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1
P2
ACTIVE VS PASSIVE:
P2
RETAINING CONVICTION
P3
P4
US MANUFACTURING
STOCK CONNECT: A
COMPARISON CHALLENGES
IN VOLATILE RUSSIA
RENAISSANCE CONTINUES
MILESTONE FOR CHINA
Redington’s David Bennett
T. Rowe Price’s Leigh Innes
Eagle AM’s Jeff Vancavage
Views from top investors as
says utilising risk-adjusted
and S. W. Mitchell’s Alexis
explains why manufacturing
China begins the Stock Con-
returns can help with active
Mathieu discuss why they
has been a growing bright
nect, giving foreign investors
vs passive comparisons.
remain optimistic on Russia.
spot in the US economy.
access to domestic A-shares.
CONNECTIONS
www.kl-communications.com - November 2014
Argentina could
top 2015 bond
market returns
T. Rowe Price EMD portfolio
specialist Jeff Kalinowski believes
Argentina could emerge from its
default turmoil to be the top
performing emerging debt outpost next year.
While Kalinowski accepts the
Argentinian bond market will
remain volatile in the near term,
he sees positive signs for the
troubled country. The T. Rowe
Price Global Emerging Markets
Bond Fund had a 5.9% exposure
to Argentina, at 31 October,
about four times the benchmark.
“We do see a recovery coming in
Argentina and the market is
pricing in an overly pessimistic
view,” Kalinowski says. “With
the expiring of the RUFO clause,
Argentina could make good on
its debt and we could see a significant bond rally next year. This
is what predicates our overweight in the country.”
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While Kalinowski accepts EMD
valuations are full in absolute
terms, he believes it still offers
compelling relative value.
“Technicals are positive, valuations favourable, and the fundamentals are improving. This for
us is a clear buy signal,” he adds.
2
CONNECTIONS
Active vs Passive: Beware of comparing apples to pears
The Active vs Passive debate lingers
on. To understand which approach
delivers the ‘best’ results, it is vital
to compare on a like-for-like basis.
David Bennett, head of investment
consulting at Redington, says riskadjusted returns can help.
Are active equity managers worth
the fee-premium compared to
passive investing?
The focus on fees paid by institutional investors has helped to fuel
the active versus passive debate. A
recent example is Hymans’ paper
and DCLG consultation for Local
Government Pension Schemes.
Also, active equity investments
typically bring a higher governance
burden at a time when resources
may be limited and higher priority
strategic matters need focus.
Comparing apples with apples
In order to help advise clients on
the merits of specific active equity
managers, valuable insights can be
obtained from quite simple analysis. The table below provides an
example of how headline returns
may show outperformance against
the benchmark, but fail to tell the
whole story. In this example, the
manager has clearly outperformed
the benchmark and met outperformance target (+2.2% net of fees
versus +2%).
However, once the benchmark is
scaled up to have the same volatility, the manager underperforms the
benchmark. On a like-for-like basis,
accounting for the level of risk taken, the manager would have had to
achieve an excess return above 14%
to meet its mandate.
The higher return appears to be a
function of using higher-risk strategies, rather than manager skill
(‘alpha’). Further insights can be
obtained by using style factor analysis. In this case, returns are regressed against value, momentum
and style factor indices. This reveals
that the manager – whose marketing refers to a value based investment philosophy – has in addition to a significant ‘long beta’ position an underweight exposure to
‘defensive’ that was far bigger than
the long value position.
An alternative to active equity
allocations
So, how best to allocate to equities
if you do not want to use active
managers? Passive strategies which
include the use of volatility control,
with 90% put options, materially
improves the risk/return profile of
equities and are gaining wide acceptance.
If exposure is obtained by derivatives, an additional benefit is the
freeing up of capital, greatly increasing strategy freedom.
There is evidence to support longterm successful active managers
deriving their success from a persistent style tilt. Excellent examples
David Bennett - Redington
would be Neil Woodford and Warren Buffett.
Fortunately, credible offerings are
starting to appear from managers
offering systematic, diversified,
‘market neutral’ access to style
factors. Adding this exposure brings
additional benefits to a portfolio via
gaining low correlation exposure to
proven sources of outperformance.
twitter: @davidjbennett1
5yrs to 03/2014
Mandate/BM
Investment target
Annual net return
Excess net return
Volatility
Sharpe Ratio
Manager
Benchmark (BM)
BM - scaled for volatility
Global
MSCI World
MSCI World
Benchmark +2%
14.0%
11.8%
15.7%
12.7%
10.5%
14.0%
19.3%
14.5%
19.3%
0.66
0.72
0.72
Retaining conviction in volatile Russian stocks
Emerging Europe equity managers
tutes an important part of Russia’s
leverage off their scale and strong
remain cautiously optimistic on the
balances, both current account and
financial positions,” he adds.
prospects for Russian stocks, de-
budget – as taxes on oil companies
spite recent pressure on the econo-
represent a large portion of reve-
my and rouble currency.
nues. As such, a weakening rouble
The rouble rout began during the
is shock absorber for oil prices.”
Ukraine conflict through to the
Mathieu believes a natural trade is
Western-imposed sanctions, while
to favour exporters, which are sell-
it intensified during the recent oil
ing in dollars but incurring local
price slide. As for equities, the dol-
currency costs, and shy away from
lar-denominated RTS Index is 26%
consumer discretionary companies.
lower in 2014, to 19 November.
T. Rowe Price Emerging Europe
Equity Fund manager Leigh Innes
says attractive opportunities can
still be found in Russia.
“Many investors look at stocks like
Magnit and simply say: ‘Russia,
macro, don’t touch’. However, the
stock has done incredibly well over
Russian President Vladimir Putin
the last five years and we have
“While it is easy to write off Russia,
we are not going to run away because of turbulence. Given recent
volatility, there are some high quality companies trading at attractive
valuations. This is providing us with
great buying opportunities.”
“In specific cases, it is best to look
been adding to it during recent
“It is important to look at the rou-
for the relative winners against
bouts of weakness,” she says. “This
ble devaluation in conjunction with
competition. For example, modern
stock will do well even if the econo-
the development of oil,” SWMC
food retailers are gaining market
my continues to slow. The way to
Emerging European Fund manager
share versus traditional trade play-
make money is to be contrarian and
Alexis Mathieu says. “Energy consti-
ers, as these companies are able to
we can afford to be patient.
3
CONNECTIONS
FundCalibre
adds 6 more
‘Elite’ funds
Leading UK fund ratings agency
FundCalibre has awarded an
Elite Rating to six further strategies, taking its number of top
ranked portfolios to 109.
These are: Hermes Asia exJapan, F&C Multi-Manager
Navigator Distribution, Invesco
Perpetual Hong Kong & China,
Smith & Williamson Enterprise,
Old Mutual Global Equity Absolute Return and Rathbone
Strategic Growth.
To become Elite, a fund must
pass a quantitative process
designed to isolate a manager’s ability to outperform
over at least three years. The
volatility of a manager’s ‘skill’
is then assessed to determine
the probability of repeating
outperformance. A qualitative
process is also made.
“We continue to search for
managers who are able to
generate alpha after fees. We
do not expect to add a significant number of funds at each
quarterly meeting, but these
additions are all highly impressive,” FundCalibre MD director
Darius McDermott says.
The US manufacturing renaissance can continue
The industrial sector, manufacturing in particular, has been a growing bright spot in the US economy.
The comparative advantage of US
manufacturing has progressed, with
energy costs declining and productivity improving. Additionally, Chinese wages have increased, making
the relative cost of manufacturing
overseas less attractive.
There are a number of structural
changes allowing US manufacturers
to become progressively more competitive globally, and at home.
Technology and innovation
Industrial activity continues to incorporate more software and automation, driving efficiencies and
increasing output. To get a sense
for how productivity has changed,
durable goods manufacturing grew
38% from mid-2009 through May
2014. Over that time the real value
added was 18%, compared to an
11% rise in overall GDP. US manufactures have employed automation and are reaping the benefits.
Through technology and innovation, Ingersoll Rand has expanded
margins and increased capital efficiency. It uses rigorous analytics to
ascertain the market’s need, drive
research and development, and
increase manufacturing efficiencies.
The shale revolution
Energy is a significant component of
manufacturing and distribution
costs. Technological breakthroughs,
such as drilling technology, have
been a game changer for energy
intensive manufacturing. In addition, success in exploiting shale
deposits has advanced US energy
independence. Natural gas production has reduced domestic energy
prices, which are currently about a
quarter of those in Asia and Europe.
One of the direct beneficiaries of
the proliferation of shale gas is
chemical company LyondellBasell,
which has a low-cost advantage
against its global competitors.
Sustained shifts in labour costs
The recession has narrowed the
wage gap between US and EM
workers. While this has been painful, labour costs were a predominant factor in the move away from
US manufacturing. Reduced labour
costs and rising productivity are
improving the value added by each
worker, an increasingly important
factor in competitiveness.
Companies such as Honeywell have
benefited from reduced labour
costs by manufacturing equipment
near the end user. The benefits are
numerous, as a strong geographic
presence can deepen relationships
and increase speed to the market.
Increasing investment activity
US investment as a percent of GDP
is well below historical levels. However, capital spending is starting to
return. As this recovery continues,
uncertainty decreases. This, combined with aging stock, should drive
replacement investments. Existing
equipment has not been this old for
nearly 20 years and efficiency gains
Jeff Vancavage - Eagle AM
from existing stock are diminishing.
Businesses will likely resume investment in productivity-enhancing
capital expenditure.
This will benefit Eaton, which offers
energy-management solutions to
help deal with rising energy costs.
In summary…
US industry has changed dramatically. The sector has transitioned
from low tech and labour intensive,
to technology intensive and high
productivity. Medical devices, clean
energy, nanotechnology and pharmaceuticals are a few examples
showcasing US capabilities and
competitiveness in developing and
commercialising new technologies.
The US is unlikely to be the industrial leader it was in the 1950s and
1960s, but the US industrial sector
will likely continue to gain global
market share over the next decade.
Eagle AM’s Jeff Vancavage is a
portfolio manager on the Nordea 1
- North American All Cap Fund
Hermes Sourcecap buys into ‘misunderstood’ Nokia
Hermes Sourcecap European Alpha
fund manager James Rutherford
has bought into Nokia, saying investors have misunderstood the Finnish group’s transformation.
After selling its phone business to
Microsoft, Nokia is now made up of
three divisions – Nokia Networks, a
patent portfolio, and the ‘Here’
mapping operation.
“Market consensus is that the new
Nokia is distinctly dull, but is now
on a more stable footing than it was
before its recent merry-go-round of
sales and acquisitions,” Rutherford
says.
“Although Nokia shares might look
expensive at first glance – 28x 2014
consensus earnings – this does not
take into account the fact it had
€8bn of net cash and equivalents on
the balance sheet at the end of
June, after selling the handset business to Microsoft.
“Adjusting for this cash, the shares
would only be on 14x P/E for this
year. Cash rich, well positioned and
with an enviable IP armoury, we
think the business has quite a long
way to go.”
Revival of Finnish giant Nokia
4
CONNECTIONS
Stock Connect: A milestone in China’s development
Jorry Rask Nøddekær – Nordea
The gradual opening up of China’s A-share market via the connect scheme is a milestone for China’s capital markets. It is a
sign of the leadership’s commitment to reform, which is one of the reasons why we have a positive long-term view on China. This scheme broadens our investment universe to include a large number of shares listed on the Shanghai Stock Exchange, which would otherwise not be accessible, including shares in the structurally growing auto, healthcare and media
sectors. In addition, as this is a two-way scheme, mainland Chinese investors are likely to buy into Hong Kong-listed names
in a number of sectors that remain underrepresented on the Shanghai exchange. The internet sector is a good example of
this, and we could benefit from our holding in Tencent. Lastly, valuation gaps between A and H-shares can be exploited.
Anh Lu – T. Rowe Price
We are optimistic about the Stock Connect, which allows foreign investors access to mainland A-shares. This is another
important experiment in the opening of China’s capital markets and the internationalisation of the RMB. Our hope is that
the limited quotas that the Connect begins with will be expanded over time, and its scope will eventually cover Shenzhen as
well as Shanghai. If successful over the next few years, the QFII scheme for foreign access to A-Shares may become increasingly redundant. The Stock Connect could also hasten the inclusion of A-Shares into the broader MSCI indices – MSCI China
is already the largest country component of MSCI AC Asia ex Japan and MSCI EM, and that weight may increase over time
with increased A-Share inclusion. The A-Share market is home to a many companies in the consumer, healthcare and industrials sectors, for example, that are not available to investors in Hong Kong-listed China companies.
Jonathan Pines – Hermes
In anticipation of this opening up, over the last few months I have significantly increased exposure to A-shares. The fact this
trade is currently dominated by relatively unsophisticated domestic retail investors has resulted in significant inefficiencies.
That does not mean most A-shares are cheap, even though the benchmark has declined for years. In fact, most A-shares are
expensive relative to their quality, with well-governed companies generating free cash flow still a rarity. So why then have I
been loading up on A-shares? This market presents two main sources of opportunity. Firstly, some issues are listed on both
the A and H-share market, and sometimes A-shares trade at a discount. For example, our fund holds Ping An Insurance Ashares, which trades at a discount to its H-share. The limited opening up of the A-share market might result in the gap closing, and if we are lucky, the gap will close by the A-share rising rather than the H-share falling.
Darius McDermott – Chelsea
One of the major concerns is that both exchanges operate in different regulatory environments. Investors should be very
aware of all of the potential risks around regulatory issues and tax implications before investing in any market. However,
this development could be important for Chinese stock markets in the longer term. The principle of allowing free access to
the country’s stocks is crucial to the sustained growth of China’s markets and economy. This is a clear signal from China’s
leadership that the stock market is at the centre of its future expansion plans and policies. twitter: @DariusMcDermott
T: +44 (0) 203 137 7823
www.kl-communications.com
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