State of decay: Does government control erode EM value?

In more developed markets, concern over state intervention centres around central bank policymaking. While that is of course highly relevant across emerging markets too, there is in fact an even larger state-led consideration when investing in these markets: the fact that c.23% of the MSCI Emerging Markets index is comprised of state-owned enterprises (SOEs).

The majority of these companies are not run with profit-maximising intention. They tend to be strategic state assets such as banks, or utility and resources companies, with heavy capital-expenditure burdens. This tends to make them poor stock investments over the long term, though a major commodity bull market can change the optics temporarily. Return on equity (ROE) is usually less important than other strategic desires of the state in capital-allocation decisions.

State ownership can provide stability, but this may involve significant shareholder value dilution, as minority investors tend to be a low priority in stressed situations or in capital-allocation decisions. Interestingly, we saw such dilution with many Western banks following the global financial crisis, and emerging-market companies are perhaps even less likely to focus on shareholder value in such situations.

We currently take zero exposure to SOEs and find the technology, consumer and health-care sectors are relatively free from state control and are where we find the most interesting investment opportunities.

Naomi Waistell, portfolio manager Emerging and Asian equity team. Newton Investment Management – a BNY Mellon Company

In more developed markets, concern over state intervention centres around central bank policymaking. While that is of course highly relevant across emerging markets too, there is in fact an even larger state-led consideration when investing in these markets: the fact that c.23% of the MSCI Emerging Markets index is comprised of state-owned enterprises (SOEs). The majority of these companies are … read more

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Tied to the benchmark?

Market cap-weighted benchmarks rose to prominence in the decades following the 1950s, when the concept of market ‘beta’ (representing the ‘fully diversified market portfolio’) was developed as part of modern portfolio theory[1]. Benchmarks are now the common proxy for beta. Originally, these benchmarks were used as a guide to help measure a manager’s performance. However, over time, market participants became fixated with analysing every difference between a portfolio and its benchmark, potentially tying investors closer to them and away from their core objectives.

With the rise of benchmark-aware investing, either explicitly (through passive mandates) or implicitly (via ‘closet’ indexing active portfolios) much of the industry has appeared to lose sight of this income-oriented objective, focusing instead on price moves in a market where the instruments redeem at par.

In our view in the credit markets, this obsession with benchmarks raises four key problems: indices are structurally-biased towards the most indebted issuers, market weights can lead to concentration risks, passive funds are prone to forced selling and ‘closet’ indexing can tie active funds to flawed benchmarks.

In our view, being more benchmark-agnostic, through looking for the most compelling credit opportunities, maximises the potential to capture beta and alpha more efficiently. In turn, we believe flexible strategies can help investors exploit the artificial barriers created by benchmarks.”

Gautam Khanna and James DiChiaro, senior portfolio managers. Insight Investment – a BNY Mellon Company

[1]Source: Portfolio Selection, Harry Markowitz, The Journal of Finance, 1952. 3 Bloomberg, Bank of America Merrill Lynch, Insight, as at June 2018

 

Market cap-weighted benchmarks rose to prominence in the decades following the 1950s, when the concept of market ‘beta’ (representing the ‘fully diversified market portfolio’) was developed as part of modern portfolio theory[1]. Benchmarks are now the common proxy for beta. Originally, these benchmarks were used as a guide to help measure a manager’s performance. However, over time, market participants became … read more

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Aviation finance – something in the air?

One investment area attracting increasing interest is aviation finance. Air passenger numbers have grown by about four or five per cent a year, with growth driven primarily by Asian emerging markets – in markets such as China – which have seen a steady rise in the number of middle income families. When people earn more they tend to fly more and the growth in tourism is another factor favouring the aviation sector.

Other factors underpinning the health of the sector include low oil prices, growing liberalisation of the aviation sector, and the development of airliners with increased capacity, such as the double-deck Airbus A380.

In a world where the search for yield continues and we have limited avenues to attain that, aviation finance is an area in which significant yield can be generated as long as investors are careful about the types of contracts they enter into. The good thing about the aviation finance industry is that contracts tend to be very tight, very specific and fully insured. Because aviation is such a regulated industry regulatory checks take place all the time and that can also deliver a degree of comfort for investors.

Paul Flood – multi-asset manager, Newton Investment Management

One investment area attracting increasing interest is aviation finance. Air passenger numbers have grown by about four or five per cent a year, with growth driven primarily by Asian emerging markets – in markets such as China – which have seen a steady rise in the number of middle income families. When people earn more they tend to fly more … read more

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Spectres of October crashes past

Keats called it the ‘season of mists and mellow fruitfulness’, but for the markets Autumn/Fall – and October in particular – can be a turbulent time.  There were the crashes of 2008 and 1987 of course, when the market sold off by 16.9% and 21.8% respectively[1].  And while an efficient market like the S&P shouldn’t be seasonal, it clearly is: the average S&P monthly growth rate in October is just 0.5%, 7 basis points below the monthly average growth rate of the S&P since 1928.

Don’t ask me why this happens – statistical regularities like this ought not to occur in an efficient stock market.  Maybe it’s just the onset of the Autumn blues (in the northern hemisphere at least).  Certainly, the markets appear jittery at the moment, with a month-to-date fall in the S&P of 5% (in dollar terms) in the first 19 days of October (-5.5% for MSCI World) and the Vix up over 19 (down from its peak on the 11th at 24.98).  More fundamentally, some are focused on the prospects for US inflation, interest rates and bond yields, with a significant minority fearful that the Federal Reserve is about to make a policy error – allowing inflation to surprise upwards and having to scramble to contain it during 2019.  For others, the Fed is moving too far, too fast irrespective of what happens to inflation – especially against a background of rising bond yields, trade conflict, de-globalization and high oil prices. That concern seems to have been the main driver of this month’s sharp falls.

Let’s not make too much of this though.  There have been plenty of Octobers when the S&P has done well – 48 out of 90 where October growth has outpaced the 90-year monthly average since 1928.  And, September, February and May are worse months on average, statistically speaking.  More fundamentally, my sympathies lie with the Fed.  I think it’s far too early to call an inflation shock – the relationship between inflation and capacity has changed markedly since the financial crisis.  Inflation expectations seem well-anchored and the very concept of capacity seems up for question, even in the US labour market.  Moreover, should growth slow sharply – because of trade conflict, oil prices or anything else, the Fed will probably react by not raising rates at the pace currently indicated.

So maybe we should take a deep breath, channel our inner Keats and remember that other great poet and stock market predictor, T. S. Eliot too.  After all, October isn’t the cruellest month; April is.  Or, as they say in the markets, ‘sell in May and go away’ – until October.

[1] Source for all data: Bloomberg, as at 10 October 2018 unless otherwise noted.

Shamik Dhar, chief economist, BNY Mellon Investment Management

Keats called it the ‘season of mists and mellow fruitfulness’, but for the markets Autumn/Fall – and October in particular – can be a turbulent time.  There were the crashes of 2008 and 1987 of course, when the market sold off by 16.9% and 21.8% respectively[1].  And while an efficient market like the S&P shouldn’t be seasonal, it clearly is: … read more

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In equity markets, the descent can be more hazardous than the ascent

A correction at the end of January has ushered in a period of relatively heightened volatility through 2018, as markets have come to focus more on potential headwinds and attention has started to swing away from growth-orientated stocks, to ones with more defensive qualities, better able to operate through more challenging market-cycle conditions. In our view, while markets have regained some poise over recent weeks, further market falls are possible against the volatile backdrop. Is it best to keep chasing momentum and growth or to hunker down and invest in companies with more defensive qualities?

In attempting to answer this question, it is informative to look at 40 years of data from the S&P 500 index of US equities and the asymmetry between the effect of falling markets and rising markets on investors’ overall returns. Put simply, it has been far better for investors to miss out on the 10 worst market days over the past four decades, than to have missed out on the 10 best days.

To draw on a mountaineering analogy, many more climbers die on the way down from the summit than on the way up. Much of this could be down to the fact that a climber will use up the majority of their resources on the way up, and will be more tired physically and mentally on the descent when many of their supplies have been exhausted.

Similarly, the asset inflation driven by loose central-bank monetary policy and the abundance of cheap debt has helped propel markets to historic highs, but as resources are increasingly withdrawn, there is far less left in the tank to sustain the markets’ upward trajectory.

To us, using the mountaineering analogy again, the message seems clear: it is more important to acclimatise, prepare properly and manage resources prudently to boost your chances of surviving the descent. In the case of equity markets, we think one way to achieve this could be to invest in companies with strong balance sheets and visible, recurring cash flows that can be captured in the form of dividend income, to help augment returns when markets are volatile or on their way down.

Nick Clay – portfolio manager, Newton Investment Management.

A correction at the end of January has ushered in a period of relatively heightened volatility through 2018, as markets have come to focus more on potential headwinds and attention has started to swing away from growth-orientated stocks, to ones with more defensive qualities, better able to operate through more challenging market-cycle conditions. In our view, while markets have regained … read more

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Roll out the barrel: positive signs ahead for global beer brewers?

The beer market is highly concentrated with the top five brewers producing about 50% of global volumes and controlling 65% of industry profits.  Volume growth has slowed and has been broadly flat in recent years due to both macro and more structural issues.  A recovery in emerging markets where per capita consumption of beer is still relatively low should see the category back to growth, but more structural volume headwinds particularly in developed markets persist.  In many developed markets demographics are less favourable, per capita consumption is mature and younger generations of consumers are drinking less alcohol than their parents and grandparents.  However, it is not all doom and gloom in developed markets.  While volume growth has stagnated, consumers aspire to “drink better” trading up to more expensive craft beers, low/no alcohol beers and flavoured malt beverages.  Emerging markets have also seen increasing demand for premium products, and the roll out of higher-priced global brands has accelerated.   Premiumisation in both developed and emerging markets has driven category value higher even as volume has remained stable.

Paul Flood – multi-asset manager, Newton Investment Management

The beer market is highly concentrated with the top five brewers producing about 50% of global volumes and controlling 65% of industry profits.  Volume growth has slowed and has been broadly flat in recent years due to both macro and more structural issues.  A recovery in emerging markets where per capita consumption of beer is still relatively low should see … read more

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Japan: Bridging the productivity gap

As Japanese society ages it will need to rely ever more on automation and new technology to bridge the productivity gap. That creates a requirement for robots to start taking on the jobs that people used to do. Employment data and labour force projections underline the point.

The Japanese jobs-to applicants ratio has soared while the unemployment rate has plummeted as the economy recovers from 20 years of stagnation and deflation during which the nominal GDP actually contracted.

Meanwhile, even though more women are entering the workforce, the number of people in work will plateau at best in the next decade. Together, the combination of a tight labour market and the structural trend of an ageing population create a real need for an automated future.

Miyuki Kashima – head of Japanese equity investments. BNY Mellon Japan

As Japanese society ages it will need to rely ever more on automation and new technology to bridge the productivity gap. That creates a requirement for robots to start taking on the jobs that people used to do. Employment data and labour force projections underline the point. The Japanese jobs-to applicants ratio has soared while the unemployment rate has plummeted … read more

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Turkey: The canary in the coal mine?

Should the recent financial turmoil in Turkey be considered an isolated event or is it one of those financial canaries in a coal mine? On the one hand, it is clear that local policy and president Erdoğan’s bellicose handling of foreign relations have both contributed to the slide in Turkish assets. Those who believe such factors have been the main driver of the sell-off argue that Turkey is going bust for idiosyncratic reasons, and so maintain that a relatively risk-on stance is appropriate.

To us, there is little doubt that the protracted nature of Turkey’s bubble has ensured a deep structural maladjustment, misallocated capital and financial excesses. The risk is that, should the market continue to command higher yields on Turkish assets in order to provide compensation for increased risks, those financial excesses may prove unsustainable. Should Erdoğan adopt a more market-friendly approach to international relations and a more orthodox approach to domestic fiscal policy, perhaps Turkish yields will decline to a level where financing costs are consistent with sustaining the status quo.

However, the other school of thought is to view Turkey as merely the symptom of a wider liquidity malaise globally. The evidence increasingly suggests that the environment of self-reinforcing expanding liquidity, indiscriminate buying of financial assets (speculation) and rising asset prices/bullish trends has come to an end. In this context, declines in Turkish asset prices are met with selling rather than being regarded by many as a dip to be bought. Moreover, while Turkey is the most conspicuous example of this pattern to date, we believe it is one that is becoming increasingly widespread, marking a departure from market dynamics in 2017.

Brendan Mulhern, global strategist. Newton Investment Management, a BNY Mellon company

Should the recent financial turmoil in Turkey be considered an isolated event or is it one of those financial canaries in a coal mine? On the one hand, it is clear that local policy and president Erdoğan’s bellicose handling of foreign relations have both contributed to the slide in Turkish assets. Those who believe such factors have been the main … read more

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Gearing up for a 5G revolution?

The last transition we had in the market was from 3G service to 4G which was largely about increasing the speed of online communication. But 5G is a more complex cellular technology which will enable completely new types of application, allowing users access to new wireless spectrum that was previously unusable with earlier technologies.

Lower latency – or responsiveness of 5G – opens up scope for new millisecond time applications such as controlled drones, autonomous vehicles and a host of other applications. 5G is really going to be about the internet of things and there will be a lot more machine to machine communication happening over its wireless networks.

A lot of operators have spent the last couple of years deploying fibre and today are now the owners of those fibre assets. While they have spent money on this infrastructure in many cases it is underutilised. As we move closer towards an interconnected world, we expect the market to put a higher value on those fibre infrastructure assets and for there to be opportunities to profit there. In the final analysis, smart cities could encompass a million applications which we haven’t even thought of yet, though you do have to enable it first.

Matthew Griffin, senior research analyst. The Boston Company, BNY Mellon Asset Management North America Corporation

The last transition we had in the market was from 3G service to 4G which was largely about increasing the speed of online communication. But 5G is a more complex cellular technology which will enable completely new types of application, allowing users access to new wireless spectrum that was previously unusable with earlier technologies. Lower latency – or responsiveness of … read more

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Mind the gap: why gender diversity matters.

Gender equality has proved a high profile media topic in the past year, with the #MeToo and #TimesUp campaigns garnering global support and attention. Recent UK pay-gap figures have also revealed the stark pay inequalities that still exist between the sexes in most industries and companies. Many such conversations centre around the possible social impact of supporting gender equality in the workplace. However, research shows that along with having a positive social impact, increasing the number of women in the workplace (and supporting them once they’re there), carries a host of potential macroeconomic benefits. This suggests working to achieve gender parity should be on the agenda of all investors, not just those with a social impact focus.

Research shows that global educational attainment is essentially very equal. For example, Saudi Arabia, where women have only recently been allowed to drive and enter sports stadiums, has a marginally higher proportion of women than men enrolling in primary education than Iceland – a notably progressive country in gender parity terms. However, despite accounting for 50% of the global working-age population, women only generate 37% of global GDP, suggesting they are a seriously under-utilised economic resource given their comparable levels of education.

Much of this discrepancy can be explained by two key factors. Firstly the lack of women in leadership positions, both professional and political, and secondly the huge amounts of unpaid care work being done by women compared to men. There are three primary benefits of increasing equality in female participation in the workforce – not just in terms of the numbers of women in work but also by improving equality in senior positions and across the sectors.

Lottie Meggitt – Responsible investment analyst. Newton Investment Management, a BNY Mellon company

Gender equality has proved a high profile media topic in the past year, with the #MeToo and #TimesUp campaigns garnering global support and attention. Recent UK pay-gap figures have also revealed the stark pay inequalities that still exist between the sexes in most industries and companies. Many such conversations centre around the possible social impact of supporting gender equality in … read more

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