EM Investor Reactions to Fed’s Decision

Ending months of speculation, the US Federal Reserve decided to hold interest rates at their historic low levels last week, as concerns for a fragile global economy overshadowed recent evidence of a strengthening US recovery.

Janet Yellen, the Fed chair, stressed that growth in emerging markets was an important consideration behind the decision to keep US interest rates on hold. Forecasts from the Fed’s board members had suggested that the first increase in nine years would take place this year, but three officials now expect Yellen to hold off until 2016, and one predicted it may even be 2017 before rates rise.

Institutional investors and analysts have already begun to speculate regarding the impact of the decision on emerging market investment strategies. In today’s blog, we have summarised some of these reactions.

As a refresher, here is an updated emerging market performance/valuation map

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Franklin Templeton:

“In our view as investors in emerging markets, this isn’t necessarily positive news, because we are still left with the uncertainty that has been plaguing the market for some time. We know that the markets dislike uncertainty, so we could also be left with continued volatility through year-end.

On the other side of this equation are the positive aspects. If in coming months the Fed feels confident enough in the US economy to raise interest rates, it could be viewed as positive news for emerging markets, particularly those with export ties that benefit from a strengthening US economy. We would anticipate a stronger US economy would likely bring increased demand for more imported goods, and a stronger US dollar relative to other emerging market currencies could put emerging markets in a more favorable trade position. Weaker currencies tend to promote exports and help manufacturers.”

J.P. Morgan Asset Management

“Regardless of economic impacts, the Fed’s rationale for its decision does suggest a slower general increase in interest rates, limiting bond market losses and potentially producing gains in some areas. It could also boost emerging market assets if investors feel less urgency to move money ahead of a more general flow of capital to the United States. Finally, it could limit U.S. equity market gains. While the Fed cited volatility as one of its reasons for not raising rates at this meeting, increased uncertainty about the Fed will likely increase volatility and thus hurt U.S. stocks even as the Fed itself, satisfied with U.S. progress, nevertheless waits on the world to change.”

Recent related piece from Gabriela Santos Global and Ben Luk from Global Market Strategy team titled Emerging markets and the Fed: A game changer?

Fidelity Management & Research

“The market was not expecting a rate hike, so this outcome is exactly what was priced in. So while there is often a lot of noise immediately following a Fed announcement, there shouldn’t be a lot of market movement in the short term. Long-term, conditions haven’t really changed. The United States remains the best house in a bad neighborhood—domestic economic progress is better than in most other developed countries. With slow growth, a low rate environment may persist for longer than many investors were anticipating. If the Fed does move to tighten in the near term, it’s going to squeeze dollar liquidity even more. In my view, that could potentially be an even bigger headwind for some areas, like China and emerging markets, which have already been hit the hardest. So, my expectation going forward is that the market volatility we’re seeing is going to remain relatively elevated.”

Recent related piece from Dominic Rossi (Global Chief Investment Officer, Equities, at Fidelity Worldwide Investment):  FT: World faces third deflationary wave – EM crisis means further fall in potential global output is unavoidable

Schroders 

“As external factors are outweighing domestic it could be argued that the outlook for the Fed now depends on the outlook for China. In our view China may get a boost from fiscal support in the coming months, but the underlying picture is one of an economy where growth is grinding lower.  The Fed could well wait beyond January before lift-off with March 2016 now the more likely date. All in all, the Fed’s economic outlook remains relatively stable and positive. However, it is clear that international developments will dominate Fed policy in the near-term.”

Deutsche Asset & Wealth Management

“While the Chinese backdrop is not encouraging, the U.S. domestic economy continues to do well and the Eurozone is getting back on its feet, meaning that any developed-market correction is likely to be short-term in nature. Emerging markets may find the going tougher. Aggregate EM economic growth remains strong but there does appear to be an underlying trend towards slower export growth, even after the recent currency depreciation. A structural shift towards consumption in many emerging markets may be one reason for this. Another could be the increasing economic complexity of Asian economies, meaning that they can handle more aspects of the production process internally with less need for foreign trade of inputs.”

UBS Asset Management

“It now looks likely that the Fed will hike in December, despite Chair Yellen’s insistence that the October meeting is still ‘live’. It is often argued that the Fed will only start its rate hikes when it has a press conference to explain, but there are procedures to call an ad hoc press conference after any meeting so that is not really a limitation. What is a limitation is that the “global economic and financial developments” are unlikely to be resolved enough in the next six weeks for the Fed to feel more confident.”

HSBC Asset Management

“EM equities are attractive for western currency based investors (USD, GBP or euro based) in our view. Within EM, Asia is our preferred region, as the prospective returns look higher, supported by the potential for currency upside over the long term, though there could be some volatility in the near term with Fed tightening approaching and a slowdown in China. We continue to believe that the global economic recovery is on track and global equity markets will post positive returns over the long term. In our opinion, continued support from global quantitative easing (QE) will, in the medium and longer term, likely outweigh headwinds created by slower Chinese growth and tighter US monetary policy.”

Lazard Asset Management

“We have taken advantage of the recent volatility to allocate capital to companies that we view as being punished in disproportion to their actual cash flow at risk. Having deep bottom-up fundamental research and clearly defined scenarios for company earnings and valuation can turn situations like these into excellent buying opportunities.

The China slowdown is to some degree inevitable as the law of large numbers and competitive pressures arising from wage increases and environmental degradation affect growth. Many companies have adapted to a range of economic changes in the last decade and will do so in this situation. Valuations are not stretched, especially after the recent sell-off, although they are above historical levels. When compared to fixed income alternatives, equities look inexpensive on many counts. Our view is that the near-panic seen in recent days in various markets could represent a capitulation that creates opportunities for investors with time horizons measured in years rather than months.”

 

Julius Baer

“The question for investors and emerging markets (EM) is not whether the Fed is going to hike rates or not. The question over the next 12 months is whether there will be negative surprises (more hikes than expected) and which emerging markets are the most vulnerable.”

State Street Global Advisors

“Resolution of China’s debt woes and a growth trough are likely to be a bigger drag than near-term fed action. While the situation today is reminiscent of the fed hike in 1994 and subsequent EM crisis, it’s important to note that the current debt in EM’s is predominantly in local currency and FX reserves still remain strong.”

Sources: Public statements, documents and websites of relevant companies. Chart is sourced from Blackrock Investment Institute.

Developments in Sovereign Wealth

Invesco Asset Management recently surveyed 59 sovereign wealth funds (SWFs) worldwide and published a report outlining some of the key themes. A few points which we found particularly interesting:

  • Studying the investment preferences of SWFs, there is continued growth in emerging market allocations for new assets, however developed markets remain a preferred choice. Two headline corrections visible are: relationship between emerging market investment and infrastructure and relationship between developed markets and real estate. As discussed earlier, a number of funds are also beginning to targer frontier markets.
  • SWFs cite a number of factors which restrict their investment in emerging markets, such as political instability, corruption, regulation change and a lack of legal protection. These risks are of particular concern to SWFs because they cannot be quantified and many emerging market investments are prohibited by risk management guidelines irrespective of potential returns.
  • The biggest challenge for SWFs is sourcing new deals. Respondents explained that sourcing deals is toughest in infrastructure and is driving greater collaboration between SWFs, especially those across emerging markets. Good example of this is last week’s announcement of Saudi SWFs $10bn into Russia via its RDIF fund.
  • As we have noted earlier with some of largest pension funds, SWFs are relying more on in-house expertise to manage their funds in an effort to bring down costs and improve performance in the low-yield environment. The report points out that the percentage of global equities managed in-house rose to 34 percent from 26 percent at the end of 2013 (see chart below). Historically the vast majority of the fund’s equity investments were outsourced to external fund managers. It is a trend worth watching, and it continues it will mean that SWFs will continue to grow in relevance to Investor Relations Teams teams. Many of the largest funds are already frequently engaging management teams.

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Perceived attractiveness of top 10 economies based on economic performance, private sector investment opportunities and investment opportunities for sovereign investors

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SWFs assets in perspective

Total Mutual Fund AUM: $74.3 tr

Global Pension Fund AUM: $37.3 tr

Sovereign Wealth AUM: $7.3 tr

Exchange Traded Funds AUM: $ 3.0 tr

Hedge Fund AUM: $2.8 tr

Additional reading

 
 

Source: Invesco Global Sovereign Asset Management Study 2015

BlackRock launches its first China A share ETF for international investors

As China is opening its stock market to greater foreign investment, licensed fund managers are using their own Renminbi Qualified Foreign Institutional Investor (RQFII) quota to offer new products to their clients. BlackRock has today launched an ETF focused on the hard-to-access A shares in China, that aims to track the performance of the MSCI China A International Index. This index represents a broad and diversified basket of over 300 large and mid cap stocks.

The fund is listed on the London Stock Exchange, giving BlackRock’s international institutional and retail clients direct access to China’s A share equity market. A shares are mainland China incorporated companies listed on the Shanghai and Shenzhen Stock Exchanges. China A shares represents about 45.6% of the Chinese equity market, as defined by the MSCI China All Shares Index, which contains A shares, B shares, H shares, red chips and private chips.

Further References:

Fund Fact Sheets

Fund Prospectus

EM Investor Alert: DFM & Goldman Sachs to hold London roadshow, 21-22 April

Dubai Financial Market is hosting its biggest roadshow since inception in London on the 21st and 22nd of April 2015 in collaboration with Goldman Sachs. Attending the roadshow will be the C- Level executives of DFM’s top 20 companies who will be giving the latest updates on the developments and strategies of their companies.

Participating companies:

Air Arabia
Aramex
Damac Real Estate
Drake & Scull
Dubai Investments PJSC
Dubai Islamic Bank
Dubai Parks
Emaar Malls Group
Emaar Properties
Emirates REIT
GGICO
Gulf Finance House-GFH
MARKA
Mashreqbank
Shuaa Capital
DFM
Orascom
DEPA

If you are an institutional investor and wish to be part of this event please send an e-mail to rchamut@dfm.ae

Drivers of Innovation in Fund Management

research study published last week by London-based think tank Create Research deserves a closer look. Amin Rajan, who is both CEO of Create and an early mentor to Closir, conducted a study into how digitisation, and the intrusion of internet and mobile players, looks set to reshape the asset management industry during the coming months.

Fund managers themselves have been slow to embrace technological innovation, although in the last 12 months a number of global trends have started to help the process along:

  • An exponential growth in number of affluent investors
  • An increasingly tech-savvy population
  • Greater flexibility in pension contributions and longer life expectancy
  • Increasing demand for transparency and synchronisation from regulators
  • Growth of geographically ‘portable’ investment products such as ETFs
  • The popularity of social media channels spilling over into the finance community

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The report outlines the emergence of several new models:

In the evolving marketplace, virtual advisors offer the mass affluent market a streamlined communication process through mobile and digital media, enabling them to take advantage of technology while retaining some of the personal touch.

Online advice platforms, or ‘robo advisors’ as they are being called by some, have already started to offer retail clients the chance to build personalised portfolios using proprietary algorithms.

Fund consolidation portals will help them to aggregate and manage investible funds across multiple platforms.

Given the obvious opportunities these trends present for ambitious and resourceful technology players, it’s unsurprising to hear Google and Apple mentioned as potential disruptors. Create’s report suggests mobile phone providers may also be well positioned to enter the fray.

Although industry players have been losing sleep over the tech giants for some time, there are obvious hurdles for data-sharing social technology companies in an industry which is defined by a strong risk culture, regulatory oversight and the importance of data security.

Strategic partnership with finance players may be a good option for technology and mobile companies, as it offers them a way to mitigate these concerns while making the most of complementary skill sets. There have already been some high-profile collaborations, with Aberdeen Asset Management forming an alliance with Google and Canadian mobile provider Rogers Communications partnering with Canadian bank CIBC.

Change may be gradual in an industry traditionally resistant to technology. Create points to the airline industry as a successful model, where both customers and providers quickly adapted to the increased efficiency offered by technology as concerns over security proved to be exaggerated.

Source: Create Research

Global pension funds to increase in-house management of assets

According to research published this week by State Street, more than 80% of pension schemes globally plan to bring more asset management responsibilities in-house as part of a more proactive approach to investing. As long term investors, pension funds have historically played a somewhat conservative role in the financial system. However, in today’s fast-moving environment it seems they are taking their destiny into their own hands, in particular by insourcing asset management capabilities and overhauling their approach to risk and governance.

The research surveyed 100 pension funds and found that the trend of bringing asset management in-house is driven partly by cost, with over a quarter indicating it is becoming increasingly difficult to justify external management fees. Over half of the pension funds are expecting to embrace lower-cost strategies alongside increased adoption of technology platforms and software solutions.

 

“Can we insource some components of the process and outsource other components? Traditionally we’ve bought the whole car. Maybe we need to buy the engine or buy the brakes or buy the engineering capability and just build the car ourselves.” – Richard Brandweiner, Chief Investment Officer, First State Super

 

The survey also points to a number of other trends that will shape the pension fund industry over the next five years.

Driven by lacklustre returns in a low-interest environment, pension funds are re-evaluating risk, with over 77% predicting risk appetites will increase. Pension funds are also expecting to make major shifts in asset allocations, steadily moving away from equities and bonds to less familiar asset classes such as alternatives in order to drive growth and meet long-term liabilities. Private equity is emerging as an attractive area for investment, with direct loans, real estate and infrastructure all expected to benefit.

Pension funds are also showing greater interest in investing in hedge funds. Globally 29% of pension funds that already invest in hedge funds plan to increase their allocations, while 25% plan to invest for the first time. It also comes as no surprise that over half of the respondents are planning to make better use of low-cost investment strategies. Many are adopting what are known as “barbell strategies” which involve blending a passive investment strategy with a higher-growth/risk strategy such as alternatives.

Finally, the survey points to some interesting conclusions around pension funds’ approach to risk and governance. One particular area of interest is the complex relationship between the pension fund and its asset manager, with 58% of respondents saying it is a challenge to get an accurate picture of their risk-adjusted performance. More than half also say it is increasingly difficult to ensure the interests of asset managers they are working with are aligned with their own.

 

Are there any implications for Investor Relations teams?

Yes, there could be, as global pension funds will increasingly look to invest and engage with companies directly. To prepare in advance it may be beneficial for IR teams to have a solid understanding of the largest pension funds, especially in North America and Europe where the above trends have been most prevalent. According to OECD, assets under management of pension funds reached $21.8 trillion in 2013 – this was concentrated mainly in the US, UK, Australia and Japan. There are a large amount of online databases and resources which can help you in your research, and we are more than happy to point you to the right direction.

 

How can Closir help?

Closir is a platform for professional investors to learn more and engage directly with Investor Relations teams. The platform is marketed to global pension funds, especially those taking a more proactive approach to investing. Closir’s reporting can give listed companies a better understanding of how industry trends are impacting the company and help them to target the most active pension funds.

 

Full State Street report can be requested online

Additional Resources:

OECD: Pension Markets in Focus 2013