Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Kempen Insight /// November 2015 OUTLOOK 2016 DOES RISK STILL PAY? DEMOGRAPHIC DIVIDEND or DEMOGRAPHIC BURDEN The two sides of Keynes Table of contents Tempered expectations /// Prognoses for economic growth and inflation 10 The two sides of Keynes 4 /// Lessons for policymakers and investors Towards growth 16 The four horsemen of the apocalypse /// Alternative scenarios /// Economic recovery remains fragile 14 6 2 Kempen Insight, November 2015 ‘Once more’ /// The making of The macro movie Outlook 2016 ‘Investing means dealing with insecurities, with risks. These risks are in the future, not in the past. That is why it is so important to look ahead, in a disciplined manner, using scenarios.’ These words were recorded in a video clip that we made for the Outlook 2016 seminar. Together, we look ahead to the coming years and the main macroeconomic developments that will influence your investment policy as well as our own. What will the year 2016 bring? We find ourselves in an environment of low forecast returns on virtually all investment categories by now. This leads us to the question as to whether investors are still sufficiently rewarded for the risks they take, especially in this world of low growth and low inflation. One is inclined to wonder whether all that policymakers around the globe can do is argue about re-dividing the pie or whether they have the tools to ensure that we have a Books that inspire /// Evert Waterlander’s selection bigger pie. Perhaps we can learn a lesson or two from 14 one of the most successful economists and investors, John Maynard Keynes. In addition to insight into matters such as strategic asset allocation, we will give you a Does risk still pay? /// Investment categories in 2016 glimpse of the books we have read 18 and we will discuss alternative scenarios. I would like to hear your opinion and look forward to your reactions, which you can send to the Column by Roelof Salomons /// Which scenario will unfold when it comes to the economic cycle? address mentioned below. 21 Lars Dijkstra Chief Investment Officer [email protected] This publication is offered to you by Kempen’s Asset Allocation Team. /// COLOPHON November 2015 ©Kempen Address Kempen Fiduciary Management 60 Cannon Street London, EC4N 6NP United Kingdom Images Cover: Jeroen Hofman Bram Belloni, Mario Hooglander Design Henrike Beukema Editors Ruth van de Belt Parisa Veldman Anja Corbijn van Willenswaard Kempen Fiduciary Management is a trading name of the UK branch of Kempen Capital Management N.V., which is registered in the United Kingdom (BR017904) at 60 Cannon Street, London EC4N 6NP and which is a limited liability company incorporated in the Netherlands, authorised by the Dutch Authority for Financial Markets (AFM) and subject to limited regulation by the UK Financial Conduct Authority (FCA). Details about the extent of our regulation by the FCA are available from us on request. This information should not be construed as an offer and does not provide sufficient basis for an investment decision. An interactive edition of Kempen Insight is available online at www.kempeninsight.nl/en /// by Lars Dijkstra photo tekst Lars Dijkstra fotoGETTY xxx IMAGES Keynes... In the 1930s, John Maynard Keynes, the father of modern macro-economics, announced that governments should pursue an anti-cyclical budgetary policy. During an economic crisis, governments need to spend money to stimulate the economy. In times of economic prosperity, governments need to cut back in order to avoid government finances getting out of hand. Keynes... “Successful investing is anticipating the anticipations of others” -John Maynard Keynes 4 Kempen Insight, November 2015 Keynes also believed in acting contrarily as an investor. He preferred equities that no-one else wanted and ignored popular equities. In fact, if Keynes noticed that many investors were coming up with the same ideas, he decided it was time to adjust his opinion as he viewed herd behaviour as one of the greatest pitfalls for investors. the economist Many governments, particularly European to recover. However, the European debt ones, have apparently forgotten this advice crisis prompted governments to introduce over the past few years. Since the Great austerity measures. Throughout Europe Recession started, many analysts have governments curbed spending and rational- pointed out that a large number of Western ised drastically in order to get their budget countries now find themselves in a balance deficits below the three percent ceiling laid sheet recession. Private individuals needed to down in the stability and growth pact. This pay off their high net debts, but low growth was the wrong move. The balance sheet and low inflation meant that it was difficult recession was not yet over and the drop in to grow out of the debts. Deleveraging or government spending plunged Europe into MONETAry restructuring was required. The private a new recession. We only need to look at the policy sector kept a tight hand on the purse strings US to see how things could have turned out and a large spending gap arose. differently. The US government continued to Fiscal During a balance sheet recession it is essential pump money into the economy for a consi- policy for policy makers to bridge this gap by derable length of time, giving the private providing budgetary and monetairy stimula- sector time to restore its balance sheets. This Financial tion. Otherwise, the recession becomes difference in government policy is one of the regulation deeper and longer. This is precisely what main reasons behind the difference in happened in Europe. Governments initially growth between the two regions over the increased spending, allowing the economies past few years. Effectivity of Government Policy USEurope Source: Kempen the investor According to Keynes, one of the basic through. And you can only do that with principles for a successful investment a small number. He was what we would strategy is the careful selection of a today call a committed long-term share- restricted number of cheap investments. holder. A truly bottom-up stockpicker. In his Just like Benjamin Graham he was a real investment manifesto, Keynes argues in value investor. Criteria: a low valuation favour of a balanced portfolio which compared to the potential Net Asset Value includes different – and preferably plus a low valuation compared to potential opposing – risks. The portfolio needs to alternative investments. contain equities from completely different The fact that Keynes believed in investing in companies. His investment manifesto also a restricted number of companies does not states that investments need to be retained Kempen goes along with the mean that he thought diversification a in reasonably large quantities in good times latest investment craze as little waste of time. His preference for a small and bad, until the valuation has lived up to as Keynes did. We draw up our number was chiefly the result of his invest- its promise or it is clear that the investment own plan and base our investment ment philosophy, namely that you need to was a mistake. In other words: Keynes decisions for the long term mostly know the companies in which you invest believed in concentrated portfolios with a on valuation. - and their management - through and long-term investment horizon. Avoid herd behaviour Kempen Insight, November 2015 5 6 Kempen Insight, November 2015 /// by RUTH VAN DE BELT photo BRAM BELLONI steering towards growth Seven years after the advent of the Great Recession, the economic recovery remains fragile in a number of Western countries. Investment Strategist Ruth van de Belt explains why we are at the end of a monetary super-cycle. Monetary policy has been used to stabilise the economy when an external shock occurs since the 1980s. Policy makers have succeeded in restricting the economic and financial harm caused by a recession by easing monetary policy and triggering a new private debt cycle. This super-cycle has now come to an end. Although central banks have again cut the policy interest rates that have been low since the start of the 2008 financial crisis, we have hardly seen credit expansion. Even a short-term interest rate of zero percent has been unable to really tempt consumers and companies into taking out loans. Keep saving We are not dealing with a normal recession, but with a balance sheet recession. (Housing) bubbles financed using loans have burst in many countries. This has led to a decrease in assets held by the private sector, while the level of debt has remained the same. In other words, net debt The end of the monetary super-cycle has grown. Low growth and low inflation have made it difficult to grow out of the debts. Deleveraging or restructuring is required to reduce the debt as a percentage of the gross domestic product (GDP). The private sector has spent the past few years restoring its balance sheets and has had no need of credit, not even at low interest rates. Lenders have also been less than Kempen Insight, November 2015 7 IMPACT OF QUANTITATIVE EASING ON FINANCIAL MARKETS YIELD Normal MONEY MOVES TO RISKIER ASSETS LIQUIDITY PUSHES DOWN CASH 2 1 Cash Now Bonds Equities RISK Source: Kempen, November 2015 generous when it comes to issuing loans as more attractive in relative terms. Investors tion of capital. Ailing companies have easily they have been busy consolidating their started to exchange their government been able to roll loans forward in order to own balance sheets. The low policy interest bonds for creditworthy credits, which were survive. Growth remains low and this is har- rates have therefore not helped boost in turn exchanged for high yield credits, ming productivity: a vicious circle. Low economic growth. The balance sheet which were in turn exchanged for equities. interest rates now will lead to low yields in recovery is not over yet everywhere. US, Yet the risk involved in these asset classes the future. European and Japanese households are still remains unchanged. Equities are still riskier, net savers. Some countries are currently and when the inevitable price correction Time to act seeing even higher levels of savings. occurs - sometime in the next few years - The end of the monetary super-cycle the question is whether the risk will be held means that central banks have fewer and by those investors who can best absorb fewer tools at their disposal for stimulating that specific risk. the economy if they need to do so. Unconventional The ineffectiveness of conventional monetary policies and the fact that central Moreover, exchange rates will start to play banks cannot reduce policy interest rates to Vicious circle far below zero were the reason for uncon- The unconventional policies were not without Although a deliberate weakening of ventional policies in the shape of quantita- consequences. Since the crisis, China and a country’s currency is parasitic behaviour, tive easing. Little or no attention was paid other emerging markets have seen unbridled policymakers seem increasingly inclined to to the side-effects of quantitative easing, in debt accrual. According to the BIS, the Bank do this. Currency volatility is growing, fact these were in part viewed as desirable. for International Settlements, since 2007 the leading to higher costs for cross-border Low yields forced investors further up the average debt burden in emerging markets goods and capital transactions. There is also risk curve, and this was aimed at triggering has risen by 50 percentage points to 167 a risk of countries imposing trade barriers. a welfare effect. percent of the GDP. In China, this figure has Central banks have done what was needed The lower expected returns on the bond risen as high as 235 percent. Furthermore, of them to stimulate the economy over the markets led to other asset classes becoming the low interest rates are causing a misalloca- past few years, but the same cannot be said 8 Kempen Insight, November 2015 a more prominent role in monetary policy. of many governments. Governments in term and increasing the potential for In this light, the refugees arriving in Europe many Western countries initially increased growth in the long term. do not pose a problem but in fact an spending, but a different wind has been opportunity. Many peripheral countries also blowing through Europe since 2009. The Reforms needed European debt crisis prompted govern- In addition to budgetary stimulation, it is Incidentally, Europe is not the only region ments to introduce austerity measures. essential that reforms are implemented. that needs to implement reforms. Invest- Countries with a budget deficit in excess of Various measures can be taken to boost the ment in e.g. infrastructure, education and 3 percent of their GDP were forced to potential for growth. The further economic technology is also needed in the US. And correct this in line with the Stability and integration of the Eurozone is crucial. As many emerging markets need to tackle Growth Pact (SGP). This left no room for economies and institutes have so far failed their structural weaknesses. These include stimulatory budgetary policy, while the to become better aligned with one another, issues such as low savings quotas, low economy was still struggling with a balance each time a shock occurs somewhere in the labour productivity, infrastructural sheet recession. However, cut-backs and monetary union questions are asked about bottlenecks and the quality of education. higher taxation made it more difficult for its durability. Europe also needs to tackle households to deleverage. Sovereign debt the problem of an ageing population. did stabilise, but at the expense of econo- Many countries have raised the retirement mic growth. age over the past few years, but this is not We believe that European countries with yet universal. Participation in the job budgetary capacity ought to use this to market needs to be increased by focusing pursue additional budgetary policies. social security more on activation, making Germany, the Netherlands, Finland and the individual job markets more flexible Austria could opt for full or partial public and reforming tax systems. Yet less financing of infrastructural and/or sustaina- conventional measures could also be bility projects, fuelling growth in the short applied, such as encouraging immigration. need to increase their competitiveness. Ruth van de Belt Investment Strategist [email protected] Kempen Insight, November 2015 9 Long-term scenario Tempered growth forecasts 10 Kempen Insight, November 2015 /// by RUTH VAN DE BELT images MARIO HOOGLANDER, HENRIKE BEUKEMA The forecast mean reversion of valuation ally used. And actual production determines ratios is crucial to expected returns in the real economic growth in the short term. long term. Changes to expected returns are This can fluctuate considerably. potentially a reason to adjust the strategic allocation. In this article we explain our Demographic burden forecasts for economic growth and inflation. Last year we indicated that potential growth In doing so, we assume the most likely would be moderate over the next decade. scenario. Yet the future is shrouded in We have not altered our outlook on this. uncertainty, and this is why we present a The ageing population means that the number of stress scenarios in the article ‘The demographic dividend has turned into four horseman of the Apocalypse’. a demographic burden in many Western Real economic growth depends on supply countries. An increasingly small portion of and demand factors. The supply factors the population is in the productive phase of determine the size of production capacity, life. The working populations in Japan and or the economy’s potential for growth. This Europe will decrease over the next few is the maximum growth an economy can years. The US and the UK will not yet be sustain in the long term without becoming confronted with this thanks to migration, overheated, which would cause inflation to but these countries are also facing a very rise. The potential for growth develops very small increase in the working population. evenly over time. Demand determines the Many emerging markets will still be able to extent to which production capacity is actu- benefit from the demographic dividend, or PotentiAL AND REAL GROWTH PRODUCTION VOLUME OP THE CYCLE OF BO CL E T Investment portfolios regularly require adjustment in order to maintain the required course in a dynamic environment. This is why Kempen annually tests its strategic asset allocation by making forecasts for real economic growth, inflation and capital market yields. TTO M OF TH EC Y TIME POTENTIAL GROWTH REAL GROWTH Source: Kempen Kempen Insight, November 2015 11 GROWTH AND INFLATION FORECASTS 1½ 2½% INF 1½ - 1½ 2½% 2½% 1½ - 1½ 2½% 2½% ½1½% RPG United Kingdom United States 1½ 3% INF RPG INF RPG Europe INF RPG 01% Japan 3½ 4½% Emerging markets RPG = Real potential growth 1½ 3½% RPG INF RPG 2½ 4½% INF 3½ 4½% Asia ex Japan INF = Inflation Source: Kempen, November 2015 Ageing turned the demographic dividend into a demographic burden at least they will if they can create the political and social conditions to take advantage of this opportunity. No temporary phenomenon Over the past few decades, between 60% and 70% of the world’s growth in GDP was driven by a rise in labour productivity. Over the next decade, the growth in labour productivity will continue to be by far the most important source of economic growth. Yet the growth in productivity will be lower than prior to the Great Recession. This is not just due to cyclical factors. Even if a correction is made for these, a downward trend is 12 Kempen Insight, November 2015 visible. A large portion of the global slow- Potential growth will be moderate over the down in productivity growth is due to coming decade and the same applies to lower growth in productivity in emerging inflation. We expect inflation in the US, markets. And we foresee no change to this. Europe and the UK to be close to the The productivity gap between developed respective central banks’ inflation targets. and emerging markets is closing, making it Although the Japanese central bank offi- increasingly difficult for emerging markets cially pursues an independent monetary to copy innovative and new technologies policy and the country enjoys a free flow of from the West. Investment in organisa- capital, the Japanese central bank is tional structure will become even more increasingly attempting to manage the yen. important. Moreover, it will become Its purchasing programme has led to the increasingly difficult in the West to raise trade-weighted yen currently being severely the educational level of the working popu- undervalued. This is having an upward lation due to the progress already made in effect on inflation. The inflation forecasts for this field over the past few decades. emerging markets are very mixed. Brazil Emerging markets do still retain capacity and Russia are likely to face very high for this, however, both in quantitative and inflation, while inflation is expected to qualitative terms. remain low in China. Single market? Factors beyond the sphere of influence of business have also contributed to the slowdown in growth. Some analysts claim that the reforms and regulation of the financial sector have decreased the banks’ ability to issue loans for new corporate investment, especially for small and medium-sized businesses. In Europe, the inability to create a single market for goods and services has reduced the regional capacity to upscale economic activity and achieve higher productivity. Ruth van de Belt Investment Strategist [email protected] Kempen Insight, November 2015 13 Books THAT INSPIRE Crises compared Hall of Mirrors offers a comparative analysis of the two great economic and financial crises of the last hundred years: the Great Depression of the 1930’s and the Great Recession that started in 2008. The response to the Great Depression still shapes the way society today reacts to economic problems. In 2008, policy makers prevented a catastrophic depression but not the rise of unemployment to excruciating high levels. Eichengreen seeks answers to the question why we didn’t avoid making some mistakes twice, while also showing how the experience of the Great Recession will permanently change how we Evert Waterlander is Director Client Solutions at Kempen. He selects books on investment for Kempen Insight. [email protected] think about the Great Depression. Hall of mirrors Barry Eichengreen ISBN 9780199392001 THE MAKING OF Insight, the macro movie á Film maker Emiel Elgersma: ‘Once more’! â Jan Bertus Molenkamp, Roelof Salomons and William de Vries are recorded on film as they address the Dutch pension system, long-term forecasts and the interest rate, respectively. 14 Kempen Insight, November 2015 Don’t be afraid of machines Economic history lesson We are approaching an era of un- Bernstein examines the concept of precedented and investment risk from a long-term exponential growth with systems opportunities investor’s perspective. This approach that can compete with the human dismisses the frequently-used con- capacity for thought. Self-driving cept of volatility as white noise. cars are no longer a Utopian dream. A deeper- rooted investment risk is What impact will this have on an event that a ffects an investment economic Traditional portfolio in such a way that capital methods of measuring productivity restoration is unlikely even in the prosperity? neglect the value of digital innova- long term. Bernstein does not offer tion. The benefits of digital advances a Black Swan theory, but instead revisits e conomic history. are therefore not being felt throughout society. The authors The latter shows there are four recurring investment risks: see a parallel with the industrial revolution, when Keynes inflation, deflation, confiscation and devastation. Which of described the process of economic adjustment. Brynjolfsson these four risks is most likely to occur and which asset class and McAfee’s book contains prescriptions for policymakers. offers the best protection? Viewed historically, the answer is Above all, be alert and focus primarily on reforms with a view inflation. The author believes that an internationally-diversified to continuing development rather than fighting the changes equity portfolio provides the best protection against most wrought by these technological advances. types of risk. The Second Machine Age Erik Brynjolfsson en Andrew McAfee Deep Risk: How History Informs Portfolio Design William J. Bernstein ISBN 9780393239355 ‘Once more’... Posing in front of the camera is not part of the daily routine for the leading actors of Kempen. However, that does not stop these gentlemen from responding succinctly and clearly to a statement about their area of expertise. Read their comments at Kindle edition (amazon.com) á Looking ahead to 2016: not a problem for Lars Dijkstra. â Paul Gerla and Jan Bertus Molenkamp go for a final take. www.kempeninsight.nl/en à Outdoor shots of the premises of Kempen at Zuidas (Amsterdam’s financial district). Kempen Insight, November 2015 15 /// tekst Lars Dijkstra foto xxx Stress scenarios 4 The horsemen of the apocalypse There is no certainty that the central scenario for the next decade will occur. For this reason, each year we formulate a number of alternative scenarios. A temporary loss of capital occurs fairly frequently: financial assets fluctuate in value. As an investor you need to be much more concerned about permanent losses. This year we have focused on factors that could lead to a permanent loss of real capital. 16 Kempen Insight, November 2015 /// by Florian Broekhuizen images MARIO HOOGLANDER, HENRIKE BEUKEMA Horseman 1 Inflation global equities, real estate, commodities frequently in emerging markets, for instance and inflation-linked bonds, provide the best in the shape of capital controls or expro- protection against an inflationary climate. priation. These are usually a result of failing government policy combined with a banking Inflation is the disaster scenario that historically occurs most frequently. The impact on the economy is enormous. Examples of periods of Horseman 2 Deflation system under huge pressure. Capital controls are used in an attempt to prevent a total collapse of the financial system. This may be in the form of a haircut, as occurred in major inflation are the 1920s in Germany, the 1970s in the US and the 1980s in South America. A long period of deflation has occurred very Cyprus (2013), a currency devaluation as in Over the past few years we have witnessed high rarely in history. One of the best-known Venezuela (2014) or the Asian crisis of 1998 inflation in countries such as Turkey, Russia and periods is the Great Depression. The cause when capital controls were applied widely. Brazil. is often a drop in demand triggered by The main impact of (high) inflation occurs via deleveraging, with far-reaching negative the supply side of an economy: how productive consequences: rising unemployment, a country is and what its government policy is. declining wages, write-offs on equity -Declining productivity decreases a coun- capital and growing numbers of bankrupt- try’s self-sufficiency and makes it import cies. However, these far-reaching conse- Devastation comes in many guises. The two more. This creates a deficit on the balance quences are also precisely the reason why main forms are natural disasters and disaster of payments, which in turn places the deflation occurs so seldom. Policymakers caused by humans, such as currency wars, currency under pressure and pushes up will do everything they can to prevent trade wars and military conflicts. While (import) inflation. Horseman 4 Devastation deflation and have plenty of tools at their natural disasters can cause major humani- -Budget deficits grow when governments disposal to do so. All the government has tarian hardship and severely affect individual spend too much structurally. The main to do is increase spending in order to drive countries, they seldom leave permanent negative effect of this is that private produc- demand in the economy and the negative damage. The impact of disasters caused by tive projects are squeezed out in the contest spiral of deflation is broken. If a deflationary humans is often much greater, but also for capital. Moreover, monetary policy is period does occur, equities and real estate generally confined to a smaller area. Diver- increasingly aimed at keeping government are vulnerable due to shrinking equity sification is the best way to protect yourself finances manageable, which leads to extra capital compared to debt levels, while against both stress scenarios, with a prefer- monetary growth. The result is upward investments such as long-term government ence for real assets such as real estate and pressure on inflation. bonds, gold and cash in fact benefit from equities. Although history shows that this climate. horsemen 3 and 4 can harm investment -In many countries wages are (implicitly) portfolios permanently, natural disasters are linked to prices, which means that when inflation occurs it becomes self-perpetuating. Inflation can undermine investment portfolios in two ways. Firstly, all investments with a nominal pay-out, such as bonds, lose Horseman 3 Confiscation notoriously difficult to predict. Taking this into account when structuring the investment portfolio is therefore difficult, other than by applying diversification. a great deal of value in the event of (unexpected) high inflation. Secondly, the cost of Confiscation can take many forms. One doing business in an economy rises, leading moderate form of confiscation is taxation. Florian Broekhuizen to real economic growth declining. Invest- More extreme forms of confiscation are fairly Investment Strategist ments with a real component, such as rare in the Western world. This occurs more [email protected] THE KEMPEN VIEW The modified economic growth forecasts and persisting disinflationary trend are causing investors to worry about deflation. One visible consequence of this is the high valuation of government bonds. However, we believe that the risk of deflation is being overestimated. Governments and central banks have both the will and the means to prevent deflation. In our view the risk of inflation is much more real, as long-term over-stimulation can harm the supply side of the economy, causing prices to rise. Kempen Insight, November 2015 17 /// by LUUK JAGTENBERG image MARIO HOOGLANDER Does risk still pay? How attractive are the individual asset classes in the coming years? Investment strategist Luuk Jagtenberg looks at each asset class in turn. Are we still being rewarded for taking risk? sufficient reward. However, this high-yield The expected returns on almost all the asset debt has generally been issued by countries classes are low from a historical perspective now facing a slowdown in the business and on average stand at about the same cycle, leading to substantial risk in the low level as a year ago. In view of current medium term. Moreover, many emerging valuations for risk-bearing investments and market currencies are difficult to hedge. the very low expected return on govern- These two factors combine to make high- ment bonds, we believe that we are still yield emerging market debt unattractive at being rewarded sufficiently for taking risk in the moment. the long term. However, the high valuations and elevated market volatility Value beats growth will yield more frequent negative returns The expected return on equities remains than in the past few years. low in a historical context. In contrast to Bonds? 18 Kempen Insight, November 2015 government bonds, equities are still offering sufficient reward for the risk Government bonds are very unattractively investors take. However, there are huge valued. Such low valuations are only geographical variations. Emerging market justified in the case of long-term deflation, equities are attractively valued. This is the which is one our stress scenarios. However, only region where the expected return is in we expect yields on government bonds to line with the long-term average. European rise and revert to normal levels over the equities are valued neutrally, while US and next ten years. This will be accompanied Japanese equities are too expensive. The by negative price returns, especially if yields expected reward for risk also varies rise abruptly. The current low expected according to the equity styles. Within the returns provide insufficient compensation developed markets, so-called value equities for this risk. are attractive compared to growth equities. In the case of credits, there is still sufficient The relative difference in valuation between reward for the credit risk taken. Credits are growth and value equities has seldom been therefore valued neutrally. High-yield so great. emerging market debt currently also offers Given current valuations, we recommend a Change WAARDERING & RENDEMENTSVERWACHTING /// tekst LUUK JAGTENBERG Overvalued Undervalued (from last year) Europe United States Equities Japan Asia ex Japan Emerging markets EMU core EMU countries Bonds EUR credits UK gilts UK credits High yield EMD High yield credits Listed EU real estate Alternatives Non-listed EU real estate Hedge funds Source: Kempen, November 2015 larger than normal weighting for value When currency pairs display mean rever- there may be more appealing alternatives. equities. sion, in other words revert to their long- It is often impossible to take advantage of Last year we described how listed real term average value, investments listed in this due to the lack of liquidity. A conserva- estate was attractively valued and had foreign currencies will be worth less for tive approach to non-listed investments is sufficient return potential. A great deal has a euro-based investor. Although hedging therefore essential and this is why we apply happened over the past year, especially as foreign exchange risk to the full is generally an ample safety margin to the valuations of concerns European listed real estate. Market not the best long-term option, we would such investments. prices soared in the run-up to the ECB’s recommend a high degree of foreign quantitative easing programme and at one currency hedging given current exchange Commodities point were as much as 30% higher than the rates. Although commodity prices have dropped level in our previous scenario update. sharply over the past year, commodities as Valuations rose substantially and listed real Sufficient liquidity estate subsequently became less attractive In today’s low-yield climate it is also worth attractive investment. We do not expect again. In the case of European listed real considering non-listed investments, such as commodity prices to revert to the levels we estate, the expected return barely compen- infrastructure, mortgages or non-listed real saw a few years ago. The oil price is likely to sates for the risk taken. In relative terms, estate. On average, these investments be lower than it has been in the past due to European equities or, from a diversification currently are providing sufficient compensa- technological and geopolitical trends. The perspective, global listed real estate are tion for the risk taken. However, there are roll yield, a major source of return/costs a more attractive option. variations within asset classes: for instance, that occurs on rolling commodity Dutch non-listed real estate is relatively derivatives forward, is also expected to be attractive, mortgages and infrastructure are negative for the next few months. Currency hedging? Yes! an asset class have not yet become an Driven by the unconventional monetary valued neutrally and private equity is policies pursued by the major central banks, currently unattractive. One major consider- Time to reduce risk exchange rates have been highly volatile ation in non-listed investments is the lack of Our central scenario and current valuations over the past two years. The rates of the liquidity: it is often very difficult to with- yield expected returns that serve as input main currency pairs spent some time draw from a position early. For example, for strategic portfolios, i.e. those portfolios fluctuating around their long-term average, once capital market yields have normalised that are best able to meet the investment but this recently came to an abrupt halt. over the next few years, the current extra objectives in the long term. Although the The euro is currently undervalued, while the reward for risk of many non-listed invest- objectives and restrictions differ according US dollar and UK pound are overvalued. ments will be small in comparison and to client, after years of a positive risk Kempen Insight, November 2015 19 attitude it is now time to reduce the risk in the portfolios. Over the past few years, we have reduced the positions in high-yield bonds to neutral. Also in the fixed income asset class, the weighting in credits has been reduced. We will continue this process over the next few months. However, we also believe it is the right time to gradually reduce our strategic weight in equities. This poses a dilemma: we believe that bonds are too expensive and not yielding the returns they ought to be. Yet the same applies to equities and in fact for nearly all the asset classes. In a longer period of high volatility a well selected portfolio of hedge funds can offer a good alternative. Finally, equities will continue to yield a higher return than bonds in the long term, and the reward, i.e. the expected risk premium, is in line with what it ought to be. This justifies a neutral risk attitude. Luuk Jagtenberg Investment Strategist [email protected] 20 Kempen Insight, November 2015 /// by ROELOF SALOMONS images Bram Belloni, Mario Hooglander Which route will the business cycle take? Every business cycle since the Second emerging markets will decline, but World War has died in more or less the strong domestic demand will compen- at Kempen and Professor of same way: the cause of death has not sate for this. The low euro and oil prices Investment Theory & Asset been old age but ‘murder’ by the central will boost consumer spending. Compa- bank. As the end approaches, corporate nies will increasingly contribute to margins narrow, wages and inflation rise, growth. Yet the European economy will as do commodity prices. Central banks be affected by weak global trade once respond by raising interest rates in order the US enters the next phase. The good for a long time, the drop in demand to curb overheating. Profits are squeezed news is that Europe’s competitive from emerging markets is causing lower and companies respond by cutting costs position has improved considerably and prices and the global economy is and postponing investment. that monetary policy will remain experiencing difficulty in growing on The economy is entering the final cyclical expansionary. trend, you are only a single external phase in the US, whereby wage growth Asian and emerging markets will shock away from a (growth) recession. is accelerating and interest rates are continue to weaken in the short term. And in this case it is not the central banks slowly rising. The latter is very moderate, The Chinese economy is in a period of that will put an end to the fun. as in spite of low levels of unemployment transition: from investment and exports The catalyst could also come from the there are still plenty of people who want to consumption. We do not predict a financial markets if they demand higher to work and inflation is low. Pressure is hard landing in China as has occurred in risk premiums. The restricted cashflows growing on earnings, on investments many emerging markets. Those coun- will squeeze the financing of debt. and on the job market. The US will head tries whose growth depended on debt Investors will be confronted with losses towards a recession as in 2017. The UK growth (often in US dollars) or exports to that will cause extra volatile outliers in will also experience a slowdown by then. China will have to implement further credit spreads due to the restricted Both consumer spending and invest- reforms, after which they can resume liquidity of the bond markets. It is then ments will contribute less to the their upward trend. Japan is the odd one a small step to companies in the West, economy and the referendum on a out in Asia. Its economy will continue to led by the US, reviewing costs and future possible Brexit will cause companies to stutter over the next two years. investments. In this scenario it would be Roelof Salomons is Chief Strategist Management at the University of Groningen. [email protected] the first time in decades that we cannot postpone investments. The Bank of England will follow the example set by This is the most likely scenario. Yet there directly blame the central banks for the the Fed and raise interest rates. is an alternative that is becoming more recession. This is highly unusual. On the The European recovery will continue and more probable. In a climate in which other hand, so were seven years of over the next two years. Exports to profit margins have been under pressure interest rates at zero percent… Kempen Insight, November 2015 21