Beyond the Beaches

Every evening, as the blue of the night darkens, the Paseo Maritimo, which winds its way  from Marbella to Puerto Banus along the Spanish coastline, is once again thronged with locals and tourists, Spanish and international, as they stroll before or after dinner, incessantly chatting, catching up on the news of the day.

The ambience is positive and relaxed as many are happy to get back to what was taken for granted in pre-Covid times. Indeed there are quite a few reasons for positivity in this area of Andalusia.

Tourist numbers are up of course, which is perhaps the single biggest driver of a positive economic outcome, but the spill-over effects are now seeing the Costa del Sol progress at a faster pace than the rest of Spain.

Andalusia now has higher economic activity, exports and property sales than prior to the Pandemic and has outpaced the national averages. But where the Costa economy has done especially well has been in the growth of the official workforce. This is now higher than pre-pandemic. One of the unforeseen side-effects of Covid was to nudge many Spaniards out of the informal economy, and into regular employment. Income tax collections from workers have been outpacing GDP. The desire for social protection, decreased use of cash (for hygiene reasons) as well as government action has reduced the use of cash filled envelopes or “sobres” as worker compensation is now based on legal contracts and tax compliance has become the norm.

The near term picture for the Costas looks bright. Tourism numbers, barring any Covid resurgence, are holding up really well. Sentiment surveys show Irish consumers determined to have a holiday and CSO data suggest that in 2022, the number of Irish visitors to Spain will be a lot closer to pre-pandemic levels. Before Covid about 2 million Irish tourists visited Spain.

Spain’s Industry Minister Reyes Maroto sees tourism business in 2022  surpassing pre-pandemic levels.

But beyond the Costas, the picture is less rosy. Spain probably suffered the most economically from the Pandemic. In the second quarter of 2020, Spain’s GDP (PIB) declined  by 18% and has yet to make it back. Spain is experiencing what the Spanish Central Bank has labelled “an incomplete recovery in an uncertain environment”.

Business and consumer confidence across Spain has imploded. The last reading on sales of household goods was negative. Spending on big ticket items is under pressure. Spanish car sales are forecast to be down on the year by about 3%.

Q1 this year posted a growth rate of just 0.2%

Even where we will see growth and investment, it comes with caveats.

One of the larger employers in Spain is  auto manufacture (accounts for 10% of GDP), which has been under pressure now for a number of years. Chip shortages in 2021 caused many plants to be idled and production lines cut. There is little sign of the industry returning to robust health in the next 6 months. Looking ahead, we will see substantial investment in electric  vehicle manufacture – but even that is bittersweet. 

SEAT are looking to expand in EV at both Pamplona and Martorell, but as such manufacture is less labour intensive, SEAT are forecasting a loss of 8000 jobs. Ford in Valencia is also looking at future job losses as they invest in EV plants.

A 10% inflation rate dominates newspaper headlines. The Head of government statistics resigned rather than continue to bring bad news! Despite surging public deficits, the government is pushing ahead with its emergency Stability Programme, which aims at adding 1.5 million new jobs. Social welfare payments like pensions for the most vulnerable are being increased by 15%. Energy bills are being reduced and public transport subsidies extended.

Many Irish visitors to Spain this summer, will see a vibrant local economy, with full restaurants, crowded beaches, and signs of re-commencement of building works.

But beyond the Costa economy, it’s a very different picture, with the rest of the country dancing to a different and more sombre beat.   

Fund Management: What’s working – what’s not

Markets have been unforgiving in 2022. Especially in the second quarter. 

A pincer movement between inflation and growth has compounded the concerns about the war in Ukraine to wreak havoc on many sectors in the world’s stock markets and in investor funds. Fund managers have had quite different experiences depending on how they have been positioned.

Looking at Irish Balanced Managed funds all with a risk rating of 4 (which might suggest we should be looking at reasonably similar outcomes), there is over a 10% range in returns delivered by managers in the last six months. For sectors like North America, the dispersion of returns can be over 20%.

So clearly fund managers have positioned portfolios differently.

For those who like labels, we can look at how value and growth styles have performed so far this year. Growth clearly has been in the ascendancy for decades with value making brief forays into the limelight. 2022 seems to be on the those episodes, and the numbers are startling – US Value is down by about 9% but US Growth is off 28%. So both styles have delivered negative returns

The catalyst for Growth’s decline is most likely higher interest rates which choke the present value of future income streams. But it’s also the case that there has been a negative business backdrop for many of the key names. The table below highlights the businesses which would feature in a US Growth index and how their prices have performed so far this year (correct at time of writing):

Amazon-38%
Apple-27%
Facebook-49%
eBay-35%
Google-26%
Netflix-70%

These stocks have been clear winners in recent years – even performed well in the pandemic economy – but have now torpedoed portfolio performance for many.

Higher yields and interest rates will continue to put pressure on growth stocks, but for some stocks that may already be in the price – especially if the view that the rate of inflation may have peaked in the US proves correct.

Did it make any sense diving deeper and maybe getting some “cover” from market conditions in the small cap arena? There has been little relative benefit from owning smaller stocks in 2022 so far. In the US, small cap indices have been as poor as their larger cousins, while in the UK small cap stocks also posted significant losses.

Even funds with the ability to go short (and benefit from falling asset prices), so called Absolute Return funds have found the conditions difficult to navigate. Over the last 6 months the two highest profile absolute return funds in Ireland on average are down 6 to 8%.

There seems to have been no hiding place for mainstream investors in 2022 to date. Obviously assets like property have performed well as rents are holding up and there is no “mark to market” risk. For a typical institutional property fund, we are looking at a 2-3% return over the last 6 months.

Even for a fund manager who had 20/20 vision and opted to overweight commodities, it wasn’t straightforward. Of course energy has done well. But in recent years many investors, wary of the geo-political risk or “ESG” risk in the energy sector, looked for indices which excluded energy but instead concentrated on the more economically sensitive industrial metals. The difference is stark. Broad commodity indices are up about 40% year to date; non-energy versions are up less than 11% and in fact have been in decline since March.

In a world of tumbling bond and stock prices, it’s been hard to find a safe harbour, and tough to act in a timely fashion. Large institutional portfolios with their incremental decision-making processes bear a lot of market pain. Many of the broker strategists stick with (usually) higher equity contents even as stocks free-fall.

Even at a stock level, it can be hard to reverse opinion, even in the face of extreme performance. Last week, an analyst with a major Wall Street firm lowered their recommendation on Netflix – after the stock had declined 70%!

A Confluence of Calamities

It sounds like some medieval curse that the Wizard Wobegone called down upon the elves of Myrtle, in response to their kidnapping of the Princess Petrushka, but this is in fact how the IMF described the current global economic and financial market situation.

IMF Managing Director Kristalina Georgieva said the global economy faces its biggest test since WW2.
The war in Ukraine has compounded the Covid 19 pandemic – “a crisis upon a crisis” – devasting lives, dragging down growth and pushing up prices. The IMF is also concerned that all of this is happening at a time of tightening financial conditions and increased financial market volatility.

And the IMF feel our ability to respond to these calamities is hampered by what it labels “geoeconomic fragmentation”. By this, they effectively mean the rollback of the freeing up of flows of capital, goods, services and people which in the past three decades have transformed the world. This globalisation boosted productivity and living standards, tripled the size of the global economy, and lifted 1.3 billion people out of extreme poverty.

But now we run the risk of slipping into a world of higher tariffs, outright trade bans and less effective supply chains. The Fund believe that trade uncertainty alone reduced global GDP by 1% in 2019. Since the start of the war, around 30 countries have restricted trade in food energy and other key commodities.

The message from the IMF is to strengthen trade and to strengthen trust.

This is hard to see in the current environment and it points to a worse outcome that what consensus thinking is today. Currently the IMF are forecasting sub 4% growth for 2022 and 2023, which if we got them, I think would be more than acceptable. Given their newly expressed concerns, I could see those forecasts being revised and the prospect of recession looming larger.

The mood music in economic and market commentary has clearly shifted since the war began and many at Davos for example spoke about the risk of a global recession. In financial markets, while the talk in the first third of the year was more about inflation, there has been a clear shift to worrying about growth.
Several factors have driven this. Surging prices for energy and soft commodities could knock several percentage points off growth forecasts. Central Banks, notably the US Federal Reserve now seem to be in a catch up mode with much more aggressive hiking of rates, at times invoking the memory and spirit of Paul Volcker in the 1980’s, where US economic growth was choked off to solve the then inflation problem.
While there are some tentative signs that inflation may have peaked – core inflation in the US has been more or less unchanged in the past three months. The question will be how sticky it is to come down to allow Central Banks relax.
Those in the recession camp have also been boosted by signs from the US bond market, namely a fleeting inversion, that recession is on the way. Global economic activity is slowing and all forecasts are being revised lower.

What could push us into a recession?
Certainly in Europe double digit inflation, were it continue at length, would erode consumer confidence and divert resources from economic activity – and we have yet to see the full impact of food shortages were the war in Ukraine to continue.

Central bank policy would be another concern. There have been 60 individual rate hikes in the past three months by the world’s major central banks and some fear that in the race to ensure they are not “behind the curve”, overly aggressive action could impair growth.

Finally there is always the risk that we simply talk ourselves into a recession if we put spending plans on hold, hold off on big ticket items or businesses cut back on investment.

The IMF is right to stress the importance of improving trade and trust.

Irish Pension Funds and the War in Ukraine

As a world event, the Ukraine War is seismic, and has edged out most topics from the financial news cycle since February. The human horror and loss is evident and growing daily. It is also having a wide impact on global politics and finance. Given its role in financial markets,  it is worth seeing what has the impact of the war been on the €130 billion or so in Irish Pension Funds and what should pension investors do.

2022 didn’t get off to a great start for Irish pension funds anyway. Fears over run-away inflation and higher interest rates at the start of the year knocked market returns. The average Irish Pension Fund lost about 3% in January. February wasn’t much better and we saw the dip continue driven by the same reasons – surging cost of living, central banks rushing to catch up, and then – the early stages of the war. The average Irish Pension Fund was down about 2% in February.

Market response to the outbreak of war in Ukraine has been complex. Immediately on the invasion, global markets fell away until they found a level in early March. From that low, by the end of the month, world equites were up nearly 10%! As the war moved into a more static phase, global shares become less responsive. This is visible in stock market volatility, which, as measured by the VIX index, peaked on March 7th and has been broadly declining since then. So since early March, we have on-going conflict coupled with positive financial markets.

This market response has resulted in a much better March for Irish Pension funds. A standard managed fund returned between positive 2 and 3% – much better than either January or February. 

In the worst of the war, pension funds have moved ahead.

In fact looking at this first quarter, factors such as global interest rates have been much more dynamic and influential for pension fund investors than events in Ukraine. In the US, 10 year yields started the year at 1.4%, but are now close to 2.8%.  German 10 year bunds went from negative 0.2% to close to 0.8% today. These are significant moves and in fact improved the health of many defined benefit pension schemes in reducing the value of future liabilities. These moves in government bond markets point to the interest rate debate being a critical one for investors.

Initial strategy calls from large global investment houses were very much to hold positions. Some advised to “take some risk off the table” while essentially meant reducing equity holdings but staying overweight. 

Several commentators looked to what stock markets had done in recent outbreaks of conflict such as the Gulf Wars, Iraq, Vietnam. In these instances markets regained their poise in relatively short order. But in certain respects many of these events were quite contained. 

There is little that is contained about the Ukraine conflict. 

It’s clear that stock markets haven’t been following every ebb and flow of events in Ukraine – especially after the initial ‘shock and awe’ of the invasion. On occasion, markets have responded on days of dramatic news, such as constructive talks – often to lose it again. Rather than the direct progress of the war, it is the secondary effects of increased energy costs, possible food shortages, supply chain disruption, job losses where markets have rightly been focussed. 

There may well be a long way to go in this conflict. The risk of corporate defaults and the inability to sell Russian assets may increase the direct systemic impact from the war. Many corporates are closing Russian operations. Several funds investing in Russia have been forced to suspend dealing. Some UK pension funds are divesting of Russian assets. Russia has been removed from many market indices but we have yet to see any material impact on the world’s financial plumbing.

Even if events take a positive turn, we are unlikely to see a swift removal of sanctions or restoration of supply chains. Investors should adopt an equally careful approach and not react to events.

Markets find it very hard to price geo-political risk. Prepare rather than predict by ensuring diversification and eliminating  disproportionate exposure to at risk sectors and stocks. But attempting market timing in a potentially volatile landscape is a risky strategy.

But it may well be that looking back on 2022, it will be the usual suspects of interest rates, inflation, oil prices and a deteriorating company earnings outlook that were the real market drivers.

Ukraine War hits all key issues for Markets

The war in Ukraine, while above all a deeply sad humanitarian crisis, may impact practically every aspect of our future lives. 

Following on the heels of a pandemic that continues to take its toll, the war will cast a long shadow.

Financial markets are one barometer of the impact beyond Ukraine’s borders. But historically, markets have found it very hard to price geo-political risk. Moves may appear indiscriminate, but they are widespread and substantial with significant impact on general savings, pension funds, sovereign wealth funds and others.

Initial calls from investment houses were very much to hold positions. Some advised to reduce risk slightly while still being “risk-on”. Several large investors looked to what stock markets had done in recent outbreaks of conflict such as the Gulf Wars, Iraq, Vietnam. In these instances markets regained their poise in relatively short order. But in certain respects many of these events were quite contained.

There is little about this Ukraine War that is contained. One of the aspects of the current crisis is that it has seismic impacts on a wide range of issues. And these issues were  already “in motion” in financial markets and were top of mind for many investors. 

For example inflation. Inflation has been a hot topic in markets for the past year as Central Banks gave up on their view of price increases being only transitory. Annual price increases of over 7% have become a hot political issue in the US. However now, the risks around cuts to oil supply or possible embargoes have pushed gas prices at the pump in the US to well over 4$ a gallon – double what they were 20 months ago. Even sourcing oil elsewhere will bring higher transportation or refining costs. Moodys estimate that a lengthy military conflict leaves oil prices extended in to 2025. Grain prices will see a similar profile. Inflation is now a more engrained problem

Covid raised the profile of supply chain disruption and the war brings further pressure especially in industries like autos, which had already been facing shortages in semi- conductors. However the added pressure especially for German car makers comes from the lack of wiring harnesses, which are typically manufactured in Ukraine for shipment to European facilities. Even transfer to other plants would increase the costs as harnesses are a more labour intensive product. Supply chain disruption remains a theme for markets

Another trend that gets amplified is the slowdown in global economic growth. Well before the war, institutions such as The World Bank, OECD and the IMF had already moved to factor in a gentle slowdown in the rate of global economic growth this year and next. The war because of issues such as the impact on investment, consumer nervousness, supply chain disruption, impaired logistics etc. accentuates that fall. And the impact is not evenly distributed  – with Europe in the vanguard. As an example, the impact of a sustained 20$ hike in the oil price would knock 0.3% off US 2022 growth, but about 1.2% off activity in the Euro area. And if conditions escalated in the Ukraine or moved elsewhere, the prospect of a global recession cannot be ruled out. 

And all of this is happening at a time when many governments were hoping to restore discipline to public finances post the spending surge in the battle against Covid. Eurozone countries debt to GDP ratios rose from 85% pre-Covid to 100%. The hope was that 2022 would be the year to reassess this emergency level spending. EU officials may now hold off reactivating the Stability and Growth Pact in 2023 given the current level of uncertainty. The mood to increase spending was exemplified by Germany’s decision to set aside €100bn for defence  spending. Increased spending commitment to NATO are also likely over the next few years. Moves elsewhere such as Ireland’s reduction in excise taxes on energy also move public finances in the same direction.

We are seeing market moves of 3-4% on a daily basis. Lack of visibility on a solution, coupled with the seismic impact events in Ukraine are having, on what were already “red button” issues for markets, suggest the volatility will persist.

Currencies – the Next Stop for Volatility?

Volatility is on the up in asset classes like stocks and bonds, as governments and central banks  around the globe look for an exit strategy from highly supportive pandemic policies. 

US bond volatility (as measured by the options market index) has practically doubled in the past 4 months and stock markets have been displaying heightened volatility over the same period.

But currencies, by their own standards, have been very calm and  at the lower bound of their historical volatility over the last five years or so. The US dollar has traded in a much tighter band with the Euro since 2017 than in the period before. Indeed at time of writing the greenback is at the same level against the Euro as  it was mid 2020. Movements in Sterling against the Euro have been equally subdued despite the ebbs and flows of the Brexit process.

The key explanation for this has been the basic “absence” of interest rates.

Major Central Banks around the world have kept rates at zero and below for a considerable time. There has been little to choose from in this world of rock-bottom rates and, until recently, a global central bank consensus of keeping these rates low.

Red hot inflation numbers have changed the landscape. The US Federal Reserve had been playing a very patient game, but  in response to faster price rises that they would like, have pivoted dramatically and will now hike interest rates several times in 2022. Some analysts are looking for as many as seven or eight increases and there is a view that these increases could be “front-loaded” i.e. sooner rather than later and in bigger increments.

And the US is not the only actor on the stage. The Bank of England is already out of the blocks with rate hikes and the European Central Bank is a late entrant. Christine Lagarde has been talking up rate prospects.

This new more “hawkish” US Central Bank, could support a stronger US dollar over the course of the year as it wins the race in hike rates. This is a view widely shared. Several of the large US investment banks are very positive on the dollar’s prospects. This bullish view is also visible in the currency funds markets where speculative positioning on the dollar sits at its most positive since 2019.

However there is a risk; and that is the risk of a policy mistake by the US Central Bank. If it proceeds too soon and at pace, could it choke off economic growth? The US economy is set to grow by about 3% in 2022. But we have seen the pace slacken in recent weeks with softer retail sales, lower consumer confidence, less positive tone to economic output and a pull-back in many higher frequency data points. Analysts are also reducing their forecasts for company profits for the first quarter of this year. 

But failure to hike rates would see the inflation genie well and truly out of the bottle. And there will be political pressure as cost of living has become a red button issue for governments globally. But there will be a need to be nimble – Inflationary pressures may well lessen if we get further away from the pandemic and supply chains get rebuilt. Base effects in energy prices may also make for some moderation.

We are starting this rate cycle at a reasonably elevated inflation level. Policy makers will be unwilling to let currencies weaken too much and import further price rises

Perhaps some of the very few resolutely dovish central banks – such as those in Japan, Switzerland and Sweden – will accept the trade-off of a weaker currency.  

It is clear that in 2022, central banks will be more active, more scrutinized and may need to be more reactive than they have been for several years. For example, we may see the US Federal Reserve actually making decisions outside their normal meeting schedule – perhaps before the next meeting which is around St. Patrick’s day. Also monetary policy across regions will be more differentiated than markets may have become used to. The “synchronised” global economy is no more.

For currency traders, after a long period of “calm”, there will be decisions to be made.

This will translate into  greater volatility in exchange rates

Investment Funds: What’s Selling and What’s Not

It’s been another fantastic year for asset management. Sales of investment products pushed through new record levels in 2021.

But what is selling? Where are investors putting their money? And what is being avoided?

Sifting through Morningstar, Citywire, Lipper, Investment Association and others, can provide direction on what’s hot and what’s not  in the investment landscape currently.

Risk on. 

It was another year when European investors piled into funds at record levels – and embraced risk  by investing into equity funds especially. 

Estimates are for over €720 bn. invested in funds in 2021, with about half going to equities. Global equities were the asset of choice for many, as economies staged a strong bounce from Covid suppression levels, company profits surged and Central Bank policy remained very supportive. In the UK over 1/3 of net retail sales went to equity funds, again with global equities taking the lion’s share. The former darling sector of Equity Income actually saw net outflows.

In Europe, flows into funds exceeded flows into ETFs by about 3 to 1. And according to Lipper, about 70% of investor cash went to actively managed funds as opposed to indexed.

Records were also smashed in the US. Investors poured $1.2 trillion into long term funds and ETFs. This was nearly double the previous record set in 2017. However passive managers substantially out-paced their active counterparts especially in the US equity space.

Bond funds were a bit of a conundrum in this period – as they managed to feature at both the top and bottom of the class. The data still shows an appetite for bond funds – close to €200 bn in Europe , which given the abysmal yields available, coupled with the prospect of Central Banks withdrawing support, seems misplaced. However when we look at some of the top individual funds, it seems more reasonable. Two of Citywire’s three top selling funds in 2021 were bond funds while the third also has material exposure to Fixed Income. However rather than plain vanilla bond exposure these were “strategic” bond funds, with the ability to go anywhere in search of some level of income. This reflects continued investor demand for income in a zero interest rate world. So two of these top three selling funds delivered returns of just 2% – but fully met investor expectations. 

However at same time, looking at the funds that suffered massive outflows, bond funds again featured, accounting for 8 out of the 10 worst.  Root cause was bond market weakness, especially in Emerging Markets but many strategic bond funds were simply wrong footed. Markets (and investors) were unforgiving. The worst fund saw an outflow of just over € 8 Billion! 

Choice of manager mattered as much as choice of asset!

ESG remains a prime driver in gathering assets, both active and indexed. 51% of the money headed to European ETFs in 2021 was directed towards those with an ESG mandate. This is up from 40% in 2020 and 10% in 2019. ESG was especially a feature in the UK, not only winning new monies but taking market share from “non-sustainable” funds.

As well as – what’s selling, it is interesting to look at –  who’s selling? 

Some 18 months ago, I wrote that one aspect of this Zoom world and WFH would be the difficulty of making new sales to new clients. Building  that very critical feature of trust may be harder in the virtual world. This would lead fund buyers to rest upon the tried and tested options and favour incumbent asset managers. This can actually now be seen from a list drawn up by Morningstar of the top ten largest US fund firms at the end of 2021 and at the start. The names and the order are practically the same. 

Making material headway with new clients in “Zoomworld” is tough!

Investors were well rewarded for owning funds and favouring equities in 2021. 

2022 with the prospect of higher interest rates, slower growth, and possible inflation has already proven to be a challenge. It remains to be seen whether the same “risk-on” strategy is vindicated.

The Central Bankers’ Christmas Party – Two

It was the night before Christmas

And all the markets were calm

The traders had all put their books away

So really there was no cause for alarm

But back in the darkened halls of the ECB

And the corridors of the Federal Reserve

Central Bankers, past and present, were keeping a watch

To make sure they weren’t behind the curve

Old Jay sez “we told them we’d taper and told them we’d hike 

But these markets are still hale and hearty”

“Ooh la la!” sez Christine “that only means one thing

It’s time for the Central Bankers Christmas party!”

So the world’s central bankers, present and past

Got dressed up and met up for a wild celebration

Jay shouts “Ain’t nothing gonna stop us now

Not even a mild bout of inflation

Well there was Powell, Draghi and Greenspan

Yellen, Lagarde and the rest of her crew

With Makhlouf, Macklem, Kuroda and Bailey 

And for some unclear reason Philip Lane too

Pretty soon liquidity was flowing

An unsynchronised conga just begun

Soon no one cared about the difference

Between M3, M2 or M1.

Now all the bankers are telling jokes

About when to expand or when to ease

Poor Kuroda from Japan was getting no laughs

That’s what happens when you only speak Japanese

“Well fire up the Karaoke”, Christine calls out

“It might help ease the tension”

But Phillip grabs the mike, thinks he’s Simply Red

And sings Money’s too tight to mention

Now Philly won’t let go of the mike

And Jay Powell wants to give it a shot

But after 23 verses of Sweet Home Alabama

He’s clearly lost the dot plot

Then a thundering noise at the door

Which opened with a mighty crack

It was little Alan Greenspan, holding a punch bowl

“Look lads, I’m bringing it back!”

There were devils on horseback and pigs in blankets

The finest food from every member nation

But the brandy souffles had taken too long

And were the first real victim of deflation.

But soon things were getting out of control

Authorities had to be alerted

Coz Jerome Powell had had too much liquidity

And like his yield curve he was soon fully inverted

And as if things couldn’t get any worse

Amidst this haze of gin, cognac and sambuca

Screaming “whatever it takes” at the top of his voice

Mario whips out his great big bazooka

Now there were governors swinging from the chandelier

There were two on top of the Holly Tree

And quietly in the corner were Yellen and Lane

Discussing macro-prudential policy

Well after a few days, the dust had settled

And the markets recovered and reset

But Jay looked around, with a glint in his eye

Whispered youz ain’t seen nothing yet!

Asset Management continues to deliver…………………certainly for the asset managers.

.

In fairness, investors generally have also been enjoying good returns through this pandemic period.
2021 will be another record year for the Asset Management industry.
Markets have performed well, investors have poured record amounts into funds, and costs have been extremely well managed.

Headlines about asset managers’ profits in the Financial Times ring with words like surge, skyrocket and sparkle. These are good times for fund managers.

The bedrock of the strong performance has been how well financial markets have done which translates directly into the value of assets under management. In 2020, markets recovered well from their March lows to be broadly positive for the year and as 2021 comes to a close it is still a positive picture. In Ireland the average multi-asset balanced funds registered a return of just over 11% to the end of November, according to the Aon survey.

And the world of “Working from Home” has helped in cost control in Asset Management. Sifting through the commentary from CFO’s at results season reveals how issues like reduced travel costs continue to feature even in year 2 of the Pandemic. Distribution, client service, company research are all possible without building up the frequent flyer miles. Especially in a world where asset managers will have to display their environmental credentials, a Zoom call, while not perfect, may well hold its own compared to an 8 hour flight to Seattle to see Microsoft’s Investor Relations manager.

So some of this cost reduction may be permanent. Further cost reduction is likely as asset management companies review just how much space they need. Richard Keers, CFO at Schroders, a leading asset management company notes how by reducing space in London and Hong Kong, having reviewed changed working habits, they have saved £16M. Over at abrdn, Chairman Douglas Flint talks of re-designing and re-purposing their office space – which hardly means expanding! So it looks like fund manager surroundings are going to change.

Even if the surroundings don’t change, there’s still a possibility that the name over the front door changes. Mergers and acquisitions remains a firmly entrenched trend in the asset management business. This is happening both at the large institutional end of the spectrum and also among smaller brokerage/wealth management firms.
Asset managers are striking mergers and acquisitions to secure profitable growth, acquire complementary lines of business, and tap into new markets or distribution, in an environment of declining fees, rising costs and the onward march of passive investing. Expect this to continue. The “Thinking Ahead” Institute notes than of the 500 top asset managers 10 years ago, 200 have gone from the list today. There is little sign of this letting up.

Asset Management is still seeing pressure on fee income. The rise of ETFs, Smart Beta and even more nuanced indexed products, ensures that the focus on fund management charges will endure. Value for money and transparency will be key drivers in the dynamics of fund pricing.
So are active managers doing what they’re supposed to do?

No, based on early numbers, not so far in 2021. A new report from AJ Bell shows only 1/3 of active equity funds outperformed their stated benchmark in 2021. And US and Emerging market equities remain the main sources of value destruction – even over a 10 year period, according to the survey. And some charge high fees despite serial underperformance.

Fund costs are moving up the regulatory agenda. The Central Bank here has looked for greater visibility in the issue of performance fees. In the UK, the FCA looks for fund managers to assess the “value” of their funds which includes how they perform, once a year. Surveys show that high net worth individuals favour performance based fee structures.


If the democratisation of investing means that more people are becoming more engaged with their money, more demanding of information, then an industry that has historically been opaque needs to become more transparent.

Language Lessons

It has been the economic surprise of 2021 and there are still voices on both sides of the argument.

Inflation has taken off as a concern for investors, consumers, producers and policy makers. The most recent number to grab headlines in the US was a staggering 6.2% – the largest since 1990. At the start of the year, 2.1% was the expected figure. 

The path to these price pressures is paved with supply chain delays, higher energy prices and higher wage bills in certain challenged sectors.

Central Banks built a defence by viewing all of these as “transitory” – which of course they may be. However the issue is when inflationary expectations are changed. Investors and manufacturers may have grown accustomed to living in a low inflation world – but there are signs of a change. The concept of “pricing power” is once again being mentioned. A recent survey in the US  has shown the proportion of  businesses thinking of raising prices is close to 50% – the highest since the early 1980’s. 

Inflation is certainly making its way into the corporate psyche and is front of mind for many CFOs and CEOs in US companies. If we look at the conference calls of the S&P 500 companies in this third quarter reporting season just ending, the percentage of companies citing inflation is over 60% –  double the norm of the past 5 years. Interestingly this hasn’t really fed through to lower profit margins yet.

Is this surprise in inflation numbers going to lead to a shock on interest rates?

For some commentators, the greatest crime a Central Bank can commit is “being behind the curve” i.e. not recognizing a change in the economic environment and having to catch up, but with the risk of inappropriate interest rate policies. 

Making this assessment is even trickier now as many Central Banks have made changes to their operating framework. Basically entities like the ECB and the Federal Reserve in the US are likely to tolerate higher inflation rates before they pull the rate trigger. In the US, for example, the Fed is looking to target average inflation over a time period rather than a spot level.

As we stand today, policy makers, certainly in the US and Europe, broadly hold on to the transitory narrative but there have been some interesting changes in language in the past few weeks. 

Closest to home, ECB chief Christine Lagarde now feels inflation will stay high for longer then she previously forecast. However she has pushed back on calls for rate hikes, sticking with the view that inflation will fall back somewhat in 2022. It is worth noting though that the ECB inflation forecasts are among the lowest around.

The actions of the Federal Reserve In the US probably matter most. Here we have had the most clearly communicated policy; namely of no action on rates until the jobs market was clearly improving. The chairman of the Fed, Jerome Powell, is reluctant to raise rates while there was still slack in jobs market, despite the surge in prices. The 6.2% number did have something of a “sticker shock” about it and the inflation numbers have been highly politicized. The situation has been complicated by the fact that we will see several changes in composition of the Fed board this year. And it is true that the most recent job numbers have been stronger.

Will this change the time-table? Comments from the Treasury Secretary Janet Yellen have become somewhat more neutral,  noting that Covid is likely to play a greater part in calling the shots on inflation and interest rates.

Most clear cut is the view of the Bank of England, which appears to be itching to hike rates. Andrew Bailey, Governor of the Bank, admits to being very uneasy about inflation being above target, suggesting action will be taken sooner rather than later. Bailey puts in very simply “We are in the price stability business”.

This more nuanced language we have heard may not change the sequence of rate rises – UK followed by US, followed at some point by the ECB – but may herald a change in time frame.

However beyond time frame, we are leaving a period when the interest rate policy of the major blocks was highly synchronised. This resulted in the very muted volatility we have seen in exchange rates – this too may change. 

Still Absolutely Not So Fabulous

Three years ago on this blog, I looked at Absolute Return Funds – funds that were still very much in vogue and in demand. They were the top selling fund type in 2016 and 2017 according to Investment Association figures. These funds typically offered cash plus 4% or more and the promise was that this would be delivered at a significantly lower risk level. Performance issues had already surfaced but the party-line for managers was to stick to their guns and rhetoric.

I thought it was a sector worth revisiting.

My conclusions three years ago were broadly that it was quite a challenging ask, lots of over-promise and under-delivery, and more than any other sector picking your manager was of key importance as there could be a wide range of returns.

The world has changed profoundly for Absolute Return funds and their managers. In the past two years (2019 and 2020), investors lost patience and this sector saw the worst redemptions in the industry. Redemptions were described as “brutal” by one manager. In 2019 and 2020, European domiciled Absolute Return funds saw over €40 billion head for the exit door. One very high profile fund went from £26.8 billion to £2.6 billion in 4 years.
The picture is similar with large pension funds though harder to map. While the overall allocation to Alternative Assets has grown, within the sector areas like Private Equity and Infrastructure have probably increased the most from a lower base. If we take hedge funds and multi-asset as a proxy for Absolute Return, in the very recent past they look to have lost ground. The picture is more stark in terms of future investing intentions. European pension funds plan to reduce allocation to hedge fund and multi-asset funds.
Many absolute return managers blamed the absence of volatility, and then, when there was volatility, it was the wrong type. Trends and asset moves became very short-lived and un-investable. Others blamed constant bull markets ,which reduced their shorting profits, even though relative performance is what determines absolute success in this sector.
I looked at the performance numbers for three of the major players in this space in the Irish market.

One YearFive YearTen YearVolatility
Fund A-0.7%1%2.6%4.6%
Fund B4.1%0.2%n/a5.9%
Fund C9.8%3.3%4.3%7.4%
Average Managed15.8%6.1%7.6%9.7%

                                                                                                (Source: Aon; Annualised %pa)


A few things stand out.


Performance as we know has been poor but also it’s hard to see any broad recovery in the sector numbers in the near term despite what the managers may have hoped for. It is also interesting that the best of the three is the one with the highest volatility level – edging closer to that of a standard managed fund. This is also reflected in CityWire statistics in the UK where the better performers in their Absolute Return sector display higher volatility levels. This would seem to point to the difficulty of earning high returns while only taking on lower risk.


How did the Absolute Return industry respond?

There have been a number of responses.
We have seen fund name changes and modification of investment objectives. For example this summer, a long standing Absolute Return fund morphed into a “Flexible Macro” fund.
We have seen fund closures and cash returned to investors. One industry leader closed a high profile fund recently in the face of desperate performance and massive redemptions.
We have also seen changes in the people actually managing the funds in the hope that new faces or a new approach would do the trick. This has meant both retirements and sackings.

There is still a large number of Absolute Return funds out there, and making a choice between managers is more important than allocating to the sector given the range of returns which remains a feature.
There is little evidence to suggest that using hundreds of analysts, steering groups, and ending up with thousands of holdings actually works any better.
There is still a role for uncorrelated asset classes in portfolio construction. Currently asset classes such as Private Equity or Infrastructure garner most attention.

An absolute return fund with genuine alpha generation potential can play a role but it would help if there was a true reset of expectations in terms of what cash plus returns can consistently be achieved.
The simple learning from the emergence of Absolute Return funds is that the link between risk and return has not been broken.

Emerging Markets – is it over?

Emerging Markets have long played a role In investment portfolios whether pension funds or retail investors. Investing in sometimes more “exotic” markets has been seen to be a way of tapping into higher returns while diversifying away risk.

Investors could have exposure to Coca-Cola bottlers in Argentina, software companies in India through to supermarkets in South Africa and all at (certainly in the early days) extremely attractive valuations. It became one of the most exciting themes in financial markets.

Emerging Markets (EM) as a term was recognised in 1981.

Investment fundamentals were based on super normal growth prospects due to features such as new wealthier middle classes across Latin America and Asia increasing the quantity and quality of their consumption at pace.

There were periods when EM provided turbo-charged returns to investors, and came to be seen as a separate asset class in itself.

Is the case for such investment still intact?

There are two aspects to this question – the near term impact of Covid and the longer trends that drive Emerging Market dynamics.

Pandemics increase whatever inequalities exist pre-crisis. Today poorer access to vaccines and weaker policy responsiveness are causing EM economies to slip back.

As recently as July, the IMF increased its growth forecasts for advanced economies while revising down the figures for the developing world. Excluding China, Emerging Market growth in 2022 will be significantly lower than for advanced economies. Rather than catching up with advanced economy growth rates, many emerging economies are slipping back and some run the risk of falling onto fragility.
This softer economic picture is compounded by policy responses such as interest rates. While developed market economies are still very much in the “lower for longer” phase, 50% of emerging market central banks have already raised interest rates.

Covid in EM will cast a long shadow in many forms.
Longer term productivity of human capital will be impacted by pandemic-driven loss of schooling time and again EMs have fared worst. In 2020 children in advanced economies missed about 15 days of school; in EM economies this figures was closer to 50.

So it’s clear Covid is a serious set-back for emerging economies. But in many ways it only exposed existing vulnerabilities.
The slipping relative economic growth picture for EM was already in place. Following the financial crisis, economic growth rates for developed economies fell by 50%, but for EM economies the drop was a more precipitous 70%. 2013 was the probably the last year when EM economies had an outstanding growth advantage.

When EM economies had their days in the sun, there were several more ingredients which supported the market explosion – interest rates were generally on a downward track, commodity price rises were supportive and trade globalisation moved up a gear.
Emerging economies exports surged as trade went from 39% of world GDP in 1990 to over 60% by 2008.

Throughout the period from 1980’s onwards, another very supportive force was a move to more liberal democracies especially in Latin and South America. The prospects for greater political stability, less corruption and higher and fairer incomes could only be positive for investors.

Against this backdrop and with attractive valuations, global pension funds and others rushed to capture this frontier market premium and drive markets up.

However today, many of these longer term trends are challenged.

Both near term and longer term, EM economic growth prospects are poorer. The share of countries where output per head is superior to the US continues to fall. Another feature is that from here interest rates cannot fall further and some policy makers are already in hiking mode. 2023 may see US rates themselves move up. Another positive pillar for EM in the past – globalisation – may have stalled and because of Covid may shift into reverse.
We’ve also seen a pause in the drive to more liberal and accountable regimes. The humanitarian disaster in Brazil, civil unrest in South Africa and roll back of fiscal reforms in Chile are all global signposts of this change of direction.

Investors need to take on board these longer term trends, as well as the short term impact of the global pandemic, when considering investing in Emerging Markets. This more challenging environment is visible in the market performance of EM. Over the last 10 years, global equities are up by 11% per annum; the figure for EM is 3.6%.

But as well as the “why” of investing, there is the question of the “how”.

Broad EM indices bring a number of issues. They can be highly concentrated. China for example accounts for 35% of the total index. This is up from 7% in 2003 . In the same period Mexico has gone from 8% to 2%. Concentration is also high at stock level. The top 3 stocks account for 16% of the index and the broad technology sector accounts for more than a third. This is not the widely diversified index that it may have been in the past. Events and policy decisions in China (such as the recent crackdown on educational tech companies) will have a profound impact on many EM benchmarks.

Are EM stocks cheaper? Yes – but the gap is nowhere as big as it was when interest in EM was very much in a growth phase.

There will always be room in investor portfolios for stocks and sectors that offer growth potential at reasonable valuations. For many years this was the EM investment case. Today the sector faces as many headwinds as tailwinds and needs to be an active decision not just a default response based on investment muscle memory.

US Economy 2021: Fire and Ice

Where does the US Economy go from here?

There are two clear views – and they are almost diametrically opposed to one another.

And we are seeing the data swing from supporting one view to the other, on an almost daily basis.

One view is that too much money is being pumped into the economy, that inflation is now embedded at worryingly high levels, the Federal Reserve is behind the curve and we need interest rate hikes soon.

The other is growth has already peaked and the negative impact of the new Delta variant is yet to be seen in economic forecasts, and that we may be facing into a slowdown.

What are the facts?
Inflation today is indeed well above target, and has policy makers on edge. Data for June shows prices up over 5% compared to 12 months ago. The US Central Bank’s target is 2% on average. Even taking out some of the more volatile elements like food and energy we still have a 4% inflation rate in the US today. By contrast here in Ireland we’re looking at 1.6% and price increases of about 2% for the Euro area as a whole.

The key question – is it temporary? That’s certainly the view of the administration and the Federal Reserve. They believe that over the coming months improving supply chain bottle-necks and continued re-opening will ease this price pressure. And many of the price increases are simply recapturing ground lost during the pandemic. This means that the Federal Reserve, despite admitting to being somewhat surprised by the higher prices, can stick with its low interest rate policy. However the inflation debate is becoming increasingly politicised as Republicans highlight the rising cost of living for ordinary Americans and raise concerns over a stagflating economy. We should expect inflation to move up the political agenda. Importantly though surveys show that while consumers do expect higher prices in the near term, longer term expectations remain anchored at just over the 2% mark.

And what about economic growth? Figures for the second quarter of this year showed a very robust 6.5% rate of growth. However this was actually lower than forecasters had pencilled in. Consensus was expecting the number to be over 8%. While the US economy is now back to its pre-pandemic level, it is also past its peak rate of growth for this cycle.

Looking into the second half of 2021, we will see a waning of the fiscal package that has been supporting workers and businesses through the crisis. There has also been a knock to consumer confidence from the current surge in prices. This paints a less positive picture for consumer spending overall. But now added into this, is the impact of the Delta variant and the roll back we are seeing in the reopening process. Hospitalisations are back to mid-February levels. We have seen some companies push back on when they would look for staff to return to the office, and major events, like the New York Auto Show, being cancelled, all with a knock -on effect on businesses. Reintroduction of face masks in some areas is also unnerving consumers. Vaccine hesitancy and breakthrough cases are both plausible causes of concern.
Policy makers are alive to the threat Delta could be for the overall economy. At the recent meeting of the US Federal Reserve, Chairman Jerome Powell noted how they were monitoring impacts on restaurants and workplaces. The Fed’s current view is that this is a manageable risk, but slow-downs in vaccination rates are a worry. Generally most current economic forecasts don’t factor in a Delta variant knock to the 2021 picture, so if we see a continued upward drift in cases, we could see a wave of economic downgrades.

It’s clear we will see a loss of momentum in the US economy in the second half of this year – the question is how much.

Financial markets naturally are very focussed on whether the outlook is more towards Fire (surging inflation, higher interest rates) or Ice (slowing growth, undermining profit forecasts).

Economists seem quite divided.

However the general population is more clear on where the risks are. A survey by Monmouth University in New Jersey last week pointed to inflation being the key concern for only 5% of households, while Covid and the overall economy were the biggest concern for nearly 30% of US households.

And in terms of where the real risks lay – this seems about right.

Fund Management – Next Steps

It’s business as usual for fund managers – in fact it’s better than usual.

Recovering markets and consistent positive funds flows have pushed global industry assets under management to a new peak of €93 trillion. That’s up 11% on the previous year. Closer to home European asset managers saw their assets up 5% to over €25 trillion.

Investors both retail and institutional continue to add to their holdings. In Europe investor inflows in 2020 were over €750 billion – that’s the highest since 2014 and one of the highest in the last 13 years.

Two recent reports, well worth reading, from McKinsey and Accenture respectively, paint a generally positive picture.

Most of the fund inflows have been into equities and this accelerated into 2021. Both Active and Passive strategies have made ground. The absolute size of flows into Active has been greater than into Passive. For example in June, active strategies recorded €21 billion of inflows compared to €14 billion for Passive. This still represents a greater momentum of growth for passive products, given the different size of the asset base.

And the asset management business is still very profitable. Despite continued pressure on fee income – down by 1/3 in last 7 years – fund management groups grew their profit margins again in 2020. There is continued focus on costs. Zero travel costs during the pandemic continue to be cited as a positive in many company annual reports. Looking at the costs of running the business compared to the income earned, this has been managed down to 59% from levels of 70% ten years ago.

Corporate activity in the asset management sector continues at pace. Globally, figures from PWC suggest that 2021 is on track to be a record year for M&A.
Ireland is no different. The last 12 months have seen a flurry of deals ushering in further consolidation in the domestic fund management arena. Increasingly the deal rationale is moving beyond just cost synergies. There have been several examples of large asset management companies looking to acquire financial planning and advisory operators to ensure great stability around route to market. This reflects a global trend. Ireland has also seen corporate activity as a fall out from Brexit as some players have opted to exit the market because of uncertainty and others enter, to ensure EU access. There has also been some regulatory driven activity which will see further changes in the Irish asset management landscape.

One fund management trend which continues to break records is that of ESG investing. In Europe overall, flows into ESG funds ballooned to EUR 233 billion in 2020, from EUR 126 billion the year before, according to Morningstar. Responding to investor demand, asset managers launched a record number of 505 new ESG funds and repurposed more than 250 conventional funds in the last year. Regulatory pressure and government policy continue to underpin this drive. This year fund managers need to categorise their funds in terms of ESG credentials further increasing transparency for investors. It is hard to see this reversing.

Increasingly ESG will become a “walk the walk” as much as “talk the talk” for fund managers themselves. Fund management companies will need to demonstrate that they operate to the same high ESG standards that they expect of their investee companies. Gender balance, rotating directors, environmentally rated buildings etc. at the fund management company level will matter for business development. The CEO of Schroders, one of the world’s leading managers, points to and welcomes this level of scrutiny on the fund industry.

And as the dust settles somewhat on this new landscape, expect to see a lot more investment in the brand by fund management companies. Practically all fund managers (97% according to the Accenture survey) see brand as a key competitive differentiator. Given the amount of change of names we have seen in the industry, the majority of companies believe they have decreasing brand awareness today. Allied to this will be a drive by many companies to ensure and promote their brand as fully aligned with best practice ESG principles. Expect to see a lot more investment in brand and brand awareness from the fund management industry.

While underlying profitability and trends were not really impacted by the pandemic, how fund managers worked, was revolutionised. Highly complex organisations moved 100% to a WFH structure smoothly and efficiently. It had been reasonably common already, especially in the UK, to accommodate “star” managers by allowing them to work remotely, whether that meant the Scottish Lowlands, York or Kensington High Street. The pandemic saw this now applied to marketing, client relationship, administration, finance etc.
The future is likely to be about striking a balance the need to coach, mentor and develop softer skills which may require office attendance; and the need to recruit and retain talent where some prospect of WFH would be a positive. Expect a “hybrid” outcome with perhaps a greater degree of structure than some might be currently imagining.

Irish Financial Services – can you trust them?

    You can’t go the distance
    With too much resistance

        Billy Joel, A Matter of Trust, 1986

    Trust in Irish Banks and other financial institutions is on the floor.

    And the disappointing thing is that in the last two years things don’t appear to have got any better.

    And trust matters.

    A 2021 survey across 28 countries and 59,000 customers revealed trust as the single most valued aspect in banking and it was ranked first across every single country surveyed. Bolstering this, a 2019 Accenture survey noted that globally consumer trust in financial institutions was “high and rising”.

    Set against this, the Irish Banking Culture Board recent report makes for very difficult reading. The data was gathered by Edelman which is the global leader in measures like trust and reputation for corporates, governments, media etc.
    This survey solely covered banks. While there is a battery of numbers, some stand out. 46% of respondents have low trust in banks compared to only 19% who would hold them in higher regard. This wholly negative outcome is at odds with a more positive view globally on banks – and by a wide margin.

    And the momentum is going in the wrong direction.

    Based on respondents aged 45 and over, only 18% feel that the sector has improved since 2008. 43% feel things have gotten worse.

    The gloom continues when the survey looks at the role banks could potentially play in the current crisis. 73% of respondents believe banks should play a key role in re-invigorating the economy but only 38% feel they have, and that quite simply banks have failed to step up. This places it bottom of the pile for the sectors included.
    .

    Admittedly the data is nuanced. Respondents were slightly more positive when asked about their “own” banks as opposed to the sector overall. And younger people (up to the age of 24) were also less downbeat. However the younger age cohort is likely to have lower engagement levels with banks, have greater exposure to many of the disruptors in financial services, or simply a shorter memory.

    The picture painted by the survey is not that surprising given the news-flow in the past 18 months in the broad financial services sector. We have seen continued fines in the tracker mortgage debacle, branch closures which can dis-enfranchise vulnerable clients, banks doing U-turns on refunding customers, court cases over pandemic insurance pay-outs, stock-broker fines and sanctions etc.

    The challenge for those seeking to improve perception and reputation across this broad sector is how to combat headline risk. Headlines, quite often specific to one company, can have repercussions for the sector overall.

    Trust is high on the agenda for financial regulators. Andrew Bailey, when at the UK Financial Regulator, made the point that trust is not just about knowledge or skill but equally about honesty and good intentions.

    In Ireland, trust features as one of the five principals that the Central Bank works to in ensuring fair and transparent market place for consumers and counterparties in general – “vision is for a trustworthy financial system supporting the wider economy”.

    Derville Rowland, Director General Financial Conduct, stated it most eloquently and managed to bring Confucius thought into the Irish financial regulatory landscape (I think for the first time!) concluding that “Without trust, we cannot stand”

    Trust must be recovered and this will be a long journey. The Financial Regulator makes the point that a truer definition of compliance is more empowering and ambitious than perhaps our minimalist interpretation; a truer definition being more about accomplishing and achieving.

    Given where we’re starting from, the IBCB and the sector overall has a truly great and meaningful opportunity, and taking account of the regulator’s more ambitious and aspirational casting of compliance, we should strive to make it not only about regaining public trust – but also respect.

    Asset Management and ESG: Doing Good or just a Business Opportunity?

    The numbers continue to amaze.

    ESG (Environment/Social/Governance) seems to be everywhere in the investment world.

    84% of flows into global equities in the past 2 years were into ESG funds according to one source. And there is no slackening in the pace –  flows in the last 4 months of 2020 were better than the previous 20 months combined.

    The pandemic has lit a fire under these investment trends. 

    And ESG is performing well.

    2020 was a blow-out year for the S&P 500, but ESG funds did even better. Looking at the numbers for those firms who run both ESG and Non-ESG mandates confirms superior performance from the ESG mandates over 1 , 3 and 5 year time periods. This is a key part of the marketing message – you can invest on a sustainable basis without foregoing return.

    ESG is likely at the top of every marketing budget, every fund launch calendar, every business development meeting agenda at major asset management companies globally.

    It’s clear there is both a response to demand and a creation of demand.

    ESG can be quite a complex space for investors to navigate, an alphabet soup of acronyms being added to on a regular basis. Added to this is the fact that ESG approaches vary considerably among asset managers.  

    In February, the Central Bank of Ireland clearly laid out the risks in such a landscape where “strong investor demand is met by products purporting to be sustainable in nature but do not meet standards”. This is a global concern for regulators – the FCA in the UK expressed similar views. The FCA said  they will be focussed on the development and integrity of the ESG market and will examine ratings as well as qualifications.

    There are a few things investors should look to in considering their ESG options. 

    Examine the fund’s track record. There have been a few undercurrents in stock-market sector performance which have played to ESG mandates favour in recent years. Many ESG funds would be underweight or not invested at all in fossil fuels. This has been very beneficial, as the energy sector has been weak due to slower economies and pricing ill-discipline. This could reverse. Also many ESG funds have found themselves overweight in sectors such as technology, which have good ESG scores and have also enjoyed phenomenal performance, partly driven by Covid circumstances. These high growth sectors may be compromised if interest rates were to rise meaningfully. 

    Also what period does the performance track record cover? It is important to point out that while many of the ESG labelled funds are new, some are simply a rebranding of already existing funds. According to Morningstar, over half of ESG funds were already in existence but have now been converted to sustainable funds. This is important for a number of reasons. Firstly just how much a re-engineering of process etc. has really taken place? Also it means we may need to be careful in looking at the performance track record that the asset management company is showing.

    The majority of ESG funds globally are actively managed. In this space active is about 4 times larger than passive strategies. 

    It is vital to look at exactly what the fund manager is doing within their ESG process. Are they really engaging with companies on ESG issues and voting at AGMs? Recent surveys have suggested that some of the larger asset managers are less pro-active than they portray. And what about how investments get rated?  Are they simply relying on third party ESG scores or do they have an integrated ESG framework and in-house expertise. Regulators have cautioned against managers mechanistically following third party ratings providers. There are often inconsistencies as ratings providers have been known to rate companies differently. 

    Important to look, as well, at the resources allocated to ESG within the asset management firm. What percentage of full time employees have they allocated specifically to their ESG endeavours? For large European asset managers this currently ranges between 1 and 4%. 

    Questions around integrated investment process and numbers of FTEs working on ESG, are really about commitment and conviction,  Both these factors appear linked to superior investment performance.

    The European Commission has established an action plan on sustainable growth investment. The most recent instalment being the SFDR guidelines. These will require fuller disclosure of the degree to which ESG factors bear on the investment outcome. Hopefully this should help crystalise many of the issues for those considering investment.

    Double Dip

    While we may gaze enviously at the pace of vaccine roll-outs in the UK or the US, so too might the European economy look enviously to the US at its pace of  economic growth in the face of the pandemic.

    While economic forecasts are being revised up for the US, with some now suggesting a strong first quarter and 8% or more for the year as a whole, here in Europe we are likely facing into a double-dip. 

    We came out of 2020 with a negative Q4 and it is now looking like the current quarter will also be in the red. We have seen the EU Commission reduce its economic forecast for the full year and push out the recovery phase more into 2022.

    We shouldn’t be surprised.

    We are still in the grips of a pandemic and many economies are as closed as they ever were in 2020. Fears over a third wave are in fact leading to increased lock down measures in Italy, France and elsewhere. Looking at Covid-impacted sectors (transport, education, construction, etc.) current activity levels in Europe are 63% below where they were pre pandemic. Lock-down stringency has been increasing across Europe since the end of October and as current actions show, isn’t easing soon. 

    As an example, air traffic in Europe currently is tracking at around 20% of 2019 levels. But in the US, that figure is up to 50% with over a million people boarding planes every day on average. 

    Some market forecasters are fearful of the US economy actually overheating. Bond investors have become increasingly skittish. And the path of the recent Covid relief package through Congress wasn’t easy, as many Republicans view the economy as doing just fine. They see little need to fuel the economy even further.

    Why the vastly different experiences on either side of the Atlantic?

    A stuttering vaccination programme in Europe isn’t helping. The US, which had lagged initially, has now 13% of the population fully vaccinated, which is better than what Europe has achieved for the first dose alone.  Supply issues and efficacy concerns have dogged the European roll-out. While there will likely be some catch up as vaccines become more plentiful, this still pushes the collective immunity threshold date further out – perhaps beyond the summer. This then becomes time critical for those European economies who depend a lot on tourism. Tourism related activities account for 11% of GDP in Southern Europe and France and 17% of total employment. If tight restrictions, similar to current, are in place to the end of Summer, it will knock a further 1-2% off GDP and be felt most in Spain, Italy Greece and Portugal.

    The other driver of the economic gap is quiet simply that governments like the US have just spent more. Looking at the amount of fiscal support relative to the size of the economic implosion that we saw in all economies, the big spenders were the US, Australia and Japan while spending in Europe was substantially lower as a percentage of GDP. And this is before the most recently agreed Biden package – so the US will surpass all major economies. This support will help generate a strong economic recovery in the near term, though will have to be financed at some point in the future.

    The European economy may well emerge from this soft spot and see a lift off from Q2. It’s all really down to the numbers and the battle between the vaccines and the variants.

    At that point, other factors may kick in to spur growth, such as a sharp boost to consumer spending as pent up demand meets excess savings. European banks have seen a near €600 billion increase in consumer deposits in the past year. Tourism would be a major beneficiary of such spending.

    Still, the most likely outcome for 2021 is that growth in the US economy will be well over double what we get here in Europe.

    A World Divided

    The global economy has reached a fork in the road.

    This is the advice the IMF provided to the recent G20 meeting of Finance Ministers and Central Bank Governors.

    As the world continues to climb back from the worst peace time recession since the Great Depression, the prospects and pace of any recovery are, in the IMF’s view, “diverging dangerously across countries and regions”. 

    The question is will policy makers in the major economies  take any action to prevent this great divergence.

    Looking at global GDP figures masks the problem. The global economy is recovering and we will see economic growth of close to 6% this year and in excess of 4% next year – but it will be a very different journey and experience for the advanced economies compared to the lower income developing nations.

    The numbers are stark. 

    The IMF estimate that the major economies will recover to be only 13% below their pre-crisis levels at the end of 2022, compared with 18% below for low income countries. However emerging and developing economies will be a full 22% shy of their pre-crisis GDP. 

    This could throw 90 million people into extreme poverty. 

    This is the first reversal in over 20 years and the worst setback to the first of the world’s Sustainable Development Goals. Developing economies would fall behind again and income inequality increase, undoing years of progress.

    There is little surprise in why the forecast economic recovery will be so uneven. Vast differences in vaccination timelines and varying abilities and willingness to provide policy support are key. 

    Vaccines are likely to become widely available in G-20 advanced economies and some emerging market economies in 2021. But for the rest of the world, broad coverage for vaccinations is not expected until 2022 or later. Early inter-actions on Covax, the global initiative to ensure vaccine access, such as withdrawing stocks or insisting on domestic demands having priority, doesn’t give much heart.

    Differences in how much governments were able to provide support is the other key factor. Decisive policy support, both fiscal and monetary, in G-20 economies has helped to prevent worse outcomes. G-20 governments have provided US$ 14 trillion in crisis related fiscal support. This has provided businesses and individuals with the necessary liquidity and credit to stay afloat, limiting the damage to economies’ productive potential. 

    The level of support has been such that in many G-20 economies, the number of corporate bankruptcies was lower in 2020 than in 2019! 

    There has also been a clear link between what level of support governments could provide and unemployment levels. Government support has been instrumental  protecting the labour markets in European economies while elsewhere we have seen savage job losses in areas like Latin and South America. 

    It was not a level playing field. In 2020, advanced economies spent 24% of GDP in fiscal support; for low income countries this figure was less than 2%

    Pandemics do nothing good for inequality. Both within and across countries, it is the young, the low skilled, women, informal workers, the already marginalised who have been particularly hard hit. Prolonged unemployment erodes skills, while reduced access to education can have a life-time impact. UNESCO  estimate the 900 million learners are still affected by school closures today.

    The IMF is highlighting how dangerous this economic divergence between advanced and developing economies is. But this divided world forecast is not yet our destiny -however it requires decisive concerted action from the G-20 countries.

    The IMF identifies three priorities; accelerate vaccine roll out in poorer countries, step up support to vulnerable countries and continue the fight against the economic crisis at home. 

    Whether governments are prepared to raise their heads over national parapets is the question.

    But as Kristalina Georgieva, Head of the IMF notes in her note to the G-20 – the crisis is not over anywhere until it is over everywhere.

    Is Investment Management the Weakest Link?

    In mid-2020, the Financial Times asked the question was investment management the weak link in the current economic/health crisis?

    The authors were thinking back to the role played by the banks in the 2008 crisis and the need to inject public money into a system which still hasn’t returned to being a growth driver. 

    Now, the value of global asset management has grown to such a scale as to far outweigh the assets of the banking system – was it too at risk?

    While we still don’t fully know the economic/human costs of the pandemic, at first glance, it would appear that asset management is performing well. In fact, what we have seen, is that many of the pre-pandemic trends have if anything been reinforced and reinvigorated.

    The key signposts for the asset management business continue to be costs, consolidation and style.

    Lower fees are by now a well-established trend in asset management. Investors today are paying lower expenses on average than ever before. 

    The drivers behind this trend are well known; increasing customer awareness of cost, growth of cheaper passive instruments, intensified competition among fund managers and in some cases changes in business model such as to fee based rather than commission based.

    On average fund costs have declined by 30% since 2013. 

    Morningstar provide a wealth of data on fund costs and flows. While all funds, on average, have reduced fees, the passive fund industry has led the charge with fee reduction twice that of active funds. Research suggests that low cost funds have a better chance of surviving and outperforming their more expensive peers.

    In short this trend to lower management costs seems well-established.

    Another fundamental trend in asset management which wasn’t derailed by the pandemic was mergers and acquisition. 2020 was in fact a banner year both in terms of number and value of deals done. Far from the pandemic choking off activity, the value of deals done in 2020 was 30% up on 2019. The reasons remain constant – the drive for scale to deliver synergies, being able to spread compliance and governance costs over a wider base, the need to broaden out a product offering.

    While on a global level, activity has been among marquee names like Morgan Stanley, Franklin Templeton, Legg Mason etc., we have also seen a pick-up in acquisition activity in the asset and wealth management business here in Ireland. The drivers have been similar to the global arena such as access to distribution, and increasing AUM to cover the ever increasing regulatory costs. Brexit has also sparked activity in the asset management sector as some UK firms were faced with the decision to invest further and incur more costs if they want to maintain a presence in Dublin.

    We are likely to see further acquisitions in this sector, with the only voice that rarely gets heard being that of the customer.

    Other established trends in asset management continued through 2020.  Flows to passively managed strategies outpaced active by a wide margin. In the battle of style, Growth was substantially superior to Value based approaches, apart from a brief respite in November. And interest in, and flows to, ESG mandates was stronger than ever. ESG investing now has a strong tail-wind of regulatory support, which will see assets under this umbrella continue to expand in coming years.

    However at the coal face, there were some standout differences in how investment managers went about their work in 2020. In Europe and the US, fund management companies along with other financial service industries simply went “home”. Now some star fund managers (usually those who had the performance track-record or AUM to demand it) already rarely set foot in the office, but for whole firms to be out of office on this scale was simply revolutionary. Fears over systems, compliance etc. seemed unfounded. As McKinsey point out there have been no major publicly reported breakdowns in technology or back offices at large asset managers, even with as much as a reported 98 percent of employees working from home. This will have impact into the future.

    One other change in asset management has been in the area of client contact or business pitch. In the world of “Zoom”, that all important first presentation or one- on-one meeting is clearly less substantial. The ability to build up trust and confidence with a new client is compromised. 

    In a competitive situation, this plays into the hand of the incumbent, where the people, values, systems etc. are already known. 

    Large diversified asset managers already in place are at an advantage. In US asset management, 80% of new business has gone to 10 firms in 2020. 

    So one of challenges for asset management in 2020 has been selling new business to new clients.

    The Financial Times can be reassured that asset management is notthe weak link. The industry has been more nimble than perhaps it knew.

    But there have been changes in how business is done, especially around the competitive dynamic, which may not be temporary.

    The End of Interest Rates

    Interest rates are the policy tool of choice for Central Bankers.

    And until the Great Financial Crisis, they were almost the only tool investors paid any attention to. 

    This was how Paul Volcker, then chairman of the US Federal Reserve, whipped inflation out of the US economy from the early 1980’s. Setting interest rate policy was how newly independent central banks were able to align their inflation goals with the business and economic cycle, as opposed to the electoral cycle which may have suited politicians more. 

    Monetary policy, with all its lags, was still how policy makers responded to the LTCM crisis and the early stages of the Great Financial Crisis. 

    However we have now grown accustomed to the unconventional becoming conventional.

    Tools such as asset purchases are now a core part of the Central Banker’s armoury.

    Partly this is a result of just how much the interest rate lever has been applied. In 1979 interest rates in the UK were 17% compared to 0.1% today. We are at, close to, or below zero in so many major economies. 

    And now the issue becomes apparent – can more cuts to interest rates work?

    This issue is known as the “Zero Bound”. Pushing rates much lower will not stimulate the economy in “minus land” as it would in more normal circumstances. Interest rates cannot continue to go negative  – investors would simply opt to hold cash – notwithstanding security and storage issues. Minus rates also undermine the banking system as an unwillingness to pass on negative rates to the retail base hits profitability.  This ‘Zero Bound” issue with negative interest rates  reduces their effectiveness as a Central Bank weapon. 

    So if rates can’t go down – can they go up?  

    Deep down in their monetary soul, central bankers like higher interest rates – simply because it allows them to cut rates if required to boost the economy. It is about keeping their powder dry.

    The problem today would be the journey to those higher rates. A defining characteristic of the global economy and global corporations today is the sheer level of outstanding debt. 

    Government debt, even pre-Covid, had been high; but increased spending and lower tax income has pushed it even higher. The Congressional Budget Office (CBO) in the US expects government debt to go to 200% of GDP by 2050. In the UK, similar forecasts, from the Office for Budget Responsibility (OBR) are for public debt to go from £2 trillion to £3 trillion by 2025. Other European economies are even more indebted as are a large number of Emerging Economies. 

    This debt build-up has been mirrored in companies, where corporate treasurers have been quick to load up on what in the past few years has been exceptionally cheap debt through the corporate bond market. Companies went on a borrowing binge in 2020, as they faced into sharp declines in business activity  Global corporate debt issuance surged to $5.4tn, a record high and over 20% more than the previous year. Companies also tapped the syndicated loan market for a further $3.5tn. Coupled with the downturn in profitability for much of the corporate world, the borrowing spree has driven up leverage ratios to all-time highs. The ratings agencies view balance sheets as increasingly unstable and forecast a rise in corporate defaults and in the number of “Zombie” companies, where interest payments exceed profits.

    The IMF estimates global corporate debt at $20 trillion and has labelled it as a “ticking time bomb”.

    This level of indebtedness amplifies any impact we could see from higher rates – a bit like the “away goals” rule in soccer. This is not an environment for aggressive rate hikes!

    Higher interest rates can now been seen as a systemicrisk given the abundance of borrowing by both public and private sector. Central banks increasingly take into account the feedback loop from the financial system to the real economy in their policy actions. This underlies the comments from so many central bankers that higher rates are far out on the horizon. As Kristalina Georgieva, Managing Director of the IMF, noted there is a “very, very high probability that they will stay low for quite a long period of time.”

    We can also see this in the more flexible attitudes to inflation that many Central banks have taken, and indeed why a number of leading central banks (including the ECB) are reviewing their overall monetary policy framework. 

    As Central Banks review their policy frameworks and the tools they may select in the medium term, such as asset purchases, forward guidance and macro-prudential policy, interest rates are not on the menu.