Standard Life Investments weekly economic briefing

There was a whiff of panic in markets at times last week.

Equities and oil prices took a hit, long-term government bond yields fell across the developed world, emerging market and high yield credit spreads widened, while the dollar climbed further.

The initial catalyst for this bout of risk aversion was a round of disappointing manufacturing PMIs in September, which brought into question expectations that the global economy is on an improving trend. Negative sentiment was then reinforced by the ECB’s failure to reveal the likely size of its asset-backed securities purchase programme, together with the perception that Draghi was hedging his commitment to return the central bank’s balance sheet to its early 2012 size.

It wasn’t until the US employment and non-manufacturing ISM reports surprised to the upside that risk appetite recovered.

So, how worried should investors be about the outlook for growth? Well, it is true that global manufacturing sentiment has lost some momentum in recent months. Besides the usual suspects in the Eurozone, sentiment fell back in most of developing Asia, as well as the US and UK which had been leading the pack.

This dovetails with the hard global industrial production and goods trade data which are displaying only modest growth. Meanwhile, consensus forecasts for 2014 have been downgraded for most G20 countries and expectations for 2015 are now starting to be downgraded as well (see chart 1 in the attached).

Yet there is no need for panic. Manufacturing PMIs receive a lot of attention from market participants, but the services sector makes up a much larger proportion of global economic activity.

In this sector, sentiment is holding up much better. Regular readers will know that we have never been bulls on the Eurozone’s growth prospects but even here investors have to be patient as it will take time for the weaker currency and recent monetary policy initiatives to feed through to the real economy.

If there is a moral to this story it is that strong US growth is still necessary but no longer sufficient to generate strong global growth.

From the US side, growth is not as import-intensive as it was in the past. And even if it were, much of the rest of the world is suffering under the weight of a variety imbalances and structural headwinds that cannot be solved by stronger US demand.

Click here to read to full Standard Life Investments Weekly Economic Briefing.

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Principal Global Perspectives

The global emerging markets landscape is changing rapidly, with the outstanding returns investors have seen in the past becoming increasingly difficult to secure.

According to Principal Global Investors, despite the volatility, emerging markets are a strategically important part of long-term investment portfolio and determining the right market exposure is more critical than ever.

The October issue of Principal Global Perspectives focusses on emerging markets, providing a compilation of articles from four of its boutique asset managers on what they see as the challenges and opportunities in this progressing asset class.

Key points:

• Waiting for growth no longer, emerging markets take action, by Milhail Dobrinov, Portfolio Manager, Principal Global Equities: “So how are emerging countries to prosper, and emerging stocks to regain their edge and outperformance in this new environment? The answer lies in applying a large dose of self-help; not just waiting for growth to happen along, but taking steps to create it. That means boosting productivity growth, reducing operating and capital costs, improving profitability, and returning more capital to shareholders. At the country level, this means structural reforms; at the firm level it requires prioritizing return on capital, rather than growth at any cost. These changes are necessary, but neither of them will be easy or popular, and some attempts will stumble.”

• Emerging markets forge ahead … on differing paths, by Ivailo Vesselinov, Economist, Finisterre Capital: “Emerging economies with large financing needs are likely to remain under the microscope as major central banks rein in global financial liquidity.”
• What to watch in emerging markets: aggregate ROI, by John Birkhold, Partner, Origin Asset Management: “What matters is not how fast a company is growing, per se, but the level of ROI that firms in aggregate have been able to achieve.”
• Emerging markets debt: as asset class evolves, by Nick Varcoe, Portfolio Manager, Principal Global Income: “Institutional buyers are likely to remain active in the emerging market corporate space, particularly as long as this attractive yield pickup over developed markets continues to exist.”

To read the full report, click here.

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David Bassanese

Anticipation of an increase in US interest rates in 2015 drove a rise in the US dollar, falling commodities prices and a sustained sell-off in the Australian equities market during the month of September, according to BetaShares’ Global Market Review.

The review, which analyses performance across seven major asset classes, found that international equities was the best performer for the month, experiencing 3.7% growth as increased confidence in the economy drove the US share market higher. The price of international equities in real terms also increased as the Australian dollar headed towards a four-year low against the US dollar.

US dollar strength was a major theme in global markets in September, with the greenback rising 6.8% against the Australian dollar over the month. Continued weakness in iron ore prices was also a major contributing factor to the weak AUD, said BetaShares Chief Economist David Bassanese.

“The fear of an end to quantitative easing hurt commodities and commodity exporting equity markets such as Australia’s – and emerging markets like Brazil – particularly hard,” Mr Bassanese said. “The strength of the US dollar added another negative factor to increasing commodity supplies and only modest global growth, making it hard to be positive on the commodity price outlook.”

Australian bonds and listed property also fell over the month, as the sell-off in the local equities market suppressed any increase in bond yields as a result of anticipated Fed tightening. Low global inflation and geopolitical tensions were likely to drive a further fall in yields by the end of the year, which could also affect the property sector, said Mr Bassanese.

“Unless the RBA moves to an easing policy bias again, 10-year bond yields are likely to head back to 4% p.a. by year end,” Mr Bassanese said. “While property is holding up well thanks to the uplift in residential construction and high land values, it could also be at risk of underperformance once the increase in bond yields begins.”

Looking ahead, Mr Bassanese noted an expectation of further international equities outperformance, with the Australian dollar moving down to 85 cents by the end of the year. “Given falling commodity prices and the AUD’s still uncomfortably high real level, I would expect medium-term weakness against the US dollar, the Euro and the Pound,” he said.

“This should drive global equities outperformance against the Australian market in unhedged terms, with the current pullback in global equities likely only a correction in a broader bull market.”

Click here for a copy of the full Global Market Review is attached.

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Insync’s Global Titans Fund now available.

International equities manager, Insync Fund Managers, has made its Global Titans Fund available on the ASX mFund settlement service (mFund).

“The growing demand for international investment by all Australian investors including SMSFs spurred us to bring our flagship fund onto mFund allowing direct investment access via the ASX.

The fund aims to grow wealth through consistent equity returns whilst protecting investor’s wealth against potential significant downturns.

Given the nature of the highly concentrated resources and financial sectors in the domestic market we concentrate on identifying opportunities that are either unavailable or under–represented in Australia. Examples of these include global healthcare IT, consumer brands, and selective industrials with dominant global market shares to name a few.

These exceptional global companies must have high return on capital, strong free cash flow, solid balance sheets and a long track record of returning cash to shareholders through growing dividends and/or share buy-backs.

Where the fund is different or unique is that we offer protection or insurance against sudden and significant downturns through the strategic use of index puts to cushion investors through volatile periods. This was particularly compelling when we witnessed the extreme volatility associated with the Euro crisis and the US debt debacle where our fund actually increased in value.

“The minimum investment into Insync’s Global Titans Fund is $10,000 with minimum additional investment of $1,000” said Monik Kotecha, CIO, Insync Fund Managers.

Insync Fund Managers has outsourced the fund’s responsible entity role to Select Asset Management (part of the OneVue group). Select is a Foundation Member of mFund.

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Institutional investors are curbing their enthusiasm.

Despite enjoying better-than-expected returns in 2013, institutional investors are significantly reining in their return expectations for 2014 and turning to alternative – and illiquid – asset classes alongside global equities, according to the latest AMP Capital Institutional Investor Report.

The survey of global institutional investors, who manage a collective US$2.4 trillion, found respondents’ portfolios returned on average 13 per cent in 2013. However, respondents see key risks to the global economy as stumbling blocks in achieving their investment returns for the year ahead. For the remainder of 2014, respondents expect to achieve average returns of 7.3 per cent.

Globally, respondents in Asia Pacific have the highest baseline and optimistic forecast for 2014 at 8.1 per cent and 12.1 per cent, respectively. Respondents from Europe and the Middle East have consistently lower forecasts on average than those of investors in Asia Pacific and also The Americas.

AMP Capital Chief Executive International and Head of Global Clients Anthony Fasso said: “Institutional investors enjoyed a stellar year in 2013 largely due to the bull market in equities around the world. Of those we surveyed, 93 per cent either met or exceeded their expectations. Allocations to domestic and international equities served investors well, with developed market equities performing better than those in emerging markets. However, investors’ planned allocation increases for the rest of 2014 are most pronounced in alternative assets especially in private equity and direct real estate and infrastructure. This is a continuation of the trend that we have highlighted in earlier issues of our Institutional Investor Report series.

“Looking ahead, investors have uncertain expectations. Their concerns are based around the risks they see to the global economy including the ongoing crisis in Ukraine, the end of quantitative easing by central banks and questions over the future direction of China’s economy. Despite this, the majority of investors surveyed expect to make no substantive change in their approach to seeking returns either through alpha strategies or by bearing more risk.”

Key findings from the survey include:

• Forty-five per cent of respondents expected to boost their holdings in private equity during the first half of 2014, more than a third (36 per cent) anticipate an increase in their allocation to direct real estate and almost a quarter (24 per cent) plan to boost their investment in direct infrastructure.

• Investors from Europe and the Middle East are most likely to increase their investment in direct real estate (59 per cent) and private equity investment (56 per cent). In the Americas, private equity (44 per cent) and direct real estate (22 per cent) allocations are expected to rise the most in respondents’ portfolios. Asia-Pacific investors expect to see the greatest rise in allocations to global equities (44 per cent).

• While institutional investors are continuing to increase allocations to alternative assets, the rise may be tempered as pension schemes, in particular, that are preparing to enter their drawdown phase may soon find themselves up against their governance limits for investing in illiquid assets. Two-thirds of investors have an average limit of 25 per cent on the proportion of illiquid assets they can hold and many already have an average allocation of 24 per cent.

• Thirty-one per cent of investors intend to move out of domestic equities, 26 per cent are decreasing their allocation to cash and 21 per cent said they would reduce the domestic fixed income portion of their portfolio.

• In Asia Pacific and in Europe and the Middle East, 29 per cent and 31 per cent of respondents, respectively, plan to decrease their holdings in domestic fixed income. In the Americas, 29 per cent of respondents primarily plan to decrease their allocations to domestic equities.

• Investors in the Americas have the greatest exposure to equities (on average 53 per cent), followed by Asia Pacific (46 per cent) then Europe and the Middle East (37 per cent).

• Average allocation to fixed income is highest in Europe and the Middle East (37 per cent) compared to Asia Pacific (21 per cent) and the Americas (20 per cent).

• Survey respondents have limited interest in considering environmental, social, and governance factors when making investment decisions despite evidence they add some value.

Click here for a full copy of the report.

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Nikko AM adjusts its global equities position.

An overweight stance on global equities that lasted for over two-and-a-half years has been cut to neutral by Nikko Asset Management’s Global Investment Committee (GIC), the company announced yesterday. Nikko Asset Management is a related entity of Tyndall Investment Management Limited. In confirming the provisional decision made in early March, the Tokyo-based asset manager cited the following concerns:

1) Heightened fear of geopolitical risk,

2) Accelerating deterioration of China’s economy and financial system,

3) Subpar US and Japanese economic growth, and

4) Little room to re-rate Western equity valuations and continued deterioration in earnings estimates.

“We believe equity valuations have peaked and that markets will trade nervously going forward. On top of that, unsettled geopolitics make us uncomfortable and the fallout from China’s reform efforts could cause some shocks,” said John F. Vail, Chief Global Strategist and GIC Chairman. “In a few markets we expect equities to do well, but against the tunnel of uncertainty looming out there—and given the slim difference between our bond and equity return forecasts—we feel a neutral view on global equities versus bonds is warranted.”

Vail expressed his views in the firm’s most recent Evolving Markets research report. Elsewhere in the report, analysts reported that 2013 fourth-quarter data on overall corporate profits in Japan (including unlisted companies) was very positive, with a record-setting quarter-on-quarter increase in the pretax recurring profit margin, while the four-quarter average hit a new high of 4.6%.

The report concludes that several other indicators confirm that Abenomics is working much better than the pessimists suggest.

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Sophievskaya Square, Kiev, Ukraine

A long-running overweight stance on global equities is being trimmed by Nikko Asset Management’s Global Investment Committee (GIC), the company announced today. Nikko AM is a related entity of Tyndall Investment Management Limited (Tyndall AM).

The GIC has been able to shoulder all the various global risks since September 2011 and still maintain an overweight stance on global equities, but earlier this week in an ad-hoc meeting, it voted to recommend slightly decreasing risk to a neutral stance.

A major reason was the Ukraine tensions, but other factors also played a role in the GIC’s concern. It has long maintained a cautious stance on China, and there are increasing signs of shadow banking defaults and declining residential property prices. Many other reforms are accelerating there, and while positive in the long-run, such will likely cause overall uncertainty and difficulties in the short term. On the other hand, certain segments of the economy will benefit strongly from the reforms even in the short term, and the GIC is by no means calling for a hard landing; rather, that economic growth will moderately disappoint consensus expectations.

As for other factors, fairly elevated US equity valuations and the strong rise in US equity prices over the last year also contributed to the GIC’s concern, especially as earnings growth will likely be hampered by the recent weather calamities.

As for the Ukraine, the GIC agreed that Putin is not likely to invade other parts of Ukraine, but that, quietly, the West likely assumed that Russia would not give up Crimea. Thus, most of the complaints from the West are mostly rhetoric and perhaps intended to make Putin look “tough”. Going forward, a stalemate and long negotiations are the most likely outcome, with the West essentially controlling 95% of Ukraine, but also needing to keep decent relations with Russia (for energy, primarily). Thus, a “Finlandization” of the Ukraine (without becoming a full EU or NATO member), with an autonomous Crimea, is the most likely outcome in the years ahead. There is always the chance, however, that the local populations begin to fight with each other, which would escalate geo-political tensions greatly. Hopefully, they will realize that the Yugoslavian break-up is not a good model and that ethnic cooperation is essential.

In sum, it is extremely rare that we make ad-hoc decisions like this, and it is meant to be temporary until we meet on March 27th in full session to make a final decision.

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Equity trustees launches new global equities fund.

With growing interest in global equities from Australian investors, the Equity Trustees Dundas Global Equity Fund is now available for investment on the BT Wrap and Asgard platforms.

The fund, which takes a long-only position in 60 to 70 companies with a minimum market cap of US$1 billion, is managed by Edinburgh-based Dundas Global Investors and distributed in Australia by Equity Trustees Limited.

David Myers, national sales manager at Equity Trustees Funds Distribution, said over the past 12 months there has been a clear increase in the level of interest in global equities, from both financial advisers and their clients.

“As a result, we have arranged with BT Wrap and Asgard to open the Equity Trustees Dundas Global Equities Fund to retail investors to meet this growing demand.

“Advisers we have spoken with have told us they are seeking to position their clients’ portfolios to benefit from growth in markets such as the US and China, as well as ensuring they are not over-exposed to Australian equities in the current economic environment.

“With many investors still focused on income, the Equity Trustees Dundas Global Equity Fund can help create a stable, regular return for investors thanks to its focus on sustainable long-term dividend and book value growth.

“This approach is particularly attractive to investors who want exposure to global equities without taking on a high level of risk,” Mr Myers said.

Mr Alan McFarlane, senior partner and founder at Dundas Global Investors, said that investors in international equities will need to pick and choose carefully in 2014.

“We saw a strong rally in 2013 in developed market equities.

“As a result, equity markets are at valuation levels susceptible to a correction, and investors should ensure they are invested in companies with a strong and sustainable return on equity as well as cash generation and internal re-investments, in order to achieve future dividend and book value growth.

“Although inflation appears to offer little threat to markets, global equities would probably have a nasty reaction to further US rate rises, and this makes it even more important that any investments in global equities are made on the basis of fundamentals, rather than expectations of across-the-board market growth,” Mr McFarlane said.

As well as opening on the BT Wrap and Asgard platforms, the Equity Trustees Dundas Global Equity Fund has recently received a ‘Recommended’ rating from Lonsec*. It has an ‘A’ rating from van Eyk and an ‘Approved’ rating from Zenith**.

Dundas Global Investors was established in Edinburgh in August 2010. Dundas is an independent partnership with their own assets invested alongside clients. Dundas offer a single strategy to investors; global equities to achieve real capital and dividend growth. Dundas has seen significant growth last year, with the strategy receiving another mandate, for $240 million, from a large Australian superannuation fund in December last year, taking total funds under management to over $500 million.

The fund aims to exceed the MSCI All Country World Index (excluding Australia) by 2.5% p.a. over rolling five year periods after fees.

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Neuberger Berman’s release its latest views on equities, fixed income and alternatives.

Managers and strategists at global investment manager Neuberger Berman envision positive momentum across many asset classes in 2014, as the global economy stabilises and generates moderate growth, according to Solving for 2014, the firm’s third annual outlook across global equities, fixed income and alternative investments.

As the investable universe has grown—across borders and asset categories—Neuberger Berman’s focus has broadened as well. This year’s edition is deeper, covering more ground than previous issues, reflecting the market’s increased diversity and the firm’s broad perspective.

The outlook provides Neuberger Berman’s views on equities, fixed income and alternatives, all on a global basis, and capitalises on the fundamental research of its portfolio managers and analysts.

“From an economic perspective, things are improving across a number of major economies,” said Joseph Amato, President and Chief Investment Officer of Neuberger Berman.

“As the Fed and other central banks adjust their approaches, investors should remain alert. Inflation trends remain moderate and we do not expect a significant uptick in rates this year. These shifts in policy merits close attention as investors adjust portfolios to capitalise on the improved growth and somewhat tighter monetary conditions.”

In equities, Mr Amato anticipates continued earnings growth this year tied to modest operating leverage as developed economies pick up.

In fixed income, investors can likely expect slow and steady growth and the potential for rising rates, said Brad Tank, Chief Investment Officer, Fixed Income.

“In my view, we’re probably in the middle innings of this growth phase in the US,” Mr Tank said.

“Things are getting better, but not rapidly. For the coming year, we anticipate a relatively benign growth environment, with continued momentum in the US, a modest acceleration in Europe and an ‘Abenomics’-driven recovery in Japan, offsetting China’s slower growth trajectory.”

An improving economy should lead to more private equity buyout activity, according to Anthony Tutrone, Neuberger Berman’s Global Head of Alternatives.

“At this point, we haven’t gotten to a major acceleration in buyouts, but we believe deals will begin to pick up,” he said.

Alan Dorsey, the firm’s Head of Investment Strategy and Risk, said a key issue for 2014 is achieving incremental return—whether through capital appreciation or additional yield—mindful that return outlooks have gradually shifted downward while interest rates remain extremely low. Alternatives are one key area that has gained traction, but another particularly important one from a portfolio allocation standpoint is emerging markets, he said.

“As investors enter 2014, improving global growth combined with shifting monetary policy are creating a nuanced environment, with obstacles but also opportunities,” said Paul O’Halloran, Managing Director, NB Australia.

Download Solving for 2014 here.

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Exposure to overseas investment up during last quarter.

The Certitude Global Investing Intentions Index (CGIII) rose in August, continuing the trend of the past quarter, indicating that more Australian investors are planning to increase their exposure to overseas assets.
The Index, which tracks net demands for global investments, rose to 175 points in August, representing a 3.5% increase from last month (169) and an 11.4% increase over the past quarter (rolling).

In addition, the timeframe for the intended overseas allocation continues to shrink. In August, 36% of investors stated that they intend to make their next overseas investment within the next three months. Over the past rolling quarter, the amount of investors planning to go global in the next three months has grown by 33%.

This is a reflection of investors’ view that global markets are likely to rise over the next year, with 74% of those surveyed expecting a rise compared to only 15% who anticipate global markets will fall.

Craig Mowll, CEO of Certitude Global Investments said: “This research has shown that not only are investors more interested in global investments but they are also becoming more serious about actually allocating assets overseas. 43% of the investors we surveyed believe they need more international exposure in their portfolios – this has remained consistent over the past quarter. What has changed is that their intentions to act on this by increasing their overseas assets have risen steadily, according to the CGIII.

“The research confirms that Australian investors, who have long held a very strong domestic bias, recognise the opportunities for growth, income and diversification that come from investing globally.”

Investors warming to Europe and China

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