Lucy Martin

Columbia Threadneedle Investments, a leading global asset management group, has bolstered its team in Asia Pacific with two new appointments. Lucy Martin has been appointed to a newly created role of Vice President, Responsible Investment Product Specialist, Asia Pacific, whilst Gregory Da Silva has been appointed Product Manager, Asia Pacific, both based in Singapore.

Lucy and Gregory will report to Sandra Cheng, CEO, Singapore, with Lucy, through her dual reporting lines, also reporting to Karlijn van Lierop, Head of reo®, based in the Netherlands.

Lucy joined the business in 2018 and will focus on the Responsible Investment business across the Asia Pacific region, from promoting ESG solutions that leverage Columbia Threadneedle’s leadership in active ownership and ESG integration to advancing its Responsible Engagement Overlay service, reo®. Lucy brings client and distribution experience from her previous roles within Columbia Threadneedle.

With clients requiring more complex solutions, Gregory has been appointed as Product Manager for Asia Pacific, with a dual role focused on supporting both institutional and wholesale distribution teams as well as leveraging Columbia Threadneedle’s global product suite with a view to develop and register across local markets.

Gregory joined Columbia Threadneedle in 2018, working within the RFP team based in Asia Pacific, which provided him with extensive knowledge across marketing, products and portfolio construction.

Sandra Cheng, CEO, Singapore, at Columbia Threadneedle Investments, commented: “We are excited to welcome Lucy and Gregory to their new positions based in Singapore, with a focus on driving awareness and sharing our Responsible Investment best practice with clients across Asia Pacific. As client demands develop, focused on balancing returns with positive societal impact, the roles of responsible investment and product solutions become pivotal.   Being able to bring together a team, steeped in market leading best practice to meet this client demand, highlights the strength of our offering at Columbia Threadneedle.”

Jon Allen, Head of Asia Pacific at Columbia Threadneedle Investments, added: “As Responsible Investment plays an increasingly central and integral role for clients, we expect the level of adoption to rise as awareness increases. The Responsible Investment landscape in Asia Pacific is complex when looking across jurisdictions and sectors, with varying regulation, governance and measurement.

“With Lucy and Greg’s appointments, we have an even stronger commitment and strength of expertise to help our clients navigate this landscape and support their evolving needs.”

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Chris will oversee the wholesale and intermediary business in Australia and lead Columbia Threadneedle’s continued growth into the Australian Wholesale Intermediary sector, focusing on implementing a strategy for future growth into new segments of the market.

Chris King has significant experience in wholesale distribution in Australia. Prior to joining Columbia Threadneedle, Chris was Head of Investment Sales and Key Accounts with First Sentier Investors before joining Pallas Capital as Head of Wealth Distribution.

Glen Giddings, Head of Distribution, Australia & New Zealand at Columbia Threadneedle Investments, said: “We are excited Chris has joined Columbia Threadneedle, he is a strong leader with a passion for delivering on client needs. With over 20 years of experience in developing strong client relations across a wide range of strategies, I know his drive to deliver successful outcomes for clients will help us to build on and expand our business in the region.” 

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Glen, will report to Jon Allen, Head of Distribution, Asia Pacific, and will be responsible for developing Columbia Threadneedle’s institutional business in Australia and New Zealand with a focus on serving existing clients and deepening the firm’s presence.

Glen has close to 20 years’ experience in the institutional business having worked for large international houses including Barclays Global Investors and BlackRock where he held similar roles. Glen joins Columbia Threadneedle Investments from NAB Asset Management.

Glen will take up his position on 3 September 2018 and will be Sydney-based.

Raymundo Yu, Asia Pacific Chairman of Columbia Threadneedle Investments, said: “We are pleased to welcome Glen on board. Glen joins us at a timely juncture where his deep institutional experience and market insights will be invaluable in accelerating the growth of our business.”

Jon Allen, Head of Distribution, Asia Pacific of Columbia Threadneedle Investments said: “Glen has deep knowledge of the Australian and New Zealand institutional markets and a proven track record in new business development. With our global investment capabilities in equities, fixed income, and multi-asset, we will continue to offer specific strategies and investment solutions which are relevant to the markets.”

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“Go Global” report.

Many Australian investors rely on regular dividend payments. Companies which boast consistently impressive dividend yields are often considered to be well-governed, generating consistently strong cash flow and prioritising shareholders.

Yet some experts are questioning whether Australian companies’ dividend payments are sustainable at their current, generous levels. In the investment manager’s view, Australia’s top companies could be stuck in a dividend spiral.

In May 2015, Morgan Stanley reported that the country’s 200 biggest listed companies were paying out 73% of their earnings as dividends, compared with as little as 50% just five years earlier.¹

This has since grown and the ten largest income payers account for approximately 50% of the total ASX income. Any Australian company that reduces its dividend risks sending a negative signal to stock market investors.

Columbia Threadneedle shines a spotlight on some of the most promising dividend-paying companies and sectors across the globe in their latest issue of Go Global.

Read the report.

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These trends are causing disruption and innovation across broad areas of politics, business and social interaction; they are not limited to the asset and wealth management industry. When change affects us, we tend to believe that things are shifting more often than they used to. In part, that is the perception the media has given us, because innovations in media technology allow us to find out about events more readily, as they happen in real time. If there’s a natural disaster on the other side of the world, we see the images and footage immediately – and then multiple times on a loop the following day. And while our awareness of global events is higher than before, it doesn’t necessarily mean that disruption has become more common.

Disruption versus innovation

When change is happening, it’s important to understand it and how it affects you. You also have to understand the nature of the product or service you offer. Disruption is a complete change in the demand for the product or service offered that affects an industry’s longterm growth. If you start to believe that people will not need your services anymore, then there is no point in continuing to offer them.

For example, gaslamp lighters have been replaced completely – that is a true disruption. On the other hand, innovation changes how a product or service is delivered, priced or used, but does not necessarily put the longterm growth of an industry as a whole at risk. Individual industry participants could be at risk if they fail to adapt to the innovation.

I believe very strongly that many of the global demographic trends are supportive of the growth of asset management and advice. However, some of the trends in generational preferences, coupled with innovations in technology affecting risk management, communications, product design and pricing, mean industry participants must adapt.

Behavioural responses: flexibility is key

There are really only a few approaches you can take to deal with disruption and innovation: you can panic, bury your head in the sand or make a plan. And only one of these actually works. The key to a successful plan during periods of significant change is flexibility. It is critical to understand what clients want to achieve and how they want services provided to them. We have all heard the legendary story of Henry Ford’s statement, “You can have any colour you want as long as it’s black.” We should ask ourselves how much we have progressed past that thinking, or are we still largely pushing our concept of what our clients should want onto them?

Technology is creating more time for delivering insights and client service

New technology means there’s more data for us to analyse. In the past we spent a lot of time collecting data and collating it into useful information, and then from there we garnered insights. A computer system like IBM’s cognitive technology ‘Watson’ is showing us how a traditional research process can benefit from innovative technology. In a recent case study a woman had a very unusual form of cancer. Watson read all the data, produced a couple of scenarios, and then an experienced doctor was able to determine a more specific diagnosis.

And that’s key. This technology doesn’t replace us as asset managers, and it doesn’t replace financial advisers. It enables us to spend more time developing and delivering insights, provided we are prepared to alter or give up some of the daily routines we take comfort in. Innovative technology allows research teams to spend less time on the basic functions of collecting information, arranging it and carrying out a basic analysis, and more time on developing insights.

For advisers, technology can help concentrate on the most valuable aspects of what they do and expand what they do into areas thought to be less profitable. Working with technology-driven approaches like robo-advisers mean human advisers will be able to spend more time on client contact.

Pitfalls to avoid

Corporate giants in other sectors can offer cautionary tales about what can go wrong for those who fall victim to two behavioural hurdles: overconfidence and the innovator’s dilemma.

Nokia was once the number one mobile phone company in the world and is now essentially out of business. It was confident that it could continue with its approach; a cell phone was a device used by people to talk to each other and the great innovation was to make it mobile and small. Meanwhile, Apple understood that an integrated approach to communication and content delivery created a different buzz, and created the smartphone.

Apple’s success was less about technology innovation as creating a new ethos: the flexibility for people to communicate and be entertained how, when and where they chose. By the time Nokia caught on, it was too late and it saw its market share collapse.

Similarly if asset managers take too narrow a view of their business, such as a provider of mutual funds rather than providing a broad and flexible set of investment solutions that are vehicle agnostic, they may face the same future as Nokia.

Kodak thought it was in the celluloid film business. It fell victim to the innovator’s dilemma: companies with a strong, established market share are often the most reluctant to accept change. Kodak was so successful at selling celluloid film it was reluctant to push innovation in digital photography. Its real mission was to help people capture memories, but it didn’t want to put its profitable celluloid business at risk to pursue that goal.

Adapting to investors’ changing demographics

Both the age and the attitude of investors are evolving – Generation-Xers and millennials have different approaches and priorities than baby boomers, and these nuances need to be reflected in the services and advice they receive. But baby boomers also face changes. Many have not faced rising interest rates in their adult lives. The shifting proportion of various ethnic groups in the overall population might be a catalyst for change as well.

Partly as a result of changing demographics and partly because new technology makes choice readily available, people want to pick and choose what they’re paying for and they expect full transparency. It’s leading to an unbundling of services, and the cable TV industry is a good example. Older generations have grown accustomed to paying upwards of $200 per month for hundreds of channels and they may only watch a handful. Younger generations are choosing to unbundle these packages and instead buy the highest speed internet and then purchase extra services to target the shows they want. Ultimately, they may not save money, and they certainly don’t save time, but they prefer having transparency into what they’re paying for.

This unbundling of services is happening in advice and asset management, too. Traditionally, the investment returns and investor services offered by mutual funds were bundled together, and the individual cost of each element was too complicated to discern within the overall fee. Increasingly, people can now pick and choose what part of a product’s investment performance they want to pay for. The performance can include beta, strategic beta (or factor exposure) or alpha. Investors can increasingly access each one individually instead of in a package.

It’s unclear how far this trend will go in the financial services industry, but the cost of services is going to become more transparent and flexible. The prices that financial advisers pay large investment firms and the prices they charge to their clients are going to be on the table, giving clients more control to get exactly what they want.

Traditional revenue streams may get disrupted for a while, but as in the case of Nokia and Kodak, it was the failure of business leaders to take a holistic view of the service they provided and to adapt to innovation that led to their demise.

There are more mobile communication devices and more photographs taken today than ever before, illustrating that innovation can present longer-term opportunities if it is embraced.

A strategy for the future

The financial services industry has dealt with huge upheavals in the past – from stock market crashes and recessions to the rise and fall of currencies and countries. History shows that change represents a risk, but also an opportunity if you’re more prepared than the people around you. At a time of uncertainty and change, a clear head and good advice are more valuable than ever. Having a strategy, rather than panicking or burying our heads in the sand, will help us succeed, together.

Read the full report.

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Mark Burgess

Equities continued to make new highs as we moved into 2017, but we are mindful that the outlook is littered with macroeconomic and political risks – not least the forthcoming elections in France, Holland and Germany, Article 50, and President Donald Trump.

Unlike late last year, when specific sectors such as financials and energy drove the bulk of global returns, the latest rally in stocks has been broader based. A weaker sterling has driven UK equity performance, though a recent speech by Prime Minister Theresa May on Brexit negotiations saw sterling leap higher, knocking back the FTSE 100 somewhat.

President Trump

Equity markets have of late focused on the growth aspect of ‘Trumponomics’ with the belief that Trump is good for US and global growth, as well as corporate profits, all of which is supportive for equities. In the US, earnings have been improving, largely on the back of a rising oil price and the US dollar, not to mention a robust consumer growing in confidence causing the market to rally. If President Trump can deliver his tax and fiscal promises in full as well as finding a constructive approach to international trade, then there is little reason why the current rally should not continue.

Underemployment suggests there is still space in the labour market and there is only moderate wage pressure coming through. Until inflation starts to pick up there will be no need for rate rises and the market can continue its recent trajectory. Add to this Trump’s mooted tax cuts in all their guises and this will only improve the environment for businesses and consumers. If the recent spike in small business confidence numbers are anything to go by Trump has improved corporate confidence and, as we know, markets continue to do well as long as their confidence doesn’t wane.

That said, alongside Trump’s tax cuts are his potential tweaks to trade tariffs, while few have been able to unravel in full the complexities of any amendments he makes to the US Border Adjustment Tax that could see both manufacturers that assemble parts from overseas as well as those importing manufactured goods into the US charged higher tax rates.

It seems clear that these factors will be bad news for emerging market manufacturing and any increase in protectionism associated with Trump could be very damaging for companies with global supply chains, as indeed could an increase in labour bargaining power. Yet the risks we see may well be tempered by supportive fiscal policy in the US and monetary policy in Europe and Japan. Global quantitative easing outside America will help keep a lid on rates, which makes for a reasonably benign, low-rate environment alongside decent growth.

While corporate credit and equities appear to be pricing in better economic growth, core fixed income is moving oppositely. There are several plausible explanations for this divergence, not least of which is that inflation expectations have increased in core fixed income markets, suggesting they might also be pricing in the better growth suggested by equities. An end to the global profits recession – with global earnings revisions at multi-year highs, is also a likely explanation for better equity performance.

Portfolio positioning

In terms of portfolio positioning, we have been looking whether we are in a bubble in high yield corporate credit. Clearly it’s not cheap, with yields at record lows and spreads tightening to late-cycle levels; but interest cover is reasonable, while defaults have (at least temporarily) fallen on the back of recovering energy prices. For now, we are happy not to move more neutral but we are keeping an eye on the risks to that view, not least if US growth begins to accelerate by more than we have anticipated.

Last year was a difficult one, leaving many investors feeling bruised. Cash balances are still high among equity investors, but we remain cautious (and sometimes reluctant) owners of risk assets, a strategy that has served us well, particularly in our asset allocation portfolios. We expect volatility to be present throughout 2017 but, as active managers, we will continue to look for opportunities to add to our high-conviction positions.

By Mark Burgess, CIO EMEA and Global Head of Equities

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Today, ultra-low, or negative interest rates have become the norm in many developed markets. More than $12 trillion of bonds yielded less than zero at the beginning of September 2016. The journey has produced stunning returns, as lower rates have propelled bond prices higher. But like so many journeys, the destination – characterised by low rates, slow growth and paltry potential returns – is a much less inviting place. Market participants are witnessing their historical framework upended and losers will greatly outnumber the winners as the positive effects of low rates fade.

Sovereign bond returns, both in nominal and real terms, will be lower. Indeed, investors in negative yielding bonds are virtually guaranteed a negative nominal return on securities held to maturity. Also troubling for investors are the reasons for today’s low yields. Markets have largely given up on a rebound in growth, instead pricing in a prolonged period of weak productivity and unexciting prospects. And although we find bonds to be overvalued, the “lower for longer” argument remains deep-rooted and may not be reversed for some time. If low rates are a persistent feature, just who are the biggest losers? The groups most harmed by today’s unprecedented policies include the following:

1. Savers, as both lower income returns and the slower pace of compounding will sharply reduce future returns.
2. Life insurance companies, as many have made return promises in excess of market yields.
3. Pension plans, as lower discount rates are forcing funding gaps to balloon.
4. Investors seeking portfolio diversification, due to the dissipating potential of bonds to provide effective diversification as yields approach a zero percent lower bound.
5. Policymakers, as rates have approached levels that reduce the effectiveness of traditional monetary policy tools.

Savers face a new reality

Although falling yields can produce robust returns from bonds, permanently lower yields do not. Too often, this is viewed only in a short-term context. An important corollary to ultra-low returns, however, is that the magic of compounding disappears. Savers are underappreciating the impact of replacing the “miracle of compounding” with the “curse of compounding”. They are making faulty assumptions that returns will normalise, allowing a repeat of the 6-8% returns of yesteryear. They further fail to recognise that a persistent low return environment hinders not only annual returns but destroys the cumulative effect of savings. For those that put aside $25,000 and earn a return of 8% per year, the value of those savings will grow to $79,300 in 15 years, assuming returns are reinvested. But that same $25,000 earning only 3.5% per annum grows to only $41,800 in the same period. And for those investors sticking to the safety of short-dated bonds, returns will be <1.0% in most sectors. The nest egg in 15 years will have grown to only about $28,000, and it would take more than a century for assets to double!

The curse of compounding: Low rates will undermine the virtues of saving

Growth in the value of £100 under different rates of return

Return expectations have not adjusted to this new reality. Investment frameworks still reflect a belief that returns will revert to long-term averages. This is inconsistent with starting valuations, the level of potential GDP growth and productivity, and the already sky-high profit share of GDP. Investment returns are likely to be materially lower in the next two decades.

What does it mean?

Savers will need to save more and work longer. Assuming an equity return profile more in line with nominal global growth of 4 to 6%, an average worker will need to work for another ten years to accumulate the same nest egg as before. The make-up of investment portfolios will also change. A demand for greater flexibility, a focus on loss mitigation will all feature in investment plans, allowing for an array of new products.

Insurance companies: a recipe for trouble

The following is not a good business model: 1) offer savers a guaranteed income return; 2) build in little ability to walk away from, or alter the terms of, those promises; 3) maintain a large maturity mismatch, in which the length of the guarantees exceeds the average length of assets; and 4) watch interest rates tumble to record lows. Sadly, this is what many in the life insurance and annuity businesses have done, and they emerge as an industry heavily disadvantaged by today’s rate environment. Life companies in Germany, the Netherlands, Norway and Taiwan are in a particularly difficult situation.

Life insurers face significant headwinds

Levels of risk in major life insurance markets

What does it mean?

In a best case outcome, life and annuity companies will experience lower profitability and ROE. A more likely case is that we begin to see insolvencies rise amongst smaller and weaker players. We expect 10-20 business failures per annum over the next two years. This should not create a crisis, but it will lead to lower returns and occasional stress in a systemically important industry.

Pensions are licking their wounds

Plunging rates have exposed the underfunded status of defined benefit pension plans. Pensions are designed to cover a liability stream in which they pay retirees fixed sums, often for long periods of time. This is easy to offset by purchasing long-dated assets that generate a similar, or higher, income stream. This model breaks down if pension plans own too little bond risk and rates fall, which is precisely what has happened. Lower rates have boosted the present value of liabilities more than assets have risen, leaving pensions underfunded. Across markets such as the UK and US, more than 75% of pension plans find themselves with liabilities in excess of assets. The gap closed Q3 at record levels.

Pension liabilities are rising much more quickly than assets

Funding Ratio (assets/liabilities)

This understates the problem. Many non-corporate plans are in even worse condition and the use of unrealistically return expectations and overstated discount rates is widespread. Adopting realistic assumptions paints a picture in which US corporate pensions are underfunded to the tune of $600 billion. UK corporations, following the post-Brexit plunge in rates, are in a £960 billion hole on a full buy-out basis. US public pension plans likely face a mammoth $3.3 trillion shortfall, assuming plausible numbers.

What does it mean?

A pension crisis is lurking, but the near-term risk appears manageable. Unfunded pension obligations are akin to other liabilities such as debt, and companies are effectively becoming more levered through the deteriorating funding status. The bad news is that this issue is now large enough to remain an important factor in driving equity and bond valuations. It also portends the occasional failure of struggling companies without outsized pension holes. The good news is that most of these liabilities do not come due for years, relieving near-term pressures. The crisis, like most debt crises, will likely explode in the next recession. A decline in profits will further weaken pension-adjusted leverage metrics, and equity holdings within the pension plan will likely decline, exacerbating the pain. On the public side, bankruptcy is likely to become a more compelling option, requiring careful selection within the municipal bond arena in the years to come.

Seeking traditional portfolio diversification?

Count yourself among the losers

Investors seeking a diversified, risk-managed portfolio have typically looked to fixed income to provide diversification and balance holdings of equities and other risky assets. Bonds tended to move higher in value when risky assets moved lower. With rates so low, there is limited ability for rates to fall still further. This weakens the role of bonds as a hedging instrument. The chart below illustrates likely total returns for G4 government bonds under different economic scenarios:

Strong returns: You can’t get there from here

Twelve-month total return projections for G4 government bonds

Yields at zero simply do not offer the potential for strong returns. If you are looking for good returns from high-quality bonds, you can’t start from here. And if the equity portion of your portfolio declines by 20%, it will not be possible for fixed income to do the heavy lifting.

What does it mean?

Investors will focus on making their bonds work harder. This requires higher-risk portfolios designed to extract true alpha. It will likely mean the “search for yield” continues. It should ensure a continued focus on flexible products, multi-asset products and solutions that combine risks in a more intelligent way. Finally, it means that the widespread belief in the traditional balanced portfolio may prove to be disappointing. A portfolio of 60% equities and 40% bonds, for example, may not provide the diversification expected in a severe market correction.

Central banks miss their target

Central banks are running out of ammunition. They have cut interest rates but have failed to resuscitate growth. Central bank options are clearly limited, and even those that are available are likely be highly unpredictable. Policymakers have created a riskier environment, while failing to achieve their desired outcome. As they fumble to find a solution, it has also revealed that they too are struggling with answers. Credibility is waning.

What does it mean?

Central banks have few policy tools left that are likely to achieve the desired outcomes. Monetisation of debt is one option that will be considered by some, particularly Japan. Ultimately, it may prove to be the turn for fiscal policy to do the heavy lifting. This will take time, and may not be a panacea if improperly implemented. Expect more volatility, as markets may begin to question the efficacy of policy.

Challenges ahead

The “lower for longer” era is not without costs and side-effects. The principal side-effects were always understood to be positive. Low rates should spur credit creation. Low rates should make it more appealing for consumers to forego savings and consume. Low rates were supposed to make investment returns more compelling relative to cost of capital and boost capital expenditure. And low rates and QE should foster portfolio rebalancing, allowing investors to sell safe havens and reinvest in riskier assets, keeping the self-reinforcing dynamic aloft.

Some of these expected side-effects never fully materialised, and some of them are simply exhausted themselves. New tools are required. In the meantime, we are left with record low rates. The longer we are in this environment, the more painful it will become for many market participants.

By Jim Cielinski Global Head of Fixed Income

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Important Information: This material in this publication is for information only and does not constitute an offer or solicitation of an order to buy or sell any securities or other financial instruments to anyone in any jurisdiction in which such offer is not authorised, or to provide investment advice or services. Past performance is not a guide to future performance. The value of investments and any income is not guaranteed and can go down as well as up and may be affected by exchange rate fluctuations. This means that an investor may not get back the amount invested. The research and analysis included in this publication have been produced by Columbia Threadneedle Investments for its own investment management activities, may have been acted upon prior to publication and is made available here incidentally. Any opinions expressed are made as at the date of publication but are subject to change without notice and should not be seen as investment advice. Information obtained from external sources is believed to be reliable but its accuracy or completeness cannot be guaranteed. The mention of any specific shares or bonds should not be taken as a recommendation to deal. This document includes forward looking statements, including projections of future economic and financial conditions. None of Columbia Threadneedle Investments, its directors, officers or employees make any representation, warranty, guarantee, or other assurance that any of these forward looking statements will prove to be accurate. This document may not be reproduced in any form or passed on to any third party without the express written permission of Columbia Threadneedle Investments. This document is not investment, legal, tax, or accounting advice. Investors should consult with their own professional advisors for advice on any investment, legal, tax, or accounting issues relating an investment with Columbia Threadneedle Investments. Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act and relies on Class Order 03/1102 in marketing and providing financial services to Australian wholesale clients as defined in Section 761G of the Corporations Act 2001. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws. Issued by Threadneedle Asset Management Malaysia Sdn Bhd, Unit 14-1 Level 14, Wisma UOA Damansara II, No 6 Changkat Semantan, Damansara Heights 50490 Kuala Lumpur, Malaysia regulated in Malaysia under the Capital Markets and Services Act 2007. Registration number: 1041082-W.a

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The UK referendum on European Union membership has introduced political and economic uncertainty across Europe. It is unclear what the UK relationship with Europe will be in future, and when the eventual EU Brexit deal will be concluded. But uncertain times like this are very good for active managers. Volatility creates opportunity.

Equity markets recovered surprisingly well after the vote. Further interest rate cuts are likely, as is further quantitative easing (already seen in the UK) – these are favourable for equities and other real assets. However, whilst monetary policy keeps borrowing costs low, it does not solve the problem of excessive debt, and monetary policy has failed to stimulate meaningful economic growth. We expect continuing low economic growth and, even though markets are calm at present, an increase in volatility.

It is important not to lose perspective, but to rely on the fundamental task of picking high-quality stocks. It is business as usual for our European equities team –volatility will provide us with good opportunities in both larger and smaller companies. As Winston Churchill said: “Never let a good crisis go to waste!”

Brexit

In the UK leading economic indicators dipped after Brexit, with weak recent PMI data across manufacturing and services providing the Bank of England with the evidence it needed for looser monetary policy. While the recent ‘stress test’ of European banks was not as negative as feared, it highlighted the weak state of many banks, with Italian banks in particular facing a capital shortfall.

Many other headwinds facing Europe are political: a presidential re-election in Austria, a referendum in Hungary, Brexit negotiations, US presidential elections, French presidential elections next year and German federal elections in 2017.

But it is not all bad: central banks have signalled action to support markets and we anticipate more fiscal policy stimulus. UK corporate earnings and the economy have been supported by a weaker sterling. European banks are in better shape than at the time of the global financial crisis, and in Italy Prime Minister Renzi has staked his political future on a reform referendum in October, so a market friendly recapitalisation of Italian banks is likely.

In terms of economic forecasts, we expect UK GDP growth of 1.25% in 2016 and 0.5% in 2017. A technical recession is possible in late 2016 / early 2017 as investment contracts, although this is not our core view. Inflation is forecast to rise to 2.5% in 2017 due to the weak pound. Following firm PMIs/economic data from the Euro Area in the aftermath of the referendum, we have marked up slightly our GDP forecasts to in 2016 to 1.4% from 1.1% previously. In 2017, growth of around 0.9% seems likely. The region should avoid recession even though domestically-focused Europe area stocks are effectively pricing one in (Figure 1).
 

Figure 1: European stocks forward price-earnings ratios and consumer confidence

Source: Barclays Research, DataStream, MSCI, as at  August 2016

 
The risks to our forecasts in the UK relate to weaker consumer confidence and lower business investment. In Europe, Brexit should prompt structural reforms and more accommodative fiscal policy, but the recent economic recovery has been driven by falling unemployment, rising consumer confidence and better credit demand (see Figure 2). Domestic businesses would be hurt by any setbacks in these metrics.
 

Figure 2: Euro Area Loan Growth to Corporates and Households

Source: Bloomberg, Macrobond, Columbia Threadneedle Investments, as at August 2016.

 
Equity valuations are still reasonable, with a near 4% dividend yield: well above the yield on other equity and bond markets. Europe is cheaper than the US on a price-earnings basis and has underperformed that market.

Volatility creates opportunity

Political uncertainty, coupled with unresolved economic stresses, will probably lead to some volatility, but long-term investors know that what can feel like an emergency in the short-term may not hold much significance some years later, so a focus on good-quality stock picking makes good sense. Time in the market is more important than timing the market.

So it is business as usual for us. Our approach focuses on investment in high-quality, long-term compounders rather than economically sensitive stocks.

Smaller companies

Smaller company stocks can be more volatile than their larger peers and this has been borne out by recent market moves. Smaller companies tend to be less diversified and with smaller balance sheets, and they tend to be more domestically oriented.

These factors have all worked against smaller company valuations, as can be seen in Figure 3, below.
 

Figure 3: European smaller companies valuations are attractive

Source: Bloomberg, Columbia Threadneedle Investments, as at 3 Aug 2016.

 
However, as in any period of volatility this impact on smaller company valuations creates opportunities for us. We spend our time picking high quality, niche-oriented growth companies and the recent market gyrations give us a chance to buy unloved or unrecognised stocks with great long-term potential.

by Philip Dicken, Head of European Equities

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Mark Burgess

We continue to live in a world of extraordinary monetary policy, where investors are no longer surprised by central bank easing and, indeed, have come to expect it.

Thus the equity market rally continued into August, buoyed in the UK by the widely expected announcement of a Bank of England base rate cut to 0.25% – the lowest it has been in the Bank’s 322-year history – along with the expansion of quantitative easing. That made for a package of complementary measures that is impactful for the UK economy.

Bond yields have fallen very sharply, supported by easy monetary policy across Europe and Japan, which in turn is underpinning yielding assets, whether that be equities or credit; with the BoE’s quantitative easing propelling yet another strong rally across core government bonds.

Recent data showing a resumption of strong jobs creation has underpinned the outlook for the US economy, and there is growth coming through in the US, albeit at lower levels than we might have seen historically. We know the Fed is looking to normalise monetary policy and raise interest rates, but its ability to do that is somewhat hampered by the aforementioned monetary policy conditions elsewhere, which may hold the Fed back in the short term. We continue to expect one rate rise this year and two in 2017.

Globally, divergent monetary policy is going to be a major influence on asset classes, with investors having ever fewer places to go in their quest for yielding assets. In my view, this will continue to be the dominant theme in the global economy for the coming months and maybe years.

Having been neutral since February, we think the US dollar is likely to trend gently higher, driven by capital flows rather than growth or monetary policy divergence, and we have lifted our weighting to a modest favour from neutral previously. But we are mindful of what this might mean for risk assets which, from a valuation perspective, are mostly at near-time or all-time highs already.

Commodities

Gold aside, commodities stand out as one asset class that has yet to see an uplift. We see commodities as a useful portfolio diversifier and are mindful of its ‘catch-up’ potential, so we have lifted our allocation to the asset class. At a broad level commodities rallied from 2000 to 2008, driven by the rapid industrialisation and urbanisation of China, but as the pace of this levelled out commodities entered a bear phase and now almost every commodity is trading below its 15-year median trading level, aside from gold, coffee and cotton. Energy in particular is trading well below its median level.

There are compelling reasons for a more favourable outlook. The key drivers of a commodity bull market are a drop in production coupled with increased demand. Since 2012 there has been a dramatic change in capital expenditure among mining companies, with capex falling by nearly 90% in four years. Against such a drop in demand, supply had to fall – but this has taken time.

Excess supply of oil is now falling, in part due to the price war that drove many uneconomic shale fields out of production, and US domestic production is expected to fall significantly this year. That leaves fewer oil producers left to turn on the taps. To put today’s oil market dynamic in context, during the oil bear market of the 1980s there were up to 15 million barrels per day of spare capacity and we were only consuming 60mbpd globally. Now, on a global basis we are consuming around 95mbpd and there is only around 1mbpd of spare capacity. Therefore, in our view a reversion to a $30 oil price would require an unforeseen collapse in demand – at a time when demand for oil continues to be revised higher as consumers react to the lower price environment. Emerging markets are key drivers of this demand.

In our view, we are now at the point where the supply/demand dynamic is rebalancing across commodity sectors, including the base metals markets.

Gold demand is soaring, and coming predominantly from investors via ETFs. Total demand in the first half of the year hit a new high, eclipsing the previous record set in 2009. Clearly, seven years ago we were in the midst of the Global Financial Crisis and there are parallels today: like then, investors clearly see gold as something of a safe haven amid dwindling bond yields and volatility across risk assets.

Investment demand drives gold rallies and the ‘lower for longer’ dynamic that we see playing out for the foreseeable future will continue to concern investors. Our world of extraordinary monetary policy and negative interest rates is new territory for many investors and so we do not envisage demand falling; instead we see it benefiting as part of a broadly-based commodity rally.

By Mark Burgess, Chief Investment Officer EMEA and Global Head of Equities

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The move was well-flagged and fully expected by markets, despite the Bank forecasting inflation to breach its target as currency weakness is passed on to households in the form of price rises. The rate cut will hurts savers, but may help banks provide loans more cheaply to firms wanting to invest – so supporting employment – and could also ease the burden on indebted households. Of greater interest to markets has been the expansion of quantitative easing (including corporate bonds), which has sent long dated gilt yields lower, and the Term Funding Scheme.

Ahead of the announcement a number of Monetary Policy Committee (MPC) members had indicated that they would be keeping in mind the impact of any move by the Bank of England on pensions, insurance and banks in order to prevent an intended loosening of policy actually tightening it. The Term Funding Scheme appears designed to offset the squeeze on commercial banks that a cut in rates delivers. That the MPC assessed the impact on pension funds of further yield declines as being relatively limited looks courageous. Their assessment that the overall size of contributions to defined benefit pension schemes have been stable over twenty years despite fluctuations in the size of their deficits deserves further scrutiny.

While the cut to BoE growth forecasts for 2017, from 2.3% to 0.8%, appears meaningful, the projection itself remains above our expectations of 0.5%. More striking perhaps are the revisions to investment forecasts: business investment in 2016 is seen at -3.75% vs May’s Quarterly Inflation Report at +2.5%; 2017’s is hammered down to -2% from +7.25%.

By, Toby Nangle, Head of Multi-Asset Allocation, EMEA at Columbia Threadneedle Investments

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