This is one of a series of articles in the January edition of Global Outlook, which also shines a spotlight on emerging markets, examines the global economy into 2016, the outlook for US bond markets and sterling, and drivers of global equities.

Alex Wolf, Emerging Markets Economist, Standard Life Investments said: “In China, we expect policymakers to continue walking a tightrope – balancing enough fiscal and monetary stimulus to prevent a sharper growth collapse, while slowly proceeding with supply side reforms to remove excess capacity. Slowing Chinese demand, which we believe was worse than official data reflected, was one of the largest causes of the emerging market trade and output contraction experienced last year. As such we see some room for cyclical upside, as policy measures take effect.

“However, our longer-term outlook on China has become increasingly negative. Our own view is that GDP growth is closer to 5% than the 6.9% reported by the Chinese authorities. Although we believe policy makers will avoid a hard landing, it is becoming more likely that Chinese leaders will not enact necessary reforms quickly, especially of state owned enterprises (SOE). SOEs are at the heart of China’s problems, and reforms here would deliver the biggest dividends from a growth and rebalancing perspective, but Beijing has been dragging its feet.

“SOE reform plans delivered over recent months were received with optimism, but we believe they failed to address corporate governance issues or the reduction of excess capacity through corporate restructuring and closures.

“Consolidation has been the preferred path, and the government seemed unwilling to sell or reduce state assets in a meaningful way. The plan will lack effectiveness if the focus on addressing loss-making companies and overcapacity is limited to a small number of centrally-owned SOEs, and not the mass of locally-owned SOEs, where most of the overcapacity and inefficiencies lie.

“If China growth does disappoint this could drive continued volatility in global markets. Sluggish growth is priced into markets but a hard landing which impacts on currency, capital flows, commodities and social stability is not. This could result in more aggressive domestic monetary easing, forcing the renminbi lower against the dollar, with adverse implications for global inflation and a blow to emerging markets dependent on robust Chinese demand for manufactured goods and commodities.

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Standard Life Investments Global Perspectives.

Standard Life Investments, the global investment manager, has examined the long-term drivers of the changing share of national income between labour and capital.

While some of the factors affecting income shares and income inequality may reverse in coming years, pressures are growing on politicians to act. Governments should keep in mind that they are best pursuing policies that have the double dividend of lowering inequality and boosting economic growth.

The latest edition of Global Perspective examines changes in the way that national income is distributed within the developed world. Not only has labour’s share of national income fallen in most OECD countries, but there has also been a widespread increase in income inequality. Both country-specific and global factors lie behind these trends. The key factors include globalisation, technological change, tax policy and changes in workers’ bargaining power.

Jeremy Lawson, Chief Economist, Standard Life Investments, said: “Our findings show that there are significant implications for financial markets, not only as the economic cycle moves forward and structural drivers alter but also as pressures grow on governments to act.  We expect the economic recoveries taking place in most countries to generate a modest increase in labour income shares as unemployment falls away,  although it is unlikely to make up for the losses of previous decades. That implies that the corporate profit share of income should fall but not far.

“If market forces are not able to generate a more equitable distribution of society’s resources, governments will come under pressure to act. For example, earned-income tax credits, other well targeted fiscal transfers, and active labour market policies all strengthen the incentives to work, or rewards from employment, and are therefore more likely to have a positive growth trade-off than sharply raising marginal income tax rates or strengthening employment protection. Slower acting but equally important are educational and training policies that raise the human capital/skills of lower income workers.”

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Among the countries where inflation has moderated, the majority are in the Eurozone, where inflation was forced down by euro appreciation, weak domestic demand and relative cost adjustments (see chart 1).

The currency’s more recent reversal will put some upward pressure on inflation over the coming year, but declining commodity prices, a weak economy and futher relative price changes will work in the other direction.

If the ECB wants to lift inflation out of the danger zone, it will have to follow Japan’s lead sooner rather than later. India and Indonesia are the only large emerging economies where inflation has declined significantly over the period.

Unlike Europe though, weaker inflation is a positive development that will relieve pressure on their central banks and make it easier to push through needed reforms. The recent plunge in oil and agricultural commodity prices will lower inflation further in the coming months, as energy and food prices make up more than 50% of their price baskets.

The countries where headline inflation has increased since mid-2013 fall into two main camps. In the first camp are Brazil, Russia and Turkey. All are plagued by the structurally high inflation that results from poorly designed product and labour market regulations, entrenched high inflation expectations and central banks that have paid insufficient attention to their inflation targets.

Turkey will benefit from the recent falls in commodities, but it is a mixed blessing for Brazil and Russia. While they will likely enjoy some moderation in headline inflation, both are net exporters of commodities and the resultant deterioration in their terms of trade will weigh on their already very weak domestic economies.

Meanwhile, inflation is likely on a long upward trajectory in the US and Japan. In the US, domestic inflation pressures are gradually building as labour market slack continues to erode. In Japan, the jump in inflation has been triggered by the April sales tax hike and the Bank of Japan’s massive policy stimulus, which has led to a 28% depreciation of the exchange rate over the past two years and a tightening in the labour market.

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Weekly Economic Briefing

Standard Life’s Global Outlook Report.

With all the negative headlines coming out of the Ukraine and Middle East in recent weeks, it has been easy to forget that the global economy is actually in fairly good shape.

Helped by generally loose financial conditions, as well as pent-up demand in most developed economies after years of tepid growth, the global composite Purchasing Managers Index (PMI) held up at 55.1 in August.

That reading is a little lower than the levels recorded in June and July, but it is still the third highest outturn since the beginning of 2011. Helpfully, the global recovery is becoming less dependent on manufacturing activity to drive growth.

Whereas the global manufacturing PMI is currently at 52.6, signalling healthy though not spectacular growth, the global services PMI is sitting at 55.5, not far from a post-financial-crisis high. Taken at face value, such levels of business sentiment are consistent with above trend global output growth, although there has been a tendency for the PMIs to overstate official GDP growth in recent quarters.

While the global backdrop is undoubtedly positive, not all countries and regions are sharing in the wealth equally (see chart 1).

Among the world’s largest economies, the US and UK continue to lead the way, reinforcing our view that the Federal Reserve and Bank of England will be the first central banks to begin raising short-term interest rates.

The US in particular appears to be accelerating into the second half of the year, led by vehicle sales and business investment. Sentiment is also holding up fairly well in Japan, although it is well below the levels recorded at the beginning of the Abe revolution and the rebound from the sales tax hike has been weaker than hoped.

However, the biggest disappointment is the Euro-zone, where the recovery is in danger of petering out before it even began. The biggest drags are still France and Italy, although even German growth has moderated of late; no prizes then for guessing why the ECB announced new easing measures last week.

The BRICs remain a mixed bag. The Chinese authorities are pushing to hit their 7.5% growth target, despite the related financial risks being generated.

Meanwhile, Russia is sinking under the weight of sanctions and Brazil has fallen into recession. Indeed, only the Indian economy seems likely to accelerate in the second half of the year.

Click here to download the full report.

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Global Perspective Standard Life Investments

Standard Life Investments, the global investment manager, highlights that investor interest in a range of real assets has been building for some time and that long-term investors are increasingly considering real assets to assist with enhancing portfolio diversification and liability matching.

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The first half of 2014 saw third party net inflows of AUD 7.7bn, record third party assets under management (AUM) of AUD 195.6bn, record total AUM of AUD 353.5bn and record operating profit before tax of AUD 189.8m.

Keith Skeoch, CEO, Standard Life Investments said “I am privileged to have been the CEO at Standard Life Investments for just over ten years now and pleased to be able to report another strong set of half year results. However, as a firm believer in the benefits of long term active investing, what pleases me most are the strong relationships we have established with institutional and retail clients around the world over the past ten years. A defining decade for Standard Life Investments which, despite some of the most volatile and challenging markets experienced in recent times, has seen:

• Third party AUM increase over six-fold from AUD 39.5bn to AUD 195.6bn*
• An unbroken decade of third party net inflows with cumulative net inflows of AUD 120.9bn representing a ten year CAGR of 14%, accounting for two-thirds of the increase in AUM
• Third party net inflows from overseas clients increase from 3% to 57%
• Operating profit increase over ten-fold from AUD 15.5m to AUD 189.8m
• Excellent investment performance with third party AUM above benchmark: one year 87%; three years 89%; five years 91%; ten years 81%
• Standard Life Investments become the largest active manager of purely UK Pension Assets, up from 20th position in 2004**
• Standard Life Investments move from 39th in 2004 to 5th in 2014 for UK retail AUM***

“The strength of our investment performance and net inflows over the last decade mark Standard Life Investments out as one of the leading asset managers. Our success and rapid growth as an active fund manager in a decade that saw a general increase in the use of passive strategies is testimony to our ‘Focus on Change’ investment philosophy. There is also growing global recognition of the benefits clients can gain by working with a manager who is seen to add value by taking a long term approach to investing.

“The addition of Standard Life Wealth and Ignis Asset Management present a great opportunity for us going forward. They will help deepen our investment capabilities, broaden our third party client base and strengthen our strategic position.

“I am confident that as we look forward to the next ten years Standard Life Investments has the proven investment expertise and global distribution capabilities that will continue to deliver both superior investment performance and innovative solutions for our clients.”

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*If the AUD 107.6bn of Ignis Asset Management funds, as at 31 Dec 2013, are included the increase is over ten-fold. ** Source FT research. *** Standard Life Investments

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Matthew Newham

Standard Life Investments, the global asset manager, is pleased to announce that its highly successful Global Absolute Returns Strategies Australian Trust (ARN 125 891 26) is now available via the Macquarie Wrap platform.

Global Absolute Return Strategies (GARS) is an award-winning multi-asset strategy, which aims to provide positive returns irrespective of market conditions with reduced volatility compared to equities.

“We are delighted that Macquarie Wrap has added GARS to its investment offering. Macquarie is a well-regarded investment platform and we are thrilled GARS has been added. GARS is building good momentum in the retail sector,” said Matthew Newham, Investment Director Wholesale Business, Standard Life Investments.

The GARS Australian Trust has delivered strong returns since its inception in the Australian market in 2009, delivering an overall net return of 10.1% per annum, over the four years from 2009 to 30 June 2014.

The multi asset strategy has a risk expectation of a third to half of the equity market, with a target return of cash plus 5 per cent per annum (gross of fees), over rolling 3-year periods. The volatility of the fund over the four-year period has been just 4.3% compared to global equity volatility of 9.7% and 12.6% for Australian equities.

“GARS has a proven consistent four-year track record of returns for Australian investors which is important as investors increasingly shift away from the traditional balanced portfolio of equities and bonds and towards absolute return investing,” Mr Newham said.

“Unlike most traditional investment strategies that aim only to beat market benchmarks, a diversified absolute return approach focuses on delivering positive, stable returns, independent of specific market or economic conditions. Importantly, the absence of a benchmark index allows absolute return managers freedom to exercise full discretion, selecting only those strategies they expect will be rewarding.

“GARS consists of typically 25 to 35 strategies that span global markets, each one selected for its return potential over a three-year horizon. Crucially, we seek strategies that complement each other so the portfolio can work as a whole even when unexpected things happen in the markets,” he said.

“An absolute return approach, offering attractive levels of growth while also limiting the risk of capital loss, merits consideration for every investor’s portfolio.” Mr Newham said.

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Speaking yesterday in Sydney, Jeremy Lawson, Chief Economist, Standard Life Investments said: “Australia should act now to reverse its structural fiscal slippage, with a rise in taxes and a drop in spending both necessary for better fiscal control.”

Australian governments have rested on their fiscal laurels during the commodity price boom and rather than squirrel large surpluses away for a rainy day, governments have satisfied voters’ appetite for lower taxes and more generous spending.

“Australia’s tax share of GDP has declined by 1.3 percentage points (ppts) since 2003, despite the increase in government finances generated by the commodity boom and rapid income growth before the global financial crisis. Only five other OECD countries have seen larger falls. Meanwhile, Australia’s government spending share of GDP has increased by 2 percentage points over the past decade, slightly above the OECD average, and could continue to rise.

“Australia’s aging population alone could add more than 5 percentage points to the budget deficit over the next 40 years, mostly due to rising health care spending. Australia’s public finances will deteriorate over time without action to raise taxes and restrain spending.

“Our view is that long-term fiscal consolidation of the magnitude required will have to involve rising taxes as well as greater spending discipline. The states and the Commonwealth must work more cooperatively for the fiscal situation to improve. The states cannot raise enough revenue to meet all of their spending obligations and rely heavily on tied grants from the federal government, as well as GST revenue, to make up the difference.

“Although centralising more spending responsibilities within the federal government structure would better align revenue raising powers with spending responsibilities, a superior course of action would be to devolve more revenue raising powers to the states. That would better provide them with the means and incentives to appropriately manage their fiscal arrangements.

“Moreover, the management of the federal budget has been poor for more than a decade. The Parliamentary Budget Office should be given more formal responsibility for monitoring the federal budget and ensuring that policy is consistent with longer-term fiscal sustainability.

“We recognise that there are no easy solutions to this problem. If, however, governments and oppositions wait too long to confront the country’s long-term fiscal challenges, Australia could eventually lose its safe haven status. That would raise government and private sector borrowing costs, as well as reduce demand for riskier Australian assets, making everyone worse off.”

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UK real estate market attracting strong investor appetite.

Standard Life Investments, the global real estate manager, believes the UK real estate market and core markets in Europe are attracting strong investor appetite, which is expected to drive returns in the second half of the year.

Speaking in Australia this week, Nalaka De Silva, Real Estate Investment Director, Standard Life Investments, said: “The UK has made a notable recovery, showing stronger growth than Continental Europe. We particularly favour the central London office market and large-scale regional shopping centres, as well as the South East UK office and industrial markets, which we expect will remain attractive in the near term.

“In continental Europe, we favour core markets such as France, Germany and Sweden, where strong investor appetite is expected to drive returns in the near term. There is also opportunity in the periphery markets such as Italy and Spain which look promising over the next 12-18 months from a pricing perspective.”

Standard Life Investments’ research highlights that only now is the wider European economy regaining some momentum after the global credit crunch and sovereign debt crisis, driving an increase in risk appetite.

“Many real estate investors are looking to move up the risk curve. As they do so, investors need to identify the most suitable strategy, or blend of strategies that they can employ to add or reduce risk within a European real estate portfolio. This requires an understanding of individual market characteristics and what future economic and real estate cycles may look like.

“In Asia Pacific, our preference is for higher-yielding sectors such as Australian logistics, along with growth sectors such as Japan offices. In Northern America, we prefer markets that have further upside from tight fundamentals that are positioned to generate relatively sturdy income, these include markets such as San Francisco and Seattle offices along with Mid-Town Manhattan offices.

“Our three-year view anticipates that global real estate will continue to outperform cash,” Mr De Silva said.

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Shareholder engagement in the UK is evolving: Standard Life Investements

Standard Life Investments, the global investment manager, believes that shareholder engagement in the UK is evolving, with more discussion on remuneration policies representing another step towards improved governance, stewardship and trust.  If 2013 was the year of responsibilities and regulation, 2014 has emerged as the year of consultation.

The 2014 UK AGM season featured the introduction of a binding shareholder vote on companies’ remuneration policies, representing a further significant development in the relationship between companies and their shareholders.

The latest edition of Global Outlook looks back at the 2014 UK AGM season to assess whether the voting indicates any change in the behaviour of shareholders and companies and considers whether the new legislation, designed to strengthen shareholder rights over executive pay, have worked as intended.

Mike Everett, Director of Governance & Stewardship, Standard Life Investments, said: “The 2014 AGM season was another step on the journey towards improved governance, stewardship, engagement and trust in the companies to which savers and investors entrust their future.

“The new binding vote on pay has encouraged engagement by companies and we hope that this will continue in years to come on broader topics such as values and business practices, audit quality and succession planning.”

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