A NEEDFUL ASSET MANAGEMENT INDUSTRY MAKEOVER

The situation couldn’t be more ironic.

On one side, regulatory pressures have left little room of manoeuvre to the financial industry. On the other side, fintech startups and social networks have soared as mushrooms. Threat and opportunity at the same time, this new phenomenon cast a shadow on the existence of traditional banks but has been democratising at the same time acces to financial information and services.

Twitter and other social networks have turned into complimentary sources of information for investors

Despite a slowdown in user’s growth, Twitter remains an impressive relay of information. Its influence is such that some even dare recognising it as a “market maker” which is nevertheless overstated in my opinion. However, truly, information relayed on social networks have been able to cause sudden and significant moves in the market. As an example, Tesla’s CEO tweet in march 2015 prompted a few minutes later a signifcant rise in the fim’s valuation in just a few hours.

Fiona Frick, CEO of Unigestion Asset Management asserts that the firm dedicated about EUR10M in technology investments over the last 3 years. As she mentions, the flood of financial informations is so abundant that it is essential to process it in order to integrate them in their investment decisions – Being technologically advanced is now critical for asset managers.

Fintechs and their attractive features for investor’s younger generations

Beside social network applications, fintech companies have been providing investors  with attractive services , competing directly with traditional financial institutions. Lagging behind due to mounting regulation presssures, the financial industry is indeed the last sector to start its so-called “digitalisation”. A thematic that is now in most bank’s top agendas but looks like too versatile for these big giants englued in heavy structures and regulation.

From mobile payment services to credit and funds raising for small businesses, fintechs have literally invaded the Bank’s “old preserve” : Ant Financial services (Alibaba), Lending club, OnDeck, Bitspark, Sparro to name a few are moving fast and with an agility that banks can barely compete with.

Long preserved, the Wealth Management industry is similarly affected by the digitalisation effect – quite logic when about two thirds of the new wealth creation comes from developing economies (Asia, Africa, Latin America, etc.). New wealthy investors located in emerging markets are indeed great adepts of new technologies and have a different mindset with respect to the use of financial institutions:

  • Gambling mindset;
  • Use of several banks as depositary institutions;
  • Use of Financial Advisors / Wealth Managers mainly for investment opinion (vs. porfolio management);
  • Limited loyalty and capacity to use different platforms / advisors as long as it matches expectations (low cost, higher yield).

Ironically, the asset management industry once assumed that developing to emerging market would only require them to locally replicate their business model. Eventually, it appears that investors themselves are driving a fundamental industry makeover: eager to reduce costs and broaden investment opportunities (beyond bank’s limited products offering) the younger generation of investors is gradually turning towards fintech services.

Large asset management institutions are therefore increasing the pace of global partnerships / acquisitions but will they be agile enough to keep up with the young generation versatility?

LATAM – CHINA : A YIN YANG CONCEPT

Latin America and China couldn’t express more clearly the Yin-Yang concept: so different but interdependent at the same time.

Having benefited of the commodities bonanza years in the 2000’s, Latin America is now painfully feeling the boomerang effect of China’s economic deceleration.

The boomerang effect after the commodities bonanza years

Last July, the IMF severly downgraded the economic outlook of Latin America (0.5% in 2015 – 1.7% in 2016) and this is obviously not surprising due to a global context that’s definitely penalizing this part of the world. China’s deceleration, commodities price slump and prospects of increased interet rates in the US are weighting heavily on the region’s growth prospects.

While these economic factors are definitely affecting the region, Petrobras related troubles in Brazil have been giving the final “knock out” effect to the region. With such a backdrop, Latin America and more generally emerging markets felt out of sight of most investors as additional corrections cannot be overshadowed.

Emerging markets remain the global economic locomotive

China’s economic deceleration rang an alarmist bell in investors mind, therefore leading to massive emerging markets outflows. Latin America in particular has been particularly slashed down but other emerging markets had to cope with the same feat. However, and without undermining the current gloomy backdrop, emerging markets potential remain one of the strongest at global level.

Representing about 50% of global GDP (PPP terms – IMF), emerging markets are also home of about 80% of the world’s population. Even if developed economies recover from the recession, the global economic growth will continue to be strongly influenced by the growing middle-class in emerging markets.

Services and consumption: engine motor of emerging markets economic growth

Long time commodities dependent, emerging markets are gradually shifting towards consumption and services driven economies – From Africa to Latin America and going through South East Asia, foreign direct investments have experienced a steady rise and are not anymore exclusively dedicated to the commodities sector: retail, real estate and services (healthcare, education, financial) are on the verge of becoming the new sector’s growth engine of emerging markets.

Emerging markets economic slowdown remains a relative one

China has been dominating the headlines over the last weeks because of the significant plunge in the country’s shanghai index. Although a hard landing cannot be totally dismissed, chinese authorities benefit from financial tools that should help the country overcome this economic shift.

Considering all the above, there is no doubt that emerging markets offer the greatest potential of investment return should the portfolio be properly diversified as growth prospects can dramatically differ from one country to another. As such, passive investment strategies seem pretty limited due their lack of stock picking strategies. Investing in emerging markets can be extremely rewarding but requires from a portfolio manager a set of 4 features: local market expertise, active management and a savvy macro understanding.

FLEXIBLE FUNDS: A MUST-HAVE IN VOLATILE CONDITIONS

Work, food and social habits are changing and so do investment products.

Investment products panels have never been so large and yet, the question remains: which framework to choose so as to optimize the potential return. Actually, the truth is that there is no ideal, standardized framework but rather specific schemes that are definitely best fitted according to the context.

In line to the current volatile backdrop, most investors are definitely unclear about where to allocate funds. In such endeavour, flexible funds offer attractive features for investors willing to capture most of markets growth but limit at the same time downward pressures.

 What is a flexible strategy?

To put it in a nutshell, flexible funds are funds that give more nimbless to portfolio managers, allowing them to choose how they allocate managed assets according to markets context. As such, flexible funds can be invested in any assets class (stock, bonds, money markets). Even if there’s no specific rule, stocks exposure usually vary from 10% to 50% or 60% to 100%. Some asset managers even offer a full flexibility approach where the stocks exposure can vary from 0 to 100% – This is the case of Dorval Finance which recently opened a “flexible management group” on Linkedin in order to open discussions about this growing trend in investment management.

 Why did Flexible Funds emerged?

Flexible management started to flourish in 2002-2003 but more incisively after the 2008 financial collapse due to the unprecedented accumulation of losses on stock markets. Flexible managers started to gain interest as part of investors thanks to a more tactical approach, aimed at providing downside protection and some sort of absolute return during volatile periods. Indeed, asset classes produce widely different returns from one period to another. As a matter of fact, a dynamic and tactical allocation usually offer better risk adjusted returns. This is even more true in current volatile conditions where anticipation and tactical approach are paramount.

 How risk is managed?

Flexible funds aim at protecting the invested capital. This is usually achieved through a proper arbitrage combined with a global macro approach that provide exposure to  growth periods and downward protection. In fine, a well managed flexible fund should have regular positive performances. Risk management is therefore paramount in order to precisely assess the best timing to alter the assets allocation.

 Similarly to any other investment strategy, choosing a flexible fund requires a good assessment of the asset manager : engine strategy, track record (that should demonstrate regular positive performances) and management team transparency about performances and investment choices.

A new investment era driven by the rise of emerging markets

Ageing population, near zero interest rates, desinflation risks, sluggish economies, geopolitical issues. Current bearish and unstable global outlook have been turning investors into extreme caution as per investment allocations. The majority has been adopting a very conservative bias in the wait of a renewed growth secular trend as we used to experience in the past . While this sounds pretty logic, the reality is all different as we may, actually, not experience similar growth paths in the future.

Emerging Markets influence

The rising power of emerging countries, driven by China, has been destabilising a well established order previously dominated by US and EU. Emerging countries are gaining ground, leading to a global redistribution game of economic powers in an increased interconnected world: any economical or financial event occurring in any part of the world will have both positive and negative spillover effects on the others. While this has always been the case, the effects are even more amplified due the increased level of global interconnections.

As a matter of fact, portfolios assets allocation have to be readdressed taking into account :

  • A long-term views as many short-term hiccups will happen on the road;
  • A geographical balance between developed and developing economies;
  • Active management so as to quickly capture markets trends.
  • Include some alternative investment features – infrastructures, commodities, real estate, etc.

Developed Markets opportunities

  • Supported by high qualified workforce and leading expertise, developed nations have a definite edge in health, technological and construction sectors. These sectors will definitely be driven by a rising ageing population and growing need for infrastructure investments in emerging countries.
  • Current wave of M&A deals over technological and telecom european corporates will also be supportive of greater stocks valuation in those sectors.

Emerging markets opportunities

  • Although China entered into a “cool down” cycle and some other asian economies are lacking structure, economic reforms are on the agenda and will be supportive of a new growth cycle over the next decade. All in all, Asia remains one of the most active emerging continent and will remain the world’s fastest growing economy in 2015-16.
  • Another region showing great promise is sub-sahara Africa, home to a growing middle-class as well as a rise of financial and services sectors.
  • Even if Latin America’s growth has been negatively impacted over the last 2 years, improved governance and economical reforms are aimed at providing the continent with a new growth story. As such Mexico and Colombia are now considered as the new Latam tigers and should deliver above expected growth rates over the next decade.

 All things considered,  Higher market volatility will definitely change emerging markets investors by forcing them to look beyond their traditional markets (local, US and UE) and add more global positions / overseas niche markets. This greater volatility should also be seen as an opportunity for foreign fund managers to capture part of these new inflows providing products are properly adapted to this new  investors profile. As such, balanced, multi-assets portfolios and active management are among the best ways to partially limit the effects of sudden redemptions, unavoidable when dealing with emerging investors, more particularly in a volatile market.

Central Banks’s musical chairs game..

Investing in Capital Markets has been like a musical chairs game over the last few years with Central Banks as bandmasters playing desperately faster so as to revive sluggish economies. The financial crisis trauma of 2008 is still in minds and fears of a financial collapse with domino’s effect are haunting the place.

In spite of their nervousity, markets seem however to show some good resilience and somehow trust in the ability of governments and Central Banks to prorperly manage tumultuous transitions.

As such Europe’s case is very interesting – Greece’s bold position with its official creditors (European Commission, International Monetary Fund, European Central Bank) have been mounting fears of a potential Grexit and financial collapse for Europe. Although markets remain nervous and demonstrated high volatility, investors are still there, showing growing appetite for Europe’s investment case.

The booster shot remedy 

Beyond Europe’s structural issues, the massive bond buying initiated by the BCE in March 2015 (EUR60bn monthly up to september 2016) provided the old continent with a powerful remedy to revive investment and domestic consumption. Definitely, the european recovery is well anchored and should appear stronger over the next months.

  • Growth earnings and operating margins are definitely on the growing trend, supported by low interest and weaker Euro – thus favoring export oriented companies.
  • Though well expected, it seems however that the market did not fully integrate yet improvement in margins. This leaves room for a potential rally when results will be announed and confirmed by the end of the year.
  • EU corporates valuations are still 30 to 40% lower compared to pre-crisis valuations, which provides potential of upward correction.
  • Not only will stock valuations be driven by export oriented corporates but also by a wave of cross-borders mergers and acquisitions that are gaining ground in Europe: with cheaper credit and improved margins, confidence is rising and time is now for organic and more oportunistically external growth.

How to choose the right Fund Manager

Beyond this very attractive backward, the whole panorama is not glossy though: inflation is still looming, structural reforms are highly if not urgently needed and not all corporates will benefit from the current favorable macro conditions.

But as we said, it is a “musical chairs” game and as such you have to keep playing while the Chief Orchestra is performing. Most important of all, you have to target the righ chair and in this case we’re talking about the right Fund Manager that won’t grant you with a broken chair. While large Fund Managers can provide reasonable and average performance, a look at boutique ones can give the opportunity to find little gems : true experts on their niche market and well introduced in the european corporate environment, they’ll be able to target the good stallions – still better than a pony..

EM Investment opportunities – not only a crude oil story..

There has been much debate over the past months about crude oil prices impacts over emerging markets (EM). When some definitely benefit from the drop in prices, others pay the price of investor’s somehow over-reaction. Emerging markets are very similar and different at the same time but investors tend to put them all in the same bucket, downgrading them all at the same time in case of any major negative backdrop.

Standard Life recently published an interview of several asset managers questioning them about crude oil prices impact among emerging markets. Although answers seem pretty straightforward and obvious, I recall here some of the main statements as investors usually tend to consider emerging markets and more particularly emerging continents as a “whole piece” rather than a more eclectic one.

As fairly acknowledged by Andrew Summers (Investec Wealth and Investment), lower crude prices are globally positive:

  • It improves consumers purchasing power;
  • It induces commodity export countries to restructure and better diversify their economy preparing ground for the next growth story.

Some are definitely current red flags

While commodity exporters are undoubtedly suffering from the lower crude prices environment, not all are to be placed on the same footing. Below are some of the most widely cited as most exposed countries. But again, contexts are different when one get into details and long-term prospects are not comparable.

  • Venezuela is undoubtedly the most exposed and endangered nation for not having been able to retain enough savings from the commmodities buyoancy years. With crude representing 95% of exports earnings, the nation’s fiscal situation is in an alarming stage, gradually driving the economy towards an inevitable collapse – A total “no-go” for investors.
  • In the same vein, Russia is in a critical position, hited by western economic sanctions and dangerously exposed to the low crude prices environment (68% crude’s export revenues). Although some remain opportunistic on specific stock picking strategies, the current situation is definitely not clear enough and unstable.
  • As a next exporter and low diversified country, Nigeria is similarly exposed (95% exports earnings) and pay now the bill of careless and over-dependance years. However, unlike Venezuela, Nigeria’s newly elected president (Buhari) brought about a wave of high expectations. While investors have temporarily stepped back, most remain in the starting blocks  as Nigeria remains anyway  one of the largest and promising growth story in Africa.
  • Less dependant on crude exports, Brazil’s current difficulties are mostly derived from fiscal imbalances, over-dependance on raw materials exports and careless management of public spending. The Petrobras corruption scandal definitely worsened Brazil’s creditworthiness resulting in massive investors outlfows. The country is now in a process of huge “spring cleaning” leaving Dilma Rousseff sole in charge of restoring investor’s confidence and laying the foundations of a new growth chapter. Notwithstanding the latter, Brazil remains anyway one of the largest economies in the world (7th largest GDP) and foreign investments haven’t stoped  flowing to the country. In fact, Temasek and GIC, the two largest Singapore Sovereign Wealth funds have been increasing their share of investments in Latin America, opening offices in Brazil and investing in large educational and infrastructure projects.  China is not on rest, having made sizeable commitments to the Latin American region (USD250bn expected over the next years).

 While others remain little gems …

Be it oil producer or not, some emerging countries were already unattractive for many reasons well before the oil crisis (Venezuela, Russia, etc.).But as fairly mentioned by the EM asset managers interviews by Standard Life, investing in those new growth stories goes well beyond crude oil prices and relates more to growth prospects, middle-class rise, industrial development, etc.

As a matter of fact, all oil producers cannot be placed in the same bucket.

Alex Wolf from Standard Life Investment finishes mentioning Mexico which engaged a few years ago in a processs of diversification away from oil production. As fairly mentioned, the Mexican economy is already one of the most diversified from Latin America and boasts from a very interesting integration with the US. Although timing is not entirely there, Mexico is definitely in a good pole position and should gradually get increased interest from international investors.