* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Download With Diverging Policy, Political Unrest and Market
Survey
Document related concepts
Financial economics wikipedia , lookup
Syndicated loan wikipedia , lookup
Land banking wikipedia , lookup
Interest rate wikipedia , lookup
International monetary systems wikipedia , lookup
Quantitative easing wikipedia , lookup
Investment fund wikipedia , lookup
Interest rate ceiling wikipedia , lookup
Investment management wikipedia , lookup
Interbank lending market wikipedia , lookup
Stock selection criterion wikipedia , lookup
Public finance wikipedia , lookup
Transcript
2015 MARKETS www.bnymellonimoutlook.com With diverging policy, political unrest and market volatility to the fore, uncertainty looks set to prevail. PREPARED FOR PROFESSIONAL CLIENTS ONLY Contents 04 T rading Places Raman Srivastava, Standish and Holger Fahrinkrug, Meriten 06 P olicy divergence won’t derail expansion Richard Hoey and Jack Malvey, BNY Mellon 08 U S rate rises are not a done deal James Lydotes, The Boston Company 10 Policy support may offer illusory benefits Iain Stewart, Newton 12 C urrency volatility E lena Goncharova, BNY Mellon Investment Strategy and Solutions Group and Charles Dolan, BNY Mellon 16 A cross the spectrum Paul Hatfield, Alcentra 18 An end to corporate hoarding in Japan Simon Cox, BNY Mellon IM Asia Pacific 22 E merging market debt: potential fallout from US monetary policy Urban Larson, Standish 24 U S housing stands on firmer ground Carl Guerin and Raphael Lewis, The Boston Company 26 H olding the faith Amy Leung, Newton 28 D ilma’s dilemma Solange Srour, ARX Investimentos 14 B ond conundrums – finding value April LaRusse, Insight Pareto 2015 MARKETS www.bnymellonimoutlook.com Volatile Market Mix for 2015 Divergences in growth and monetary policy around the world are expected to lead to a more volatile market mix in the coming year. In this special report, experts from across BNY Mellon Investment Management and its affiliates present their views on what to expect in major capital markets for 2015 and why an active, flexible approach to investing will be more important than ever. BNY Mellon Chief Economist Richard Hoey expects the global economy to continue to expand, despite some short-term disruption as policy normalization progresses in the US. Portfolio manager James Lydotes of The Boston Company, however, believes that US interest rates may remain “lower for longer,” perhaps even until 2020 because of ongoing weakness in the US economy. One area where continued weakness in the US can be seen is the choppy recovery of the housing market. Boston Company research analysts Carl Guerin and Raphael Lewis don’t expect 2015 to feature a snapback recovery that housing experienced after recessions in the mid-1970s and early 1980s and 90s. Unlike the US, the Eurozone is warding off deflationary pressures, but there are nonetheless likely to be investment bright spots for discerning managers. Paul Hatfield, Chief Investment Officer of Alcentra points out that opportunities for direct lending to small and medium-sized European companies will grow in the new year as increased regulation and higher capital requirements compel banks to reduce lending. Urban Larson of Standish Mellon Asset Management points out that emerging market debt may feel the effects of developed market central bank policy shifts keenly. He believes investors should look to sovereign and corporate issuers that are less dependent on the cheap international financing that has been so abundant. With reduced liquidity and a strengthening dollar, differences in fundamentals across emerging economies may matter more in 2015. Amy Leung of Newton is watching the progress of China’s shift to domestic consumption after 30 years of export-driven growth. She sees a slowdown in 2015 as reforms proceed, but still expects China to successfully re-engineer its economy in the longer term. Brazil in 2015 offers another example of the increasingly varied states of health among emerging market economies. Solange Srour, chief economist at ARX Investimentos, BNY Mellon’s Rio de Janeiro-based investment affiliate, says hoped-for reforms that could benefit investors may be at odds with the agenda of newly reelected President Dilma Rousseff. Currency is another source of risk investors may want to pay closer attention to in 2015. Charles Dolan and Elena Goncharova of BNY Mellon’s Investment Strategy and Solutions Group* expect currency volatility to make a comeback, as monetary policy diverges around the world. However, Iain Stewart of Newton and Jack Malvey, Chief Strategist at BNY Mellon Investment Management, both say that investors should focus less on seeking opportunities created by monetary policy and more on factors such as corporate earnings and geopolitical risk. *BNY Mellon Investment Strategy & Solutions Group (“ISSG”) is part of The Bank of New York Mellon (“Bank”). 3 MARKETS Trading places Raman Srivastava, Co-deputy chief investment officer, Standish Holger Fahrinkrug, Chief economist, Meriten A growing divergence between US and European bond yields reflects the shifting strategies of global central banks. But as markets look towards further change in 2015 what implications does this hold for global investors and wider bond markets? Here, Raman Srivastava, co-deputy chief investment officer at Standish and Meriten chief economist Holger Fahrinkrug consider the likely outcomes. An unfamiliar pattern is emerging in global bond markets. Toward the end of 2014 benchmark yields on a swathe of European government bonds, from German Bunds to Spanish bonds, fell to new lows1. In contrast, five-year US Treasury yields have more than doubled since 20122. These moves partly reflect the contrasting monetary policies of the US Federal Reserve (Fed) and the European Central Bank (ECB). While the Fed wound down its quantitative easing (QE) programme in October Europe is still loosening its monetary policy and looking for ways to stimulate growth in a flagging regional economy. As part of these efforts the ECB announced a multi-billion euro initiative to buy covered bonds and asset-backed securities3 in September 2014. Commenting on the origins of recent divergence, Standish’s Srivastava 4 cites the 2013 market ‘taper tantrum’ – which followed the Fed’s announcement it was to start reducing QE – as a key trigger for interest rate and bond yield divergence between the US and Europe. “Taking a global view, it is clear that following a period of a number of years where many interest rates moved together, the taper tantrum initiated a new environment where interest rates and central bank policy have begun to diverge, in some cases meaningfully. This environment now looks set to be with us for the foreseeable future,” he says. Divergent paths Commenting on the impact of central bank policy divergence on bond yields, Meriten’s Fahrinkrug says the shift also reflects a deeper underlying economic divergence of the US and European markets. He contrasts the www.bnymellonimoutlook.com sustained economic recovery in the US – and also the UK – with the economic stagnation, near record unemployment levels and deflation fears still evident in the Eurozone. Commenting, he adds: “This combination of real economy slack and deflation woes in the euro area has pushed the ECB into unconventional policy territory, sent German Bund yields lower, and spreads of other European Union member government bonds over Bunds to historical lows.” Central bank strategy and bond yield divergence have already led the dollar to strengthen against the euro and could have wider implications, according to Srivastava, although he expects their impact to vary widely across a range of markets. “Looking ahead – for emerging markets in particular – there will be an extreme amount of difference between rates of growth and responses to potential reforms and this is likely to create a lot of market dislocation,” he says. “Even in developed markets a lot of the trends that were in place for a number of years are shifting. Chinese economic growth is slowing, commodity prices are lower and the fact some major central banks will almost certainly begin to tighten policy in the short term are all very different dynamics and will affect bond markets in different countries in different ways.” Market response A key question in the current market is how fixed income managers can best respond to the changes ahead in 2015 given growing US/European bond yield and interest rate divergence and the varying approaches to monetary policy being taken by central banks. Srivastava anticipates more market volatility ahead as investors adjust to shifting trends. 1 2 3 He believes this environment will make country selection increasingly important but could also create a range of potential opportunities for nimble investors. Commenting, he says: “For investors in global bonds growing divergence means two things. Firstly, country selection will become a lot more important than it used to be. Secondly it means investors may need to be a lot more active in terms of their asset allocation. “We anticipate more volatility as the market struggles to adapt to shifting central bank activity. Such bouts of volatility can provide opportunities to benefit from dislocations caused by market technicals where fundamentals remain sound. In future investors will have to pay a lot more attention to the countries they are investing in. Investors may also have to be a lot more active with their yield curve and duration position than they perhaps used to be.” A watching brief With US QE now concluded, Fahrinkrug says global investors will be closely watching the ECB asset purchase programme in the months ahead to determine its success or failure, likely market impacts and potential investment opportunities and pitfalls. “Assuming that the US cycle moves ahead as expected, the key focus must be on the factors determining ECB success. Perversely, its failure based on the measures already announced might be as good, or even better, than its success, for investors in euro area government bonds. However, the market’s verdict will be straightforward, with the result getting either a straight thumbs up or the thumbs down. Consequently, investors and managers should be highly alert and analyse the parameters of the bank’s success very carefully. “In the event of ECB success, the likelihood of full-blown QE in Europe will decline sharply, and this could cause both yields and volatility to rise. Investment managers therefore need to be aware that euro area government bonds might not be as low-risk as the low-volatility assets they used to be in the first three quarters of 2014,” he says. Despite some degree of market uncertainty, Fahrinkrug remains hopeful the ECB will implement its support programmes as planned and uphold the threat to expand even into purchases of European Economic and Monetary Union (EMU) government bonds if other measures do not assist market recovery. “This combination should be sufficient to keep German Bund yields at or around current levels, and to contribute to further, albeit gradual, tightening of peripheral spreads in the months ahead. Consequently, we trust that euro area government bonds will still have value for domestic investors though they will need to carefully consider the currency factor as gradual euro depreciation is a part of the ECB’s strategy.” he says. The next 12 months hold the potential for further significant bond yield movements and volatility as central banks fine tune their strategies. However, these shifting sands could hold present opportunities for investors able to adapt their tactics to capitalise on specific market moves. Commenting on the broader global investment market outlook Srivastava adds: “In the near term we see a challenging investment landscape related to low growth in Europe, slowing growth in China, a stronger dollar and a rolling over of commodity prices. While sector fundamentals remain generally strong, we do believe bouts of volatility associated with market technicals will make tactical, rather than structural sector allocation especially important.” Draghi is bonds’ best friend as yields fall to records. Bloomberg. 06.06.14. Rising yields give bond buyers and issuers pause for thought. The Wall Street Journal. 28.12.13. ECB bond-buying scheme begins. FT. 21.10.14. 5 MARKETS Policy divergence won’t derail expansion Richard Hoey, Chief economist, BNY Mellon Jack Malvey, Chief global markets strategist, BNY Mellon The long-anticipated normalisation of monetary policy by the Federal Reserve and Bank of England could finally arrive in 2015. But BNY Mellon chief economist Richard Hoey and chief global markets strategist Jack Malvey say policy divergence among developed country central banks will be only one force affecting the global economy and financial markets in 2015. For the past three years, global economic growth has advanced slowly and unevenly, averaging nearly 3%, but with some regions such as the eurozone performing less strongly than others. While that uneven pattern of growth is likely to continue in 2015, BNY Mellon chief economist Richard Hoey expects somewhat stronger overall growth as the expansion of the US and global economies accelerates and central banks in the US and UK normalise policy. “Stimulative monetary policies have generated only sluggish growth so far in this expansion due to a combination of drags from fiscal tightening, private sector deleveraging and restrictive financial regulation,” he says. “Substantial fiscal tightening has already occurred in most developed countries and is likely to prove less of a drag over the next several years. Debt burdens remain high in Europe and China, but US households have substantially reduced their debt.” Hoey expects US real GDP growth of about 3% and real growth plus inflation of 6 about 5% in the US for the next several years. Like many capital market professionals, Hoey identifies the divergence of monetary policy among central banks in developed countries as a defining feature of the global economy in 2015, with the European Central Bank (ECB) and the Bank of Japan (BoJ) maintaining easy policies while the Federal Reserve and the Bank of England (BoE) may gradually normalise interest rates by tightening policy. Policy normalisation, though, will likely be only one factor affecting financial markets. For equities, chief global markets strategist Jack Malvey says policy divergence means relatively little. “The central bank theme has been overdone in capital market coverage and media. Historically, some banks are always tightening while others are loosening. Capital markets will be driven by many factors,” says Malvey. www.bnymellonimoutlook.com “Neither the rise of the Islamic State, the conflict between Russia and Ukraine nor the spread of Ebola were forecast at the beginning of 2014, but each exerted a pull on markets during the year that followed.” Malvey says corporate earnings will be among the key drivers of equity market performance in 2015 and he expects them to rise by 6 to 8%. Merger and acquisition activity, abetted partly by hedge funds and partly by companies doing strategic acquisitions, is also likely to push equity valuations higher. “The cost of debt capital is low and should remain low, so it’s a fairly ideal time to make acquisitions because both equity and debt financing are available and relatively inexpensive,” he says. Another factor in equities’ favour in 2015 may be the relatively modest opportunities offered by other asset classes. “Ten-year Treasuries at 2.10 or 2.50% are unappealing on an after-tax basis,” says Malvey. “Municipal bonds offering effective yields of 2 or 3% are also unappealing compared to the potential return from good, strong companies paying dividends.” Despite the positives for equities, Malvey expects markets to turn more volatile than they have been in the past three years. “A typical characteristic of the middle of the business cycle is that markets become increasingly choppy. Markets gave a taste of that when they turned volatile in October 2014,” he says. Malvey also notes that equity market performance will naturally vary across the world, with some emerging markets likely to fare well and the eurozone likely to lag. Central bank policy will play more of a role for fixed income markets than for equities. “Fixed income securities in 2015 will have impetus from central banks pushing for higher rates and demand from some investors for high-quality securities that have even a meagre coupon,” says Malvey. “By the end of 2015, 10-year Treasuries could be in the range of 2.50-3.25%.” We feel fairly comfortable that the federal funds rate will be higher at the end of 2015 than at the beginning of 2014. It’ll stop somewhere between 2 and 3% over the course of the next two to three years, depending on the actual vigour of the US economy.” Hoey also expects interest rate normalisation to be a multiyear process in developed countries, gradual enough to not disrupt sustained economic expansion. The speed with which interest rates rise will be determined partly by inflation expectations. Hoey sees the global economy beginning 2015 with underlying inflation below the targets set by all four of the G4 central banks. “Our expectation is that underlying inflation will rise to or above target over the coming years in both the US and UK. The underlying inflation rate should drift higher in both Japan and Europe but remain below target for the next several years.” Foreign exchange is another area affected by changes in monetary policy. Hoey and Malvey both expect the US dollar to strengthen over the coming year. “Monetary policy divergence will likely contribute to the basic dollar uptrend and be accompanied by widening interest rate spreads as US and UK rates rise and the ECB and BoJ’s balance sheets grow relative to those of the Fed and the BoE,” says Hoey. “Currency weakness in countries with weak growth and currency strength in countries with strong growth should help rebalance global growth and inflation. The US dollar should also benefit from the continuing rise in US energy production. These factors help explain the dollar’s rise in 2014 and they should contribute to a further rise in 2015.” Another effect of the stronger dollar, Malvey notes, is that earnings of US multinationals will be somewhat dampened by the stronger dollar. “A stronger dollar will also slow US export growth while hopefully stimulating European economies,” he adds. “Meanwhile, Japan will continue managing the yen to encourage exports.” Even more difficult to anticipate, says Malvey, will be the geopolitical risks that may affect markets in 2015. “Neither the rise of the Islamic State (IS), the conflict between Russia and Ukraine nor the spread of Ebola were forecast at the beginning of 2014, but each exerted a pull on markets during the year that followed.” 7 MARKETS US rate rises are not a done deal The consensus expectation is that the Federal Reserve will raise US interest rates, but the Boston Company’s infrastructure portfolio manager, James Lydotes, thinks differently. James Lydotes, Portfolio manager, global infrastructure, The Boston Company Lydotes, who heads the Global Infrastructure Dividend Focus Equity strategy and covers the non-US healthcare, utilities and technology sectors, cites four main factors that support his thesis: modest inflation expectations, weak global growth, an accommodative European Central Bank, and a demographic shift driven by the ageing baby boomers. He does not see these dynamics changing any time soon. “Yet,” he adds, “There’s consensus across the equity markets that rates are going higher and will pull up banks’ valuations while destroying the valuation of utility companies and bond proxies.” At the start of 2014, two-thirds of active US large-cap equity managers were positioned for rising interest rates, resulting in a close alpha correlation between their portfolios and interest rates1. Around half were very closely correlated. But, Lydotes observes, rates didn’t follow the course that these managers expected. Instead, “rates went down, taking with them the performance of those active equity managers who were resting on that view.” 1 8 Factset, Correlation as of 1/1/2014 While rates are widely viewed as having bottomed, he does not believe their imminent rise is a foregone conclusion. He notes that the US market has sustained a catastrophic market correction following a real estate bubble; increasing net federal debt as a percentage of GDP; and a zero interest rate policy implemented to stimulate growth, which failed to work when banks did not lend. “Add to that the once-in-a-generation issues faced with an ageing baby boomer population, and it starts to seem possible the next move in rates is not up — but down,” says Lydotes. There is not much indication of stronger growth elsewhere across the world either. China, which has fuelled global growth for the past 20 years, has been very open about moderating that growth and switching to a consumption-based economy. Meanwhile, Brazil does not look likely to replicate the performance it contributed in the past, and Russia is increasingly following an isolationist policy. www.bnymellonimoutlook.com “India is probably the one bright spot,” says Lydotes, “But it is highly unlikely that India can offset subdued growth from the rest of the world.” Meanwhile, the bulls’ favourite arguments for the return of ‘normal’ growth rates start to fall apart upon closer inspection. The first of these centres on the replacement cycle, namely that technology and medical equipment as well as office furniture and fixtures are vastly older than their 30-year average and will need to be replaced soon. “The real trouble is we have been waiting for this to materialise for the past few years, and we have not seen it. This equipment does not self-destruct when it reaches a certain age,” he says. At the headline level, healthcare equipment that is 8% older than its 30-year average seems like a convincing statistic, but in fact, that only equates to four months2. Meanwhile, another panacea trotted out by growth enthusiasts is the record levels of cash on companies’ balance sheets. In the US, companies are hoarding more than US$3.5 trillion in cash, far above the levels seen before the global financial crisis3. At the same time, however, they have taken on more debt, so US$3.5 trillion only represents 40% of corporate debt levels. Back in 2005, the US$2 trillion of cash held was the equivalent of 55% of total company debt4. “You want to focus on yield growth rather than absolute yield levels, as it is more predictive of growing income streams in a business”. Rising inflation, which would be a prompt for the Federal Reserve to hike interest rates, is not expected to come into play either, with little sign of wage or commodity inflation to drive it higher, says Lydotes. He will be keeping an eye on both of those metrics as well as looking for any rhetoric reversal from the ECB. Any surprises in global growth could also lead Lydotes to revisit his thesis. In the meantime, income orientated asset classes in the form of high quality US equities, global natural resources and infrastructure could offer opportunities. “You want to focus on yield growth rather than absolute yield levels, as it is more predictive of growing income streams in a business,” he concludes. “Companies are hoarding cash, but at the same time, they are borrowing at record levels, so their urgency to spend that cash is pretty greatly reduced,” Lydotes points out. In addition, capex is no longer subdued, he says, and in fact has already closed the gap and surpassed levels experienced before the global financial crisis5. US Department of Commerce, Bureau of Economic Analysis 31/12/13 Factset 31/12/13 Deutsche Bank Global Markets Research, FRB, Haver Analytics as at 31/12/13 5 Bloomberg 31/3/14 2 3 4 9 MARKETS Policy support may offer illusory benefits Iain Stewart, Investment leader, real return, Newton Iain Stewart, who leads Newton’s Real Return team, examines the reasons for the team’s reluctance to invest in assets that have benefited from the policy actions of the authorities. In contrast, the team’s preference is to concentrate on the fundamental investment attributes of individual holdings as well as focusing on diversification. The policies that have been used by the authorities to foster growth in the aftermath of the financial crisis run the risk of making matters worse, we fear. Our concern is that once the near-term ‘gains’ from lower debtservicing costs have been exhausted, vulnerability to unexpected events could even be greater. Although the policies put in place to support growth may well have been inspired by good intentions, they could make our economies more fragile and more vulnerable to shocks. Such is our level of concern that we have been less willing to participate in those areas of the market that we judge are particularly dependent on policy support from the authorities. As part of the policy support, injecting money into economies has the effect of skewing incentives and creating transfers of resources from one part of the economy to another. Using evergreater financial incentives to drag future activity into the present can lift activity in the short term but bring 10 forward demand from the future with deflationary consequences. Not only does cheap finance enable ‘zombie’ companies to limp along and just survive, it also allows new capacity to be built that would otherwise have failed to meet a required rate of return. The airline industry, for example, is once again challenged by price competition as the ready availability of finance has encouraged rapid fleet capacity expansion. Challenges Unconventional policies have also tended to exacerbate challenging social trends. The deliberate inflation of asset prices has created disparities in wealth and income. It encourages those that do have savings to divert their capital into financial speculation (that proves unproductive for the economy) rather than holding cash that offers no yield. How the related distortions ultimately manifest themselves will depend on www.bnymellonimoutlook.com cultural factors, such as the structure of the economy and who gets most benefit (or is closest) to the new money. Putting cheap money into economies, such as the UK and the US, is much more likely to create a credit expansion that fuels consumption or investment in unproductive assets, particularly real estate. Culturally, this is less likely to be the case in, say, Germany or France. China Globally, cheap money has also created a giant (perhaps the giant) credit expansion in China, which has funded investment in productive capacity and infrastructure. A continuing combination of debt-funded overconsumption in much of the West and debt-funded overcapacity in the emerging world has the potential to be increasingly deflationary. High valuations for risk assets, such as equities and high yield credit, need to be validated by increasing growth and profit expectations. The opposite has been the case; long-term growth forecasts, such as those issued by the IMF, have continued to fall. Although imminent ‘escape velocity’ or the strong reacceleration of growth has remained the dominant narrative, the near-term data releases globally have continued to look anaemic. Opportunities The apparent disconnect between investor confidence that policy is working and faith that policymakers will continue to act as the buttress for any risks market participants may face means that investors should expect more volatility. This does not mean that we view markets as offering no investment opportunities. However, it is likely to require more selectivity in ideas. Economies are likely to only be able to sustain nominal growth rates that will continue to be a source of disappointment. In such an environment, the positive support for healthcare spending implicit in our investment themes – ‘Healthy demand’ and ‘Population dynamics’ – suggest that the healthcare sector, in both the developed and emerging worlds, is likely to continue to offer attractive investment potential. (Newton identifies global investment themes that it believes represent key forces of observable change and exert a long-term influence on the global economy.) Equally, beneficiaries of technology spending should be relatively resistant to cyclical volatility in the economy. Winning companies in this area should benefit as businesses adapt their operations to the technologies that consumers have long since adopted. In turn, consumers in the emerging world are expected to leapfrog the historic patterns of the developed world and move straight to e-commerce on increasingly affordable mobile devices. In contrast, many businesses associated with the development of Chinese infrastructure, for example, such as mining companies and local banks, appear on the surface to offer attractive valuations. However, the structural headwinds caused by a prolonged investment boom and the associated accumulation of debt suggest that this is likely to be something of a mirage. Maintaining infrastructure exposure through specialist third party funds, can, for instance, offer uncorrelated returns. Such investments can provide strong income streams that come from the public-private partnership projects in which they typically invest. Markets diverge from fundamentals as debt rises MSCI Index with and without impact of PE re-rating 4,000 0 $bn % change since start of period 50 2,000 -50 Sep 08 Sep 09 Sep 10 Sep 11 Sep 12 MSCI World equity index MSCI World index at constant PE since end Sept 2008 Federal Reserve balance sheet, $bn (RHS) Sep 13 0 Sep 14 Source: Datastream, Bloomberg, Newton September 2014 11 Currency Volatility Comes Back Elena Goncharova, Investment Analyst BNY Mellon Investment Strategy and Solutions Group Charles Dolan, Chief Strategist, Fixed Income, Cash and Currency BNY Mellon Investment Management Currency volatility has been subdued in recent years as many investors have increased allocations to international assets. But Elena Goncharova, Investment Analyst with BNY Mellon’s Investment Strategy and Solutions Group, and Charles Dolan, Chief Strategist, Fixed Income, Cash and Currency, say those investors should be prepared for a potential increase in currency volatility in 2015. Since the global financial crisis, many investors have sought to diversify their portfolios across geographic regions to overcome weakness in their home countries’ economies while also seeking lower correlation and higher yields. Global diversification has benefited those investors partly because currency volatility has been low in recent years. But the US dollar’s surge in late 2014 has called into question whether volatility will remain low, and investors now must consider whether to ride out what may be a passing squall or batten down to face hurricane season. While attempting to predict exactly when exchange rate volatility will return is futile, the increasing divergence in economic growth rates and monetary policies between countries suggest that volatility is likely to rise. Consequently, we recommend that international investors consider currency risk management in addition to the usual risk, return and correlation estimates they use for domestic investing. How low is low? Being concerned that volatility is too low might seem counterintuitive. But as Nassim Nicholas Taleb points out in his book Antifragile, markets need a certain degree of chaos in order to be robust, and bad outcomes often occur when everything is moving in the same direction. In fact, the two previous points during the past 20 years when volatility declined to levels comparable to recent lows occurred during the run-up to the bursting of the technology stock bubble and prior to the global financial crisis. Implied volatility is one of several means for measuring risk and volatility. JPMorgan’s wellknown volatility index has tracked implied volatility for G7 currencies since December 1993 and emerging market currencies since January 2000. It shows that recent volatility has been much lower than historical averages, especially for developed countries. Indeed, on April 30, 2014, the G7 index reached its lowest value to date before ticking upward later in the year. The rise in implied volatility that began in the second half of 2014 could abate, but we believe history suggests it is more likely to herald a return to historically typical volatility levels. The return of more normal volatility is partly the result of divergences in growth and policy among major economies and also from changes in global investment flows as Europe and Japan replace the US as the primary sources of liquidity from quantitative easing. 12 www.bnymellonimoutlook.com Rolling 3-year volatility of monthly spot rates 1.5 1.2 0.9 0.6 USDAUD USDNOK USDTRY USDEUR USDRUB USDGBP Volatilities of developed market and emerging market currencies have converged So-called realized volatility, the rolling three year volatility of monthly spot exchange rates for various currencies against the US dollar, provides another measure of how unsustainably low recent volatility levels have been. Historically, the realized volatility of emerging markets (EM) currencies versus the US dollar has been much higher than that of developed markets (DM) currencies versus the dollar, but this is no longer true. Over the past 20 years, average DM currency volatility hasn’t changed appreciably, while EM currencies’ average volatility has declined sharply to roughly the same level as DM currencies. While it is certainly possible that EM currencies have entered a new paradigm where their exchange rates versus the dollar are no more volatile than those of developed countries, it is more likely that EM exchange rate volatility will eventually increase to reflect the geopolitical and other risks that remain greater in emerging economies than in developed ones. USDBRL USDZAR USDJPY USDSEK Diversification may not reduce risk The variegated nature of emerging markets at first appears to offer investors the opportunity to diversify away a degree of currency risk. It seems reasonable to expect that economies as different as those of Brazil and India, for example, might perform rather differently over the same period and that their currencies would experience correspondingly low correlation, thus providing investors with a degree of downside risk protection. But historical data shows that in times of crisis, emerging markets have instead shown remarkably high downside correlation. Between 1994 and 2003, for example, EMs were shaken by the 1994 peso crisis, the Asian currency crisis from 1997 to 1998 and the Russian default in August 1998. During the 10-year period surrounding these events, EM currencies, DM currencies and even safe haven currencies, such as the Japanese yen moved in lockstep. USDMYR USDCHF 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 0.0 1994 0.3 USDMXN USDTHB What is to be done? No one can precisely predict when the next currency shakeup will occur, but the increasing divergence in economic growth rates and monetary policies between countries sets the stage for increased market volatility. Given how ubiquitous international investments have become in both institutional and retail portfolios, we believe that investors need to formulate realistic correlation and volatility assumptions. Investors may seek to protect their portfolios from currency volatility by considering strategies such as hedging, dynamic trading and the use of options. Those approaches all involve upfront costs, foregone gains or a combination of the two. Accepting those drawbacks may not be easy for many investors, but we believe that those who do not take steps to manage currency risk may regret not doing so. 13 MARKETS Bond conundrums – finding value April LaRusse, Senior product specialist, Insight Pareto Although interest rate hikes are expected in 2015, the timing of such action is an unknown while the extent of a market reaction (or lack of one) when it happens is a mystery. Here April LaRusse, senior product specialist at Insight Pareto, looks at the state of credit attractiveness for the year ahead, irrespective of policy surprises. Fluidity and adaptability will be key for fixed income managers in 2015 as it could be a highly changeable year with much depending on investor sentiment and reactions to interest rate moves – or lack of them, according to Insight Pareto senior fixed income product specialist April LaRusse. The credit sell-off in September and October 2014 helped bring valuations to more attractive levels but yields remain low and LaRusse expects in the aftermath they could move lower still. As hunger for yield continues it could lead investors into different, less mainstream and illiquid areas of the fixed income universe, although perhaps less so than in 2014 given the autumn sell off in conventional bonds. “If we see another bout of risk aversion and high yield was to get back to say 6-7% yields then yes, more attention would probably shift back to ‘mainstream’ fixed income assets. The main reason for looking outside of ‘plain’ corporate or government bonds Wall Street Journal 21 July, 2014: Shining a light on covenants 1 14 and into more esoteric and/or illiquid instruments or low level credits has been the hunt for yield.” LaRusse believes investment grade credit looks more attractive post the autumn 2014 bond sell-off and feels the environment ahead, even if growth remains anaemic, looks well suited to the asset class. “One of the best environments for corporate bonds is trend growth – well above trend and companies start to behave recklessly and start increasing leverage, too slow and may struggle to service their debts.” Another area that looks attractive for 2015, given the expectation of continued low yields, is securitised corporates, issues that use a physical or tangible asset as collateral backing the bond. “These types of bonds are attractive for two reasons. First of all, the additional complexity means they tend to have a higher yield than an unsecured bond issued by the same www.bnymellonimoutlook.com company. In addition the language within the bond typically limits how much leverage can be put into the structure”. Policy moves? Although interest rate rises are seen as unhelpful for bond markets, LaRusse believes companies are more than capable of coping with what are likely to be only slight increases. Many companies in the UK and US (and Europe to a lesser degree) are generating solid free cash flows so they are able to service debt and also can pay it down, she notes. “Typically rates go up because growth is strong so companies can tolerate initial moves and we expect any rate move in 2015 to be small, not enough to cause difficulty.” As such she expects defaults will continue to benign for some time yet. For defaults to rise significantly from current low levels it would take something like a recession (perhaps caused by tighter monetary policy) or a paralysis in the capital markets making it impossible for some companies to cover their obligations, she comments. She believes aggressive monetary policy tightening is unlikely for 2015 as the inflation picture looks unremittingly good. “There is no inflationary reason to hike rates right now and so long as it remains below central bank targets there will be no rush. Indeed even if it did become an issue it is possible central banks may even use other instruments –macro prudential policies – to tackle it. The Bank of England has already indicated it may look for other solutions to slow down sections of the economy without using the big hammer of interest rate moves.” New issuance is likely to continue through the year although with the spectre of higher rates the impetus for refinancing is slightly less than in 2014. However, LaRusse says ‘lower for longer’ rates and the continued tight lending environment means bond issuance, will remain be a noticeable trend in fixed income through the coming year. Going with the flow… Because investor demand for yield will still be strong in 2015 the recent watering down of covenants for both high yield and loans is another development expected to continue. In July it was reported that the US had seen US$260.1bn of issuance in 2013 and US$129.6bn through early June 2014, according to Standard & Poor’s Leveraged Commentary and Data unit – far above the pre-crisis peak of US$96.6bn of issuance in 2007. While weaker investor protection is never welcome, LaRusse points out investors put up with weaker protection in their demand for yield, providing little motivation for companies to tighten covenants. Liquidity is also not projected to improve markedly in 2015 but LaRusse says bond investors are becoming used to this situation and have adapted. “Given how little extra yield investors get from investing in a corporate bond over and above a government bond, you are not compensated for unexpected deterioration in the credit quality of the business or a sudden increase in market volatility. As such you have to be careful what you invest in and ensure it is an improving company with solid fundamentals.” This means flexible bond funds need to be even more nimble in positioning, with managers sometimes moving earlier in a trade than they would have otherwise. “Anything substantial in size may take longer to move.” So what will hinder fixed income for 2015? It is hard to see, according to LaRusse. Rate rises are unlikely to cause too much stress but as the October volatility proved, the market could be easily spooked. This means duration positions will have to be more fluid, LaRusse says. For instance heading into the final quarter of 2014 markets had practically removed all expectation of a future rise in interest rates – having gone from too much anticipation of a rate move earlier in the year. This will change again and it could happen rapidly, she adds. The inflation picture, while good, could be affected by the kind of winter we have and the demand it places on oil; but how authorities contend with inflation if or when it does appear will be closely watched. 15 MARKETS Across the spectrum Paul Hatfield, Chief investment officer, Alcentra Against a low interest rate backdrop, Paul Hatfield, chief investment officer and head of the Americas at the Alcentra Group, takes an upbeat stance on credit and loan market prospects despite some market concerns about the potential for overheated valuations and deteriorating credit values. Here, he explores the latest developments and prospects in the sector. In a volatile global investment market, subinvestment grade corporate credit markets enjoyed mixed fortunes in 2014. But viewing the sector as a whole we remain very positive on the market and believe there is still capacity for significant new issuance in both the US and Europe. earlier this year, following warnings from US Federal Reserve (Fed) chair Janet Yellen that high yield bond valuations appeared “stretched.”2 But this situation has since stabilised and we do not see the shift in flows as a reflection of fundamental concern about credit quality. There are several reasons for this. From a loans perspective, the current interest rate environment remains benign, providing a supportive backdrop to companies. We believe action by the European Central Bank (ECB), lowering interest rates and injecting new stimulus to fixed-income markets will also help. Overall fundamentals in the US high yield market remain in good shape with corporate performance strong despite some mixed performance data1. Cautious approach New regulator and capital requirements on banks are also driving them to pull back from lending. In Europe, there is a growing dearth of capital supply for small and mediumsized companies and this creates significant investment opportunities. The credit market did see some significant retail outflows from high yield bond funds High-yield corporate bonds could repeat 2013’s performance. FT Adviser. 11.02.14. Retail investors dump high-yield bond funds. FT. 25.07.14. Credit bubble fears put central bankers on edge. FT. 02.04.14. 1 2 3 16 In recent months some market commentators3 have expressed fears valuations are becoming overheated, credit quality is deteriorating and that a new credit bubble may be building. However, while it is true that the market saw rising leverage in 2014, this did not cause us any major concern given the current low interest rate environment, although we continue to keep a close watch on leverage levels. From an investor protection perspective the increase in covenant lite issuance has been a major feature of the market over the past 18 months or so – about 70% of the US market is already ‘cov-lite’. A few cov-lite loans have also come to market recently in Europe, though it is still too early to tell if these will start a wider trend in continental www.bnymellonimoutlook.com Europe. Despite the increasing popularity of these loans, we continue to take covenants very seriously. While we have seen some weaker sectors coming to the market and the launch of some aggressive structures, we believe lenders should remain focused on managing downside risk. We believe businesses that generate strong cash flows rather than those that might offer massive upside potential with weak fundamentals look more attractive in this environment. Market strength From a default perspective, the current market looks very robust. Major markets and ratings agencies are not expecting widespread defaults any time too soon. Credit quality is also strong. In the US particularly we are watching for any signs of excessive leverage, lack of covenance or excessive dividend recapitalisations. But collateralised loan obligations (CLOs) now account for more than half of the market in terms of holding leveraged loans and they tend to be more disciplined than retail funds.4 The rise of loan funds and the realisation there are alternative sources of capital available in size to either complement or supplant the banks have both helped to create new market opportunities. Diversification across asset classes is a useful strategy – particularly if investors can gain exposure to both loans and bonds. Increasingly we see institutional investors demand global funds with a strong degree of investor flexibility. Beyond specific asset allocation it is also important for investors to choose which geographical exposures they want access to. The US market for both loans and bonds is deeper and more diverse than the European market and trades more frequently, offering greater liquidity. However, unlike Europe, the weight of money entering the US market, particularly from retail ‘hot money’ flows, has driven new issue spreads tighter and put pressure on covenants resulting in weaker deal structures which promise lower recoveries in the event of default. Relative value between US bonds and loans and European bonds and loans is constantly changing, resulting in the need for a flexible mandate that can respond by adjusting allocation to maintain the best risk adjusted returns across these four sectors. Future challenges sector. Geopolitical questions – such as ongoing problems in Russia, the Ukraine and Iraq may also intensify, making markets more volatile than they have been in recent times. Beyond these important factors we feel the introduction of new regulation could have the single biggest impact on the sector. The aftermath of the 2008 financial crisis has seen a wave of new regulation sweep the banking sector. Some regulations – such as the Basel III rules in Europe – will not fully come into effect until 2016-2019. When new risk retention rules come into effect in the US, such as the Volcker rule, these will also have a much bigger impact on domestic lending and credit particularly in areas such as the CLO market. Whatever challenges do lie ahead we do believe the current credit/lending market continues to offer attractive opportunities to institutional investors. However, this is a highly specialised area which requires dedicated expertise from experienced managers who can provide robust investment selection and credit analysis. Looking ahead a number of factors are likely to influence credit markets over the next 12-18 months. The end of the US quantitative easing (QE) programme will have repercussions across various asset classes, though we believe this is largely priced into the market and will have more of an impact on the global equity market than it does for the global fixed income CLO sales surge to seven-year high. FT. 09.04.14. 4 17 MARKETS An end to corporate hoarding in Japan Simon Cox Managing director and investment strategist, BNY Mellon investment management Asia Pacific In 2014 investors enjoyed a welcome break from several years of fretting about ‘mountainous’ public debt in the mature economies. The United States was spared another nail-biting showdown over the debt ceiling, a Congressional limit on the amount the federal government can borrow. On the periphery of the Eurozone, worry about painfully high spreads on sovereign debt gave way to wonder at surprisingly low yields on the same paper. With luck, this calm on either side of the Atlantic will continue in 2015. In the year ahead, the most interesting sovereign-bond market may lie not in the US or Europe but in the country with the highest public debt ratio of them all: Japan. Which one is Japan? G7 governments’ net interest payments (2014F) 6 % of nominal GDP 5 4 3 2 1 0 1 2 3 4 5 Source: OECD http://www.oecd.org/eco/outlook/economicoutlookannextables.htm 18 6 7 www.bnymellonimoutlook.com G7 governments’ net interest payments (2014) 6 % of nominal GDP 5 4 3 2 1 0 Italy UK US France Germany Japan Canada Source: OECD http://www.oecd.org/eco/outlook/economicoutlookannextables.htm Japan’s gross government debt exceeds 1 quadrillion yen, a number most people have to look up in the dictionary. By the end of 2014 its public liabilities amounted to almost 230% of its GDP, according to the OECD’s calculations. Given these mindboggling numbers, most people assume Japan’s economy is already buckling under the weight of a punishing interest burden. Presented with a chart showing the government’s net interest payments in each of the G7 countries (Canada, France, Germany, Italy, Japan, UK and the US), many people assume Japan is the first or second economy on the left, handing out big chunks of its annual income to its creditors. But this assumption is wrong. Japan’s interest burden is surprisingly light. It is in fact the sixth economy on the chart, with net interest payments amounting to only about 1% of GDP in 2014, according to the OECD’s projections. That is a lower percentage than the US or even Germany pay on their significantly lower debts; see chart above. To put these figures in concrete terms, Japan’s government is paying the equivalent of four days’ worth of national income in net interest on debts that are equivalent to 838 days’ worth. How is this possible? First, quite a lot hangs on that small word ‘net’. Japan’s net government debt is much less frightening than the gross figure that is commonly reported. Japan’s government and socialsecurity fund hold over ¥400 trillion in financial assets, according to Japan’s Cabinet Office. Therefore its net public debt will be about 143% of GDP by 2014, not 230%. The other big reason why Japan’s interest payments are so light is, of course, because interest rates are so low. The yield on a 10year Japanese government bond (JGB) was less than 0.5% in November 2014, according to Thomson Reuters. These low yields reflect the central bank’s efforts to reflate the economy through minimal interest rates and maximal asset-buying. The Bank of Japan already owned over a fifth of outstanding JGBs by October 2014, according to its figures, when it surprised markets by saying it would buy government paper at a still faster rate. If it maintains its pace of buying into 2016, it may end up owning about 40% of the government’s bonds, according to calculations by Capital Economics. 19 MARKETS An end to corporate hoarding in Japan CONTINUED Japan’s monetary policy is lax but what lies behind the looseness of its monetary policy? The Bank of Japan’s extraordinary easing is part of a longstanding effort to encourage borrowing and spending in an economy that persistently does the opposite. Japan’s corporations are chronically reluctant to spend as much as they earn. It is this propensity to hoard that allows Japan’s government to borrow so cheaply and also obliges it to borrow so much. In a healthy economy, the corporate sector is a net borrower from the rest of the economy. It makes use of the funds households wish to save, ploughing these resources into new factories, machinery, equipment and research. That is how an economy makes progress. But corporate Japan is a peculiar exception. Each year since 1998, it has run a financial surplus rather than a deficit: it has consistently spent less than it earned, using the remainder to repay past debts and accumulate financial assets. By mid-2014, private non-financial corporations were sitting on ¥229 trillion in cash alone, according to the official flow-of-funds statistics. For any individual company, building up cash 20 buffers and accumulating financial assets might make perfect sense. But such financial retentiveness makes no sense for the corporate sector as a whole. Companies are supposed to create the real, physical assets on which financial claims can be issued. If companies are all buying bonds, who is left to issue them? If companies are all hoarding deposits in the banks, whom are the banks supposed to lend to? These persistent financial surpluses represent a drain on demand, reinforcing Japan’s deflationary tendencies and deflation in turn encourages firms to hoard nominal assets, rather than building real ones. Since the corporate sector refuses to borrow and spend, the government has been forced to do so instead. Its deficits mirror and offset corporate surpluses. From the 1998 fiscal year to the 2013 fiscal year, these corporate surpluses added up to a cumulative ¥311 trillion, or over 60% of Japan’s 2014 GDP, according to the official flow-of-funds statistics. Without them, Japan’s net public debt might now be about 80% of GDP not over 140%. Corporate thrift makes government deficits sustainable, it also makes them necessary. Corporate dis-hoarder But throughout 2015 that may begin to change. Now prices have started rising again, albeit weakly, financial assets make less attractive stores of value. The reflation of the economy and the revival of demand will encourage firms to increase their capital outlays and they will face other pressures on their cash-flow also. Workers are demanding higher wages and big institutional investors, such as the Government Pension Investment Fund, are paying closer attention to dividends, buybacks and returns on equity. Both trends will eat into the financial surpluses that firms are accustomed to hoarding. It is already possible to spot some statistical straws in the wind. According to the latest official flow-offunds figures published in September, the financial surplus of Japan’s nonfinancial corporations turned into a ¥6.3 trillion deficit in the second quarter of 2014. Private non-financial corporations reduced their holdings of currency and deposits by ¥3.47 trillion and their holdings of centralgovernment bonds by ¥1.66 trillion. www.bnymellonimoutlook.com Japan’s Japan’s private private non-financial non-financial corporations corporations s urplus vs deficit 25 25 Yen, trillion Yen, trillion 20 20 15 15 10 10 5 5 Financial surplus Financial surplus 0 0 Financial deficit Financial deficit -5 -5 -10 -10 -15 -15 -20 -20 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 This second-quarter deficit is suggestive, but not conclusive. These numbers can be volatile. In the past, Japan’s firms have run the occasional quarterly deficit, only to return to surplus for the rest of the year. It must also be remembered that the second quarter of 2014 was a peculiar one, disrupted by the April hike in Japan’s consumption tax. Nonetheless, the pronounced deficit in April-June, the biggest since 2008, might be a harbinger of things to come. Firms may begin losing their appetite for cash and government bonds in favour of higher wage payments, bigger dividend payouts and bolder capital outlays. “The Bank of Japan already owned over a fifth of outstanding JGBs by October 2014, when it surprised markets by saying it would buy government paper at a still faster rate.” Source: Bank of Japan Source: Bank of Japan If so, their altered appetite will increase demand in Japan’s struggling economy, reviving growth and tax revenues. For the government, it will become harder to sell its bonds, but also less necessary to issue them. The result may be a long-awaited increase in Japan’s government bond yields. If so, the increase will not reflect a heightened risk of default. It will instead reflect heightened demands on corporate revenues. An increase in Japan’s bond yields, I believe, will be a sign of success not a signal for alarm. Japan’s Japan’s private private non-financial non-financial corporations corporations s pending habits 60 Financial asset accumulation 20 Overseas direct investment 0 Debt repayment* -20 Financial surplus -40 Fiscal year ending March 31st 2013 2011 2009 2007 2005 2003 2001 1999 1997 1995 1993 -60 1991 Yen, trillion 40 *Negative number indicates debt accumulation Source: Bank of Japan 21 MARKETS EMD: potential fallout from US monetary policy Urban Larson, Senior product specialist, emerging markets debt, Standish Mellon Asset Management Historic links between the performance of US Treasuries and emerging market debt make the actions of the US Federal Reserve an important consideration in analysing the asset class, according to Urban Larson, Standish senior product specialist, emerging markets debt. Despite the market volatility of the past two years, emerging market (EM) economies remain fundamentally sound, by and large. Valuations of both US dollardenominated and local currency emerging markets bonds remain reasonable, particularly given the strong credit quality of the asset class, reflected in an overall investment grade rating. Going forward, the potential for higher US interest rates will be an important theme in emerging market debt (EMD), but the asset class does not and will not behave in a synchronised fashion. The increased uncertainty over the global monetary environment has affected all types of EMD, but in stark contrast to 2013, the uncertainty of 2014 was purely over the timing of an eventual tightening of US monetary policy. This is likely to continue through the first half of 2015. Linked in The correlation between US dollardenominated EMD and US Treasuries is only logical as the former are priced off the latter. Generally the lower the spread between their respective yields 22 the higher the correlation. Additionally, dollar-denominated debt is mainly held by international investors who are particularly sensitive to monetary conditions in the developed markets. That is why in mid-2013 when the ‘taper tantrum’ was set off by the US Federal Reserve’s first comments regarding a potential end of quantitative easing, there was also a sell-off in emerging market dollar-denominated debt. This affected higher quality, longer duration EM sovereign bonds the most as global investors rushed to cut their duration exposure. Corporate bonds were less affected by the sell-off than sovereign bonds, given their higher spreads and shorter duration. While the correlation between US Treasuries and EM local currency bonds is less direct, these have also been very sensitive to US Treasury yields in the past. EM currencies – by virtue of their high degree of liquidity – have borne the brunt of this. Currency volatility has risen as investors have moved to reposition themselves and as the US dollar has strengthened. www.bnymellonimoutlook.com “Over the next 12 months we expect a lot more differentiation among dollardenominated bonds, and between local currency debt markets, as US monetary conditions gradually normalise.” The correlation between the US dollar-denominated EM sovereign bonds in emerging markets has been quite striking during this period of unusual monetary policy. We have also seen similarly high correlations among EM local currency bonds. Yet over the next 12 months we expect a lot more differentiation among dollar-denominated bonds, and between local currency debt markets, as US monetary conditions gradually normalise. Local yield curves have been more stable as they continue to be driven primarily by local monetary conditions, while local bond markets continue to be dominated by local investors who naturally have a home country bias. The differing degrees of vulnerability of EM countries in an environment of rising US interest rates should drive increased divergence in the performance of their bonds. All eyes on the US A focus on quality The market has been pricing in the first US rate hike either in the second half of 2015 or in early 2016, in line with our expectations. When the Federal Reserve does begin to hike rates, it is likely to move gradually, given the recovery in the US has been slow and shallow. There is no real inflationary pressure and the average citizen in the US has been slow to feel the recovery. In both US dollar and local currency debt we believe investors should focus on those sovereign and corporate issuers that are less dependent on cheap international financing. This means holding the bonds of countries with the greatest flexibility in fiscal and monetary policy, the currencies of those countries that have healthy external accounts and the bonds of corporates that have sound credit profiles. Meanwhile, market forces are also likely to keep US Treasury yields from rising quickly, with weak growth in Europe and Japan keeping rates low elsewhere in the developed markets. By comparison with the near-record low yields on some European bonds even the current very low yields on US Treasuries are attractive. Within the US dollar space – and aside from corporate debt – quasi-sovereigns provide an alternative to sovereign bonds, particularly in the larger countries such as Mexico, Indonesia and Turkey. The bonds of quasi-sovereigns – which are 100% state owned – benefit from an implicit (and sometimes explicit) government guarantee and so share the credit quality of the sovereign. Both corporates and quasi-sovereigns can offer an attractive spread pick-up to the higher quality sovereigns which often trade at very tight spreads, given limited new supply. In addition to a more reasonable valuation, the wider spread generally means that corporate and quasi-sovereign bonds are less correlated to US Treasuries. EM local currency bonds do not offer as many liquid alternatives to pure sovereign exposure. This asset class is the most liquid among emerging market debt since the bigger, higher-quality, sovereign issuers can borrow long term in their own currencies and are not generally issuing new dollar-denominated debt. When investing in EM local currency bonds it is essential to look separately at currencies and at local yield curves. While the valuations of both will ultimately reflect a country’s fundamentals, currencies can be much more volatile in the short term as they are affected by such external factors as global risk appetite and the outlook for the US dollar. The ongoing but gradual transition to less supportive, more conventional, monetary policy in the US may lead to some volatility in EMD, but the surprise factor that led to the 2013 sell-off is gone and the asset class continues to offer opportunities to investors who focus on the fundamentals. Valuations remain reasonable compared with history and versus other asset classes where credit quality is not as strong. 23 MARKETS US housing stands on firmer ground Carl Guerin, Research analyst, The Boston Company’s US Opportunistic Equity team Raphael Lewis, Primary research analyst, The Boston Company’s US Opportunistic Equity team With the US housing economy still in recovery mode more than six years on from the peak of the financial crisis, what do the coming years hold for US housing and what role do the so-called ‘millennials’ have to play in this story? Carl Guerin, research analyst and Raphael Lewis, primary research analyst on The Boston Company’s US Opportunistic Equity team, discuss. The US housing market is still in the midst of a healing process. From housing starts (the number of new residential construction projects that have begun during any particular month), vacancy rates, house prices, to all matter of other housing data, the numbers suggest the US housing economy is still some way from its peak mid-2000 peak levels. Is this a result of the scars of the financial crisis (on both the consumer and business levels), the reticence of the so-called ‘millennials’ or that the peak years of the 2000s were simply abnormal and unsustainable? It seems likely the truth lies somewhere between these three factors. From annualised levels in excess of two million in the early 2000s – peaking at 2.3 million in January 2006 – US housing starts plateaued throughout 2014 at around the one million mark. “There has been plenty of discussion among investors and forecasters as to a more reasonable and likely range over the coming years: one million seems too low but the peaks of the last decade seem too high. A 1.2 million to 1.5 million range seems appropriate,” explains Guerin. 24 “This is a slow burner and we aren’t expecting to see the kind of ‘snapbacks’ witnessed in the mid-70s and early 80s and 90s. The post-crisis years have been dominated by lesson-learning; regulation has increased, lending rules have become stiffer.” Ultimately, the appetite for housing risk has diminished noticeably. “The peak of the mid-2000s was a function of heavy speculation on an asset traditionally seen as an ‘easy’ source of wealth accumulation. With their fingers burnt, it seems unlikely the US consumer will return to that way of thinking anytime soon,” adds Guerin. That’s not to say there haven’t been improvements in the underlying housing market. Negative equity numbers have benefited from price inflation while foreclosures were down 35% year-on-year to June 2014, according to real estate data provider CoreLogic. The consensus opinion is that much of this was driven by speculative builds in the 2000s; these have fallen significantly in number since the crisis. www.bnymellonimoutlook.com Bearing the scars Many commentators believe one of the key reasons behind the slower-thananticipated demand for housing rests at the feet of the so-called ‘millennials’ – defined as those born between the early 1980s and early 2000s. Marrying later, having kids later, saddled with student debts, living with parents for longer, much thought is being given to how this demographic can be encouraged to buy into a traditional path that has dominated US life for the past century. It remains the billion-dollar challenge. Ultimately, are ‘millennials’ shying away from home ownership because of economic reasons, psychological reasons or just because they are a culturally different group of people from the rest of the US population? “The so-called ‘sharing’ generation is re-shaping the market; for example, home-improvement retailers don’t just have to worry about people sharing houses, they also have to worry about people sharing hammers,” says Lewis. There is also the challenge of sky-high student debt levels with which to contend. Indeed, the share of 25-34 year olds with more than US$50,000 of debt tripled between 2001 and 20101. “Clearly, indebtedness is a challenge. But improvements in education mean students will now enter the workforce better qualified and equipped than the classes of the recent past. They are also contending with the psychological scars of the financial crisis although the further the crisis disappears in the rearview mirror, the less snake-bitten this generation will be,” he adds. There are also positive signs in the job market, as the unemployment rate has continued to fall, which will ultimately push wages higher. This is especially true for college graduates, who have been able to find jobs more readily and earn higher salaries than their lesseducated counterparts in this recovery. Another promising development is the groundswell of public protest against the ballooning costs of higher education. As a result, the US government has begun to implement some pockets of debt relief and to consider greater regulation of for-profit schools. According to the US Department of Education, students at for-profit colleges make up about 13% of the total higher-education population, but represent about 31% of all student loans and almost half of all loan defaults.2 Staying in credit Lewis says: “As far as the problem of credit availability is concerned, much of the debate in the US has been centred on getting more creative, on using the vast swathes of data available to understand and properly evaluate the nature of risks; lending should be less broad brush. The key is to use data in a smarter and more efficient way and ‘millennials’ should be the beneficiaries.” “As for the major forces holding back the ‘millennials’ from US housing, they are a combination of psychological and economic – the scars of the post-crisis years coupled with the pain of the present. The good news is it’s hard to imagine the situation getting any worse – it should ameliorate over time,” says Lewis. Like with any bubble and the ensuing burst, lessons have been learned (for a while at least), according to Guerin. “It seems unlikely we’ll see another housing crisis in the next 10 to 20 years. The scars of the past 10 years will provide a constant reminder to the ‘millennials’ and beyond. But, of course, it’s a fact of life that different mistakes will be made in the future.” US housing starts – a fundamental shift? 2.375M 2.125M 1.875M 1.625M 1.375M Average 1.372M 1.125M 875.00K 625.00K 375.00K 1990 1995 2000 2005 2010 US Housing Starts (SAAR) Sep ’14 1.017M Source: US Census Bureau, October 2014. Banks and other housing-related businesses have cited a desire for more regulatory and legal clarity to free lenders from the uncertainty restraining their mortgage businesses. “But at the same time, progress has already been made and the positive news is starting to come in. The nation’s largest banks have struck a series of landmark, multibillion-dollar legal settlements with the federal government for alleged misdeeds during the peak bubble years, removing some doubt,” Lewis adds. In late 2014 US Federal Reserve Chair Janet Yellen expressed sympathy for the banks’ frustrations and pledged to clarify the rules around mortgage lending to foster a greater extension of credit. “This is not likely to be a fast process but it’s a sign that we are due to see better days,” he adds. Some commentators argue the post-crisis years have been dominated by overconservatism, or that this conservatism has continued for longer than required. “It is no surprise the government and banks are working to sensibly loosen lending criteria,” says Guerin. “The pendulum, which had swung too far the other way, is being righted. It is a welcome change that solid supply and demand factors are starting to drive the housing economy; we are not seeing a return of the speculative 2000s. It is also a welcome change that the importance of US housing to the broader economy is less now than it was. A generational and cultural shift is underway and this is a good thing.” Harvard University Joint Centre for Housing Studies, June 2014. “Obama Administration Takes Action to Protect Americans from Predatory, Poor-Performing Career Colleges,” U.S. Department of Education, March 14, 2014. 1 2 25 MARKETS Holding the faith Amy Leung, Asian equity team, Newton After years of rapid economic development in China, stellar growth has given way to growing market uncertainty as markets look towards 2015. But, despite the many challenges facing the country, its ongoing reform programme could yet deliver significant long term gains, says Amy Leung, a member of Newton’s Asian equity team. Since the late 1990s the China story has been one of rapid development, social change and economic growth. From 1993 to 2007 alone China averaged growth of 10.5% a year1. Throughout the 1990s/2000s the world’s second largest economy became the manufacturing engine room of the world and one of its largest importers and exporters. In the past 18 months, however, a series of factors, including weakening global economic recovery, falling industrial output and a rising dependence on credit have all contributed to lower Chinese economic growth. This in turn has fuelled concerns the Chinese economy could be heading for a major correction. As economies, including the US, show increasing signs of recovery, questions centre on why the Chinese economy seems out of step with broader recovery and whether its current economic issues represent a short term blip or a longer term challenge. 1 2,3 4 5 26 When giants slow down. The Economist. 27.07.13 The great hole of China. The Economist. 18.10.14. A test of will. The Economist. September 20.26.14 Alibaba IPO ranks as world’s biggest after additional shares sold. Reuters. 22.09.14 At Newton we acknowledge China faces a variety of tough challenges but we believe the Chinese government remains genuinely committed to reform under its current leader, Xi Jinping. From a structural perspective we remain positive on the longterm outlook for China although we expect to see some market volatility in the short to medium term due to what we call triple excesses in the country. These consist of excess capacity, excess leverage and, at an environmental level, excess pollution. Structural challenges China clearly faces some challenging structural problems as it transitions from a manufacturing-led to more consumer-led economy. Most recently the exponential growth of its debt – now more than 250% of GDP2 – has become a genuine cause for investor concern. The ongoing property sector boom in China has also seen supply dramatically outstrip demand – creating a potentially damaging market bubble. www.bnymellonimoutlook.com World Trade Organisation in the early 2000s only exacerbated this. Those who move from rural areas do not currently enjoy equal status to existing urban citizens and are not entitled to a full set of social benefits. This has given rise to growing workforce dissatisfaction and disharmony. Fortunately the Chinese government has made tackling this a priority through its hukou reform programme. Change will take time but we believe the country is at last heading in the right direction on this. On the debt front, however, we are not entirely bearish. Unlike some markets, China’s investment driven leverage is almost entirely domestically financed, savings rates are high and various government controls and financial ‘buffers’3 exist which should help China to offer its economy at least some protection in any worst case scenario. As just one example, Chinese financial regulators have recently put pressure on banks to be more disciplined in managing offbalancing sheet exposure.4 The reform of state owned enterprises is also on the agenda with the State-owned Assets Supervision and Administration Commission of the State Council finally moving beyond the talking stage to implement real change. This is likely to involve the restructuring and perhaps disposal of some of the more inefficient public sector assets. In tandem, the government has launched a powerful anticorruption campaign designed to clean up graft and improve transparency within the public sector. China is currently using various measures to push its credit risk further into the future. Its monetary policy continues to show an easing bias. Targeted easing was a theme in 2014, with the government variously providing affordable financing for small and medium sized companies and for the farming and social housing sectors. The danger is that some of the monetary tools China is using are beginning to lose their effectiveness. While many assume China is a closed economy the country has in fact done much to liberalise its capital market in recent years. The internationalisation of the renminbi currency continues apace and the Qualified Foreign Institutional Investor and Qualified Domestic Institutional Investor have opened significant gateways for foreign investors – albeit through tightly supervised quotas. Market access Inflationary pressures Beyond the debt challenge, wage inflation is also a major issue, with China facing a growing contraction in its working population. The number of working age people in China has shrunk by over 2.4 million in the last year alone and continues to decline. The rapid and growing urbanisation of China over the last decade has also created its own problems, driving a huge movement of people from rural China into cities to get better paid jobs in factories. Entry to the On the investment market front, China recently opened the new Hong KongShanghai Stock Connect trading scheme, which aims to broaden investor access to the Chinese market. The new scheme, dubbed the ‘through-train’, is designed to enhance foreign access to China’s Shanghai A-share market and will also allow some mainland Chinese investors to access Hong Kong’s H-share market. The launch met with some delays, partly due to the disruption caused by recent Occupy Central protests in Hong Kong. Whatever change lies ahead, the Xi Jinping administration knows that in a country of over 1.3 billion people it must tread cautiously with reform – even if this means continued support for some ailing public sector companies in the interest of maintaining jobs and social cohesion. That said, while we do expect to see some injection of liquidity we do not anticipate any rush to full blown quantitative easing measures that might inflate sectors already suffering from overcapacity. As the recent democracy protests in Hong Kong illustrate, maintaining a level social and political balance in a modernising China embracing new communications media is paramount. At heart China is still very much a command economy but its leaders recognise both the need for reform and social and economic stability. From a market perspective, while some companies may regain the growth levels seen in the early 2000s, the Chinese economy is fundamentally changing from one which is manufacturing led to one which is both more globally oriented and increasingly consumer driven. The record breaking US$25 billion initial public offering of Chinese e-commerce giant Alibaba5 Group this year suggests the future may ultimately lie in service sectors such as e-commerce. No one expects the transition away from manufacturing to a more fundamentally balanced economy will take place seamlessly overnight. But, as markets look to 2015 and beyond, the Chinese government’s gradual approach looks set to deliver positive long term economic change. While recent growth levels may have slowed in China – leaving it temporarily out of step with other recovering economies – there is much evidence to suggest it is ultimately moving in the right direction. 27 MARKETS Dilma’s dilemma Solange Srour, Chief economist, ARX Investimentos In the Brazilian elections in October 2014, after a long and fraught campaign President Dilma Rousseff won a narrow victory. Political uncertainty may have subsided but with the Brazilian economy in the doldrums and commentators banging the drum for harsh reforms, what are the prospects for the dilapidated poster-boy of South America? Solange Srour, chief economist at ARX Investimentos, the Brazilian investment boutique of BNY Mellon, looks at the economic challenges facing the president in her second term. As President Dilma Rousseff addressed the Brazilian people following her narrow re-election in October, she could have been forgiven had her relieved smile collapsed into a worried frown. She may have won the election and in-so-doing gained another four years in power, but the position of strength enjoyed by her Worker’s Party a few years ago is now long gone. The election result was too close. Gone are the buoyant days of her early presidency. Her victory speech was one dominated by words of collaboration and compromise. She spoke of greater dialogue with industrial leaders, banks and business in general. She talked of her desire to be a better president in her second term. That she failed to mention her rival, Aécio Neves da Cunha, who had gained 48% of the vote, spoke volumes, though. The market-friendly Aécio campaigned and 28 spoke for industry, banks, business and the squeezed middle classes. Indeed, it was a damning indictment of Dilma’s first term in office that 2014 saw an almost perfectly negative correlation between her strength and weakness in pre-election polls, and the performance of the Brazilian equity market. But how has the president managed to put up so many hackles in the business world? The list of blemishes is a long one. In 2012 she forced state-controlled banks to reduce consumer lending rates, hurting the rest of the sector; in 2013, changes were forced upon electricity companies to lower tariffs; while the oil and gas giant Petrobras – which makes up around 13% of the domestic index – has been hampered by enforced price controls. The ‘business-unfriendly’ tag has firmly stuck. www.bnymellonimoutlook.com Giving with one hand… It is unfair to brand her presidency this far as one wholly dominated by investorunfriendly policy, though. Certain tax cuts have made sense and made a real difference; her commitment to Bolsa Família – the country’s largest social welfare programme – continues to keep millions from the clutches of poverty, while she has also been good on education. However, ultimately her first port of call when it comes to policy is ‘intervention’ – this has affected foreign investment, while it is no surprise that business and consumer confidence are back to their 2009 lows. Ultimately, Dilma bears this responsibility. Bolsa Família, the brain-child of the former, and revered, President Luiz Inácio Lula da Silva, has provided invaluable financial aid to poor Brazilian families. Yet while its success can’t be ignored – around 12 million Brazilian families benefit – it has had its fair share of critics who cite the problems of benefit addiction and the programme acting as a source of discouragement from work. The programme may well help around a quarter of the population but for the remaining 75% the overriding concern is inflation and the rising cost of living in the country’s major cities. Some 85% of the population lives in urban areas. In her victory speech, Dilma declared the country undivided. While this may be true in terms of the north/south divide alluded to by many external observers, it is a country divided by those reliant upon welfare programmes and those who aren’t. It has reached a stage at which the heavy focus upon social welfare programmes is proving too big a burden for the Brazilian economy. Tightening belts The economic situation in Brazil is not a rosy one. Currently in recession, a nearterm rebound seems unlikely. Inflation remains high, the primary surplus is close to zero (it needs to be closer to 1.5% of GDP) and the strength of the Brazilian real continues to hamper the economy. It is the squeezed middle classes who are bearing the brunt of this pain. With inflation sitting at more than 6% and greater inflationary pressures set to come as price controls expire, interest rate rises seem imminent. And they are needed. Dilma has spoken much about the importance of employment and economic growth but this is not possible without fixing the underlying problems. Even with progress on inflation, the primary surplus and the currency, the sad truth is that an interventionist government underscores an inefficient and uncompetitive economy. For example, the effects of inflation will only get worse as areas in which the government has frozen prices, such as fuel, are released. At the same time, fuel price freezes have severely hampered the ability of largely state-owned companies, such as Petrobras, to thrive. Dilma’s administration has limited the value of these companies by using them as a political lever. It is a similar story with the state-owned banks; used as a tool for cheaper credit availability, there is a need for significant capital raising within the banking system over the next few years. In her second term, Dilma will have to let go of the price controls if she has a genuine desire to improve investor confidence in Brazil, increase the primary surplus and allow efficiency and competitiveness a foothold in the economy. However, long-term gain would come at the cost of short-term pain. infrastructure, well below the developingworld average of 5.1%. It is also barely high enough to keep up with depreciation of existing infrastructure. Meanwhile, just 14% of the country’s roads are paved, according to The World Bank. Seemingly simple processes such as transporting corn to ports are made needlessly more expensive and strenuous by a lack of basic infrastructure. Yet the crux of the spending problem is that the public sector just doesn’t have the money to invest. It needs to attract private sector investment but, given the track record of the Dilma government, who would want to do business with them? Too much focus on subsidised public sector bank investment is now coming back to bite the government. Ultimately, over the longer term these challenges are surmountable. A greater emphasis on business-friendly policy would do much to build bridges with the private sector. Dilma is rightly proud and protective of Lula’s first-world standard welfare legacy but the cost is now being borne by the middle classes; those who should be at the core of the country’s economic impetus. Action is required and pain is necessary if the country is to reawaken from its post-commodity boom slumber. Is Dilma capable of changing her spots and becoming pro-business? To some degree, perhaps, but a wholesale change of heart seems highly unlikely. The more probable outcome is four more years of high inflation and low growth and competitiveness. Dilma’s dilemma is likely to be one she largely ignores. Building for the future? Infrastructure spending or stark lack thereof, is also high on the agenda of Dilma’s critics. The country is held back by significant public transport limitations and remains some way behind the rest of the world when it comes to infrastructure spending. According to The Economist, Brazil invests just 2.2% of its GDP in 29 MARKETS About BNY Mellon BNY Mellon’s multi-boutique model encompasses the skills of 13 specialised investment managers who are all leaders in their respective fields. Each is solely focused on investment management, and each has its own unique investment philosophy and process. Located in London, New York and Boston, Alcentra is a global asset management firm focused on sub-investment grade debt capital markets in Europe and the US. With expertise in macro analysis and bottom-up stock selection, ARX Investimentos is dedicated to investments in Brazil and Latin America. Headquartered in Rio de Janeiro, the group’s philosophy is to optimise risk adjusted returns, with a focus on capital preservation. The Boston Company is a global investment management firm providing a broad range of active, fundamental research driven equity strategies, including both traditional long-only portfolios and alternative investments. Focusing exclusively on public, private, global and US real estate, CenterSquare’s investment approach includes both a top-down market/ country selection and a bottom-up underwriting of properties, companies and management teams. Insight is a London-based asset manager specialising in investment solutions across liability driven investment, absolute return, fixed income, cash management, multi-asset and specialist equity strategies. Meriten has an adaptable investment approach that combines fundamental and quantitative analysis. The firm is a specialist in European fixed income, equity and balanced mandates. Meriten does not offer services in the U.S. Newton is renowned for its distinctive approach to global thematic investing. Based in London and with over 30 years’ experience, Newton’s thematic approach is applied consistently across all strategies. Headquartered in Boston Standish is a specialist investment manager dedicated exclusively to active fixed income and credit solutions, with a strong emphasis on fundamental credit research. 30 www.bnymellonimoutlook.com BNY Mellon Investment Management is an investment management organization, encompassing BNY Mellon’s affiliated investment management firms, wealth management organization and global distribution companies. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and may also be used as a generic term to reference the Corporation as a whole or its various subsidiaries generally. The information in this document is not intended to be investment advice, and it may be deemed a financial promotion in non-U.S. jurisdictions. Accordingly, where this document is used or distributed in any non-U.S. jurisdiction, the information provided is for Professional Clients only. This material is not for onward distribution to, or to be relied upon by Retail Clients. Any statements and opinions expressed in this document are correct as at the date of publication, are subject to change as economic and market conditions dictate, and do not necessarily represent the views of BNY Mellon or any of its affiliates. The information contained in this document has been provided as a general market commentary only and does not constitute legal, tax, accounting, other professional counsel or investment advice, is not predictive of future performance, and should not be construed as an offer to sell or a solicitation to buy any security or make an offer where otherwise unlawful. The information has been provided without taking into account the investment objective, financial situation or needs of any particular person. BNY Mellon and its affiliates are not responsible for any subsequent investment advice given based on the information supplied. This document is not investment research or a research recommendation for regulatory purposes as it does not constitute substantive research or analysis. To the extent that these materials contain statements about future performance, such statements are forward looking and are subject to a number of risks and uncertainties. Information and opinions presented in this material have been obtained or derived from sources which BNY Mellon believed to be reliable, but BNY Mellon makes no representation to its accuracy and completeness. BNY Mellon accepts no liability for loss arising from use of this material. If nothing is indicated to the contrary, all figures are unaudited. Any indication of past performance is not a guide to future performance. The value of investments can fall as well as rise, so you may get back less than you originally invested. This document is not intended for distribution to, or use by, any person or entity in any jurisdiction or country in which such distribution or use would be contrary to local law or regulation. This document may not be distributed or used for the purpose of offers or solicitations in any jurisdiction or in any circumstances in which such offers or solicitations are unlawful or not authorized, or where there would be, by virtue of such distribution, new or additional registration requirements. Persons into whose possession this document comes are required to inform themselves about and to observe any restrictions that apply to the distribution of this document in their jurisdiction. The investment products and services mentioned here are not insured by the FDIC (or any other state or federal agency), are not deposits of or guaranteed by any bank, and may lose value. This document should not be published in hard copy, electronic form, via the web or in any other medium accessible to the public, unless authorized by BNY Mellon Investment Management. Issuing entities This document is approved for Global distribution and is issued in the following jurisdictions by the named local entities or divisions: Europe, Middle East and Africa (excluding Germany, Brazil, Dubai): BNY Mellon Investment Management EMEA Limited, BNY Mellon Centre, 160 Queen Victoria Street, London EC4V 4LA. Registered in England No. 1118580. Authorised and regulated by the Financial Conduct Authority. • Canada: Services offered in Canada by BNY Mellon Asset Management Canada Ltd. • Germany: Meriten Investment Management GmbH which is regulated by the Bundesanstalt für Finanzdienstleistungsaufsicht. • Dubai, United Arab Emirates: Dubai branch of The Bank of New York Mellon, which is regulated by the Dubai Financial Services Authority. This material is intended for Professional Clients only and no other person should act upon it.• Singapore: BNY Mellon Investment Management Singapore Pte. Limited Co. Reg. 201230427E. Regulated by the Monetary Authority of Singapore. • Hong Kong: BNY Mellon Investment Management Hong Kong Limited. Regulated by the Hong Kong Securities and Futures Commission. • Japan: BNY Mellon Asset Management Japan Limited. BNY Mellon Asset Management Japan Limited is a Financial Instruments Business Operator with license no 406 (Kinsho) at the Commissioner of Kanto Local Finance Bureau and is a Member of the Investment Trusts Association, Japan and Japan Securities Investment Advisers Association. • Australia: BNY Mellon Investment Management Australia Ltd (ABN 56 102 482 815, AFS License No. 227865). Authorized and regulated by the Australian Securities & Investments Commission. • United States: BNY Mellon Investment Management. • Canada: Securities are offered through BNY Mellon Asset Management Canada Ltd., registered as a Portfolio Manager and Exempt Market Dealer in all provinces and territories of Canada, and as an Investment Fund Manager and Commodity Trading Manager in Ontario. • Brazil: this document is issued by ARX Investimentos Ltda., Av. Borges de Medeiros, 633, 4th floor, Rio de Janeiro, RJ, Brazil, CEP 22430-041. Authorized and regulated by the Brazilian Securities and Exchange Commission (CVM). The issuing entities above are BNY Mellon entities ultimately owned by The Bank of New York Mellon Corporation BNY Mellon Company information BNY Mellon Cash Investment Strategies is a division of The Dreyfus Corporation. • Insight Investment Management Limited and Meriten Investment Management GmbH do not offer services in the U.S. This presentation does not constitute an offer to sell, or a solicitation of an offer to purchase, any of the firms’ services or funds to any U.S. investor, or where otherwise unlawful. • BNY Mellon owns 90% of The Boston Company Asset Management, LLC and the remainder is owned by employees of the firm.• The Newton Group (“Newton”) is comprised of the following affiliated companies: Newton Investment Management Limited, Newton Capital Management Limited (NCM Ltd), Newton Capital Management LLC (NCM LLC), Newton International Investment Management Limited and Newton Fund Managers (C.I.) Limited. NCM LLC personnel are supervised persons of NCM Ltd and NCM LLC does not provide investment advice, all of which is conducted by NCM Ltd. Only NCM LLC and NCM Ltd offer services in the U.S.• BNY Mellon owns a 20% interest in Siguler Guff & Company, LP and certain related entities (including Siguler Guff Advisers LLC). GE015-31-05-2015 (6M). Issued 27.11.2014. T1415 11/14. 31