Tradewinds

Fund Managers – Brave New World

Galaxy

2018 was a tough year for fund managers. Markets were unforgiving and saved a lot of the angst for the last month of the year. Performance suffered and what the Financial Times labels “flowmaggedon” , where we saw very hefty outflows from funds across a wide range of asset, combined to hit the P&L accounts at fund management companies. According to the FT, the sector lost a quarter of its value in 2018.

Asset management CEO comments in the first few weeks of the year haven’t been all that up-lifting. Active fees continue to be ground down under pressure from the growth in indexed, cheaper alternatives. In US equity funds as an example it is now 50/50 between active and passive. This will continue. Here in Ireland auto-enrolment, with its cap on fees, will be further highlight the cost gap.

We have also seen this year further indications of the road map that regulators have for the asset management industry. At the start of February the FCA in the UK issued further rules for the industry on fund benchmark and fee disclosures. While there are a number of issues the key question that the regulator wants to help the consumer answer is:

“Is my fund manager doing a good job?“

Performance benchmarks come under scrutiny. Why were they chosen? Are they appropriate? How can we assess the manager’s performance relative to that benchmark? If fund managers work under a tracking error constraint, the degree of divergence will need to be highlighted.

And if the manager doesn’t use a benchmark there has to be some way for the customer to answer the same question – how do I know this manager is doing a good job. This could well be the case in multi-asset or outcome orientated-products. The level of risk taken on to deliver returns will be under the microscope.

And these performance disclosures will have to be as straight and jargon free as possible. As the CFA noted, it is about protecting those customers least able to actively engage with their investments.

Good fund managers do all of the above already – it now becomes a hurdle for all.

Regulators globally are all on the same hymn sheet so we can confidently expect a similar pathway in all jurisdictions.

In this regard it is very interesting to see what the prudential regulator in Australia is proposing, in seeking to address the issue of poor performance. Like the UK, greater clarity on performance benchmarks and investment outcomes is being demanded. But also the Australian regulator is considering intervening in underperforming funds. Whether this could mean revoking licenses, forcing consolidation etc. is not clear but it would certainly be a major step.

Brave new world.

The Next Big Thing

So there’s been a bit of a recovery in stock markets so far this year after a dismal December. It’s not very surprising and it does seem to lack conviction.

earnings

The year so far has been marked mainly by official downgrades to global economic growth, accompanied at times by “Game of Thrones” rhetoric and headlines such as “Darkening Skies” (courtesy of The World Bank).

We are likely to see more of these downward macro revisions – institutional economists are very aware of what their peers are saying, and don’t reverse direction easily. Other issues which have unnerved markets in recent months are still on the table – end of supportive Central Banks, health of China’s economy, increasing trade friction etc. These are guaranteed to resurface.

Yes, markets may offer better value than 3 months ago – but valuation alone is never enough.

A slower pace to economic growth is not a catastrophe. In fact sustainable slower growth which doesn’t force the pace of inflation or interest rates is quite a benign backdrop for equity markets.

It’s the degree to which corporate profit forecasts may be out of synch with that economic reality that really matters.

There is quite a strong correlation between analyst revisions to their forecasts and stock market direction.

It can be hard for markets to make progress in the face of a storm of analysts downgrades. The next few weeks will see profit forecasts being revisited on the foot of quarterly numbers and company updated guidance. As far as we can tell, this is the next big thing for markets, and at least it’s grounded in company fundamentals and not determined by the next tweet from 1600 Pennsylvania Avenue.

Analysts did move at the end of 2018 to rein in their numbers for the outcome for 2019. Today the consensus forecast for growth in global profits this year is just under 6%. 2020 numbers at just over 10% do seem a bit elevated still. The key question is whether that 6% figure for 2019 comes under further pressure. There will be wall to wall coverage of the actual quarterly announcements, but remember this is a highly choreographed event with companies guiding the stockbroking analysts as to how close their forecasts are to the likely outcome. There is little real predictive power in the exercise.

To make sense of markets it is better to focus on the company statements (like Colgate who last week spoke of profits actually being lower in 2019 than 2018) and critically whether analysts take the red pen to their forecasts.

If we weather that near term storm then the possibility of a Fed pause, perhaps a softer US dollar, and subdued bond yields would all provide support for stocks.

Laundry List

llist We are smack bang in the middle of the “market outlook 2019” season. Despite the fact that economic and market fundamentals don’t really recognise the Gregorian calendar, economists, strategists, commentators et al, rush to give their views on what the next 12 months holds – usually conveniently forgetting what they may have said at the start if 2018!

2018 was a tough year – it was tough to make money. Global equities declined by about 12%.

This in itself yields the first article of faith put forward in this outlook season – equity markets are cheaper now.

Probably true – as long as prospective earnings don’t fall commensurately. But here’s the thing; in the short term it doesn’t really matter. Valuation does not drive markets in the short term. It is more of a hygiene function. The fact that equities may be cheaper now is a good thing but it is not a catalyst for major market moves. Markets, like stocks, can stay cheap or dear for an extended period.

For 2019, It may be more important to focus on those catalysts to try and chart a course through markets. And many, if not all, are the same as in 2018.

There is no shortage of potential catalysts – in fact It’s a laundry list.

Among the issues which could drive markets in 2019 are:

When will we see a US recession? Many feel that the indicators point to late 2019 or 2020. Current data is still robust but some forward looking indicators are softer, especially new orders. We shouldn’t talk ourselves into despair and a slowing economy isn’t necessarily a bad thing for stocks.

Will the US Federal Reserve pause on interest rate increases if the economy slows? They have more or less said they would. However this could be a mixed blessing. In Janet Yelland’s tenure at the US Central Bank, decisions not to hike rates sometimes unnerved markets even more.

China continues to loom large as a potential catalyst for markets. We have of course the soap opera of the trade talks where the tone and pace is driven as much by US domestic politics as global trade patterns. Recent numbers from Apple show how a less confident Chinese consumer directly impacts on US corporates.

There is also the overall health of the Chinese economy itself, and the question of whether Chinese policy makers will be as supportive in the event of weakness, as they were during the Global Financial Crisis. It does appear that they have less room for manoeuvrability given aggregate debt levels etc.

Closer to home, Europe could play a more material role for markets than it did in 2018. Brexit rumbles on. Macron’s position is clearly weaker. German politics is in transition. Italy remains unresolved. European elections in May could well see a further shift to populist policies. With economic growth subdued and the ECB shifting gear, there is ample opportunity for policy mistake.

I see these as key catalysts for market direction in 2019. And as they get resolved we can move into sunnier climes for investors. Equally they have the potential to upset.

So much of what may drive markets this year is less to do with economic fundamentals and more to do with politics and policies.

A recent Financial Times editorial was headlined

“Investors must rely on political common sense”

And that’s what’s scary!

The Central Bankers’ Christmas Party

Santa Draghi

‘Twas the night before Christmas

And all through the Central Bankers’ house

The governors were snuggled up and fast asleep

With no more interest rates left to announce

The up piped young Mark Carney

“This is all too quiet, I say

Let’s have a Central Bankers’ party

For tomorrow is Christmas Day!”

So they sent old Mario Draghi out

For wine, beer, puddings and cakes

And Mario set off and confidently replied

“I will get whatever it takes!”

Then Mark Carney shouts out

“Let’s do a Panto” to Ben Bernanke

“Cause I could play George Clooney

And you could be the Widow Twankey”

But look Mario’s back with hampers aplenty

And welcomed as a real Christmas hero

Says he “it’s amazing how much you can afford

When you keep your rates at zero”

Well now there’s dancing, kissing and hugging

Though in fairness a bit too blokey

But then Kuroda gets a better idea

“It’s time for Karaoke!”

But Kuroda won’t let go of the mike

And Powell wants to give it a shot

But after 23 verses of Sweet Home Alabama

He’s clearly lost the dot plot.

There were governors swinging from the chandelier

There were two on top of the Holly Tree

And quietly in the corner were Lane and Yellen

Discussing macro-prudential policy

But soon things just got out of hand

The authorities had to be alerted

For Jerome Powell after ample liquidity

Like his yield curve, he was now fully inverted.

Soon the Central Bankers’ house was quiet again

So the markets need not take fright

And the words of the governors rang around the world

“Happy Christmas to all and to all a good night!”

The day Mark Mobius came to Dublin

Mobius Pic

Look, it may not have been the only time, but such visits certainly aren’t that frequent. And the Emerging Markets guru did stand out in his off-white suit and encircled by his entourage. At least he made it to the city centre – one of his analysts spent his Dublin visit in the private jet on the tarmac at Dublin Airport as some visa issues arose.

So anyhow Dr Mobius addressed a small gathering in the Conrad hotel, no notes, and from what I recall no Powerpoint. It was a tour de force performance on Emerging market investing with depth, breadth, enthusiasm and story-telling. And then straight back to the airport, and the jet, and the analyst.

I was reminded of the visit this week, as several asset managers have tipped Emerging Markets as the place to be in 2019. I spoke with one manager who is very positive on EM bonds and I note that Morgan Stanley have gone bullish on EM equities, moving from underweight to overweight.

Are they right?

EM assets certainly appear cheaper than they were 12 months ago! Global EM stocks are down 13% so far this year compared to 5% for stocks overall

Investors will have to form their own view, but there are a number of issues worth bearing in mind in coming to, or implementing a view.

Valuation: most strategists look at Price to Book as a default valuation metric and yes – P/B is somewhat below the 20 year average. But that average contains a period (2006 -2008) when we know valuations were daft, which elevates the longer term figure and flatters the current reading.

Experience counts. EM does dance to a different rhythm and I value managers who have managed successfully over several market cycles. Conventional desk top research has greater limitations, in my view, in an EM context. Anthony Bolton, the highly successful Fidelity fund manager, found the investing environment quiet different when looking to transfer his own investing skills and process, which worked well in Europe, to China.

Open or closed. Once you’ve made your decision the issue then becomes how to access the opportunity. While there is a wide range of open ended funds investing in Emerging Markets, it can be worthwhile researching closed ended funds as well. They are not bashed around by inflows or outflows and can stray away from the high liquidity large caps that everyone tends to own. When I’ve compared investment trusts and open-ended funds run by the same manager, the trust usually performs better.

Big picture. I think currently, more than ever, global factors are playing a role in the progress of EM. The two most significant factors currently are the US dollar, and the health of the Chinese economy. A strong dollar has put emerging economies under pressure due to capital flow impacts and debt servicing costs. In periods of dollar strength in 2018 we have seen EM sell off. A lull in the rate of growth in China has also played into EM weakness. What would work well for EM in 2019? A sense that the US Federal Reserve was close to the end of its rate cycle and would pause, and also if markets are convinced that the current pro-growth policies in China will prevail and outweigh any negative trade war impacts, would be very supportive of EM as an asset class. If you think the US dollar strengthens further and China stalls, it would be hard to square with a positive EM view.

Don’t buy the label. There is quite a degree of differentiation within that EM category. Turkey and Argentina’s experience in 2018 was quite different from many of the other constituents of the EM universe. EM economies overall may be in better shape than in previous downturns (better balance of payments etc) but there are still outliers. I believe that this argues for an active approach at regional, country and stock level. If you have a risk budget to spend, I believe you will see a better return from it here, rather than, say, in large cap US equities.

I do think there is opportunity here and now.

And who knows we might get Mark Mobius back in Dublin…….

Are Fund Managers a cultured bunch?

What do you think? Do they know their Verdi from their Vardy?, Van Gogh from Van Morrison, or their Rigoletto from their cannelloni? Hard to know really! But this culture thing seems to be getting more and more attention. In Ireland the Central Bank has been devoting a lot of resources to this issue and getting the banks to refresh/redefine/find their appropriate culture. My initial reaction used to be that this type of thing was a bit waffly, with little real world application. Management consultants immersed themselves in these concepts, and for a reasonable fee their clients could dip a toe in, as required. But if we strip away a lot of the jargon and think of culture as just being “the way we do things around here” (Bower), I think it becomes more meaningful in an asset management context, and should be considered in evaluation, selection and review of managers. Towers Watson and Roger Urwin have been flying the flag on this for many years. Since the early 1990s it has been a critical component in their formal manager evaluation. For them, culture is a unique ingredient in generating alpha and a bedrock on which a competitive advantage is sustained over a long term. They have published good research on the topic, seeking to define and measure what constitutes culture in an asset management context. This is by no means an exact science. Factors involved will typically include leadership, ownership, procedures, policies, diversity, respect, remuneration etc. Should we care? – or should we only care about investment outcomes. Positive culture should underpin alpha generation and importantly (in my view) its persistence. However there my be times when strong performance can disguise a weak culture. Equally weak performance can exacerbate culture issues. How does a solid asset management culture deal with disappointing performance. I read one of GMO’s quarterlies recently where they spoke about the importance of “crying over spilt milk”. This means when things go wrong, try and understand why, and see what might be done better. Other managers speak of having a WWW (what went wrong) wall, noting poor investment decisions and focussing solely on the learning points. I think that acknowledging poor performance (because it will happen!) is a necessary and positive aspect in a good asset management culture. Investors and selectors should view it similarly. In recent weeks, a named lead manager for a large blockbuster fund that had been through over 5 years of failure to meet targets, suddenly announced a decision to leave. So I presume there had been 5 years of meeting with clients justifying and defending performance and process again and again. But conviction may have morphed into stubbornness and It seems to me that the final outcome (manager departure) didn’t really do clients any favours. Maybe a culture where there was some crying over spilt milk and learning opportunities sought along the way would have served clients (and the asset manager) better.

Money for Nothing

Funds, fees and the future

So you’re an investment manager – would you work for free? – nothing, nada, zilch, zero?

Fidelity grabbed headlines recently with a zero charge on fund management – granted it was for a basic index product where fees were minimal anyway and stock lending can provide the manager with an income. But it was another milestone in a trend.

Fees are falling.

There’s nothing new in this. In the UK, for a typical equity fund the annual management charge (AMC) has fallen by 22% over the last 5 years. Costs matter – the data shows that for both active and passive funds, the cheapest 20% of funds attract the vast bulk of flows.

The reasons for cost compression are well-known:

– Greater use of cheaper options such as index funds and ETFs

– Demand for transparency from consumers, intermediaries and critically regulators

– Auto-enrollment with its cap on charges will heighten the use of “cheaper” options in the mix

– Value for money issues in a world of lower and more volatile returns.

The FCA in the UK has highlighted the issue of value for money in what asset management companies charge and the Central Bank here has written extensively on the complexity of performance fees and issues around their calculation.

For the majority of investors still however the issue is the overall charge as distinct from performance fee calculations. And the issue is very much about value for money.

Asset management is a very attractive business with operating margins in the 30% range (source: Bernstein) with reasonably assured growth into the future and through the cycle. Barriers to entry are very much in the regulation and reputation spheres. It will continue to attract attention from would-be players from other sectors. Ali Baba through Ant Financial is now offering investment product. It will also attract growing attention from regulators.

There are very few businesses where you would pay the same price irrespective of outcome (either relative or absolute). There needs to be a greater link between charges and outcome – certainly in actively managed funds. Of course fund returns depend on what markets do but they are also made up of thousands of decisions (asset allocation, stock selection, etc.) made by the manager and ideally there should be some evidence of “skin in the game”.

Should remuneration be based wholly on investment outcome in any given year? I’d argue not – asset management businesses need some predictability of cash-flow and profitability so that they can plan ahead, invest in the business and resource it properly to provide the required outcomes in a compliant and sustainable structure.

Bottom line: Asset Management charges will continue to fall and if today you’re paying the same as you were 5 years ago, you’re probably paying too much.

As well as the overall level, I suspect we’ll see some moves to align the fees charged with the outcome delivered. So rather than the question being what level the market can bear, it will be about what level is fair.

Absolutely not quite so Fabulous Darlings

Sure who wouldn’t like them?

Investment funds that can deliver positive returns in any kind of market conditions at a lower level of risk. That’s broadly what Absolute Return funds say they do. (Yes I know, the managers will use phases like over a reasonbable time frame, market cycles etc. but let’s be grown up here – reasonably consistent positive returns was the pitch)

And it was very – I mean very – successful. In the UK Investment Association Absolute Retun category there were 20 funds in 2009. There are 74 today with total assets of £69bn. These funds have been a huge success both on an insitutional and retail basis. Well a huge success in asset gathering terms!.

Investor experience hasn’t been that great.

It’s been poor – and as far as some of the block-buster funds in the sector are concerned it’s been poor for quite some time.

For a while it was that market conditions didn’t suit (even though they weren’t supposed to be a factor at all). Reminds me of 1991 when British Rail complained about the wrong type of snow!

Drawdowns (moves from peak to trough) have also been more severe than was anticipated. Investors rightly get unnerved when we see a downward shift in value of c. 8% in a proposition that emphasises low volatility.

Absolute Return funds seem to polarise the investment community. We have seen some outflows, quite significant in some funds. In aggrgate according to Morningstar data we did see outflows in mid 2018, but this was the first since 2011. However most investor surveys suggest a signifcant proportion of investors are looking to increasetheir allocation to the category over the next 12 months.

Can performance pick up? Well yes it can and I suspect that’s the reason we haven’t seen a greater level of outflows. Investors hoping to recapture some of the lost ground.

However, hope is not great as an investment strategy.

Remember even with all the diversification and risk management going on within a multi-strategy absolute return fund, it still hinges on a “view” – a view on growth, interest rates, inflation etc. And this view underlies a lot of the portfolio positioning. These views can lead to a long position in European banks, a position in copper futures or a short position in developed market soveriegn bonds etc. But what if the view is wrong……..?

Also increasingly I believe we have seen more and more macro outcomes not translating into the asset outcomes we might have expected in the past. I believe this is one of the reasons that recent reality has not mirrored the promise.

Consistently delivering a return of 3-4% above cash is a challenge. Especially in a climate of low inflation and bond yields and equity markets well advanced in the cycle. Absolute Return funds in the past have had the benefit of benign tail winds of both strong bonds and equities and improving economies. This can’t be counted on.

For funds who look to beat a benchmark such as the S&P 500 in the US or FTSE in the UK, underperformance may mean that you don’t make as much as the overall market. In the absolute return world, underperformance translates directly into losses.

I believe Absolute Return can work but it’s tough. I think the range of performance withinthe sector is greater than in conventional sectors. I also think consistency of performance is harder to establish – beware of fantastic one year records!

I looked at the performances in the Morningstar Absolute Return Multi-strategy sector. For the top ten funds over one year, only five even existed three years prior. Of the top ten over three years again only five existed two years before that and for the top ten funds over five years only three existed in the prior period. Fund selection is critical – this is not a generic sector. Manager skill and risk budgetting are the key differentiators.

Future articles will focus on the track record of absolute return managers in single asset classes and whether this might offer a more stable outcome.

Passing the Buck

bank note banknote banknotes bill — Photo by Pixabay on Pexels.com

I know it’s always been the case, but lately in chatting through how markets have done, I find myself talking as much about currency moves as asset moves. Yet in my experience, currencies never feature that much whenever we try to look ahead. The talk at that point is more around asset fundamentals like economic growth, interest rates, profits etc.

But we can’t ignore currency if we’re putting money to work globally.

As that well known group of currency gurus, 10 cc, noted in Wall Street Shuffle:

“You need a yen to make a mark

You need the luck to make a buck”

And currency matters a lot.

I looked at 3 major currency blocks – US dollar, Yen and Sterling – over the past three years from the perspective of a Euro-based investor. In that period the return from investing in US stocks was almost entirely from the asset with actually little currency impact. In Japan, we got about 11% from the asset and in fact the same again from the move in the Yen. In the UK, a positive return of nearly 20% was more than wiped out by an even bigger move in Sterling. This is not about volatility – currencies should be less volatile than stocks- but lately they seem to be playing a bigger role in investment outcomes.

But I’ve rarely seen market commentators zoning in on what a currency might do over the next 12 months while they will happily talk/write at length about GDP growth rates and company profits.

Why is this? Are currencies harder to call? Are investment managers less comfortable/confident in managing risk and return in forex? Research shows that a lot of institutional fund managers simply accept the currency exposure that comes along with global investing. In explaining this approach to clients they may use highly technical language such as “swings and roundabouts”! (what you gain on the swings, you’ll lose on the….).

Other investment managers, much cleverer than me, say that a 50% hedge on any currency exposure provides the most optimal outcome from a statistical risk/reward perspective.

Others may take positions based on PPP (purchasing power parity) and when that doesn’t work, move onto IRP (interest rate parity). Both tend to be a tad long term….

Why is currency a concern now if it’s always been in the mix?

Well, a lot of folks think that the returns we’re likely to see from investing in stocks over the next few years could be lower than what we might be used to. Mid-single digits is probably a reasonable estimate. This is all based on above average stock market valuations, peak margins, more modest top line growth etc. – all fairly plausible.

However, I’ve seen nothing to suggest that currency moves are going to be any less dramatic into the future.

So in any given period, currency swings may swamp asset moves by a factor we haven’t seen in the past with a direct impact on investor returns.

Why not just hire a bunch of clever gals and guys to manage this part of the return. Some do and call it an “overlay”.

It may be tougher than we think. I looked at a survey of currency managers and their funds (15 in total) where they focus purely on getting forex moves right, In the past 12 months, only one actually produced even a positive return and that was a staggering 0.2%!

All others were negative.

So in a world where we may see greater bottom line impact from currencies compared to the underlying assets (especially if some world leaders see currency as a weapon to achieve geo-political goals) it is a decision whose importance increases.

“Swings and roundabouts” may not suffice anymore – we’re going to need a bigger playground!

Fancy a Coffee?

Nestle certainly does. They are set to pay $7 billion to add Starbucks’ products to its portfolio. And this is at a time when Starbucks growth rate has been on a decline since 2015. But that decline may have more to do with Starbucks than the industry overall.

There’s still a whole lot of coffee drinkin’ goin’on.

In the US, the NCA (National Coffee Association obviously) estimates that 64% of the population drink coffee every day. This is up from about 50% at the start of the millennium and is now back to the previous peak of 2012. That rate may well be peaking around these levels, but within this, the percentage who consume espresso based coffees has gone from 4% in 2003 to 24% today. Starts to explain a lot…….

Afternoon drinking is a problem. Apparently we are not doing enough of it! Starbucks has mentioned it at practically every quarterly conference call over the past two years. Some coffee experts feel that the baristas are more focused on cleaning up and restocking than enhancing the customer experience in the afternoons.

Starbucks are also facing a bit more competition now. Though I suspect that statement has been true for a number of years. The advent of McDonalds and McCafe is changing that competitive landscape. And not all coffee drinkers are the same! A recent research report from Bernstein outlines the key differences (psychographic distinctions they call them) between those who take their caffeine at Starbucks and those who head for the Golden Arches.. The survey results suggest that compared to the coffee drinkers at McDonalds, the Starbucks folks are somewhat younger, with higher income, watch less television, are more tech savvy, more environmentally conscious and tend to eat out more. If there was a box for “can linger 4-6 hours with a MacBook Pro and half a cold latte”, Starbucks would have won that too I suspect.

Any business built on passion and enthusiasm as Starbucks is, is to be regarded but on the ground in the US today, in terms of same store sales, McCafe is making headway.. Starbucks are taking action on this (closing some underperforming stores), but a snippet in the Sunday Times this morning also points to potential elsewhere. Starbucks plan to open a new outlet in China every 15 hours and have more than 5000 up and running by 2021. That’s a lot of coffee.

Now a really interesting survey would be the psychographic distinctions between Lyons Tea drinkers and Barrys!

It’s the Politics, Stupid!

Except it’s not – really.

James Carville, Bill Clinton’s campaign strategist was right, way back in 1992, when he advised that it was the economy that would drive the political outcome, and not the other way around.

But for investors it’s very easy to get distracted by politics, but maybe it’s not that helpful.

We are bombarded. Every market outlook piece I read these days highlights politics (or if you prefer geo-politics!) as a key risk. I’m sure it was always there, but just seems more prevalent in recent years. And politics has certainly been newsworthy – but also you can argue that the 24-hour news cycle beast (both financial and conventional) needs to be fed. Today some market commentators worry over the market impact of the political pandemonium that is the Trump Whitehouse, the never ending process that is Brexit, the softening/hardening in North/South Korean relationships, the two way traffic in Russian and UK diplomats, etc. etc. There’s a lot.

But there’s a lot we can’t do much about either or add any value to.

And there’s a lot that probably (whisper it) doesn’t matter.

There was a good piece of research last year from JP Morgan Asset Management, looking at over 30 years of political economic and market data. The factors with the biggest impact on market returns were those like leading economic indicators, confidence and jobs. The factors that had least impact were political uncertainty and geo-political risk. The Financial Times recently highlighted how markets can be impervious to political events noting how the US economy hummed along nicely during the debt ceiling stand-offs and government shut downs in 2011 and 2013. Similarly both the market and economy punched in great numbers during the Bill Clinton impeachment proceedings in the late 1990s.

And so recently we’ve had the Trump tariffs garnering huge headlines, dominating the news agenda – but on the day of the announcement the stock market lost just over 1% and had gained that back by the following day! Last week – similar: big reaction, then claw-back.

So what’s the take-away? A lot of politics (or geo-politics!) is noise and while people (buy-side, sell-side, clients, etc.) may love to engage, and offer opinions it may not be that critical for how investment managers do their job. Being able to make sentences using phrases like “Straits of Hormuz” or “Capitol Hill” may be a skill but may not make you a better investment manager.

I know it’s a cliché but “focus on the fundamentals” (i.e. profits, inflation, interest rates, things that affect the quality or quantity of a future earnings stream) is maybe more important.

Views as always my own

VIX or Vicks – which is more useful?

Vicks

VIX as we know is the much quoted index of stock market volatility. It’s been getting a lot of air-play of late. It’s supposed to give us a heads up on market conditions and volatility.

Vicks is a widely known nasal decongestant, vapor rub etc. that’s been around for years.

Which is more useful?

VIX has a huge profile in the investment world. For many it fulfills a “canary in a coal mine” role to indicate when risk is on the rise and dictate what asset allocations might make more sense. There are even some ETFs which directly play on how VIX performs. Some folks regard volatility as an asset class in itself.

So you’d think the VIX index would be a useful thing.

It’s been quiet for years and then one day last week it pops up by about 130%! Was it useful? Certainly not in predicting the surge in volatility. Did it fulfill its “canary” role? Well to be honest there was an entire flock of canaries alerting us to the fact that vol had risen. The Wall Street Journal managed to get the words plunge,panic, rout, shatter anf jolt all into the one paragraph so I kinda got the higher volatility message.

I honestly think it’s good as a coincident indicator and a short hand for demonstrating market stress…….but that’s about it.

As for Vicks, it does what it says on the jar or inhaler but does seem to have a whole battery of uses. Some feel it has around 20 separate functions. A few of them are:

make up artists use it if actors need to cry
it can help to repel mosquitoes
foot-ball players can use to help breathing (saw it being rubbed on Oliver Giroud’s chest but didn’t do much good!)
gets rid of nail fungus
stops cats from scratching hard surfaces
helps paper cuts
etc.

So, it’s pretty clear to me that Vicks wins out.

So next time the markets get shaky, grab a jar of Vicks and breathe easy.

(Views as usual are personal)

That gets my goat

Goat

First of all the whole goat thing and the “getting of”. They say it had to do with the practice of putting a goat in a stable with an unruly horse, and the goat would have a calming influence on the horse before a race the following day. So if the goat was stolen, the horse would become anxious, annoyed, vexatious etc. and not able to run well. Clearly it was a much simpler time.

But one thing that gets my goat is people making grand pronouncments and forecasts over things that we know we know nothing about!

China springs to mind.

Financial Times on Friday this week carried a headline

“Chinese growth hits 2-year record”

I’ve no reason to doubt them – the folks at the FT are very bright. But I recall just over two years ago a highly regarded Global economist (name available on request!) with a highly regarded Global investment bank, shouting from the roof-tops that China and the global economy were teetering on the brink of disaster. China’s economy would ground to a halt (by its own standards) and pull the world with it. It was akin to an economist version of Private Fraser from Dad’s Army: “We’re all doomed,doomed I tell ye!”. It was in August 2015 and that was a perfectly good Irish summer ruined. Currency and stock markets did what they always do, until they went back to where they were before all hulabaloo started. Happened again a few months later, and to be honest they’ve been the only major sources of market volatility in recent years.

Yet at the same time, if you’d avoided the great complex economic models and just focussed as much as you could on what was happening on ground, you would have had more of a Corporal Jones attitude “Don’t panic,don’t panic” Proprietary surveys I saw at the time showed that growth may have slowed but was still robust and reasonable for such a huge economy.

Complex analysis and building detailed models on the Chinese economy may give us spurious results. Charlie Munger once told me (and about another 15,000 in the same room) “If it’s not worth doing, it’s not worth doing well”

Personally I don’t pay much heed to the official numbers. I’m not saying they are wrong but they are certainly smoothed. I don’t pay much heed to Five Year Plans but would look at numbers of strikes or protests to get a sense of government impact on economy. I don’t pay too much heed to huge debt levels as a lot of it resides in the Party-State balance sheet. Real data, where you can see it, makes more sense than economic modelling.

I see that Chinese consumption of avocados has doubled – but Im not sure what to make of that!

Surely “that gets my goat” would have been something that the horse would have said. He/she being the one that got vexed.

Don’t get me started on talking horses!

Is this a good time to be an Investment Manager?

I read again an interesting piece from Oliver Wyman and Morgan Stanley from earlier this year (2017) on the asset management industry, basically saying that for fund managers the world “had been turned upside down”.

You know the arguments – income falling (increased competition from lower margin products, increased transparency), with costs rising (increased regulatory infrastructure etc.). In their most pessimistic scenario, they have investment managers’ revenues in 2019 about 30% less than in 2016

All of this is true – and in the report well argued and well researched.

Those who are contemplating careers have not missed this tough business outlook. John Authers in the FT points out that only 6% of this year’s graduating class of Harvard MBAs chose to go into investment management. This is half what it was in 2011.

There is (rightly) a greater focus on value for money – the regulator sees it, financial media see it, and most importantly the customer sees it. For example, regulators across Europe have been raising the issue of “closet-indexing” where some funds have been marketing themselves as active stock pickers (and charging fees accordingly) but in fact rarely steering far away from the benchmark – which a lower fee option could do just as well. And indexed solutions and ETFs are where we have seen the greatest growth in investment products.

Fees will also come under closer scrutiny if absolute returns are lower in the future than historically. It’s one thing to pay 1% in fees if you’re getting 15% in fund performance but another thing if you are getting 4 or 5% returns. Also the next generation of fund investors is going to be a lot more tech-savvy, and expense comparisons and general use of technology is going to tighten fees charged.

The costs of doing business are also on the up with the increasing regulatory requirements and reporting.

So all in all quite a challenge for the fund management business………

……… So then I went and looked at how fund management companies had actually done in share price terms in 2017, given the apocalyptic view. (not an exhaustive list, just some names I know)

Schroders + 18%

LionTrust +27%

Jupiter +46%

Man Group +74%

(Source: Bloomberg 28^th Dec.)

Not too shabby.

Well-run quality fund management companies with good performance will do well despite the world being turned “upside down”.

The Lex column in the Financial Times this week was big enough to point out how it was wrong with a negative view on a particular investment management stock in a call earlier this year.

There will be changes. We will see more consolidation and continued cost cutting. Boutiques will look to out-source everything apart from core asset management. I suspect we’ll see more “hub and spoke” structures where finance, compliance etc. are carried out at the centre, with individual fund management companies (within the group) focussing wholly on managing money.

Asset gathering and management will continue to be a long-term growth story despite what may seem like near-term storm clouds. The fact that Private Equity continues to have an appetite for investing in this space (TA Associates and Old Mutual Global Investors) underlines this potential.

But I do suspect the landscape will change.

All views are, as always, my own.

Money’s too tight to mention (Simply Red 1985)

Simply Red

This time of year you often get called upon to write or contribute to pieces for newspapers or magazines reflecting on the investment out-turn for 2017. Papers tend to use these in those slack days between Christmas and New Year.

It looks like 2017 was in fact a great year for stocks but maybe just an OK year for investment returns. The difference lies in what currencies did – specifically for Euro-based investors and specifically in relation to the US dollar.

Simply put the US dollar weakened relative to our own Euro currency and this took a lot of the gloss off returns from US assets for investors here. At time of writing, the gap is about 12/13%. This wouldn’t have been in many forecasts at the start of the year. What drove this is that the Eurozone economy was better than expectations and at the same time in the US, the Federal Reserve (Central Bank) didn’t move rates up at the pace that was assumed.

So currency mattered a lot in the investment return outcome, but really they always do – they’re just tricky to forecast. Even pure currency funds and fund managers can struggle to navigate a successful course in global currency markets, and will often blame a lack of volatility, or too much volatility or the wrong type of volatility…

So where do we stand today?

Well I think interest rates are very important, and in the US we are likely to see 3 or maybe 4 increases all going well. Eurozone interest rates aren’t moving. This should be supportive of the US dollar but maybe the moves won’t be all that dramatic.

So the fact that the “money’s too tight to mention” or at least getting a wee bit tighter may mean a higher US dollar in 2018.

Either way you’ve got to love a song that can get “Reaganomics” into the lyrics.

Tis the season to be……….

Eugene

Here we go again. It’s that time of year. The so called festive season is nearly upon us. We may not do all the pagan rituals that marked this bleak mid-winter time in the past, but we do like the ould bit of ritual all the same it seems. Soon the TV crews will decamp to Dubln Airport, as they do every year, to intrude and wallow in the emotion and high spirits as loved ones come home for Christmas, only to go back 5 days later to intrude and wallow in the emotion and low spirits as loved ones leave again. Some rituals don’t stand the test of time. When I was growing up there was a ritual of visiting all the churches to compare cribs – now there’s the 12 pubs!

Another ritual is that all the clever people start giving their economic and market predictions for the coming year; along the lines of “What does 2018 hold in store for investors?” There’ll be a lot of deep thinking and beard stroking as folks look deep into their crystal balls. You’ll notice a few things in these proclamations. There usually isn’t much reference to what was said 12 months ago, and there will also be a range of comments that are so general as to be reasonably useless. People will say things like “in 2018, selectivity will be the key!” Actually selectivity is pretty much the key every year. Another favourite is that market volatility is likely to pick up. This has been a refrain for a number of years. And today volatility is at epoch lows. So it’ll be right at some point.

Of course the really clever folk don’t do forecasts, they do “surprises”. They give a list of things that have some chance of happening but are not really expected to. This has a double benfit for the forecaster in that if it doesn’t happen, they simply say “well of course it was just an outside possibility”. And if it does happen – “Told ya!”

Personally I don’t get too hung up on the calendar year stuff. Many of the trends impacting on markets are blind to the changes in the Gregorian calendar and simply ebb and flow as always. Maybe best just to keep a weather eye on a few key things like credit spreads, valuations, debt levels etc. to get a sense of how exposed or protected we may be from the impact of the event that most likely none of the 2018 forecasts are actually talking about.

Beware: stock markets could be heading for a crash

hourglass

Yup that’s what the Irish Times said this morning; so it must be true.

And on a Saturday morning as well – just to set the week-end off to a good start. If I was heading to my club downtown, or a dinner party in the Hamptons, it would be the subject du jour.

But unfortunately I’m not

I know the journalist and he’s one of the good ones. And it is true, there has been a growing clamour over the health of finacial markets. Last week, Niall Ferguson wrote about financial red lights flashing again, and in bold print saying “ I saw the 2008 crash coming and was ignored – a new one is looming”. Looming is a great word; scary but with absolutely no sense of time-line!

But to get back to the Irish Times piece, there’s a lot that’s good in it. It’s balanced, highlighting both the concerned and the more constructive views. To be concerned you have to worry about the “three Xs” – extreme leverage, extreme sentiment and excessive policy tightening.

Looking at each.

Leverage is high but financing cost are low and we have seen improving asset values in recent years. There was a good piece from Lombard Street Research on this in October.

Extreme sentiment? Are investors complacent? Certainly not at any of the investment strategy group or trustee meetings that I’ve been to recently. Also the ML survey of fund manager positioning shows little sign of irrational exuberance. The VIX (volatility index) is low but I don’t think it ever says a lot about where we may going, and just a little bit about where we are.

Excessive tightening by Central Banks. Do you really believe central banks are going to squander all they have achieved through a snail paced monetary policy to date, by hiking excessively or catching markets off guard?

Look we are late in this cycle – but to use one of my favourite cliches “bull markets don’t die of old age”.

We have growth in economies and in profits and I think we will continue to see reasonably low interest rates and inflation. For choice I’d prefer not to be starting from these valuation levels but I think it’s more relevant in the medium term to see that impacting on levels of returns rather than whether they have a positive or negative sign in front of them.

At least I don’t have to pretend anymore

QE2 So anyway there I was listening to Morning Ireland, and this chap, who used to be big name in the ESRI, giving their highly thought of views every quarter, garnering acres of media coverage and attention, but now he’s saying “I’m not in the forecasting business anymore so I don’t have to pretend that I have a great sense of what’s actually going to happen”

Pretend!

He never mentioned the word pretend when he was handing down the pronouncements of the great and the good in the economic community. Forecasting GDP growth and its components to a decimal point seemed to carry an air of (self) importance that didn’t entertain the concept of pretending. Nor was there ever use of phrases like “ we were wrong”; no – people simply revised their initial assumptions! If you’re interested have a look at the ESRI Medium Term 2005-2012 Review and see how closely it captured the outcome.

I don’t pay huge attention to economic forecasts. If the economic growth outcome is 2.1% or 2.5% doesn’t really make that much difference in the investment world. Pay more attention to things like whether growth is running ahead or below potential.

And it’s not just that we can’t forecast the future, we don’t even know where we are today. Historic economic data gets revised and rebased often and sometimes in a very material way.

So should we pay these forecasts so much heed when the task seems akin to Rowan Atkinson’s description of the blind man in the darkened room looking for the black cat that isn’t there.

And it’s not just me who questions the usefulness of the effort. Elizabeth Windsor ( HRH Queen Elizabeth II, see above) put it to the highly regarded economists at the London School of Economics following the great financial crash “well lads, yis missed that one” (I para-phrased that somewhat).

Investors shouldn’t spend a lot of time or effort on forecasts which will most likely be wrong. Time is better spent looking for well managed companies generating good returns on capital and good cash flow. I read of a fund manager, many years ago now, who abandoned macro-economic forecasting in his investment process altogether – and did very well indeed. His name was JM Keynes.

He probably knew a thing or two

Alan Shearer was one

Shearer It was a Sunday evening in August way back in 1993. I was stood in that cauldron of emotion, United Park, where Drogheda United were playing Blackburn Rovers in a pre-season friendly. Blackburn were on the verge of greatness at that point. The first half was scoreless, which was a very good performance from Drogheda United. Kenny Dalglish wasn’t happy. He kept his team on the pitch at half time. Second half – no real change. The he sent on Alan Shearer who nonchalantly scored a couple of goals and basically ended the match. That late summer evening in United Park, I had seen a “game changer”

“Game changer”

It’s a word that gets bandied about a lot in financial markets. People look for that one big thing that sets the direction for prices over the next six months, year, three years. I’m not so sure they exist. It may look like they exist in hindsight like AOL/Time Warner signalling the dot com crash. Actually it was as much coincident as causal. And it’s rarely that simple one single factor or event determining a complex outcome. “Mono-causality” is what people much more intelligent than me call it.

But life is never really that straightforward

If you had the same European history book for Leaving cert as I had, it went through the eight causes of the first World War. Eight!

As another example, reports looking at the 2010 Macondo Deepwater Horizon well blow-out cite between eight and ten reasonably unrelated issues that led to the tragedy.

I think it’s the same in markets. It’s an array of factors that move markets in a certain way, at a certain pace. Today, the removal of Quantitative Easing, and specifically the cessation of bond buying by some of the world’s leading central banks, is seen by some as a possible game changer. Of course, it is important but it has to be seen in the context of many other factors such as improving economies, better corporate earnings, stretched valuations, investor attitudes etc.

Don’t be swayed by bombastic statements that hinge on one single event or factor. It may be dramatic but not really that useful. Also the financial world can be fickle – what seems to be all important today, and garners huge attention and comment, can quickly become an irrelevance.

I recall one day, many years ago, a US strategist called in and told me to forget about things like GDP growth or earnings or suchlike and go and learn everything I possibly could about a man called Ross Perot (then a US Presidential candidate) because his views on tax policy, jobs, international trade was going to be the most important thing in markets for the next three years. Well you know how that went…….

So apart from Alan Shearer that evening in United Park, there aren’t that many.

Penneys or Louis Vuitton?

“I don’t subscribe to labels. Unless I’m labelling other people” *

I met a US Equity fund manager in Dublin last week who told me about a “once in a lifetime” opportunity for his style of investing. In fairness to him, he did say that he had been through town almost exactly 12 months ago and said exactly the same thing!

He was a Value fund manager. And a very good one. His fund has a very good performance track record against other value managers.

I’m not so sure I get all this label stuff – like Value or Growth. Certainly I think it sounds better to be a value investor, and that value matters. It wouldn’t seem right to set out to buy things that weren’t good value. Value also sounds right and a bit homely. Value in the world of investments means you’re looking for stocks that trade at a price, where that price relative to its book value or relative to earnings is less than the average in the market. The more conservative you are, the more of a discount against the average you might look for. And if you want to be really sneaky you’ll use words like “intrinsic value” which is basically whatever you’re having yourself.

And then there’s Growth. Here you’re buying stocks where you think the growth in earnings or sales is going to be better than the average. (For shorthand think Amazon or Google). Equally growth sounds nice too!

The idea is that when times are bad and growth is scarce or in short supply, investors should place a premium on stocks that can deliver growth. On the other side when things are picking up, value stocks are the best and cheapest way of getting a slice of the action.

Now the investing world is divided into those who swear by Value as a strategy to make money and those who swear by Growth. And the Value folks will point out how if you go back 30/40 years owning a “Value” portfolio has made you better off than owning a “Growth” one. Problem is since 2007 Value has performed poorly compared to Growth – and that’s about 10 years. (I’ve had careers shorter than that). That’s why I’m not too keen on labels. The length of time when your label can be out of favour can be very long indeed. (See graph)

STYLE

And I know that the discount between value stocks and the market overall is as wide as it’s ever been and yes we did see a bit of a bounce in Value in last quarter of 2016 into this year, but I’m not sure I know what the catalyst is for a sustained period of out-performance. They used to say rising bond yields were well correlated with the value style performing but I suspect that’s because they were seen as a proxy for better growth. Economic growth today is good and looks resilient but “Value” is not responding. John Authers in The Financial Times thinks this means investors are generally negative.

I wouldn’t hang my investment hat on either style, given how long they can be out of favour and that it’s difficult to call the turning points. Also I think stocks which in the past were considered value, may now have valuations which shoves them into a growth basket.

I’d rather look for stocks which are mispriced relative to their potential, whether that’s driven by assets or future profits.

I do think these labels may play a role in risk management in as much as high flying growth stocks when they do hit an air pocket in terms of some disappointment can fall sharply whereas expectation in the value sector may be more modest to begin with.

*Gaby Dunn