Steve Merlicek

Steve Merlicek, IOOF’s Chief Investment Officer, recently spent a week in Washington DC meeting with a number of economic strategists and think-tanks discussing investment trends.

While traveling, the hot topic was, as expected, Donald Trump and his policies. The consensus that emerged was that it would be difficult for him to get anything through Congress – despite Congress being dominated by the Republicans.

Mr Merlicek said, “As one Republican explained, President Trump is a tenant in the White House that can’t be evicted. With record low popularity for a new President, the inability to get legislation through Congress (the recent win on healthcare could be an exception – though still has to pass the Senate) and what many would characterise as irrational behaviour – all seems a recipe for disaster.”

Despite the above, the Dow Jones Index has rallied nearly 20% since his election, business and consumer confidence is high, corporate earnings good, unemployment low, various positive forward-looking indices are good (such as the US ISM Purchasing Managers Index). Various other indicators such as retail sales and first quarter GDP are not so good and the latest consumer confidence figures have declined.

Listed equity markets and many other asset classes are at elevated levels. This largely is a result of the Fed’s policy since 2008, as it has dropped interest rates to historical lows and expanded its balance sheet (quantitative easing). It has expanded its assets from $800 billion pre crisis to $4.5 trillion currently. The Fed’s policy since 2008 has been to increase risk taking to get yield and to inflate asset prices – which it has been very successful at.

The other discussion point was geopolitics, be it North Korea, China, Syria, Russia and so on. Whilst a lot potentially can happen on all these fronts, the markets so far have been totally uncorrelated to geopolitical events. If anything the markets are climbing the wall of worry and unless there is actually an outbreak of hostilities, it seems that the markets will ignore geopolitical events.

In concluding, Mr Merlicek said, “Despite possible legislative gridlock in Washington and a whole host of geopolitical events, markets are focused on other factors. It should be remembered that under Barack Obama there was gridlock and little major legislation was enacted. Despite this, US equity markets had one of the largest rallies in history.

“Factors to watch going forward will be (apart from the usual economic indicators): whether Trump can get tax cuts through Congress; whether substantial fiscal stimulus will occur as a result of defence and infrastructure spending; and, not to forget, that the actions of the Fed will always be critical to the direction of markets.”

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The ‘Recommended’ rating indicates Lonsec’s strong conviction that the Fund can generate risk adjusted returns in line with its objectives.

The Fund is an actively managed multi-manager fund, providing exposure to a selection of global equity managers chosen for their different, yet complementary investment styles.

In its report, Lonsec endorsed IOOF’s thorough research process, noting the rating is underpinned by a robust and transparent investment process and portfolio construction. Additionally, it identified the depth of experience of the Fund’s Portfolio Manager, Stanley Yeo.

Steve Merlicek, IOOF Chief Investment Officer, commented “We are pleased to have received the sought-after ‘Recommended’ rating from Lonsec for this Fund. The rating recognises the quality of IOOF’s Investment team, the meticulousness of our approach to investing and our ability to continue constructing superior multi-manager investment solutions that meet our investors’ needs.”

This rating now sees the full suite of IOOF multi-manager funds rated as ‘Recommended’ by Lonsec. It follows the recent introduction of the IOOF MultiSeries range in October 2016, where all funds debuted with a ‘Recommended’ rating, a fantastic achievement for any new product range.

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Steve will continue his association with IOOF following his retirement on 30 June 2017, by remaining as a member of the Investment Management Committee. IOOF Managing Director, Christopher Kelaher commented, “I am delighted that it is Steve’s wish to maintain a close association with our business and continue contributing to its ongoing
success.

Steve has made an outstanding contribution to IOOF and has been instrumental in delivering impressive investment outperformance over the long-term. Steve has also built a strong and capable investment team, testament to which is the elevation of Dan Farmer to the Chief Investment Officer role.”

Dan has been with IOOF for seven years and during this time has played an integral part in the award winning team’s delivery of quality multi-manager investment solutions and strong
performance.

Mr Kelaher added “I am very pleased that we have the talent and bench-strength to appoint an internal successor. The company has supported Steve in building a high calibre investment management team. I am confident that Dan and the investment team will continue the strong track record of investment outperformance following the planned transition.”

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Mr. Acosta joins IOOF from Western Asset Management, where he was responsible for managing the trading of fixed income securities, and implementing interest rate strategies across a number portfolios, including core fixed interest and global mandates.

Commenting on the appointment, IOOF Chief Investment Officer Steve Merlicek said, “The appointment reflects IOOF’s increased funds under management in this area and the need to split the management of the cash and fixed income portfolios.

“Osvaldo will be a great addition in this space with significant experience in both cash and fixed interest. He has pathed a successful career in investment management, having held various roles at Australian Unity and within Treasury functions.

“We are delighted Osvaldo is joining the IOOF Investment team. Osvaldo will enhance our capabilities in this space and will assist us in continuing to drive our award-winning performance going forward.”

Mr. Acosta will work closely with Juanita Escobar, former Portfolio Manager, Cash and Fixed Income. Ms. Escobar will continue to run the outperforming cash funds as Portfolio Manager, Cash.

Mr. Acosta is based in IOOF’s Melbourne office.

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Steve Merlicek

Asset prices have risen to record levels in recent years owing to central banks embarking on a policy of monetary easing and direct intervention in the aftermath of the GFC.

According to IOOF, this asset price inflation is in no way surprising as it was the intention of monetary authorities to support asset prices – and they have been very successful. Maybe too successful.

Despite this success, central banks have not managed to achieve their goal of growing the real economy by encouraging investment. Investors are still reluctant to borrow and lenders are nervous to lend, despite ultra-accommodative monetary policy. The boost to the ‘real’ economy that was expected has not occurred.

With interest rates very close to zero or in some cases negative, monetary stimulus measures have largely come to their natural end-point meaning other measures, such as fiscal policy, will be required. To give due credit to monetary authorities, they did not really have a choice; the economic situation after the GFC would have been a lot worse without their intervention.

Irrespective of how it happened, this leaves financial markets in Star Trek territory; needing to boldly face the unintended consequences of asset price inflation and seek out new ways to find value.

Expensive asset classes – where do we see value?

All asset prices are benchmarked in terms of their risk by using the ‘risk-free rate’. Yet with the risk free rate close to zero, this has huge implications for all asset classes.

Bond markets are now characterised by return free risk rather than risk free return. With many bond markets earning negative returns, either in nominal or real terms, investors are not being rewarded for holding these instruments. In this environment, it is very hard to hold sovereign bonds as they generate little or no return but can cause losses on a mark to market basis.

The pre-existing relationship between bonds and equities is also breaking down and reduces the benefit stemming from portfolio diversification. Traditionally, bond prices would rise as equities fell. This is unlikely to occur now, or to a much lesser extent than in the past. Bonds will still tend to protect capital in the event of an equity market fall – but the same can be achieved with cash and it won’t decline if interest rates increase.

The natural consequences of low bond rates is that investors seek to gain exposure to other fixed or floating debt instruments to obtain income. The danger is that investors on the hunt for yield go too far out on the risk curve and end up with equity type risk rather than bond type risk. Despite these risks and the large rally in many debt type instruments over the last few years, we still see relative value in various private debt/credit instruments. Of course, this is often a relative value trade and if official interest rates were to increase substantially, these types of instruments would be negatively affected.

To counter this, it is important to try and utilise floating rate instruments in higher quality companies that would be less impacted by official interest rate increases and a downturn in the economy. At this stage there does not seem to be the preconditions for a large increase in official interest rates and the risk of recession seems quite low in most countries around the world. Thus, corporate debt, bank loans, mezzanine debt and selected bank hybrids all present opportunities in the current market – but one needs to be selective.

With respect to equities, they have had a significant rally since the GFC, benefiting from low interest rates, multiples expansion and their ability to generate yield, which is particularly attractive in a low interest rate environment. Equity markets are no longer cheap – tending to be overpriced (though not substantially) in many markets. There have been significant pockets of cheapness, such as emerging markets and resources stocks, but in more recent times these sectors have enjoyed significant rallies.

Whilst equities do seem overpriced, compared to bonds they still offer reasonable value. This is largely because bonds are so expensive rather than because equities are cheap. The other aspect to consider is TINA – there is no alternative to equities – if you sell out of equities where do you go?

With respect to alternative assets the picture is more mixed. Areas like infrastructure have had significant positive performance owing to the hunt for yield, but other areas such as hedge funds have significantly underperformed.

The outlook and performance of private equity has been mixed and needs careful assessment on a case-by-case basis, even though overall valuations in private equity are linked indirectly to the equity markets with a lag.

Property has been a direct beneficiary of low and declining interest rates – thus the double digit performance of REITs over the last five years. As interest rates have declined, the capitalisation rates in direct property have also fallen significantly over the last few years – though there are still pockets of value and the asset class still looks relatively attractive when compared to bond valuations.

In conclusion, it is very difficult to find cheap asset classes in the current environment. In this scenario it is important to take a fully diversified approach. This will not only cushion the portfolio but allow greater flexibility to capture mis-pricings and downtimes that will inevitably occur from time to time.

By Steve Merlicek, Chief Investment Officer

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