S. Department of Labor, press release, Jan. 30, 2015.
http://www.bls.gov/news.release/eci.nr0.htm
10
BNY Mellon Investment Conference 2015
But he argues that it is too simplistic to
judge the country by the merits of one
region. Rather, he views the US as four
distinct areas: the Northeast (which he
compares to France or Japan), California
(which could be described as the world’s
fastest-growing economy), the South,
and lastly the manufacturing hub, which
includes states such as Ohio, Michigan
and North Dakota.
“The manufacturing hub is most like an
emerging market; on a productivity basis,
wages are not dissimilar to Eastern
China. Companies had been outsourcing
to Detroit rather than India, and as such,
job numbers had stayed strong. Dollar
strength is now making it a little harder.
“The US dollar has performed well
because people are chasing strength, but
it probably has to revert a little bit now.
I think this will happen as we see some
economic surprises from other regions in
the world, such as Europe.”
this year compared with last year. But
that is what makes certain areas even
more compelling. For example, some
small, regional banks have worked
through the pain and are lending again,
and they look strong.”
The negative impact of a stronger dollar
will mainly affect large caps because
they tend to make a greater proportion
of their earnings overseas, according
to Daglio. They are also the companies
that benefited the most from a weaker
dollar. Meanwhile, smaller companies are
having a good earnings season, he notes.
Daglio also thinks certain companies
in the technology sector are attractive
based on valuations and a previous lack
of tech spending by companies, which has
resulted in pent-up enterprise demand.
Additionally, once wage increases start to
come through, he predicts consumers will
spend more on tech.
“I think there could be weaker earnings
growth now, and we could even see lower
earnings from the S&P 500 as a whole
“In this type of environment, not everybody
wins, but that’s when the case for active
management is most compelling.”
11
Investing in
distorted
markets
T
he consensus wisdom
that the US and UK
economies have recovered
because their central banks
successfully implemented
quantitative easing (QE) early
on in the financial crisis takes
too linear an approach, says
equities leader at Newton,
Iain Stewart.
Iain Stewart
Equities leader
12
BNY Mellon Investment Conference 2015
He says the view the US Federal Reserve “has your back” and the only potential problem on the
horizon is interest rate rises is very naïve.
“Inflation is very important to the theory that QE will lead to an increased confidence in spending
and investment from companies and create a sustainable investment cycle, but there is not
that much evidence of inflation coming through. In fact, we would say the opposite is true and
deflation is a greater concern.”
Without rising inflation we are unlikely to get a normalisation of interest rates, says Stewart,
adding that in January there was mild deflation of -0.1% in the US – the economy which is
supposed to have responded best to loose monetary policy.
“Income is relatively flat and profits have plateaued at the company level, with expectations for
2015 showing the same pattern. Why then does everybody believe we should be buying risk and
selling bonds?”
Central bankers assume in their QE models that money is neutral and affects all parts of the
economy equally. What has actually happened is all the people who got hold of the extra money in
the system –asset owners, financial institutions and the people that work for them – have done
the best out of it, says Stewart.
In an attempt to create general inflation through asset inflation authorities have succeeded in
distorting financial markets and distorting the economies they operate in, all while they have
failed to create sustainable inflation.
The reason for this, notes Stewart, is that QE leads companies and politicians to believe there
is demand in the system, and in stepping up to that demand businesses create an excess of
capacity, which in turn drags prices lower.
Another important aspect of the fiscal and monetary policies implemented since the onset of the
financial crisis is that they have not taken place in a vacuum. These policies do not just impact
the domestic economy they have a huge influence abroad, which has
seen cheap money emanating from the developed economies find
itself in the developing world.
In an attempt to compete with one another, all around the world
there are rate cuts occurring, as economies attempt to devalue their
currencies. This is leading to a deflationary environment, says Stewart.
“The chance we can grow out of this current situation seems unlikely,”
he adds.
Pointing to valuations, Stewart says only twice in the past 100 years
have cyclically adjusted PE ratios surpassed the current readings
– ahead of the Great Depression of the 1930s and the tech bubble
bursting in 1999/2000. Two of the worst times in history to invest.
When the corrections come they tend to be very rapid, he adds.
These structural issues will continue to create volatility and in this
environment the Newton Real Return team wants to find potential havens,
which can continue to demonstrate growth in a low-growth world.
“
Income is relatively
flat and profits have
plateaued at the
company level, with
expectations for 2015
showing the same
pattern. Why then does
everybody believe we
should be buying risk
and selling bonds?
He is finding these kinds of opportunities in healthcare and IT areas in equity markets, while
some developed market sovereign bonds and exposure to infrastructure also feature in his
portfolios.
”
“We are pretty defensively positioned relative to where we have been in the past but we feel it
is prudent to remain that way in the current environment where further state interventions and
underlying capital market illiquidity create potential for significant volatility,” he says.
13
Capturing a broad
opportunity set
G
eopolitical risks may be front and centre in many
minds at the moment but there have always been
events occurring somewhere in the world and that is
unlikely to change. This is why multi-asset portfolios
should put risk management at the centre of their
construction, according to Steve Waddington, fund
manager in the multi-asset strategy group at Insight
Investment.
As lead manager of the Insight Global
Absolute Return and Global MultiStrategy portfolios, Waddington and the
team of portfolio managers look across
and within asset classes and capture
opportunities within four broad global
groupings: fixed income, equities, real
assets and total return strategies, with
the freedom to invest across them all.
Waddington says dynamic management
of the first three components is
important as these directional exposures
rely on markets being positive to
generate a return for clients. This is also
where the final aspect of their strategy,
total return strategies, comes into play
as it aims to capitalise on the divergence
in performance between various assets.
He notes this is particularly helpful when
assets are falling overall or trading within
ranges.
He explains there are a number of ways
to achieve such an aim, notably through
the use of range-bound or break-out
strategies.
“If we think an asset is going to continue
to trade within a range then we will try
to capture a positive return from that.
Similarly if an asset has been trading
within a range for some time and we
think there is a factor likely to prompt it
to break out of that range – be it to the
upside or downside – we can implement
a trade that looks to take advantage of
that,” he says.
These total return strategies can be
implemented across all the asset classes
Steve Waddington
Fund manager,
multi-asset strategy group
14
through the use of futures and options. To
help manage risk and deliver a smoother
return profile the team typically holds
between 40-60 positions and aim to
make incremental positive returns from
each of them.
The team constantly monitors their
portfolio positions and makes use of
profit targets and loss limits before
investing, a discipline essential in
managing such strategies.
“If a position goes through our profit
target we will potentially keep running
the trade and raise the target but we
will take profits along the way. If it goes
below our tolerance for loss, however,
maintaining the discipline of a rigorous
process is essential to avoid ‘falling in
love’ with positions that are hurting a
portfolio.” Waddington adds.
The total return strategies are typically
based on a three- to six-month
investment view although they can be
extended beyond that period.
A recent example was a short euro/long
US dollar trade the team had in place for
the second half of last year. “We saw the
economic data coming through showing
positive improvements within the US.
Now we could say the same for Europe
but at the start of last year the regions
were diverging quite markedly. Our view
was that the European Central Bank
BNY Mellon Investment Conference 2015
needed to stave off deflation and while
it could not explicitly say ‘we want to
weaken our currency’ we thought it was
on the cards.
“The euro/US dollar had been trading
within a range and we felt the euro
would weaken, falling to 1.30 to the
dollar but it went far lower. This meant
we went through our profit target and
subsequently reset the trade four times
to capture more of a return, taking profits
all the way. That position was closed in
February 2015 but could be added again
as we think it could move lower yet until
the euro is trading at parity to the US
dollar.”
This outlook has been executed
differently in the equity markets where
Waddington and the team felt the
outperformance of US equities over
European equities (ex-UK) had become
excessive.
Eurostoxx 50 is up by 19%, while the
S&P 500 is roughly flat.
“Now, we think the flow into European
equities has been quite extreme, so
we have removed the position from
portfolios at the moment, although we
could readily re-instigate a position to
capture this longer-term trend.”
In terms of outlook, Waddington believes
monetary conditions will generally
be easy and therefore supportive for
equities, although he tempers that by
adding the sub-par economic recovery,
being held back by deleveraging, will lead
to shallower and shorter business cycles,
so economies are likely to flirt with
recession far more frequently.
“Global growth will likely be positive
but divergent; we are flexible enough
to be able to take advantage of such a
scenario,” he concludes.
“During the seven years from December
2007 to December 2014 the US equity
market had outperformed Europe by
80%,” he noted, “We felt the potential
growth increase from a low base in
Europe was supportive for European
equities to reverse this move. To capture
this we had a position where we bought
the Eurostoxx 50 index and sold the S&P
500. There has been quite a marked
move and since the start of the year the
15
European distressed debt
attracts renewed focus
T
he European distressed debt market
looks set for a significant increase in
activity this year as banks seek to dispose
of a wide range of non-performing assets
across the region, according to Siguler
Guff Managing Director James Gereghty.
Outside Europe, Gereghty sees strong
distressed debt opportunities in the
global shipping sector, with oversupply
of shipping volumes driving operating
rates and asset prices to cyclical lows,
but creating attractive niche investment
opportunities to capitalise on existing
demand and eventual market recovery.
James Gereghty
Managing director
Commenting on the global outlook for
distressed debt investment, Gereghty,
who also acts as the Portfolio Manager
for the firm’s series of distressed
opportunities funds, says current
moderate to low levels of distressed
debt activity in the US are contributing
to a continued shifting of focus towards
growing investment potential in Europe.
Pointing to a range of factors driving
opportunity, Gereghty highlights growing
economic challenges within the eurozone
area and the impact of regulatory
initiatives such as Basel III and Solvency
II. With European banks making good
progress in repairing their post financial
crisis balance sheets, he adds many
are now in a strong position to sell large
tranches of their non-performing assets.
Commenting, he says: “In the distressed
debt market the opportunities today
lie primarily in Europe and we believe
European distressed debt will be
one of the largest global investment
opportunities in absolute dollar size.
“Last year we saw record transactions
in non-performing loans and nonperforming assets and we think this year
will be even bigger for this sector. This
16
presents a potentially huge opportunity
for investors. Ongoing regulatory changes
in the region add deleveraging pressure
and will increase European banks’
motivation to sell their non-performing
loans.”
Commenting on risks, opportunities
and common misunderstanding
surrounding the distressed debt sector,
Gereghty explains: “A lot of people share
some common misassumptions about
distressed debt and regard it as a very
high risk investment strategy. We actually
think the opposite is the case. As an
investment manager, we become involved
in investments at the deleveraging stage
and are getting involved with companies
after their problems have already
occurred. We play an important role in
rehabilitating them and bringing them
back to robust financial health.”
“The market is, however, highly cyclical.
Different asset classes will operate at
different points at different cycles and no
two investments are ever the same. It is
therefore incumbent on us to identify the
risks inherent inside any potential deal/
opportunity and then structure a solution
that is customised to that opportunity
whilst minimising risk,” he adds.
According to Gereghty, sustained
negative energy costs following the
recent global oil price slump could also
create new distressed debt opportunities
in the booming US shale oil and gas
sector, should sectoral debt defaults rise.
Commenting on the “tremendous amount
of senior secured paper” currently being
issued in the US, he adds that recent
increases in leverage in the domestic
corporate debt market could, in turn,
signal the first signs of some medium to
long-term problems for the sector but
could also create fresh opportunities for
distressed debt investors.”
“
“Last year we saw
record transactions in
non-performing loans
and non-performing
assets and we think this
year will be even bigger
for this sector.”
”
BNY Mellon Investment Conference 2015
Searching for yield in
European fixed income
T
here are a number of market preoccupations
including whether Europe is going to be mired in
Japanese-style deflation, says Henning Lenz, head of
corporate credit at Meriten Investment Management,
also posing the question whether trading liquidity is
the ‘elephant in the room.’ In a jocular aside, negative
yield bonds constitute Europe’s fastest growing asset
class, he observes.
Among positive factors, “growth is
back”, with the outlook for global growth
remaining satisfactory, comments Lenz.
Within Europe, Purchasing Manager
Indices have shown signs of stabilisation
and Germany has resumed its role
as the engine of growth. However,
macroeconomic recovery in Europe
remains fragile and dependent on
accommodative monetary policy.
The European Central Bank (ECB) has
started an unprecedented programme
of €1.1 trillion private and public debt
purchases, offsetting the ‘tapering’ of
the US Federal Reserve. The effect of
this quantitative easing (QE) could be
substantial in Europe, with the ECB set
to buy more than the growth in fixed
income, in contrast to the pattern in the
US when the Fed engaged in QE, notes
Lenz.
The ECB’s expansion of its balance sheet
will result in a portfolio rebalancing by
private investors towards credit, with the
‘crowding out’ possibly unprecedented
in character. This portfolio rebalancing
is likely to have a significantly positive
impact on credit spreads, pushing them
down. In Lenz’s view, there is still room
for spreads to tighten further.
The challenge is to earn adequate levels
of yield, although this has to be weighed
against the risks taken, says Lenz.
Taking on more risk requires a better
understanding of what is being bought.
Moreover, markets are proving illiquid
and this illiquidity makes it more difficult
to trade. Risk factors increase and
become more idiosyncratic in nature.
A focus on sound credit selection
underpinned by credit analysis helps
to tolerate volatility when it occurs,
opines Lenz. And different risk factors
can be managed according to particular
client needs, i.e. combining duration
management with credit management.
“
“The ECB’s expansion
of its balance sheet will
result in a portfolio
rebalancing by private
investors towards
credit, with the
‘crowding out’ possibly
unprecedented.”
”
Henning Lenz
Head of corporate credit
17
Investment
panel debate
Dave Daglio
The Boston Company
DD
James Harries
Newton
JH
Q
How would you describe your
current market sentiment –
bullish, neutral, or bearish?
SW I’m cautious, but there are areas for optimism. The
areas we want to be staying away from are commodities, where
we have zero exposure, and aspects of the fixed income market
such as high yield, where we also have no long holdings. On the
other hand, Europe, which was has been suffering from very
slow growth, is starting to see the benefits of some structural
reforms coming through, while the US market seems to have
reached a growth plateau at the moment.
DD
In the short term, I am neutral as the market is trying to
digest if rates will move up in the US and what will happen if and
when they do. However, in the long term, I do not see signs of a
market top - this is the most attractive time I have seen to buy
stocks since I started doing this for a living – valuation spreads
are some of the widest I have seen in my career.
Steve Waddington
Insight
SW
Andy Cawker
Insight
AC
AC Over the long-run it is difficult to be clearly bullish.
Anything beyond 12 to 18 months depends on what happens
after the normalisation of interest rates and whether the
negative impact that has had on equity valuations is offset
by profit growth. Looking at technological advancements and
ageing demographics in many western economies it is difficult
to see how growth can pick up substantially. On saying that,
equities are the only clean shirt in the dirty laundry basket of
capital markets. Companies are being given a free chance to
refinance cheaply by the bond market. But markets are not
driven by valuations right now, there is more at play and an
excess of capital in the system. Consequently we are finding
more short opportunities at the moment than we have been for
some time.
JH I’m bullish on the bond market, cautious on the equity
market and bullish on gold. Asset prices should be reflective
of investment productivity rather than leading the economy
as has been happening under QE. Ultimately we think QE
will be deflationary because it is sending the wrong signal to
economies to build capacity which will ultimately not be needed
owing to QE inspired over-optimism. Most of this is likely to have
been built in China.
f you had to go long or short oil at US$60 a barrel,
QIwhat
would you do?
JH Oil is very instructive in terms of how QE works. The
shale industry in the US has been largely debt financed. Cheap
money has allowed it to happen and a lot of supply has been
created. We do not need it all and so this has been deflationary.
A lot has been said on the supply side of the oil slowdown
but we think it is about demand too because all commodities
are falling in step. We think oil will recover more quickly than
other commodities but most producers at the moment are not
incentivised to reduce production. So I would short.
SW I would agree the demand side is also impacting oil
at the moment. Saudi Arabia wants to make sure it maintains
market share so it is not likely to slow production any time soon.
We’re negative on oil at the moment, but we need to think not
18
only of the current underlying supply and demand but also what
could change that. It is because of this that we would never put
a one-way bet on in such a manner.
DD Shale was a great idea and, like all great ideas, return on
capital was high in the beginning. Then capital markets flooded
open and everyone wanted to look there. That was part of QE. We
have been following the shale space for 10 years, but now the
specialist infrastructure has been built. There is an enormous
glut of energy services assets if shale-oil growth slows, which
we think it will. Some of these businesses need to be closed,
yet demand is coming back. The media has it wrong and has
simplified the story.
BNY Mellon Investment Conference 2015
Q
How does macro outlook impact
your investment process?
SW We are in a very challenging but interesting environment.
We are coming out of six years of tremendous support from
central banks and governments and we are starting to see the
beginning of a real divergence in policies. Some are starting to
test the water and the strength of their respective economies
to see if it really is there and if so how they can remove their
support. Others are increasingly propping up their economies.
With this divergence of policy there will be dislocations
within asset classes and it is our job, from this, to try and find
investment opportunities.
DD As a bottom-up, fundamental investor, it is important
to understand the macro and how it is distorting the
microeconomics of companies and sectors as well as markets.
Right now, I am focused on the slowing of the paradox of thrift,
which is the notion that saving rather than spending can worsen
a recession. This may have previously been the case, but now
companies are starting to increase capex, so we believe the
paradox is reversing.
AC When I started managing money 25 years ago you sat
down with reporting accounts and worked through the balance
sheets of a company and that is how you picked stocks. Now
you not only know who the governors of the central banks are,
you also know their timetables. We are spending a lot more time
focusing on monetary policy. As a manager of long/short as
well as directional strategies I can try to hedge some of those
risks out. The world is considerably different now, but it won’t
always be like this. It will change again as ultimately stock
fundamentals will re-assert themselves.
JH We use themes rather than macro per se as a
framework for our ideas and to cut down the opportunity set.
Currently there are two asset classes telling us different things
– bonds telling us the recovery is an illusion and equities telling
us it is real. We believe ultimately the bond market is likely to
be correct and it is suggesting caution which is reflected in our
portfolios.
DD I agree, fixed income markets in the past have predicted
where markets are likely to go, but now they are factoring in the
exogenous force of central banks and this could be distorting
signals.
ow has the implementation of quantitative easing (QE) in its
Q Hvarious
guises and its potential withdrawal affected your portfolios?
Is it pricing active managers out of the market?
DD In almost every meeting, I get a question about active
management. Clearly there is an element of big exogenous
impacts and the distortion of real rates by authorities. Now
people are starting to ask what the world looks like as QE in
the US ends. We can debate when the day, week or month of
interest-rate rises will come, but the truth is nobody knows. In
the US, it looks like many indicators that have been slow are
accelerating. Household formation, capital spending and wage
inflation are taking off. Can we grow with higher real rates? That
is the issue for the market right now, and there is no agreement
on it.
JH I am sceptical. I am not convinced QE is raising the
price of bonds – in the absence of QE I’m not sure bond yields
would not have been lower still. The bond market is showing the
artificial and policy driven nature of the boom. In my experience
the bond market gets there first and gets it right but nobody
wants to believe it.
SW It is a question of what alternative there was to stave off
depression and what the long-term implications of quantitative
easing are. I think QE will ultimately be inflationary, but how long
will that take to come? We are not sure. In terms of what it aimed
to do at the time – stave off depression - it has worked.
19
Investment panel debate continued
Q
What do you see as the greatest
risk to markets and also your
portfolio?
SW A reversal of the divergence between central bank
policies and economies we have been seeing. There is a lot
riding on growth in the US and the support from authorities
being withdrawn. If that support is removed and the economy
cannot hold up alone it could be very challenging for investment
markets. Europe and Japan are on the opposite side of the
spectrum [from the US], and are increasingly supporting their
economies. We are using this divergence to capture a lot of
opportunities in total return strategies within our portfolios by
placing range-bound and break-out trades depending on our
view of an index or asset class.
AC The greatest risk to markets today is the withdrawal of
QE and its impact on growth and liquidity. It is something that
has never been done before on such a vast scale and there are
a lot of plates which have to be kept spinning. So the biggest
risk is one of policy error such as a premature interest rate
hike. When the world is growing at 7% small changes do not
matter, when it is growing at less than 3% they do. In terms
of the biggest risk to our positioning I would say a softening
in consumer sentiment. We are quite close to the consumer
in Europe and the UK, so a slowdown in consumer spending I
would see as a risk.
JH A lack of liquidity is the biggest risk to markets.
Underlying liquidity in and of itself does not matter unless you
want to change your portfolio. I suspect because many investors
have migrated into areas not typical for them, coming back to
their more traditional investment comfort zone is going to be
difficult and could create a squeeze.
DD I agree with James’ last point a lot – rebalancing is tough
for markets. Within this we look at companies that have very
high return on equity (ROEs) and we question whether they are
sustainable. Many of these can be described as ‘bond proxies’.
I think we are 30 years into a trade and it is incredibly crowded.
In the US, if you look at the value of dividend payers versus nondividend payers, we are seeing a lot of opportunities in stocks
that do not pay dividends. I pinch myself because it is surprising
that we can be five years into a bull market and still finding a lot
of great value, but it is the case.
JH As someone who is bullish on bonds I am very happy to
hold equities with bond-like characteristics.
Q How will US equities perform in the event of a continued strong dollar?
SW We do not try and forecast what level the market will
get to. Overall we are supportive of equities but if earnings do
not come through that will create downward pressure. It is
a question of whether we are seeing a genuine recovery and
the progression of that recovery, and some early indications
of wages ticking up could start to impact profit margins. But
overall we are less concerned about how much further the
market rally can go because of our broad opportunity set and
total return focus.
20
DD I get lots of questions about valuations, and the reason
the US is doing so well is because the biggest part of our equity
markets are growing – biotech is exploding and tech is doing
really well. Investors are focused on anything that looks like a
bond at the moment because it is paying a yield; we think that’s
where valuations are stretched.
JH As we are bullish on bonds we are bullish on those
equities that look like a bond, or bond proxies which means
one should be happy to hold these investments up to a higher
valuation than would otherwise be the case.
BNY Mellon Investment Conference 2015
Q
What is an obvious short for your
right now?
SW Commodities. The supply and demand dynamics are
both causes for concern.
JH I do not want to invest in most assets related to China. It
is over-invested and the weakest link in that region of the world
is emerging market debt (EMD). Investing in EMD right now you
are taking on liquidity, currency, capital and spread risks.
DD When there is universal consensus about one asset
class or sector and that is accompanied by large asset flows, I
would be wary. There has been an enormous amount of money
invested in high-yield emerging-market bonds, and that is an
area of concern.
Q What do you find the most attractive right now in your universe?
AC TOWIE – the only way is equities, and if you add an extra
E, European equities. From a bottom-up valuation perspective
it is the most attractive market on a 12 to 18 month basis. The
companies we meet in Europe are finally starting to feel the
benefits of banks’ lending again; added to that you are also
seeing the knock-on effect from the devaluation of the euro.
Also for us there are a lot of ‘investment grade’ equities that are
paying dividends providing a better level of income and capital
protection than a lot of bonds.
JH I agree with Andy but I would have my European
equity exposure denominated in US dollars. Further down
the line emerging market equities will provide some fabulous
opportunities. This will be when there are forced sellers, leaving
a lot of world-class companies on low valuations and in cheap
currencies; that will be the time to re-engage with that region.
DD It is obvious to me where to put capital: If the entire
world is afraid to invest in growth, then I would look for
companies that can provide it. So, right now, I see value in US
technology companies where valuations are at 50-year lows but
the innovation you see is incredible and the growth opportunity
is as well.
21
Strategies for I
a challenging
investment
environment
n a challenging investment
environment and with
the added complication
of ‘baby boomers’ coming
up to retirement, there is a
case for arguing for active
and flexible approaches, an
emphasis on diversification
and strategies that aim to
provide an asymmetry of
returns, says Paul Flood,
portfolio manager. The
prevailing environment is one
of lower returns (a race to the
bottom) and more volatility
in marked contrast with
1982 (Fed funds rate of 12%)
compared with 0.25% now.
Paul Flood
Portfolio manager
22
BNY Mellon Investment Conference 2015
An illustration of the predominant
‘financial repression’ is the way the
declining yield on a 60/40 portfolio
(the 60% equities/40% bond split of a
balanced portfolio) is forcing investors
to accept more risk, notes Flood.
A sign of significant risk taking is the
enthusiastic response of investors
to the debut US$1 billion dollar debt
sale of Ethiopia, a country with one of
the lowest per capita incomes in the
world. Illustrating the potential liquidity
problems that may arise amid sell-offs,
Flood evokes the image of investors
exiting an investment at the same time,
likening it to what happens when there
is only one place to cross the river, such
as when wildebeest are migrating to new
pastures. This is when volatility can be
used to the investor’s advantage as asset
classes get sold off in unison providing an
opportunity to purchase quality assets at
distressed prices.
Chasing yield can prove dangerous, as
underscored by comparing forecast
and realised dividend yields, says Flood.
By way of example, Transocean, one
of the world’s largest offshore drilling
contractors, cut its dividend by 80%
as the plunge in oil prices prompted
companies to reduce their exploration
activity to conserve cash.
A number of events, such as the Swiss
National Bank ending its peg to the euro
or OPEC cutting oil production, bring
home the challenge of navigating the
investment environment.
Multi-asset investing – core to Newton’s
investment philosophy and process –
can be a way of seeking to avoid such
pitfalls, especially by investing on a
global basis and enjoying the flexibility to
invest across the capital structure, says
Flood. Focusing on Newton’s investment
themes that highlight the key forces of
change in the global economy also lends
perspective. Diversification is about
ensuring that the investor does not have
all the eggs in one basket but, for Flood, it
means choosing the right baskets at the
right time and not having an egg in every
basket.
When looking to generate an income
for investors, Flood thinks more about
providing a sustainable income rather
than about benchmark weights. He
says the primary objective is to find
companies with sustainable business
models that can pay and grow their
dividends over the longer term,
irrespective of the economic backdrop.
Doing this in a single holistic portfolio
provides a good understanding of
the overall portfolio risk and ensures
there are no unintended or secondary
risks. An example of this would be the
oil & gas industry, which makes up a
significant proportion of benchmarks
in equities and bonds. Flood also points
out that it is important to consider
secondary exposures, such as emerging
market bonds, for instance, where
many countries are reliant on oil & gas
revenues. The sell-off in 2014 of emerging
markets debt involved the most liquid
instruments but it was indiscriminate
and included some of the good credits.
This presented a buying opportunity,
where Flood could be specific about the
emerging market countries to which he
wanted exposure, something that is more
difficult with a fund-of-funds approach.
Investing across the capital structure is
also important for Flood and can involve,
for instance, opting for preference
shares and/or convertible bonds, which
respectively offer potential for some
equity upside, while providing better
downside protection.
Among alternatives, infrastructure
can hold up relatively well when equity
markets fall as the asset class is
uncorrelated to economic cycle and
governments typically stand behind PFI/
PPP infrastructure projects. In contrast,
construction offers low margins and
tends to be highly volatile.
For Flood, the asymmetry of returns aims
to generate both growing income and
attractive total returns. This requires
full flexibility across asset classes
and the ability to harness the power
of compounding. Having full flexibility
allows Flood to determine the asset
class able to achieve the best income
opportunities and where to find capital
growth as the income objective is
purposely set at the fund level and not
at the individual security level.
For investors close to retirement and
further into that stage of life, there is a
requirement to generate a sustainable
income without depleting capital. An
important element is benefiting from
diversification by understanding what
is owned and why it is owned.
23
I
ncreasingly competitive currency
markets and an ongoing US recovery
look set to drive an improving picture
for investors in emerging market local
currency debt, according to Standish
head of emerging market debt
Alexander Kozhemiakin.
Alexander Kozhemiakin, CFA
Head of emerging market debt
24
BNY Mellon Investment Conference 2015
An
improving
picture for
emerging
market
debt
The emerging market debt (EMD) sector
has disappointed many investors over
the last 18 months, with significant
outflows from EMD in 2013 and early
2014, mainly driven by retail investors.
But Kozhemiakin believes the potential
for downside currency risk has
diminished while the yield pick-up in
emerging market local currency debt
remains attractive to global investors
seeking to diversify and hunt for new
sources of yield.
He added many of the factors which have
driven recent volatility in the EMD sector
such as growth disappointment relative to high
expectations have now been priced into the market
and that the ongoing US recovery should eventually help
lift the emerging markets, especially considering their now
much more competitive currencies.
Commenting on the sector, Kozhemiakin acknowledged the recent slump in oil prices had
taken markets by surprise, adding the strength of the US dollar was unhelpful to US dollarbased EMD local currency investors.
“The past couple of years have not been very kind to emerging markets in terms of growth
and the sector has disappointed investors. But for all the negative factors which have
impacted emerging markets during that period, it is getting difficult to be continually
surprised by market events and a lot of the bad news is now priced into the market,” he said.
According to Kozhemiakin a growing number of European
investors are starting to allocate fresh money to the EMD local
currency sector, buoyed by the combination of the impact of
European Quantitative Easing (QE), recent positive returns in euro
terms and the reduced volatility of EM local currency debt from
the perspective of euro-based investors.
Commenting, he said: “By depressing yields in Europe, QE is
helping to make the asset class more attractive in relative terms.
Since the second half of 2014, institutional European inflows to
the sector have started to recover.”
Kozhemiakin said he believed yield will be the biggest return
driver in 2015 for emerging markets. While he is concerned about
the current strength of the US dollar, he is also optimistic any
forthcoming interest rates rise from the US Federal Reserve (Fed)
will encourage fresh inflows to EMD local currency debt, as one of
the key sources of uncertainty is removed.
“
The past couple of
years have not been
very kind to emerging
markets in terms of
growth and the sector
has disappointed
investors.
”
25
Across the EMD
Universe
T
he emerging market corporate debt universe is an
under-utilised resource for yield-hungry investors,
according to Colm McDonagh, head of emerging market
debt at Insight.
Commenting, McDonagh said this is
especially the case in a world where 52%
of all government bonds yield less than
1%. “The low yield environment causes
problems,” he explained. “It creates a real
challenge for investors.”
McDonagh noted how the relatively low
take-up of emerging market debt (EMD)
is in spite of average yields of around
5% for emerging market credit, at both
the corporate and sovereign level - and
said investors’ perceptions may have
been coloured by the recent disparity
of returns across the EM universe. This
is apparent in the negative returns for
Brazilian and Venezuelan US dollar
sovereign debt, for example, which have
experienced significant headwinds;
while those for countries as diverse as
Indonesia, Mexico and Ecuador had
been positive. The same divergence is
apparent in US dollar-denominated
corporate debt where companies from
Russia, Brazil and the Ukraine have
suffered, while those in countries such
as China and the UAE all offered positive
returns.
Partly this divergence is a product of
weaker oil pricing, which has had a
disproportionate effect on countries and
companies in emerging market countries
that are dependent on oil revenues. It
has also been exacerbated by the rise of
the US dollar, particularly for companies
whose debt is denominated in dollars.
But for McDonagh, far from being a
shortcoming, any recent headwinds only
serve to underline the variety available
in emerging market debt and the need to
adopt a discerning approach to investing.
“There’s debt stock outstanding of
just over US$14 trillion and it’s not
homogenous,” he said. “There is ratings
dispersion and investors do need to be
aware of quality.”
One effect of the low yield environment
has been a tendency for even relatively
weak companies to be able to issue debt.
This, said McDonagh, has increased risk
for undiscerning investors. “Financial
repression has come back to hurt
people,” he said. “When we see countries
such as Montenegro issuing bonds at 4%
it does makes us question the market a
little bit and whether people are making
the right choices.”
Looking forward, McDonagh was bullish
on the prospects for future growth in the
global economy, noting an improvement
in the macroeconomic backdrop. Lower
inflation, partly the result of falling
food and fuel prices, has created an
environment where Central Banks
can loosen policy rates and even allow
currency devaluation without significant
fears of an inflation pass-through effect.
“Weakening currencies and fiscal
loosening should have a positive macro
Colm McDonagh
Head of emerging market debt
26
effect going forward but there is a time
lag,” commented McDonagh. “It should be
supportive.”
McDonagh noted that countries aiming
to stimulate growth initially attempt
to adopt three policy choices: cutting
interest rates, increasing fiscal stimulus,
and weakening their currency. The
second of these choices presents a
significant challenge for emerging
market countries, which tend instead to
“
“In Europe, for example, we
can already see the countries
that engaged in the most
painful structural reform
are now experiencing the
highest levels of growth.”
”
focus on interest rate cuts and efforts to
devalue their currencies. On the latter,
McDonagh noted: “We believe there is
still some way to go. But we also believe
markets will overshoot as currency
devaluation is increasingly adopted as a
policy tool. There are many moving parts
and this to us provides opportunity.”
A fourth crucial step is structural reform
- and this is one area in which the fund
looks to discover hidden value. All the
BRIC nations, particularly Brazil and
China, have faced challenges in this
sphere, said McDonagh, but, despite
the apparent long-term benefits of
grappling with reform, few countries have
done so meaningfully with the possible
exception of Mexico, Indonesia, India and
belatedly Brazil and China. “But there
is clear evidence of reform working,”
he concluded. “In Europe, for example,
we can already see the countries that
engaged in the most painful structural
reform are now experiencing the highest
levels of growth.”
BNY Mellon Investment Conference 2015
Protecting portfolios
from ‘risk-on’ reversal
I
nvesting in companies that remain
good value at a time when markets
are elevated should help to insulate
portfolios from a ‘great migration’ down
the risk curve, says Newton’s Global
Income manager, James Harries.
In the hunt for yield that has ensued
since the financial crisis, investors
have gradually taken on more risk as
traditional income-producing assets
have either seen a fall in yields or
become increasingly expensive.
Harries worries that a reversal of ‘riskon’ positioning, may be approaching
which could be caused by a number of
factors including investors trying to take
money out of emerging market debt
(EMD).
“European banks in some cases have
exposure to emerging market debt
whereas exposure in the US is more
limited. In the past the Federal Reserve
felt it needed to act to offset problems
in emerging markets but it might not
be minded to act again. In such an
environment a cautious approach
and limited exposure to peripheral
currencies is sensible along with a
material exposure to the US dollar.”
With this backdrop, Harries says the US
economy continues to look good and
over the longer term the US dollar is
likely to get stronger, which could make
it difficult for non-US debtors that have
issued a lot of dollar-denominated
bonds to service their debt. He also
points out the recovery of the US does
not guarantee other economies still
taking part in quantitative easing will
succeed in the same way.
In such an environment Newton’s
‘state intervention’ theme remains of
paramount importance, he says, noting
more than 40 central banks have cut
rates so far in 2015. This has led him
and his team to believe the onset of a
long-lasting deflationary environment
in developed economies has become
of greater concern than an inflationary
one.
“We fear that QE encourages the
misallocation of capital by triggering a
supply response from economies which
is seeking to service a level of demand
that itself is stimulated by QE and
therefore is artificial. This links in with
another of our themes ‘financialisation’,
which postulates that the financial
economy is driving the real economy in
a way it should not. This is an inevitable
function of low interest rates.
“Taking higher risk while economies are
healthy and valuations are attractive
is sensible, but at some point when
volatility increases and things start to
feel uncomfortable investors want to
migrate back down the risk spectrum
and that is when liquidity will become
an issue,” he adds.
Attractively valued, cash generative
stocks with a strong dividend discipline
suggesting sound capital allocation
are likely to perform reasonably well
in such a likelihood, and while some
commentators would argue valuations
have started to look inflated, he
believes there are still opportunities to
be unearthed.
James Harries
Global Income manager
27
High yield:
an evolving asset class
H
2007 to around US$2 trillion with 1,747
issuers in 2014.
“In the UK and the eurozone, corporate
fundamentals are in reasonably
decent shape,” he said. “Leverage is
not out of control by any stretch of the
imagination. In the eurozone, interest
rates are going nowhere while US
rises are going to be slow and gentle.”
Together, said Hatfield, this makes for
an attractive entry point into credit
markets.
One other major change has been
the rise of non-US high-yield. Where
pre-financial crisis, the US accounted
for some 75% of the market, by the
end of 2014 that figure was down to
55%. Europe has made up some of the
difference, rising from 9.6% in 2007
to around 21.4% of the market with
US$350bn high yield debt outstanding.
It is, says Hatfield, a well-established
market, albeit with less liquidity than
the larger US universe and therefore
somewhat less accessible to smaller
investors.
istorically low default rates, attractive
yields and improving economic
fundamentals are creating a favourable
environment for investors with appetite for
exposure to sub-investment grade credit,
according to Alcentra global chief investment
officer, Paul Hatfield.
In the US the recent sell-off of energy
instruments has made overall pricing
look attractive. “Improving economic
data here too will help high yield
issuers,” he said. By way of contrast,
Europe is already seeing valuations that
are “pretty high”, he added.
On the question of defaults, Hatfield
remains upbeat. “There is no way,” he
said, “that even the most pessimistic
person at the ratings agencies is lying
awake at night worrying about defaults.”
Partly this is due to what Hatfield
described as the boutique’s focus on
“much steadier, lower volume asset
classes”. On this approach, he explained:
“We’re not going to shoot the lights out
with 30% returns, but by the same token
you won’t lose your shirt with a 30%
loss. We’re buying the debt of cashgenerative widget-makers. Essentially,
our funds are boring.”
But how has high yield developed
since the financial crisis? Over the
past five years, according to Hatfield,
the universe has evolved significantly,
more than doubling in size from a
US$840bn market with 998 issuers in
Paul Hatfield
Global chief investment officer
28
Quality has increased too, partly as a
result of the wider economic recovery.
BB-rated credit now accounts for 52.4%
of the universe, against 39.4% five years
ago. Likewise, CCCs now account for
only 12.4% of the universe compared
with 18.6% in 2009.
Sterling issuance has also risen,
doubling from just over 3% in 2007 to
just over 6% now. Observed Hatfield:
“The UK is a creditor friendly jurisdiction
- it’s designed to help investors get their
money back. We would have liked to
have seen more.”
BNY Mellon Investment Conference 2015
UK innovation
alive and kicking
H
ealthcare and technology are set to be two
of the most exciting sectors in the UK market
over the next few years, proving British businesses
are still at the forefront of innovation, says
Newton’s UK equities team.
Emma Mogford, alternate manager
of the Newton UK Income Fund and
Paul Stephany, UK Equity and UK
Opportunities’ manager at the BNY
Mellon boutique, say there are many
opportunities to be unearthed in the
domestic market, often in previously
unloved sectors or stocks.
Healthcare is one Mogford is
particularly positive on and one that
also plays into Newton’s approach,
particularly its population dynamics
theme. “Everyone know the ‘baby
boomers’ are about to reach retirement
and so we look for companies that
are finding ways to benefit from this
structural change,” she adds.
In the early part of the century research
and development (R&D) spend in many
healthcare companies was vastly
inflated. Laboratories spent billions
only to come up with a few drugs, or to
acquire biotech firms where there was
no evidence it would pay off, she notes.
“There was poor capital allocation and
the sector became less loved. Now
healthcare companies have become
much more focused,” Mogford says,
adding she believes we are seeing the
beginnings of a new wave of innovation
in the sector.
Mogford points to advances in
immuno-oncology as one of the
most exciting areas of real growth for
healthcare companies. Vaccines are
another growth area, with inoculations
against malaria and ebola currently in
the development phase. Ordinarily drug
trials take up to 10 years to come to
fruition but such is the demand for help
in containing the spread of diseases
like ebola it has gone into trials after
just six months, she notes.
The UK has a supportive environment
with among the lowest corporation
taxes in the world (half that of the US
and the lowest of the G20) and for
healthcare companies it is lower still
thanks to a tax break known as the
‘Patent Box’. Phased in since 2013,
companies can apply a lower rate
of corporation tax to profits earned
from its patented inventions – 10% as
opposed to 20%, she explains.
Meanwhile, Stephany also looks to
identify innovative companies when
allocating to his UK Opportunities
portfolio and he too believes the
UK has an edge in certain sectors
such as technology. For instance
he notes UK online companies are
advanced in mobile applications
for their businesses and a leader in
e-commerce globally.
“Scale is crucial in gaining market
leadership when it comes to online
businesses: scale begets scale.
Businesses have to get the first
product to market and they have to get
it right. This is what gives them growth
and cash up front. With an internet
business there are very few overheads
and very little cost to capital, so
management teams have all the tools
to improve shareholders returns at
their disposal. That is dividends or
value-accretive acquisitions which
bolster barriers to entry,” he explains.
A prime example of this is food delivery
site Just Eat, which is 11 times bigger
than its nearest competitor Hungry
House, according to Stephany. “Hungry
House is outspending Just Eat
dramatically in terms of advertising
and promotions but Just Eat has built
up such a strong market lead it will
prove very hard to catch up.”
Often the market does not give
credit for the barriers to entry such
companies exhibit and so they are
undervalued, he comments, adding
that as such he looks to take advantage
of these valuation anomalies. This has
led him to build up a 20% overweight
to internet businesses versus his
comparative index.
Emma Mogford
Paul Stephany
Portfolio manager
Portfolio manager
29
More money,
more problems
I
n a world awash with liquidity, investors will need to
take a more nuanced approach to their allocations,
according to Standish co-deputy chief investment
officer Raman Srivastava.
Highlighting some of the unintended
consequences of central bank easing in
recent years, Srivastava said: “There’s
more money in the world. Since the
financial crisis, central banks have
flooded markets with money and it
doesn’t look like it’s going to end any time
soon.” The result, he said, is the current
low or even negative yield universe, which
in turn is creating both challenges and
opportunities for investors.
One consequence of the widely
discussed hunt for yield has been
enduringly strong flows into high yield
assets. What is perhaps less known is
the degree of long-term growth in higher
yielding debt markets. Net annual flows
into the asset class have been positive
in 17 of the past 23 years, for example.
Net outflows have only occurred in six of
those 23 years.
Meanwhile, retail ownership in the asset
class has also skyrocketed. According to
Morgan Stanley data, about 20% of US
high yield is now owned by mutual funds
or ETFs. That compares with 5% in 1993.
Observed Srivastava: “More of the market
than ever before is now owned by retail
investors.”
Accompanying this overall growth in
the levels of debt has been an almost
commensurate decrease in the ability
of the market to cope with inflows and
outflows, as increased regulation, such
as Basel III, has stymied the ability of
banks to take on inventory.
According to Srivastava: “As the market
has grown, the amount of dealer capital
available to trade fixed income has fallen.
The liquidity of bond markets versus
equities has always been low but now it
is even more so.”
The trend is reflected, he said, in the
frequency of bond trades versus that of
equities. In January 2015, for example,
the percentage of NYSE stocks with zero
trades was 0.1%. For bonds, that figure
was 53%. The percentage of equities with
more than 25 trades a day was 99.7%.
For bonds, that figure was 0.4%.
But what to do with this information?
Srivastava says investors need to take
the implications of this new environment
into account. For Standish, one focus
has been to become more tactical in
its allocations. “You no longer just take
notice of fundamentals, you have to look
much more at technicals in fixed income
as well,” said Srivastava.
One instance was the so-called ‘taper
tantrum’ of 2013, where the market
reacted to comments by then US Federal
Reserve (Fed) chairman Ben Bernanke
on gradually reducing or “tapering” US
Raman Srivastava
Co-deputy chief investment officer
30
“
“There’s more money
in the world. Since the
financial crisis, central
banks have flooded
markets with money
and it doesn’t look like
it’s going to end any time
soon.”
”
quantitative easing. The result was a
sudden outflow from the high yield space
and a material widening of high yield
spreads.
“Coupled with lower overall liquidity
in the market, this kind of technical
event creates an environment where
markets may be liable to overshoot,” said
Srivastava. “Now that it’s so much more
difficult to trade, the moves on some of
these redemptions become exaggerated.
You have to be able to react to that.
You have to be more nimble in your
allocations.”
Looking forward, Srivastava highlighted
emerging market (EM) debt as one area
of potential opportunity in 2015. He
noted how emerging market growth has
underperformed expectations for the
past three years but described current
pessimism around the asset class as
an overreaction. He explained: “It’s been
a perfect storm for EM currencies and
countries and until now we’ve tended to
avoid EM debt. But I do think this is going
to be a big opportunity once we have
more clarity around the Fed interest rate
hike and more stability around oil pricing,
both of which we believe will occur within
the next three months.”
BNY Mellon’s
boutiques
that were
present at the
conference...
BNY Mellon’s
multi-boutique model
encompasses the skills of
13 specialised investment
managers. Each is solely
focused on investment
management and each has
its own unique investment
philosophy and process.
Located in London, New York and Boston, Alcentra is a global asset
management firm focused on sub-investment grade debt capital markets
in Europe and the US.
The Boston Company Asset Management is a global, performance-driven
investment management firm committed to providing creative active equity
solutions for its clients.
Insight is a London-based asset manager specialising in investment
solutions across liability driven investment, absolute return, fixed income,
cash management, multi-asset and specialist equity strategies.
Meriten has an adaptable investment approach that combines
fundamental and quantitative analysis. The firm is a specialist in European
fixed income, equity and balanced mandates.
Newton is renowned for its distinctive approach to global thematic
investing. Based in London and with over 30 years’ experience, Newton’s
thematic approach is applied consistently across all strategies.
Siguler Guff & Company is a multi-strategy private equity investment firm
currently managing over $10 bn1 in assets across its multi-manager funds,
direct investment funds and separate accounts.
Headquartered in Boston, Massachusetts, Standish is a specialist
investment manager dedicated exclusively to active fixed income and credit
solutions, with a strong emphasis on fundamental credit research.
1
October 2014
31
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as rise due to stock market and currency movements. When investments are sold, investors may get back less than they originally invested. This
is a financial promotion for Professional Clients only. This is not investment advice.
Any views and opinions are those of the investment manager, unless otherwise noted. This material may not be used for the purpose of an offer or
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authorised and regulated by the Financial Conduct Authority. Newton, BNY Mellon Centre, 160 Queen Victoria Street, London EC4V 4LA. Registered
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entities. BNY Mellon Investment Management EMEA Limited and any other BNY Mellon entity mentioned are all ultimately owned by The Bank
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