ISSUE 43 AUTUMN 2019
THEMATIC INVESTMENT Finding powerful, enduring trends
HONOURABLE INCOME Resilience amid volatility
ESG investment: the new normal ESG investment: the new normal
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CONTENTS & WELCOME
CONTENTS 4. What is thematic investing and why should investors care?
6. Don’t be distracted from China’s enduring qualities 10. Emerging markets bonds: value beyond the noise 12. Honourable income - finding resilient companies in uncertain times 16. Easy does it
WELCOME
18. ESG setting the scene 22. How smarter ESG integration can preserve your free lunch 24. Asia the next dividend powerhouse? 28. Income. Sustainably 32. The £1 Model Portfolio Service: simplifying the advice process 36. Why defence makes sense 38. For they shall inherit the earth
Climate change is being discussed everywhere, from the corridors of government to the streets of London. Those companies with poor environmental records are increasingly exposed, which matters for their share price. As such, it is becoming an increasingly pressing issue for investors. Fund management groups recognise the urgency, but also the opportunity. Companies that score highly on environmental, social and governance criteria tend to perform better over time. As such, there should be a chance to add value by finding them. No longer a sideline, advisers have an increasing range of options for investments in this area. In this month’s Hub News, Square Mile and LGIM look at how advisers might go about selecting them and the risks inherent in doing so. We also showcase new funds coming to market, including the Aviva Investors Sustainable Income and Growth Fund. A focus on ESG is just one way in which markets are becoming more thematic. There are a number of
pressing global trends that are increasingly difficult to ignore. Schroders discusses how an awareness of these factors informs its stockpicking, helping it target new and exciting companies, while avoiding those likely to be disrupted. We also tackle subjects as diverse as China, Asian income, emerging market bonds and the importance of the millennial pound. The team on the Investec Diversified Income Fund explains why protecting against falls can be just as important as generating high returns, while Invesco discusses its new model portfolio service. As always, we hope you find it an illuminating and insightful read. Please send any thoughts or feedback to enquiries@adviser-hub.co.uk. Cherry Reynard Editor www.adviser-hub.co.uk
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THEMATIC INVESTMENT
WHAT IS THEMATIC INVESTING AND WHY SHOULD INVESTORS CARE?
Thematic funds focus on powerful, long-term global trends that are transforming the world and creating a wealth of investment opportunities, says David Docherty, Schroders Investment Director, Thematics.
The power of human ingenuity is at the heart of thematic investing. This ingenuity ignites the innovation which solves imbalances in the world. In turn this creates growth which hasn’t yet been recognised in share prices. By seeking out these opportunities, thematic funds offer a whole new way of investing, with the aim of achieving sustainable, long-term growth. The world’s current imbalances might be between populations and resources, such as climate change. Or they might be within individual markets, where disruptors can appear and transform an entire industry by displacing long-established incumbents. This interaction of ingenuity, innovation and the tackling of imbalances creates investment themes. These can be pervasive and compelling, such as climate change, urbanisation, disruption, energy transition and healthcare.
INGENUITY IS EMBEDDED IN WHO WE ARE (AND ALWAYS HAS BEEN) Human ingenuity has defined us from ancient times, helping to transform the world and the way we think. This evolving process continues to this day and will prevail in the future. 4
The impact of inventions or discoveries made by ingenious individuals throughout history continues to be felt to this day. For example, Hippodamus, an ancient Greek philosopher, mathematician and architect who lived during the fifth century BC, is considered the originator of town planning. Hero of Alexandria, meanwhile, invented the world’s first vending machine (which dispensed holy water) in the first century AD. The legendary Leonardo Da Vinci has been credited with a number of ideas and inventions in a diverse range of fields, such as engineering, mathematics and physics. Although some of his ideas (many of which were well ahead of their time) were wildly impractical, one of his inventions was a machine for testing the tensile strength of wire, a forerunner of today’s focus on smart materials. Thomas Edison has been described as America’s greatest inventor. However, he can also be seen as one of the first disruptors in areas such as entertainment, with the development of the phonograph machine and motion pictures. French-Polish scientist Marie Curie conducted pioneering work in the use of radiation to fight cancer, a battle which continues today using the latest developments in personalised medicine. More recently, Intel founder Gordon Moore devised Moore’s Law. In an indication of the pace of innovation, the law asserted that the number of transistors in a dense integrated
“This interaction of ingenuity, innovation and the tackling of imbalances creates investment themes. These can be pervasive and compelling, such as climate change, urbanisation, disruption, energy transition and healthcare.”
circuit board doubles every two years. Finally, serial entrepreneur Elon Musk has been responsible for a number of technological advances in software and online payments, as well as the development of electric vehicles, solar power and artificial intelligence. Just as Moore’s Law predicted the increased capability of semiconductors, new technologies are spearheading an acceleration in the pace of change in a range of sectors. The time taken for electricity to achieve 50 million users was 46 years. Television achieved the same feat in 22 years, while the internet took seven years. By comparison, social media site Facebook secured 50 million users in four years while for Pokémon Go, the augmented reality game played on smartphones, it was just 19 days.
THEMATIC INVESTING IS FOR THE LONG TERM Thematic investing is all about looking for opportunities. The interaction between ingenuity, innovation and imbalances creates sustainable, persistent and (most importantly) long-term investment themes. This in turn creates the opportunity to achieve long-term positive returns. Themes such as climate change and the energy transition (the move from fossil fuels to clean renewable energy) are not only powerful but will also provide investors with longevity. The rise of global cities is also a long-term trend, with the majority of the world’s population expected to be city-dwellers by the end of the century. In the energy transition, for example, the amount of investment that will be needed across the entire energy system will be huge. To fully achieve the transition, an estimated $120 trillion will need to be invested by 2050 in the areas of clean energy generation; energy storage; electric transport infrastructure; transmission and distribution; and smart-metering and demand response. Sales of electric vehicles are set to increase in the next few years. Many countries have set targets for sales of new internal combustion engine vehicles to end. This is causing consumers to switch to more environmentally-friendly electric vehicles in a bid to limit the effects of climate change. The dates of these targets range from 2025 ( just six years away) in Norway, to 2040 in the UK. This will open up a huge range of opportunities for a number of companies, including auto makers and energy providers, but also companies supplying charging points and equipment for testing batteries.
LIFE-CHANGING INNOVATION Innovations are changing lives, whether that’s scientists developing an artificial human heart or simply the ability to use your smartphone to watch TV or arrange your finances. New companies are challenging existing ideas and disrupting established industries with radical new technologies. These could be innovations in healthcare, where companies are trying to solve some of the big global demographic issues. Other companies are facing up to the challenge of climate change and urbanisation. Although new technology is disrupting the established order, this process is also opening up new opportunities for many companies. Change is happening now and the pace of change is accelerating. These are no less than global transformations and they are opening up huge opportunities for thematic investing. As with all investing, the value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Important Notice Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall. All investments involve risks including the risk of possible loss of principal. The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. We accept no responsibility for any errors of fact or opinion and assume no obligation to provide you with any changes to our assumptions or forecasts. Forecasts and assumptions may be affected by external economic or other factors. The views and opinions contained herein are those of Schroders’ Economics team and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds and may change. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Any data has been sourced by us and is provided without any warranties of any kind. It should be independently verified before further publication or use. Third party data is owned or licenced by the data provider and may not be reproduced, extracted or used for any other purpose without the data provider’s consent. Neither we, nor the data provider, will have any liability in connection with the third party data. Any references to securities, sectors, regions and/or countries are for illustrative purposes only. Issued by Schroder Investment Management Limited, 1 London Wall Place, London EC2Y 5AU. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority. 5
CHINA OPPORTUNITIES
DON’T BE DISTRACTED FROM CHINA’S ENDURING QUALITIES
China’s vast economy, policy reforms and emphasis on higher-value growth offer abundant opportunities for equity investors, even with the backdrop of a US trade war, says Vincent Che, portfolio manager of the Merian China Equity Fund.
China’s recent shift in focus from rapid growth driven by fixed-asset investment and cheap manufacturing, towards a more sustainable, high-quality economic expansion is aimed at improving living standards and boosting efficiency. It should also provide opportunities for investors. The country has undergone rapid social and economic development since market reforms were introduced in 1978, with GDP growth averaging around 10% a year, the fastest sustained expansion by a major economy in history, according to the World Bank. The demographics of Asia’s largest economy remain attractive, with a population of 1.4 billion, increasingly urbanised, and a growing middle class. China’s GDP per capita of around $10k lags that of many developed countries and highlights the considerable upside in the value chain. The government’s Five-Year Plan to 2020 targets 6.5% annual growth – still robust by global standards. The country is moving toward a more consumer- and services-led economy with cleaner energy and industry. The government has initiated structural reforms, including changes to state-owned enterprises and moves to encourage innovation and more open markets. The trade war undoubtedly throws up challenges. We see it as a potential medium-to-long-term headwind that will generate additional periods of market volatility. We estimate the additional 6
US tariffs may reduce China exports in the low single-digit percentage. While there may be some single-issue agreements, an accord on intellectual property may be more unlikely in the short term. China economic data in the year through June was mainly on track but there were signals of downward pressure related to trade. Policymakers announced fiscal and monetary measures including VAT changes and cuts in the reserve requirement ratio for banks in an effort to boost lending. We expect the government to use reforms, stimulus and its considerable fiscal resources as a safety net to stabilise the economy and protect growth. Policymakers are likely to provide additional stimulus in the second half of the year in the form of rate cuts, looser rules on infrastructure spending. China is keen to attract international capital and has begun to speed the opening of financial services to foreign companies. The securities regulator has modified rules to allow international financial firms to become majority owners of local joint ventures. Goldman Sachs, JPMorgan and Credit Suisse are among the international banks that have applied to increase the ownership of their Chinese JVs. Another reform is the Stock Connect program, collaboration between the Hong Kong, Shanghai and Shenzhen exchanges, which allows international and mainland Chinese investors
to trade securities in each other’s markets through their home exchange. As part of a program called Shanghai-London Stock Connect, Huatai Securities raised $1.54bln in July, becoming the first issuer to list GDRs in London on the Shanghai Segment of the London Stock Exchange. We believe China assets become more attractive as the economy moves into a period of quality growth. We see potential for higher returns on equity and increased revenue growth as capital expenditure requirements ease. This should lead to improved cash flow and dividends.
“We expect the government to use reforms, stimulus and its considerable fiscal resources as a safety net to stabilize the economy and protect growth.”
In the Merian China Equity Fund we are currently focused on companies with strong fundamentals in the consumer, healthcare, utility and financials sectors, as well as trading opportunities in the materials and industrial sectors. Trade war or not, we believe the China growth story remains intact, that less restrictive government policy is the trend and that current valuation levels make Chinese stocks more attractive. We see good opportunities for longer-term investors who are seeking an entry point to Chinese equities.
Past performance is not a guide to future performance and may not be repeated. Investment involves risk. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested. This communication is issued by Merian Global Investors (UK) Limited (“Merian Global Investors”), Millennium Bridge House, 2 Lambeth Hill, London, United Kingdom, EC4P 4WR. Merian Global Investors is registered in England and Wales (number: 02949554) and is authorised and regulated by the Financial Conduct Authority (FRN: 171847). Nothing in this communication constitutes financial, professional or investment advice or a personal recommendation. Any opinions expressed in this document are subject to change without notice. MGI 09/19/0059 7
WE’VE JOINED FORCES WITH ONE OF THE REGION’S FINANCIAL GIANTS.
TO CREATE A CUTTING-EDGE CHINA FUND
Merian China Equity Fund Investing in Chinese equities can appear daunting to an outsider. That is why the Merian China Equity Fund is managed by Ping An of China Asset Management (Hong Kong), part of one of China’s largest financial companies.
Combining forces: • Unique resources and access to Chinese companies • Ping An’s quantamental investment process brings together the best of quantitative modelling with fundamental, on-the-ground research • Brought to you by Merian Global Investors, a truly active manager with a trusted, UK-based brand
TO FIND OUT MORE, SEARCH:
Merian China
Principal partner
merian.com/chinaequities Investment involves risk. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested. This communication is issued by Merian Global Investors (UK) Limited (trading name Merian Global Investors). Merian Global Investors is registered in England and Wales (number: 02949554) and is authorised and regulated by the Financial Conduct Authority (FRN: 171847). Its registered office is at 2 Lambeth Hill, London, United Kingdom, EC4P 4WR. Models constructed with Geomag. MGI 09/19/0011.
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For Investment Professionals only
INVESTMENTS THAT SHAPE THE FUTURE BUILT BY M&G
For financial advisers only. Not for onward distribution. No other persons should rely on any information contained within. This financial promotion is issued by M&G Securities Limited which is authorised and regulated by the Financial Conduct Authority in the UK and provides ISAs and other investment products. The company’s registered office is 10 Fenchurch Avenue, London EC3M 5AG. Registered in England and Wales. Registered Number 90776. SEP 19 / 390101
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EMERGING MARKET DEBT
EMERGING MARKETS BONDS: VALUE BEYOND THE NOISE
Claudia Calich has been fund manager of the M&G Emerging Markets Bond Fund since December 2013. She discusses the risks and opportunities in the sector in the medium term and how she is positioned for what lies ahead.
WHAT HAS BEEN THE BACKDROP FOR EMERGING MARKET DEBT OVER THE PAST 12 MONTHS? There have been a number of key macro drivers. The Chinese and US tensions have played a role and there has also been a large repricing on expectations of global growth. We’ve also seen a reversal in expectations for monetary policy globally. At the start of 2019, some markets, particularly the US, were still pricing in additional rate hikes and policy tightening, but there has been a major shift. The underlying data has been weaker than expected – and very disappointing in parts of the eurozone - but not particularly bad in the US. We believe markets are ahead of the data at this point.
HOW HAS THIS BEEN REFLECTED IN MARKETS? It has been mixed. There was a rally at the start of the year, with certain pockets doing very well - Chinese corporates and some of the high yield names; then the headlines started up again and we saw spreads over developed market bonds widen out. More recently, there have been country-specific events such as Argentina. While this was an isolated case, there was some contagion in areas such as the frontier markets and sub-Saharan Africa. We’ve seen repricing in certain credits over the last month. From our perspective, that’s likely to provide some opportunities.
Now we’re actually looking to start reversing that again, to increase exposure to the China complex, for example, because a lot of the names have underperformed quite a bit and value is starting to appear in China. We recently added one of the real estate developers, which is also a high yield name and are looking for additional opportunities there. We also added Ukranian and Serbian bonds. We’ve also been reducing certain issuers in euros and buying back the equivalent in dollars – Ivory Coast, Senegal. They have become expensive – a reflection of the negative yields in the eurozone.
HOW DO YOU SEE THE MAJOR RISKS AND POTENTIAL OPPORTUNITIES? Sometimes the risks provide the best opportunities. We are still of course monitoring the global macro environment. There’s still quite a bit of pessimism over a recession in the US. With that in mind, we’re relatively comfortable with some of our exposure to countries that are tied to the US economy – Mexico and Central America, for example. Even though the US economy may be slowing, the market has been quick to price in a recession over the short term and we think it might take longer. It’s very unlikely that there will be any resolution in the trade war over the next 12 months. The big question is what happens with the US elections and whether Trump is re-elected. A Democrat would change the tone to some extent, although some of the underlying issues would remain regardless of which party happens to be in power. If we get a change in administration, we may see maybe at least a bit more predictability of events.
HOW HAVE YOU DEALT WITH THIS ENVIRONMENT IN THE PORTFOLIO? WHAT DO YOU SEE AS THE BIGGEST RISKS TODAY? The portfolio is flexible, investing in a combination of government bonds, corporate bonds, hard currencies (dollar and euro) and also local currency bonds. Our allocation between hard currency and local currency has been neutral. We had been increasing exposure to local currency bonds, but as the headlines started to surface in China/US, we reduced those currencies we thought were fundamentally weaker, or were not fully pricing in the risk.
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If we were to see a de-escalation of the US/China trade war, we should see quite a strong rally on emerging market assets, including currencies. This would be very bullish for some Chinese assets. The risk at the moment is that there have been very low expectations and if the market is presented with anything good, there could be a rally.
Politics are always very difficult to time and there will always be the usual suspects in the background - tensions in the Middle East and Iran and potential sanctions in countries such as Turkey. Oil prices have been dropping and we’ve seen some underperformance by oil-related credits, such as Nigeria, but we’re not expecting some massive collapse in oil prices as we saw back in 2014. In terms of politics, it will be interesting to see what happens with Lebanon. We’ve seen a very large underperformance of their bonds in the last few months. They have one of the highest debt levels in emerging markets. The prices reflect the possibility of some debt re-profiling. We are keeping watch.
WHAT IS THE PHILOSOPHY OF THE FUND? We take a flexible investment approach with a medium-term outlook. We try to anticipate big turning points with the aim of avoiding rapidly deteriorating situations, but also recognising when a country is likely to improve. I’d rather buy a weak country that is turning, than a strong country that is starting to deteriorate. We want to avoid the tail risks as far as possible. It is important to size positions appropriately. If we get it wrong, it shouldn’t destroy our long term performance record. We blend top-down and bottom-up analysis. In our top-down down assessment of global macro conditions, we are looking not only at the emerging markets, but to the global environment. We take into account key variables - global growth, monetary policy inflation, the implication for commodity prices, political events - anything that could impact emerging markets either for good or for bad. That will determine two things in the portfolio. One is on the overall level of risk, whether to be more defensive or more aggressive and also the weighting between hard and local currency. For the bottom-up, if we are comfortable with the country, we can take a position in a variety of ways – local or hard currency, or through corporate bonds. Ultimately, we decide on the best way to express the country view.
“Even though the US economy may be slowing, the market has been quick to price in a recession over the short term and we think it might take longer.”
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INCOME OPTIONS
HONOURABLE INCOME – FINDING RESILIENT COMPANIES IN UNCERTAIN TIMES
As risks mount in the corporate bond sector, Torcail Stewart, manager of the Baillie Gifford Strategic Bond Fund, explains why he has moved to be more defensively positioned. As with any investment, your clients’ capital is at risk. It has been a buoyant few months for corporate bonds as expectations of monetary policy have reversed. But scratch the surface and there is a lot going on underneath. At the bottom end of the market, default rates have been rising and there have been some high-profile corporate failures. For Torcail Stewart, manager of the Baillie Gifford Strategic Bond Fund, it is a time to be hunting for ‘honourable income’ rather than seeking out bargains. What is ‘honourable income’ in this context? For Torcail, it means lending to resilient companies with resilient capital structures, rather than chasing risk or higher income. He says: “Within the high yield market, there will be certain areas where investors aren’t being sufficiently compensated for the risk they’re taking, particularly in the depths of CCC-rated bonds. It matters more than ever to identify investments where there is balance sheet improvement occurring, and where there is the potential for the risk premium to reduce.” Since the start of the year, he has been reducing risk within the fund. The high yield portion has dipped below 30%, from about 35%, and 40% at the start of the previous year. The rally in government bonds over 2019 has helped support investment grade bonds. As such, the rotation has been good for performance. This shift has come as Torcail has started to see signs of a maturing global economy. Even though central banks have shifted policy, there will be a lag effect and there are limits to their powers. With this in mind, it pays to pick bonds with care. This plays to the strengths of the Baillie Gifford Strategic Bond Fund. He says: “We target businesses that are growing. The average top-line growth for companies in our portfolio is greater than 10% per annum and they will have a sustainable competitive advantage and a resilient capital structure. We believe there are just certain risks you shouldn’t take.” Growth is key: “Even with cyclical companies, if you’re lending to businesses that are growing, producing the products and services of the future, with a sustainable role within society, it’s more likely that capital providers will step in in their hour of need if necessary if things go wrong.” In contrast, a cyclical downturn can be the straw that pushes companies in structural decline into bankruptcy. Those are the companies to avoid. While they can be useful to add income, that comes with real risk of capital loss. 12
The fund invests in corporate bonds, aiming to add value through credit selection. In true Baillie Gifford style, they are looking to lend for three to five years. Baillie Gifford wants to lend with conviction – with just 60-80 bonds in the Strategic Bond portfolio. Bond selection is at the heart of their lending process. Torcail also likes to have a number of idiosyncratic ideas bubbling away in case the environment changes. At the moment, he is watching a basket of companies that may do well should the US and China resolve some of their differences: “Investors are worried that the US and China trade tensions may tip over into the economic cycle. Ultimately, we see some sort of deal being sought because of the US election cycle.” Among the companies in the portfolio today is PureGym. This chain of low-cost gyms is taking market share. Torcail believes the balance sheet will improve with time and investors should get capital growth as well as yield. The Co-operative is another holding. It works to source locally and should have a competitive advantage post-Brexit over those sourcing from Europe. It is defensive and also has its funeral business. National Grid and Legal and General are also trading with a ‘Brexit discount’. While the fund is positioned more defensively, each company needs to bring something different to the portfolio. With this in mind, Torcail has been buying AstraZeneca: “People have been very cynical about the company for a long time because it has a significant patent cliff. However, it has done a lot of work identifying new growth areas and we think the balance sheet will improve with time.” He also has a number of holdings in ‘mis-rated’ bonds, where investors are still getting to grips with new business models. Netflix, for example, came to market with B rating, but he believes the business could go to BBB and investment grade. “It has added the population of Australia in terms of subscribers in the past year and is building up fantastic back book of content.” The fund will never have the highest yield on the market, but is comfortably top quartile for total return. Torcail says: “I think that comes down to stock selection, buying businesses and not chasing yield. We want businesses that have something quite special about them.” View the full paper at: www.bailliegifford.com/insights
“Even with cyclical companies, if you’re lending to businesses that are growing, producing the products and services of the future, with a sustainable role within society, it’s more likely that capital providers will step in in their hour of need if necessary if things go wrong.”
ANNUAL PAST PERFORMANCE TO 30 JUNE EACH YEAR Name
2015
2016
2017
2018
2019
Strategic Bond Fund Class B income IA Sterling Strategic Bond sector median
4.2% 1.8%
3.4% 2.3%
10.7% 7.3%
1.8% 0.3%
7.2% 4.9%
Source: FE. Returns reflect the annual charges but exclude any initial charge paid. Past performance is not a guide to future returns. The manager believes this an appropriate benchmark given the investment policy of the fund and the approach taken by the manager when investing. For financial advisers only, not retail investors. All data is as at 30 August 2019, unless otherwise stated. The views expressed in this article should not be considered as advice or a recommendation to buy, sell or hold a particular investment. The article contains information and opinion on investments that does not constitute independent investment research, and is therefore not subject to the protections afforded to independent research. Some of the views expressed are not necessarily those of Baillie Gifford. Investment markets and conditions can change rapidly, therefore the views expressed should not be taken as statements of fact nor should reliance be placed on them when making investment decisions. 13
STRATEGIC BOND FUND
TOP QUARTILE PERFORMANCE OVER ONE, THREE, FIVE AND TEN YEARS WITH BOTTOM QUARTILE FEES.
SEEK AND YOU SHALL FIND. With our Baillie Gifford Strategic Bond Fund (formerly known as our Corporate Bond Fund) we aim to achieve a high level of monthly income for our clients by investing primarily in a diversified bond portfolio. A defining characteristic is great bond selection that looks further than the usual one-year horizon. We go off the beaten track to find companies that are embracing change and those that are producing the products and services of the future, not the past. You could say our portfolio comprises the ‘best ideas’ we can track down across the high yield and investment grade markets. You can see the results for yourself from the table below. Performance to 30 June 2019* 5 years
10 years
Strategic Bond Fund
30.2%
151.4%
IA £ Strategic Bond Sector Average
19.0%
82.5%
As with any investment, your clients’ capital is at risk. Past performance is not a guide to future returns. The manager believes this is an appropriate benchmark given the investment policy of the Fund and the approach taken by the manager when investing. For financial advisers only, not retail investors. For a fund that aims to achieve a high level of monthly income through a diversified portfolio, call 0800 917 4752 or visit www.bailliegifford.com/intermediaries
Long-term investment partners
*All data as at 30 June 2019. Source: FE, B Inc shares, single pricing basis, total return. Your call may be recorded for training or monitoring purposes. Baillie Gifford & Co Limited is the Authorised Corporate Director of the Baillie Gifford ICVCs. Baillie Gifford & Co Limited is wholly owned by Baillie Gifford & Co. Both companies are authorised and regulated by the Financial Conduct Authority. 14
GSAMFUNDS.com
me l-Ti a e R
n Disruptio Emerging Markets
Sust aina bility
Le arn ing
Ma ch ine
Dem ogra phic s Na tur al La ng ua ge Pro ce ssi ng
w ies rro log mo hno To Tec ed anc Adv
tion Diversifica
nt me n o ir ty Env ili at l Vo
Risk Management
Flexibility
We believe investors today are faced with a series of trends that are likely to redefine the investment landscape over the next five years. While trends evolve over time, we think that investors are able to position themselves in anticipation of many of these today. Contact your GSAM representative for more information on the key trends that we believe investors should consider when constructing their portfolios.
For Third Party Distributors Use Only – Not For Distribution to your clients or the General Public. This material is provided at your request for informational purposes only. It is not an offer or solicitation to buy or sell any securities. In the United Kingdom, this material is a financial promotion and has been approved by Goldman Sachs Asset Management International, which is authorized and regulated in the United Kingdom by the Financial Conduct Authority. THIS MATERIAL DOES NOT CONSTITUTE AN OFFER OR SOLICITATION IN ANY JURISDICTION WHERE OR TO ANY PERSON TO WHOM IT WOULD BE UNAUTHORIZED OR UNLAWFUL TO DO SO. Prospective investors should inform themselves as to any applicable legal requirements and taxation and exchange control regulations in the countries of their citizenship, residence or domicile which might be relevant. Views and opinions expressed are for informational purposes only and do not constitute a recommendation by GSAM to buy, sell, or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice. Confidentiality: No part of this material may, without GSAM’s prior written consent, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient. © 2019 Goldman Sachs. All rights reserved. 163557-OTU-952840 15
ECONOMIC OUTLOOK
EASY DOES IT
Markets are lacking extremes on either end of the valuation continuum but are subject to rising risks - the potential for recession, flareups of volatility, and political shocks. GSAM explains why ‘Easy Does It’ seems the right response.
The continued economic expansion, the fluidity of global politics, and the shifting tectonics of monetary policy: all are reasons we think staying invested, but staying focused on alpha and on risk, is the appropriate path. Easy Does It, in our view, is the appropriate mindset in a climate that calls for a risk-aware adherence to strategic investment allocations. We see current conditions as largely benign as long as investors understand that risk may no longer be linear. Political shocks and policy-related risks are the variables to watch, whereas we see recession risk as still moderate.
“The slowdown in global growth— and the downside risks associated with a possible further intensification of trade conflict—has been accompanied by a moderation in market inflation expectations, which are now at multi-year lows.”
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Investors who believe in risk assets but think they offer limited upside from this point forward may revisit strategies with the potential to offer equity-like returns, but with less equity-like beta. In our view this means examining a range of possibilities in income-oriented investing and alternatives. It may, in short, mean adopting an Easy Does It philosophy— seeking to optimise risk in the tenth year of an equity bull market. Consequently we would emphasise: sticking to the plan, by maintaining strategic asset allocation weights; alpha-oriented, bottom-up strategies over pure equity beta; income-oriented investing and alternatives as a response to moderating returns.
MACRO Uneven global deceleration… The recent slowdown in activity and growth has had at least two remarkable features: 1) its protracted length, and 2) the manufacturing sector’s weakness, whose signal should not be over-emphasised as its share of US GDP is only 10%. Other parts of the global economy—notably the services sector—have been much more resilient in the face of uncertainty over trade policy and the associated disruption to supply chains. …has lowered inflation expectations... The slowdown in global growth — and the downside risks associated with a possible further intensification of trade conflict—has been accompanied by a moderation in market
inflation expectations, which are now at multi-year lows. Additionally, currently low inflation may still overstate consumer prices due to the mismeasurement of quality enhancements, particularly in healthcare and communication services. …and provided flexibility for renewed central bank easing. The easing of inflationary pressures and the perceived predominance of downside risks to growth have created leeway for central banks to ease monetary policy if they so desire. In the case of the Fed, while policy interest rates have remained low by historical standards, the aggregate amount of tightening injected by the FOMC over the prior three years has provided ample room to ease aggressively, if required. Number of Months
60
15 10
55
5 0
50
-5 45
-10 -15
40
1998
2000
2002
2004
2006
2008
2010
Consecutive Months when PMI Rises or Falls (RHS)
2012
2014
2016
2018
Global Manufacturing PMI (LHS)
Source: Haver and GSAM.
MARKETS Seemingly divergent signals from stocks and bonds... On the surface, exceptionally strong 1H 2019 equity market returns appear to contrast with the cautious signal of falling fixed income yields. The message may not be so mixed. Part of equities’ strength reflected a rebound from 4Q 2018 oversold conditions, while low-to-negative rates reflect expectations for continued loose monetary policy. ...may simply reflect maturity in the economic cycle… A moderating but resilient expansion undergirds the current mature point in the economic cycle. While the US corporate earnings growth rate has likely peaked, earnings levels are set to reach new highs this year and next. Historically a peak in
earnings growth has not represented the beginning of the end for investors. Strong returns have often followed, including positive two-year S&P 500 returns 91% of the time since 1947. …and the impact of an extraordinarily low rate environment. The impact of unprecedented accommodative global monetary policy may be a key explanatory factor for seemingly dissimilar messages across equities and bonds. Based on the latest impulses from central banks, we believe that long-term rates are likely to be rangebound, with ultra-low and negative yields in Europe and Japan limiting US Treasuries’ normalisation. In this environment, maximising flexibility and dynamism is key.
S&P 500 index Level
Treasury Yield (%)
3100 3000 2900 2800 2700 2600 2500 2400 2300 2200 2100 2000
3.4 3.2 3 2.8 2.6 2.4 2.2 2 1.8 Jan 2018
Apr 2018
S&P 500 (LHS)
Jul 2018
Oct 2018
Jan 2019
Apr 2019
Jan 2019
US 10-Year Treasury (RHS)
Source: Bloomberg and GSAM. Views and opinions expressed are for informational purposes only and do not constitute a recommendation by GSAM to buy, sell, or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice. Although certain information has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness. We have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. In the United Kingdom, this material is a financial promotion and has been approved by Goldman Sachs Asset Management International, which is authorized and regulated in the United Kingdom by the Financial Conduct Authority. © 2019 Goldman Sachs. All rights reserved. Confidentiality No part of this material may, without GSAM’s prior written consent, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient. 17
SUSTAINABLE INVESTMENT
ESG SETTING THE SCENE Victoria Hasler, Director, Research & Consulting at Square Mile discusses how investment managers today are integrating environmental, social and governance considerations.
AN OVERVIEW OF THE MARKET The Business Roundtable, a prestigious association of American chief executives, shook up the business world recently, when it redefined the purpose of a company. For as long as anyone can remember, the primary focus of public companies has been to increase shareholder value. This group has put out a statement, however, signed by almost 200 CEOs, saying that companies should also look out for the interests of customers, workers, suppliers and communities, and aim to increase diversity and protect the environment. It seems the world is changing, and that includes investment. There is no doubt that ESG (Environmental, Social and Governance) is a term increasingly heard in investment circles, from asset managers, investors and the media. Spurred in part, no doubt, by the increasing focus in wider society on issues such as plastic pollution and climate change, which have received some high-profile media attention in the last few years, conscious consumerism is a growing trend, and investment is no exception. While the absolute amount of assets invested in strategies that employ ESG remains relatively small, flows into these funds are picking up steadily, and growth in these assets is surprisingly fast, albeit from a low base. The fund management industry has picked up on this, of course, and we have seen a number of fund launches using ESG approaches of various kinds. One figure suggests that the number of responsible funds which employ ESG available in the UK has increased tenfold in the last 20 years. Concentrating on the growth of the number of funds in the industry can be a bit misleading, however, because the other trend which is fast gripping the industry is that of ESG integration. Simply put, this assumes that rather than investing in specific responsible funds, investors expect all their funds to look at elements of environmental, social and governance factors as part of their normal research and investment processes. Managers who support this trend would argue that looking at these factors makes sense not just from the point of view of delivering better ESG outcomes for investors, but from a financial point of view as well. The logic is that companies which think about these factors should be better placed to thrive in the future. While the logic is irrefutable, the evidence is less so, and because of the reasonably long time horizons involved in investing, it may be some years before this can be conclusively proved one way or another.
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Those who have been investing ethically for many years will have noticed another relatively recent trend. Historically, many funds which have labelled themselves as “ethical” have applied negative screens to their investment universe. They may well have used the exact same investment process as their peers managing conventional funds, but applied a screen to exclude companies whose revenues derived from, for example, tobacco, oil and gas, armaments, alcohol etc. The more recent launches in the responsible space, however, have leaned towards a positive engagement approach. Different managers will interpret this slightly differently, but the basic premise is that, rather than excluding companies involved in “dirty” industries or practices, it is better to engage with them to encourage and reward good behaviour, and to try to change these industries from within. An example might be investing in an energy company which derives a large percentage of its profits from oil and gas, but is investing heavily in clean energy solutions such as wind and solar. In this way, advocates argue, investors can be a force for positive change in the world.
CHALLENGES FACING THE INDUSTRY There are several challenges facing the industry at present, but one of the biggest is simply confusion. Confusion around terms, confusion around the best approach, confusion as to who is using real ESG approaches and who is green washing. There is even confusion over whether ESG is a real trend or simply a fad. In this environment one can hardly blame investors for being slightly bamboozled. Let’s start with the fundamental questions. What is ESG? How far should it go? What should it include? Are negative screens better or worse than positive engagement? Or do you need both? The problem is that ESG means something different to each investor. To one person it’s carbon footprint that is overriding, whilst for others the thought of investing in pornography and tobacco is repugnant, and negative screens are therefore a must. Other investors are happy to invest in “bad” companies if their fund managers are actively engaging with the companies to try to improve them. As with any investment it is important, as an investor, to know what you want from a responsible fund. This is the starting point to go and find one that meets your objectives.
“While the absolute amount of assets invested in responsible funds strategies remains relatively small, flows into ESG funds are picking up steadily, and growth in ESG assets is surprisingly fast, albeit from a low base.”
Confusion around language and terminology is also rife. The terms ethical, ESG, sustainable and impact, to name just a few, are used almost interchangeably by many investors. Even more confusingly, when asset managers or investors do define what they mean by the terms, each one defines them slightly differently. We desperately need some standardisation in terms and in the way in which we talk about this topic. Thankfully, the IA is doing some great work here and its framework for responsible investing is likely to address at least some of the confusion. We think this is a great initiative and would welcome any clarity in this area. Another challenge, one which is whispered about, but of which investors should be aware, is that of green washing. Let’s start by saying that there are some truly outstanding responsible funds out there, as well as some asset management groups who are very serious about integrating ESG across their businesses. Many of these groups and funds are doing amazing job of delivering ethical, impact and sustainable outcomes for investors. Unfortunately, whenever there is a trend for something you are bound to find some people jumping on the bandwagon who have no right to be there. All we will say on this is that, as with any investment, it is important to do your research and to make sure that what you are investing in is meeting your desired outcomes, be they monetary or otherwise.
THE FUTURE OF THE MARKET As the market for responsible funds grows and matures, there are several ways it could develop. We expect, more and more, that asset management groups will want to integrate ESG into their investment processes on all funds, to a greater or lesser extent. This is likely to become a hygiene factor which investors will simply expect. At present the market seems to be moving more and more in the direction of positive engagement, rather than funds which simply apply a negative screening process (exclusion funds). If this trend continues then it will present another challenge for the market – that of measuring success. It is relatively easy to measure success in financial terms (performance), but a large part of the philosophy investing with a responsible mindset is to recognise that not all costs and benefits of investing are monetary. So how should investors measure the non-monetary benefits (and costs) of investing? This is, as yet, a rather undeveloped art (and it probably is more art than science), and it will be very interesting to see how it develops. A potential solution is to try to map investments to the UN Sustainable Development Goals (SDGs), although this is difficult to do and anyway probably not a perfect solution. One thing is for sure though – as the market develops, investors will start to demand better reporting on the sustainable/ impact/ exclusion side of investing, and it will be interesting to see what solutions the industry can design.
CONCLUSION Whether or not you want to invest on an ethical or sustainable basis, there is no doubt that the trend for ESG investing is growing. As investors become better informed, and managers become better placed to offer solutions, it will be exciting to see how this space grows. Perhaps it is time for the industry to stop skulking in the slightly dark finance corner and get out and make a positive impact on the world.
In October, Square Mile launched ESG integration across their Academy of Funds and have also launched Responsible ratings. Find out more at squaremileresearch.com
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Important Information
20
This communication is for the use of professional advisers and other regulated firms only. It is published by, and remains the copyright of, Square Mile Investment Consulting and Research Ltd (“SM”). SM makes no warranties or representations regarding the accuracy or completeness of the information contained herein. This information represents the views and forecasts of SM at the date of issue but may be subject to change without reference or notification to you. SM does not offer investment advice or make recommendations regarding investments and nothing in this communication shall be deemed to constitute financial or investment advice in any way and shall not constitute a regulated activity for the purposes of the Financial Services and Markets Act 2000. This communication shall not constitute or be deemed to constitute an invitation or inducement to any person to engage in investment activity. Should you undertake any investment activity based on information contained herein, you do so entirely at your own risk and SM shall have no liability whatsoever for any loss, damage, costs or expenses incurred or suffered by you as a result. SM does not accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance is not a guide to future returns.
Is ESG taking a bite out of your diversification?
21
ESG IN ACTION
HOW SMARTER ESG INTEGRATION CAN PRESERVE YOUR FREE LUNCH
The first generation of ESG strategies excluded whole sectors from investors’ portfolios. Such approaches are still widely used, but investors may be underestimating their impact on portfolio diversification, says David Barron and Jennifer Shering, Legal & General Investment Management. We know some investors value the peace of mind that comes from owning lots of different assets in their portfolios, so their risks aren’t too concentrated in any one area. They want diversification, in other words. Equally, we know that some investors want to reflect environmental, social, and governance (ESG) considerations in their portfolios. For some, that can mean excluding fossil fuels – typically meaning the entire energy sector – from their portfolios. In a sense, these two desires – building a diversified portfolio and avoiding vast swathes of the economy – are mutually exclusive. We wanted to investigate this apparent conflict in order to quantify more accurately the relationship between negative screens and portfolio diversification in equities. Put simply, are they friends or foes?
SECTOR INSPECTOR As a starting point, we looked at the correlation of each sector in the MSCI World index to that parent index. This gave us a long-term picture of the diversification dividends yielded by each sector, as illustrated in Figure 1. We see here that some sectors have consistently been diversifiers. These include consumer staples (which include tobacco, of course), healthcare, and utilities. However, we must remember that correlations between sectors are dynamic, not static. For example, energy was a diversifier through the 2000s; technology and then financials have been highly correlated to the MSCI World index for long periods but this has changed at inflection points rather than staying fixed. Correlations can switch unpredictably at key moments and so excluding sectors can deprive investors of diversifying assets unexpectedly or expose them to greater risk if the retained sectors converge in periods of market stress.
FIGURE 1: AVERAGE FIVE-YEAR ROLLING CORRELATIONS BETWEEN MSCI WORLD INDEX SECTORS, 28.02.1995 TO 28.06.2019 WORLD WORLD
1
ENERGY
-0.0910
MATERIALS
INDUSTRIALS
CONSUMER CONSUMER DISC STAPLES
HEALTH CARE
FINANCIALS
IT
TELECOMMS UTILITIES
REAL ESTATE
1
MATERIALS
0.2006
0.3929
1
INDUSTRIALS
0.1596
0.0584
0.4161
1
CONSUMER DISCRETIONARY
0.1254
-0.3466
-0.0201
0.2155
1
CONSUMER STAPLES
-0.6149
0.0688
-0.1520
-0.1195
-0.2440
1
HEALTH CARE
-0.5208
-0.0221
-0.2678
-0.2206
-0.3040
0.6284
1
FINANCIALS
0.3467
-0.1361
0.0765
0.1784
-0.0030
-0.1080
-0.1208
1
INFORMATION TECHNOLOGY
0.3367
-0.3499
-0.2506
-0.1763
0.2161
-0.5831
-0.4393
-0.3275
1
TELECOMMUNICATIONS
-0.1780
-0.1672
-0.3375
-0.4222
-0.1395
0.0543
0.0738
-0.3754
0.1218
1
UTILITIES
-0.5743
0.2101
-0.1156
-0.1435
-0.3542
0.6302
0.4568
-0.1814
-0.5031
0.1507
1
REAL ESTATE
-0.0263
0.0139
0.1668
0.1166
-0.0252
0.2161
0.0411
0.2681
-0.3128
-0.2511
0.2248
Source: LGIM, MSCI, Bloomberg
22
ENERGY
1
WEIGHT WATCHERS
MATTER OF FACTOR
This possibility prompts another question: when sectors are omitted from a market-cap portfolio, how is their index weight redistributed among the other sectors? This can obviously lead to unintended risk exposures if it concentrates a portfolio in sectors that are either more or less correlated to the index. In the former case, the portfolio could end up with a higher beta than desired; in the latter scenario, the portfolio may not offer the required market performance.
We can also look at the factors – or risk premia – that the energy sector has contributed over time. The decline in the oil price from 2014 clearly left energy heavily overweight the value factor, although this has moderated of late. This has led some to the erroneous presumption that such negative screens systematically underweight value. This is not the case. Excluding energy in recent years has certainly left portfolios underweight the value factor, but not so long ago quality and momentum were major forces in the energy index. Investors may have been willing to forgo value exposure over the past few years as that factor has underperformed, but would they have been so happy to minimise the quality and momentum factors under previous market regimes? Although there isn’t a formally recognised dividend or income factor, we would also note that excluding energy – and tobacco – is likely to have impaired a portfolio’s yield through this period.
FIGURE 2:AVERAGE SECTOR OVERWEIGHTS IN MSCI WORLD EXCLUDING ENERGY INDEX (PERCENTAGE POINTS), 31.01.1995 TO 28.06.2019 Materials Industrials
0.53 0.96
Consumer Discretionary
1.03
Consumer Staples
0.81
Healthcare
0.94
Financials
1.84
Information Technology
1.07
Telecoms
0.43
Utilities
0.36
Source: LGIM, MSCI, Bloomberg
As Figure 2 displays, when energy is excluded, the largest overweights have tended to be to consumer discretionary, financials, and technology. Comparing this with Figure 1, we see that the overall effect of rebalancing away from energy and into these three sectors – each of which has a relatively high correlation to the MSCI World index – is likely to be an equity portfolio with an above-average beta. The consistent diversifiers – consumer staples, healthcare, and utilities – receive more modest upgrades.
PORTFOLIO PERMUTATIONS With all this in mind, traditional negative screens may be most appropriate for investors who are obliged to avoid certain sectors. But other investors may be able to preserve the diversification benefits from sectors like energy without sacrificing their ESG criteria by integrating those criteria into their investment process in more nuanced ways. At Legal & General Investment Management, we believe ESG scoring gives us a framework for engaging the companies in which we invest and also allows us to tilt portfolios to reflect ESG criteria while maintaining diversification.
Important notice
“Correlations can switch unpredictably at key moments and so excluding sectors can deprive investors of diversifying assets unexpectedly or expose them to greater risk if the retained sectors converge in periods of market stress.” Again, though, we have to reiterate that these weights will vary through time – not always to the investor’s advantage. The overweight to financials, for instance, reached its zenith just in time for the financial crisis. Turning to the present day, the most significant overweight in the MSCI World excluding Energy index is now information technology at 0.98 percentage points. This additional exposure to tech stocks has important consequences for investors, not least for those who have already chosen to overweight technology elsewhere in their portfolios. An additional point is that we have focused on global developed market-cap exposure here, which has well over 1,000 securities across more than 20 countries. For investors thinking about regional allocations, the impacts of reweighting can be even more pronounced. In the UK equity space, for example, three energy stocks – from just two issuers – make up over 15% of the FTSE 100. Exclude these and the redistribution effect can lead to an overweight of almost four percentage points to financials within that adjusted index.
The value of an investment and any income taken from it is not guaranteed and can go down as well as up; you may not get back the amount you originally invested. Past performance is not a guide to future performance. This document is designed for the use of professional investors and their advisers. No responsibility can be accepted by Legal & General Investment Management Limited or contributors as a result of information contained in this publication. This document is provided for information purposes only and we are not soliciting any action based on it, and is not a recommendation to buy or sell securities or pursue a particular investment strategy; and is not investment, legal, regulatory or tax advice. Specific advice should be taken when dealing with specific situations. The views expressed here are not necessarily those of Legal & General Investment Management Limited and Legal & General Investment Management Limited may or may not have acted upon them. This document may not be used for the purposes of an offer or solicitation to anyone in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it is unlawful to make such offer or solicitation. As required under applicable laws Legal & General will record all telephone and electronic communications and conversations with you that result or may result in the undertaking of transactions in financial instruments on your behalf. Such records will be kept for a period of five years (or up to seven years upon request from the Financial Conduct Authority (or such successor from time to time)) and will be provided to you upon request. © 2019 Legal & General Investment Management Limited. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, including photocopying and recording, without the written permission of the publishers. Issued by Legal & General Investment Management Limited. Registered in England and Wales No. 02091894. Registered Office: One Coleman Street, London, EC2R 5AA. Authorised and regulated by the United Kingdom Financial Conduct Authority, No. 119272.
23
ASIAN INCOME
ASIA THE NEXT DIVIDEND POWERHOUSE?
Asia has typically been viewed as an investment destination for those seeking capital growth with relatively high levels of volatility. However, against a global backdrop of growing demand for income-related investments, the dividend story developing in Asia remains underappreciated. Could Asia be the future investment destination for your income needs, asks Jochen Breuer, Portfolio Manager, Fidelity Asian Dividend Fund.
Over the last few years we have seen significant developments from Asian companies in terms of dividend policies, driven by a combination of investor demand, regulatory change and more disciplined capital allocation. While growth is still a key goal for Asian companies and the structural growth opportunities remain, companies are increasingly rewarding shareholders via increasing dividends and buybacks while being more disciplined when it comes to capex decisions.
Another example is in Korea, where companies face tax penalties for sitting on too much idle cash and tax incentives for putting this cash to work for shareholders. The result has been a rise in dividends and buybacks from Korean corporates. At the same time, the region has dividend stalwarts such as Australia, driven by demand from local superannuation funds and a very attractive franking credits scheme, as well as Taiwan, where companies face tax disadvantages for retaining earnings.
MAJOR USES OF OPERATING CASH FLOW FROM ASIAN COMPANIES
ASIAN DIVIDEND PAYMENTS HAVE ALMOST DOUBLED IN THE LAST DECADE
100%
350,000
90%
300,000
80%
250,000 (US$bn)
70% 60% 50%
50,000
30%
0
20%
2010
2011
2012
Capex
Buybacks & dividends
2013
Asean
2014
Taiwan
2015
HK
2016
Korea
India
2017
2018
Others
2017 2018
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
China Aust 1997
1995 1996
10%
M&A
Source: Jeffries, Factset, August 2019. Aggregates are bottom-up calculated without free float adjustments based on current universe (MSCI Asia e x Japan ex Financials).
This is generally supported by a more progressive regulatory environment. For example, in China we have seen improving dividend payouts in the last couple of years, especially among state-owned enterprises where it is being driven by government directives. In fact, in US dollar terms Chinese companies are now the second largest payer of dividends globally, forking out over $145bn to investors via cash dividends in 2018 - UK companies paid out $115bn over the same period.
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150,000 100,000
40%
0%
200,000
Source: Jeffries, Factset, August 2019. Bottom-up aggregated free float adjustments based on current universe (MSCI Asia-Pacific ex Japan). Based on dividends from cash flow statement.
Yields across the region vary, from low yields in India (where the growth opportunity is high and valuations relatively expensive) to global-leading yields in Australia. However, the general trend is higher payouts and - as the chart above shows - the absolute amount of dividends paid out by companies is increasing at a healthy rate. As a result, we have seen superior dividend growth in Asia versus other markets in recent years.
Yet it is not just attractive yields supported by solid balance sheets that investors can benefit from. The Asia region is still in its development phase and continues posting economic growth rates above that of developed markets like Europe and the US. Asian companies are able to tap in to this structural opportunity driven by rising incomes, a growing middle class and demographics to grow further, and as they do, they generate more cash for dividend growth.
750
L15Y dividend CAGR (03A-18A): DM = 8.1% EM = 13.2% USA = 8.7% AC Europe = 7% Asia ex Japan = 12.3% Japan = 11%
650 550 450 350 250 150
USA
AC Europe
Asia ex Japan
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
Forecast 2004
50
2003
Dividend index rebased to 100 (local currency, current universe)
DIVIDEND GROWTH BY REGION ASIA LEADS THE WORLD
Japan
Source: Jefferies, Factset, August 2019. Note: Dividend growth of MSCI regions since 2003 (based on current universe).
Crucially, dividends are supported by strong balance sheets, which can be traced back to the 1997 Asian financial crisis. During this period companies learned a hard lesson in what happens if you do not allocate capital correctly and borrow for domestic ventures in foreign currency. As a result, Asian companies now enjoy some of the most solid and stable balance sheets in the world, creating a strong foundation for increasing dividend payments.
ASIAN COMPANIES HAVE STRONGER BALANCE SHEETS
80 72.8
60 55.8
50 44.3
40 30
USA
AC Europe
Japan
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
24.5
2005
20
2004
Net debt to equity (%)
70
THE CURRENT ENVIRONMENT - BOND PROXIES TRADING AT HIGH VALUATIONS We have observed an interesting development across Asia over recent months, in that companies which underperformed strong markets in the first part of the year have continued to underperform during a period where sentiment has been impacted by trade tensions and concerns over the health of the global economy. As a result, we have not witnessed a mean reversion or the swapping of market leaders, despite some significant policy and macro changes. A lot of the names which have underperformed are cyclicals where investors are in no rush to buy, despite cheap valuations, given the increasingly uncertain outlook and subsequent earnings downgrades. Energy names and banks are prime examples of this phenomena. All the while, we have seen outperformance of so-called “bond proxies” and high-quality compounders (i.e. names with very high earnings visibility). A number of these types of companies now trade on very high relative valuations and as a result it is increasingly difficult to find new ideas in this space. So where are the opportunities for investors? Looking at markets today, I think valuations in companies who pay lower dividends but with decent dividend or earnings growth prospects look attractive. I also see an interesting middle ground of companies that have traditionally been labelled as defensive, but have continued to underperform, mainly due to stock or country specific reasons. Chinese telecoms and Hong Kong conglomerates and property stocks fall into this category. This area now offers selective opportunities as relatively low valuations should also provide a decent margin of safety if macro headwinds continue to intensify.
Asia ex Japan
Source: Jefferies, Factset, August 2019. Net gearing trend of MSCI regions ex Financials (based on current universe).
*Based on 12-month gross trailing dividend yield excludes impact of special dividends. Data based on Fidelity Asian Dividend Fund as at 31 July 2019.
Past performance is not a reliable indicator to future returns.
Important notice This information is for investment professionals only and should not be relied upon by private investors. The value of investments and any income from them can go down as well as up so the client may get back less than they invest. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. The annual management charge for the Fidelity Asian Dividend Fund is taken from the fund’s value, so it may give a higher income, but the fund’s capital may decrease, which will affect future performance. The fund can also use financial derivatives which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Changes in currency exchange rates may affect the value of an investment in overseas markets. Investments in small and emerging markets can also be more volatile than other more developed markets. Reference in this article to specific securities should not be interpreted as a recommendation to buy or sell these securities but is included for the purposes of illustration only. Investments should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document and current and semi-annual reports, free of charge on request, by calling 0800 368 1732. Issued by Financial Administration Services Limited and FIL Pensions Management, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM0919/24375/SSO/NA 25
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27
SUSTAINABLE INCOME
INCOME. SUSTAINABLY
With rates at rock bottom, investors are turning away from annuities, but demand for income is in ever greater demand. Investors nearing or in retirement need an alternative. Francois de Bruin discusses how the Aviva Investors Sustainable Income and Growth Fund can help fill the gap.
Over the past two years, it appeared income seekers may be in line for a reprieve as central bankers tentatively started to raise interest rates. Today, the picture is very different – the US Federal Reserve has dropped rates twice, Europe has resumed its quantitative easing programme and the Bank of England has flagged that it too may cut rates. Investors need to continue to be diligent and creative in their hunt for income. For those looking to retirement, the level of income is not all they need to consider. They also need to mitigate longevity risk, which means generating returns ahead of inflation capable of sustaining their income over many years. Income cannot come at the expense of capital growth. Many solutions fail on this point. Bond yields are so low – around a quarter of global bond yields are negative – investors have sought growth from global equities. Having made capital gains from equities, they have sold units to deliver income. This is fine if stock markets continue to rise higher. However, if the environment turns, investors may not be left with sufficient capital to generate the income they need: the phenomenon of ‘pound cost ravaging’. Aviva Investors’ new Sustainable Income and Growth Fund aims to provide a solution to the difficulties of income. The multi-asset product, launched in July, aims to deliver a 5%
“Starting yields don’t have to be high, but we are minutely focused on dividend growth and highly selective. We need to understand where the future income is coming from.”
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‘natural’ income and to grow the income stream over time. Manager Francois de Bruin says this is only possible by taking a security by security view, as opposed to sweeping ‘top-down’ allocations to bonds or equities. Companies in the portfolio are selected on the basis of sustainable business models and underlying revenue streams, with an emphasis on cash flows. This allows them to deliver returns that compound over time. De Bruin believes that by focusing on assets likely to generate dividends and coupons rather than selling shares for income, the drawdown problem can be mitigated. The fund draws on much of the expertise across Aviva Investors and may at any point include developed and emerging market equities, listed real assets, credit, emerging market sovereign and corporate bonds or high yield bonds. De Bruin says: “We have to be very selective. We have around 76 holdings and our approach is very different to a top-down approach. “Starting yields don’t have to be high, but we are minutely focused on dividend growth and highly selective. We need to understand where the future income is coming from.” If a company is putting its balance sheet at risk to pay dividends that’s an automatic red flag.
In terms of the companies they like, de Bruin gives the example of Texas Instruments, a leading US semi-conductor manufacturer. It pays a 2.8% dividend yield and has shown 20% dividend growth over the past five years, supported by significant buybacks. Since 2004 there has been a 45% decrease in its share count, yet the amount of debt is unchanged. Instead it generates $6bn in free cash flow, which allows management to distribute profits to shareholders. This is the type of opportunity they are looking to find for the portfolio. The bottom-up selection guides asset allocation and the income discipline gives the portfolio a natural contrarianism. De Bruin says: “If equity markets rally, we’ll be selling some of this equity and rotating it into higher-yielding opportunities. When equity markets sell off, yields are rising, we’ll be selling some high yield bonds, or listed real assets. The income opportunities force us to make hard decisions, where it is least comfortable to do so, forcing us to take profits and rotate the portfolio.” As it stands the fund has around one-third in credit and two-thirds in ‘growth’ asset classes – including a 24% holding in ‘real assets’. There is no neutral positioning. Importantly, however, there won’t be any ‘hiding’ in cash; “we know we need to be fully invested in the most productive assets – our clients have long time horizons and need growth,” he says. Today, de Bruin is finding plenty of value within European equities, where there are lots of dividend-paying companies. He points out that 60% of European equities deliver yields greater than 3%, though admits it is important to avoid the value traps. One of the largest holdings in the fund is insurance group Allianz, which has a 4%+ yield and has delivered consistent dividend increases. On its balance sheet, it has a 220% solvency ratio. The team also likes Shenzhou International which is the manufacturing engine behind Nike and Uniqlo. It has a strong, visible production pipeline and has consistently delivered 20% growth in its dividend yield.
In credit markets, de Bruin takes a slightly different approach because there is no inherent growth in a bond. At the moment, he holds bonds in Mexico’s second-largest bank, Banorte, with yields of over 7%: “It is not where most investors are willing to do the work,” he says. “We have the breadth of team to find individual opportunities.” He also holds an eclectic mix of emerging market sovereign bonds, including bonds in Sub-Saharan Africa where the IMF’s commitment to the region gives him confidence. In Ghana, for example, he sees considerable reform and yields are attractive, although he focusses on near-term maturities. De Bruin’s ‘real assets’ holdings include a weighting in REITs: “We really like the return driver of income plus income growth – especially when it’s contractual. There are a number of REITs that offer a combination of yields in excess of 4% income and 4% income growth with irreplaceable portfolios from California to Hong Kong. These are the type of opportunities we like.” With bond yields still at historic lows and risks mounting in the global economy, income is not easily found and certainly not at lower risk, but investors cannot ignore longevity risk. The answer, says de Bruin, is a targeted portfolio of individual assets built with a specific outcome in mind.
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For today’s investor
For professional clients and advisers only. Issued by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: St Helen’s, 1 Undershaft, London EC3P 3DQ. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. 30
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The new view on equity investing
Capture tomorrow’s growth potential with our thematic investing range Enormous technological and demographic shifts have helped companies span more industries and countries than ever before. But much of the world still relies on traditional sector definitions when it comes to investing. We believe that focusing on long-term growth drivers, through our thematic equity range, can help investors tap into this evolving economy. Investment involves risks, including the loss of capital. Discover more at: ADVISER.AXA-IM.CO.UK/THE-EVOLVING-ECONOMY
For Wholesale/Professional Clients only, as defined by applicable laws and regulation. Not to be relied upon by retail clients. This communication is for informational purposes only and does not constitute an offer to buy or sell any investments, products or services and should not be considered as a solicitation or as investment advice. This communication is issued in the UK by AXA Investment Managers UK Limited, which is authorised and regulated by the Financial Conduct Authority in the UK. Registered in England and Wales No: 01431068. Registered Office: 7 Newgate Street, London EC1A 7NX. In other jurisdictions, this document is issued by AXA Investment 31 Managers SA’s affiliates in those countries. © AXA Investment Managers 2019. All rights reserved.
MODEL PORTFOLIOS
THE £1 MODEL PORTFOLIO SERVICE: SIMPLIFYING THE ADVICE PROCESS
Invesco has now launched its Model Portfolio Service, which is now available to Intelliflo users and promises to revolutionise the way advisory portfolios are managed.
Consumer behaviour and expectations are shifting in ways that are challenging financial services providers to rethink how they service their clients. Against an increasingly complex market backdrop fuelled by shifts in technology, regulation and global events, we are offering investment solutions in a way that’s designed to meet specific client goals. As such, Invesco has partnered with Intelliflo to provide a differentiated Model Portfolio Service proposition that will enable you to spend more time giving financial advice and to add real value to relationships through an engaging and digitally enabled planning process. This is the first service to use Intelliflo’s Integrated Model Portfolio Service (iMPS), which aims to streamline the advice process and provide automatic client communication. This flexible service will harness the global expertise of Invesco and brings a 60+ strong team to the task of building and maintaining diversified investment solutions. The service launches with two ranges of multi-manager model portfolios investing across 20 leading asset managers, targeting either income or growth.
“As an actively managed solution for an advisory investment service, the Invesco Model Portfolio Service will enable advisers to outsource all aspects of the building and ongoing management of a range of portfolios.”
Each portfolio has its own risk profile and objective and is rated by four external risk rating agencies – Evalue, Defaqto, Synaptic and Finemetrica – allowing you to match your clients to the right portfolio. Consisting of an optimised blend of equity, fixed interest, alternative assets and cash, a maximum of 25% of each portfolio can be allocated to any one asset manager, including Invesco. As an actively managed solution for an advisory investment service, the Invesco Model Portfolio Service will enable advisers to outsource all aspects of the building andongoing management of a range of portfolios. Advisers will benefit from Invesco’s deep investment skills while having access to extensive market insight and commentary to share with their clients. Initially offered on the Fidelity FundsNetwork, Aviva and 7IM platforms, the service will be made available on other platforms in the near future. It has a clear and competitive charging structure of just £1 per client per month (plus VAT), capped at £70 per month (plus VAT) per advice firm. Clients will simply pay the relevant underlying fund and platform charges. Chris Lyes, Head of Retail Distribution at Invesco, said: “Consumer expectations and preferences are changing, challenging financial services providers to reconsider how they serve their clients and help them achieve their investment goals. We are meeting these challenges by offering advisers access to Invesco’s global network of investment experts through a technologically sophisticated service that saves advisers time, ultimately helping them to make the most of their client relationships whilst being able to develop their business.” Using the service, accessed by installing the new Invesco MPS App available in Intelliflo’s iO Store™, advisers will be able to harness straightforward end-to-end processing. And with ‘one-click’ acceptance of portfolio changes via the Personal Finance Portal (PFP), end-investors will be able to accept their adviser’s recommendations quickly, securely and remotely. Your advice - brought to life and delivered with a click.
Find out more For more information on the Invesco Model Portfolio Service, including the investment team, their process, the portfolios and availability, please visit invesco.co.uk/invescomps
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Investment risks The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested. Important information This article is for Professional Clients only and is not for consumer use. All information as at 24 September 2019, unless otherwise specified. Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice. Issued by Invesco Asset Managers Limited Perpetual Park, Perpetual Park Drive, Henley-onThames, Oxfordshire RG9 1HH, UK. Authorised and regulated by the Financial Conduct Authority.
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Our Model Portfolio Service Delivering your investment solution The much-anticipated Invesco Model Portfolio Service is now available to Intelliflo users, providing risk-targed portfolios focused on income or growth and offering a combination of benefits that you won’t find anywhere else: – Access our expertise in research, asset allocation and portfolio construction – Partnered with Intelliflo to streamline advisory portfolio management and give you more time to focus on your clients – Only £1 per client per month to access the portfolios*, with no portfolio management costs for your clients Get started at invesco.co.uk/modelps Capital at risk.
This ad is for Professional Clients only and is not for consumer use. Invesco Asset Management Limited is authorised and regulated by Financial Conduct Authority. *Up to a maximum of £70 ex. VAT per firm per month. 34
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DEFENSIVE INVESTMENT
WHY DEFENCE MAKES SENSE
Jason Borbora-Sheen and John Stopford, Co-Portfolio Managers, Investec Diversified Income Fund explain why having a lower downside capture than upside is a sensible approach irrespective of the market backdrop.
AT A GLANCE •
The worst drawdowns typically happen in recessions. Investors have experienced even worse drawdowns in this bull market than previous ones. • This is particularly harmful to investors with nearer-term horizons, who are relying on assets they have built up previously, such as retirees who need attractive, sustainable income in their later years – especially now they’re living longer. • Why is this happening now? We believe a changing market structure caused by slower economic growth, central bank intervention and more passive investors in the market could be the culprit.
RECESSION OBSESSION Many commentators are talking about an increasing risk of recession. Our own recession probability models agree, showing more than a 50% chance of a recession happening in the next two years. As recessions are typically associated with much worse market returns, this increasing risk has led investors to look for defensive strategies that emphasise drawdown management. We believe that even outside of periods of increased recession risk, defence makes good sense for investors – particularly for those whose investment horizon is limited.
MISBEHAVING DRAWDOWNS We think the nature of markets has evolved since the global financial crisis. Our analysis of markets since 1987 (the year of the Black Monday crash) shows that before 2009, outside of the ‘bear markets’ often associated with recessions – when stock markets drop 20% or more from recent highs – investors tended to see drawdowns that were ‘well-behaved’: an equal weighted bond-equity portfolio suffered very few drawdowns of more than 5%, and never as much as 10%. By contrast, in the current cycle we have so far seen six episodes of more than 5% drawdown including one of more than 10% – an unprecedented frequency and magnitude of drawdown for a bull market over the last 30 years. This can be seen in Figure 1.
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FIGURE 1: DRAWDOWN OF AN EQUAL WEIGHTED BOND/EQUITY PORTFOLIO
Source: Bloomberg and Investec Asset Management, 31 July 2019. Drawdown of equal weighted portfolio refers to MSCI ACWI & WGBI.
IS A CHANGING MARKET STRUCTURE TO BLAME? We think there may be multiple drivers of this increased fragility across asset classes: • The rate of economic growth has been slower over this cycle than in past cycles, meaning the global economy has teetered closer to the edge of recession (and therefore to the risk of severe drawdowns) than it did before. • To deal with this, central bank market intervention has become more significant and creative than it was previously, potentially leading to a ‘feast or famine’ environment for liquidity. • The ability of private sector banks to absorb risk has been curtailed by regulation and shareholder demand for their business models to become more dependable. • Passive ETFs/tracker indices make up a greater proportion of the investor base, potentially leading to more herding into and out of positions, thereby exacerbating market moves. The impact of these changes is evident in the number of ‘flash crashes’ – instances when asset values changed significantly over a short period of time – seen in this bull market. These flash crashes aren’t just confined to equity markets and are likely a consequence of liquidity becoming more susceptible to drying up than before.
“In the current cycle we have so far seen six episodes of more than 5% drawdown including one of more than 10% – an unprecedented frequency and magnitude of drawdown for a bull market over the last 30 years.”
WHY DEFENCE MAKES SENSE
CONCLUSION
The Investec Diversified Income Fund focuses on defensive returns, which we define as having a lower downside capture than upside. We believe this focus makes sense irrespective of the market backdrop to investments. This chart shows the peak-to-trough performance of the Fund and its peers in the most severe recent drawdown episodes. The blue line shows the least dramatic falls during these challenging periods, meaning our approach shielded against capital losses more so than any of our comparative peers. By then ‘un-hedging’ risk when appropriate, we were able to recover losses more quickly and so avoided the worst of the negative impact.
For investors, the benefit of investing in a defensive fund during a recessionary period should be clear, as the aim to reduce drawdowns in significantly falling markets makes it easier to regain capital in the future. However, with market structure changes leading to the increased frequency and magnitude of bull market drawdowns and flash crashes, a defensive strategy has an important role in an investor’s portfolio throughout the cycle, particularly for those investors with nearer-term liabilities and needs.
FIGURE 2: PEAK TO TROUGH PERFORMANCE DURING DRAWDOWN EPISODES
We believe this is why defence always makes sense. Past performance is not a reliable indicator of future results, losses may be made. The Fund may invest more than 35% of its assets in securities issued or guaranteed by a permitted sovereign entity, as defined in the definitions section of the Fund’s prospectus. Where charges are taken from capital, this may constrain future growth.
For further information, please visit www.investecassetmanagement.com/DIF
Past performance is not a reliable indicator of future results, losses may be made. Performance is for the I-Acc share class, net of fees (NAV based, including ongoing charges), gross income reinvested (net of UK basic rate tax pre 5 April 2016) in GBP. Calendar year % returns for the Fund, Index and Sector, respectively 2018: 0.41, -9.47, -2.97. 2017: 4.82, 13.10, 3.89. 2016: 5.92, 16.75, 2.18. 2015: 1.97, 0.98, 2.30. 2014: 5.32, 1.18, 3.15. 2013: 6.19, 20.81, 7.93. Source: Morningstar, 31 August 2019.
This communication is for institutional investors and financial advisors only. It is not to be distributed to the public or within a country where such distribution would be contrary to applicable law or regulations. English language copies of the Fund’s Prospectus and Key Investor Information Documents are available from Investec Asset Management on request. Issued October 2019.
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DEMOGRAPHICS
Will Oulton First State Investments
FOR THEY SHALL INHERIT THE EARTH Forget talk of avocado toast and endless selfies, asset managers and advisers need to wake up to the fact millennials will look to responsible investing (RI) as ethics drive their financial choices.
Over the next 30 years, it is estimated that £23trn of assets will move into the hands of millennials. This pattern of shifting wealth presents two challenges to fund houses. Firstly, research indicates that around 70%-80% of assets usually leave a firm when older generations pass, so businesses really do need to be thinking about how to retain their new, younger clients. Secondly, considering investors generally start becoming serious about investing between the ages 45 and 55, the oldest millennial is now around 38, so investing behaviour will need bedding-in soon.
DIGGING DEEPER First State Investments conducted research to uncover what impact this generation’s attitudes have on the investment chain. Around 80% professed themselves interested or very interested in RI – that is, the incorporation of environmental, social and governance (ESG) factors into stock selection. The research also revealed a belief among millennials that decisionmaking was being hobbled by insufficient information and education on RI. From an investment point of view, there was confusion over potential investment outcomes, as around half of millennials thought that RI sacrificed performance. The research also found that millennial investors could be sensitive to controversies in underlying portfolio investments.
WHAT TO DO, WHAT TO DO? Starting with regulators, in general it seems there is a lack of standardisation on how ESG performance is measured and displayed, and how training is structured and advised, which could be addressed. Within the defined contribution schemes, committees, boards and consultants could potentially do with further training to understand RI better, particularly as trust-based schemes become mandated this October by the Department for Work and Pensions to disclose ESG factors in the public statement of investment principles. For asset managers, meanwhile, millennials are set to serve as the investment managers of tomorrow and need attracting and retaining. It means promoting and expanding ESG-focused funds to become part of the mainstream selection. Finally, when it comes to platforms, investors need further education to understand why RI can produce better investment outcomes.
APPEALING TO A GENERATION Millennials are passionately engaged with climate change concerns; they are outraged by social injustice and bad corporate actors; and, when looking for work, they find a firm’s ethics essential in the decision-making process. Investing, they realise, is a way to express their deep-seated beliefs regarding social, environmental and political values. When it comes to how asset managers should think about product development for millennials, the clue is perhaps in the label. RI will not just be an interesting product feature in the future, but a strategic – and essential – requirement. Will Oulton, Global Head of Responsible Investment, First State Investments
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PARTNER DETAILS AVIVA INVESTORS t: 020 7809 6521 e: BDEUK@avivainvestors.com w: avivainvestors.com/en-gb
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JUPITER ASSET MANAGEMENT t: 020 3817 1063 e: intermediary-sales-support@jupiteram.com w: jupiteram.com
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LEGAL & GENERAL INVESTMENT MANAGEMENT t: 0345 070 8684 e: fundsales@lgim.com w: lgim.com/uk/ad
BNY MELLON INVESTMENT MANAGEMENT t: 020 7163 8888 e: salessupport@bnymellon.com w: bnymellonim.com
M&G INVESTMENTS t: 0845 600 4125 e: advisorysales@mandg.co.uk w: mandg.co.uk/adviser
FIDELITY INTERNATIONAL t: 0800 368 1732 e: premierline@fil.com w: professionals.fidelity.co.uk
MERIAN GLOBAL INVESTORS t: 020 7332 7524 e: clientservices@merian.com w: merian.com
FIRST STATE INVESTMENTS t: 020 7332 6500 e: enquiries@firststate.co.uk w: firststateinvestments.com
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GOLDMAN SACHS ASSET MANAGEMENT t: 020 7774 7779 e: fundinfo-uk@gs.com w: gsamfunds.com
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