Video ID:
8658
Job Number:
6964
Meta
Description:
David Coombs of Rathbone Unit Trust Management, John Ventre of Skandia Investment Group and Nick Samouilhan of Aviva Investors take part in this Multi-Asset Masterclass.
Bookmarks:
29|The US economy
376|American lag effect
633|Structural shift
966|European view
1157|Global outlook
1952|Equities
2241|Non-correlated assets
2587|Indexed linked gilts
Duration:
00:46:21
Recorded Date:
28 November 2012
Video Image:
Transcript:
Presenter: Hello and welcome to Asset.tv’s Multi-asset Masterclass with me, Mark Colegate. We've got an expert panel here for the next 45 minutes, so let’s meet them. They are: John Ventre, Head of Multi-manager at Skandia Investment Group; David Coombs, Head of Multi-asset Investments at Rathbones; and Nick Samouilhan, Fund Manager, Multi-asset Funds at Aviva Investors.
John Ventre, just taking a quick look at what’s going on in the world economy at the moment, some better numbers coming out of the US in the last couple of months, is it now riding to the rescue of the world economy or is it flattering to deceive?
John Ventre: Well, I think what’s got us particularly encouraged more recently is better US housing data. Because really as the US housing market improves, the US consumer gets a bit more spending firepower. And while certainly there’s a rise of an emerging market consumer and plenty of other engines of growth, the US consumer is such a substantial part historically of how we've achieved growth, you know, we don’t really feel we can get a good global expansion going without them.
Presenter: And, David, when you hear a piece of news like that, how quickly does that transfer into something that you do on your portfolios?
David Coombs: Interesting question, in that this is not the first time we've seen positive data from the States this year actually. Over the whole year, by and large the data’s been relatively positive, particularly in housing, as John was talking about, so we've actually been positioned in the US earlier this year. So what’s happening now isn’t really affecting how we invest in our portfolio, because we’re already overweight the States, because we've felt more positive on the US versus Europe, and who hasn’t, frankly. So it doesn’t really have an impact short term so to speak.
Presenter: So it’s really sort of confirming a view you took earlier, or supporting a view you had earlier in the year?
David Coombs: Yes, I mean I don’t want to try and look smart after the event, but as I say this data the last few weeks is just actually confirming earlier trends in the year. I think what is different now though is that a lot of stock analysts in the States have been downgrading their forecast for next year, and what I do think this does give an opportunity is that there could be positive surprises from corporate earnings in Q1 and Q2. So it may be like a second leg to support the US market. So, if you haven’t got in yet, I don’t think it’s too late.
Presenter: So why are the analysts downgrading if the news it getting better?
David Coombs: I think the US fiscal cliff clearly has been overshadowing sentiment in the US. Again, we've been fairly sort of relaxed about that. We think that, given the election result, given the Republican got a bit of a kicking, we think there is more of a let’s work together reaction in the States. So we think the alternative to not addressing the US fiscal cliff is so bad that it will be addressed. But I think that’s affected sentiment and data in the summer was slightly weaker, and I think that’s, and also they’ve had a good run: I mean corporate earnings have been very strong in the States over the whole last 12 months.
Presenter: Okay, Nick Samouilhan, if we could bring you in here, first of all could you just run through for us what the fiscal cliff is, because it’s two words, but I know it’s obviously quite complex what’s going on over there?
Nick Samouilhan: Essentially, it’s the expiry of tax cuts which happened a long time ago, and the agreement reached back then was that they would automatically expire and spending would be put back if there was no agreement reached. And that was made to concentrate people’s minds on coming to an agreement. Unfortunately, we've got in the US over the last 12 months even a greater divergence between different camps. So now what we’re likely to see, we agree completely that we think it’ll be resolved, but you'll see a lot of short term volatility as this brinkmanship happens over the next few weeks. So we’re expecting certainly short term some concerns in the markets over that, but we agree completely that the US housing is the key here, and we've increased risks in all our portfolios on the back of that.
Presenter: And is US housing now looking strong or just a heck of a lot better than it did a year ago?
Nick Samouilhan: I think the latter. So there is going to be a bounce, but it’s a case that it’s no longer subtracting is the first most positive thing, and then from that if it starts to contrary positively, then ultimately that’ll become reinforcing. So we don’t need housing to do very well to see the US do really well, but it will certainly be very hard to imagine the US booming with the housing market’s sudden depression.
Presenter: So what you're expecting to see over the next few weeks is these tax breaks, the politicians will agree these tax breaks can remain in place for another 12 months or?
Nick Samouilhan: There’ll have to be some kind of adjustment. So even the markets themselves would welcome some kind of adjustment on the medium term outlook; if that’s a 1% adjustment, then we think markets can handle that. So what we’re expecting is that there will be an agreement to address this, there will be some medium term arrangement around that. Our main concern is not that you won't reach an agreement, but given the uncertainty that’ll feed through into consumers cutting back on spending, and that could then feed through into the real way into the economy, that’s where our focus really is.
Presenter: And John, sorry.
John Ventre: Yeah, I completely agree on that point. This kind of reflexivity argument that Soros has used a lot, which is it’s not actually the risk itself but people’s reaction to that risk that creates the problem. That said, we’re definitely kind of positioned risk on. But our take is a bit different, a bit sort of differentiated in that we’re actually underweight US equities, thinking that other markets will benefit more from a vibrant US economy in particular, particularly a US consumer, through the period that the US consumer was most strong, sort of 2002 to 2007, the US market was not the top performer.
Presenter: So where are the geared plays on US recovery then, for want of a better word?
John Ventre: Well actually ironically still emerging markets. There’s a lot of talk about global rebalancing, and we definitely think a lot of that is happening, but the economy, the sort of global economic dynamic isn’t changing as rapidly as some people think. And accordingly, when the US consumer booms, you know, they still buy stuff that gets imported from emerging market producers.
Presenter: So you don’t see a lag effect that it makes US companies feel better first and it’s three, six months down the line before they feel better in Japan or China or wherever it happens to be?
John Ventre: Well the companies might feel better, but I think the actual flow, the business flow happens elsewhere.
Presenter: And if we’re talking about the American government, which have got huge deficits, David, which are clearly an issue for the bond market, if they're now going to start having to hand out more tax breaks, what does this mean for fixed income globally?
David Coombs: Well the thing is if they do extend the tax breaks and you get trend or even above trend growth, then your tax receipts actually could go up net. So in effect that would actually reduce the deficit, okay. So I don’t think it makes a huge difference. I think when it comes to the bond market anyway, because of the problems in Europe, the US dollar has become the reserve currency of the world, yet again, and there’s no dispute over that. And therefore the US can run a much greater deficit than most other countries, if not all other countries, because it still has that reserve currency status.
So I don’t think this has a big impact. If the US growth continues at the rate it is and we see even greater growth then actually as I say tax sheets go up, even if the tax breaks stay in place. I agree that they won't. I think there will be some negotiations around the edges to keep the Democrats and the Republicans, both sides of the parties happy, but broadly speaking it would be absolutely suicide not to extend the tax breaks, because if the consumer becomes more negative, then you'll see those growth numbers fall off a cliff.
Presenter: And Nick, what do you make of John’s argument that the US is recovering, that’s a reason to put risk on, but the best place to put it on is emerging markets rather than the States itself?
Nick Samouilhan: We share similar views on that. So it’s not just a case of feeding through into consumers; it’s just a case that to a large extent, although there is some rebalancing going on, Asia is still the export led, and that feeds directly to the US consumer. So we are playing that largely through Asia and EM but agree completely with that view. It’s not just a case of just spending by consumers; it’s how all the linkages feed together.
Presenter: And, David, are you overweight Asia as well?
David Coombs: Not particularly, I think clearly the emerging markets is the story, but I do think there’s, the US manufacturing base is expanding and I think there will be more capex in the States. This is about supply chain, and some of that supply chain will be in the States and some will be outside, whether it’s in Europe or emerging markets. And again you can play emerging markets through Europe, ironically, and the German manufacturing sector is a good play on China. Yum Brands in the States is a good play on China. So I think it is an emerging markets developing story of GDP, but as we've seen from the past you can't necessarily look at a country with the highest GDP growth and buy that equity market. China being a good example, India another good example, a very volatile market, you know, corporate governance in those markets.
So I think it is an emerging market story, but it’s not necessarily always about the local markets. And having said that I think if you are looking at emerging markets and you want to take that risk, then take a more geared approach and go into maybe some of the frontier markets, an ASEAN in Asia where I think there are some interesting developments, whereas some of the older, more mature emerging markets, if you like, are they still emerging markets, question.
Presenter: And what, this is the likes of South Korea, Taiwan or?
David Coombs: South Korea, Brazil, Taiwan, you know, they're not really emerging markets when they’ve got better investment ratings than European countries.
Presenter: John.
John Ventre: What’s intriguing for me is that we are having this discussion about whether they're even emerging markets anymore, but they still kind of attract in valuation terms a kind of emerging market discount to reflect some of those emerging risks, poorer governance, poorer sort of credit, position in credit rating, and actually we could be wrong about their growth profile but right to be overweight anyway, as some of that emerging market discount fades away, as they become more established parts of global markets.
Presenter: But can you really put a bet on like that, John, in the sense that I mean pretty much every fund manager whose market tells you that it’s actually different now from the way it used to be a few years ago, and it’s time for a sort of structural shift in how it’s seen, and they’ve been saying that about Asia for years, I mean it never happens.
John Ventre: Well, it’s never different this time, to my mind. But I think my point is rather if it turns out that these things are effectively the growth profile is changing, and they are becoming more developed, then you are going to see that sort of risk premium if you like go away, effectively because their economies are becoming less volatile. So you're not relying just upon the growth story and maybe being successful to win with that bet; it’s a bet which might work out well for you, just not in the way you expect.
Presenter: Okay, and the big sort of economic block that we've not, we've touched on but not really discussed, Nick, is Europe. What are your thoughts on is now a good time to be overweight or underweight Europe?
Nick Samouilhan: Well I mean that’s tricky. In Europe essentially you're betting on what the politicians are going to do. Our view next year is that it’s going to be much of the same. So our starting point on this thing from our economists is that if you look across the Eurozone, each individual country may have some current account deficit, current account surplus, something that’s structurally wrong. If you treat the Eurozone as a single country that all falls away. And what that means, what we understand, what politicians understand is that the only way to solve that is to move to some, the remorseless logic that if you share a currency you also need to share a sovereignty and many things. Well to get there though the path is not going to be straightforward. You're going to see politicians pushing back against that, it’s very hard to give up your own sovereignty.
So what you'll see next year is the continuation of what we've seen in the past two years. Things will get much worse, they’ll go past some pain thresholds, politicians will be forced to act, then markets will recover and so on, and you'll eventually get to a point sometime in the future where Europe as a country starts to be normal. And I'm not sure where we are in terms of that cycle, but we’re a long way to go I think.
Presenter: So how much longer can we sort of have a process where I suppose the stronger parts of Europe say to the weaker parts do you want this money or do you want a bit of self-respect almost, I mean how long does that keep going for?
Nick Samouilhan: I don’t know the answer to that. This is a structural not a cyclical issue. It’s interaction between, in the past year it’s been an interaction between national states that, elected politicians of national states, and the IMF and the ECB and Eurozone at sort of that level. I think going forward the debate’s not going to be on that level; it’s going to be between elected politicians and their own populations. So do we still have a mandate in these different countries to continue to give up sovereignty, continue to push through this austerity, and those are going to be the touch points going forward I think.
Presenter: But you see it being a little bit like what’s going on in the States with the fiscal cliff, in that there’s a lot of politics, there’s a lot of this sort of reflex to issues, but fundamentally the Europeans will hold it together. They’ll just be it’s a bumpy ride while they do it?
Nick Samouilhan: Ultimately I think it comes again to the argument of just the alternative is just so bad that you'll get to the brink and then you'll go well okay I don’t want to cross that brink, I’ll happily accept something which I don’t really like but it’s better than the alternative.
Presenter: John, would you go along with that, or is it actually the worst thing that could happen, a break-up of the euro?
John Ventre: Well I think first of all I'd say we think the sort of decision’s been made to hold it together. The thing is don’t expect policymakers ever to say that, don’t expect their rhetoric to be kind of kinder to markets, because as sort of a public policy thing the best way of getting Greece or Spain or Italy to behave if you like is to keep the pressure on them. I mean you can't really let Greece off the hook by just jumping in, bailing it out and then setting it back on a normal path. So you can almost differentiate between what’s likely to happen and what the politicians are going to sound like.
We think the big game changer here is the involvement of a central bank willing to defend the currency. The sort of every reserve currency, every major currency in the world has a central bank willing to stand behind it in emergencies, and sort of part of the problem particularly in 2011 is, with Trichet at the helm of the ECB, the market didn’t believe that he would be there in a crisis.
Presenter: Okay, David, would you go along with the other two, the sort of belief in?
David Coombs: Yeah, I mean I think Europe doesn’t look as bad as it did last year, and I think one of the reasons is we have the German elections this year, and these are key, and these have been overhanging the markets and the rhetoric that John was talking about was quite extreme at times last year, you know, is Germany going to save those lazy southerners, this sort of stuff, not very helpful. Expect more of that in the run up to the German elections in October, no doubt, but I think we can look beyond the rhetoric. You know, I think there’s absolutely no doubt whatsoever that the ECB will stand behind the currency and will look to retain all members of the euro and do whatever it takes. If that means QE, it’ll be QE. It won't be called QE; it’ll come up with some other acronym that Europe loves, but it effectively will do the same.
So I think our view on Europe is probably zero growth next year would be quite a positive outcome, and actually if it is zero growth, that’s pretty positive for equities actually because the US growth we were talking about, if that can be sustained, together with a recovery in the Chinese economy, which I think is likely this year, now that the transition of the new governments have been accomplished, I think zero growth in Europe is just about okay to give us growth across the globe. And I think Europe can do that. I think the markets are a bit bored about Europe as well, I think we’re seeing less reaction in sentiment.
Presenter: But then when you take all of that view and express it in your portfolios, does that mean you're overweight European equities or underweight but less underweight than you were?
David Coombs: It depends on the strategy. We would overweight Europe in our most aggressive strategy, through some investment trusts that have all been on big discounts because nobody’s wanted Europe. In our sort of middle of the road fund, we are overweight Germany, underweight the rest of Europe.
Presenter: And, Nick, how are you expressing your European view?
Nick Samouilhan: It comes down to that argument we made earlier on where, so structurally we’d be underweight Europe, but there will be periods where because of some policy announcement Europe will definitely outperform, and you just be careful of that, and you need to be quite responsive. If there’s uncertainty you should just be neutral in the portfolios. So I think structurally we’d be underweight, but we’d be very careful of being underweight permanently regards what happens in the passing environment.
David Coombs: The only thing I should add is that in Asia over the last two to three months we've seen the spat between Japan and China, and we've seen exports from Japan to China drop dramatically. I think in October car sales were down 82%. Germany for example has been a beneficiary of some of this. So I think you’ve got to look company specific, and being underweight and overweight regions is becoming less important, and I think we’re spending less time on that and increasingly using global funds for example where managers have that opportunity to cherry pick European stocks that actually aren’t that reliant on what the policymakers do in Europe and are more reliant on actually what the policymakers in China are doing.
Presenter: I'd like to pick up on this point about the use of global funds, but Nick, just before I do, if you're structurally underweight Europe but you say there will be periods of great opportunity, how do you put a tactical play in on your books in a cost effective manner?
Nick Samouilhan: So it’s not a play; it’s just a case of we have a particular view which Europe will be underperforming. There’ll be times when the reasons behind that are no longer there, and what we do is just put on the futures in a very cost effective way, bring that up to sort of a neutral position that obviously depends on the fund itself, and we then look to take that future off in time when we feel that the underlying structural view comes back into being.
Presenter: Right, but you're not doing it by sort of buying more units in a European fund?
Nick Samouilhan: No, the idea is we always run our portfolios on the long term view, which we define as sort of seven years. That’s the view. There will of course, especially given this kind of environment, times when you would deviate from that view, and we try to do that very sparingly, and we do that very cost effectively.
Presenter: And when you look back over time, how accurate is the seven year view? If you went back to sort of 2007, does it add up?
Nick Samouilhan: It does, and so that’s not just us. Academic research shows that if you look at long term returns, so what’s the long term return from different equity markets, weirdly enough that’s quite easy to get right. It’s because next few weeks, next few months, markets get buffered around by animal spirits and Greek politicians. In the long term though what comes through is valuations, and if you can have some measure of valuation that markets would anchor on, then you can go well right now equities are quite cheap, so your returns would be higher than in the past, and you can get that broadly correct. Again in the short term it’s obviously focusing on things like politicians and policymakers, which is very hard to get right.
Presenter: Okay, now just on global funds, John, can I bring you in here? I mean if you, as a multiasset manager, start to buy a lot of global funds, aren’t you effectively saying you're investing in people that are pretty much doing your job for you, aren’t you?
John Ventre: Well I think David makes sort of a good point that markets are becoming more global, and you get stocks in markets which are driven less by kind of regional factors and more by the shape of their global business. Let’s not really pretend that Apple is really a US company, for example. It doesn’t make anything in the US and it sells most of its stuff outside of the US. That said we sort of believe in having managers based locally. It’s much more likely that you're going to know the company in a lot of detail if you're sort of focused on the home market. So we still are likely to use a limited number of global managers and much more likely to use sort of single region equity mandates and managers, but we’re not trying to restrict them to just trying to capture say the US economy because they happen to be a US equity manager; it’s really the closeness to the corporates that’s key for us.
Presenter: Okay, but are you sort of, can you see a day when your core of your portfolio will be global equity or global bond funds and then you would be expressing sort of more localised views via mid and small cap funds around the edges because they have smaller exports?
John Ventre: I think it’s unlikely, just because I think it’s quite difficult to find a global manager who can credibly profess to being an expert in companies that diverse and all over the globe. Well, not necessarily even an expert, but the best expert we can find, if you like, and that’s really our goal is to find the best people to manage these pots of money that we can, and accordingly we think we’re just much more likely to find those guys when they're focused on their home market, on businesses that they're closer to.
Presenter: Okay. David, where do you…?
David Coombs: We’re slightly different. Yeah, I take a slightly different view. I think ten years ago most global managers were benchmarked to the MSCI and I would totally support what John has just said in that context. I think we've moved on; I think there are many more interesting global funds. So we would look at global managers, your large cap core, you know, do you want to buy Apple or do you want to buy Samsung or do you want to, they can go anywhere to buy the best in class stocks in large cap. I think a global manager can add some value there; they're probably more top-down driven typically than bottom-up; and we see them as being quite a core part of the portfolio. Whereas, say take Latin America, for example, I'd want a manager that was not so benchmark aware, who was local - I totally support that view - but is probably playing in a mid and small cap area, so using their real specialism in that market, knowing domestic players, domestic drivers of sentiment. I don’t think you want a global manager picking small cap stocks in Brazil, for example. I think that would be a disaster.
So I can see a time when I have, they're not there yet, but when my core equity will be global and my satellite will be local bottom-up type managers. I think we are moving that way and I think we have to, my view is because, take the FTSE, we've heard the stats a number of times, it’s a global index, and I think it’s making less and less sense to allocate by listing rather than revenue.
John Ventre: So our sort of solution to this is to make our managers much more benchmark unaware, and in fact our portfolios tend to be quite concentrated at the stock level and look very not really like the index at all. And we’re making our asset allocation decisions, a bit like Nick, using passive instruments or using futures to almost differentiate the stock selection decision from the asset allocation decisions. Because there are certainly managers in our US portfolios that don’t really reflect the US market or the US economy, and that’s deliberate for a lot of the same reasons that David prefers a global approach.
Presenter: Okay, well, Nick, we can, because we've got a little bit of disagreement between David and John, I know we can't get a consensus on the panel, but we can get a majority. Do you tend to look at managers as either global or local, or a manager will always have a bit of global in the large caps and everything else is local?
Nick Samouilhan: Well I can straddle that, I think. So it depends on the particular portfolio we’re running. For our risk target funds, we do the regional approach, and we tend to put the emphasis on asset allocation as opposed to stock selection, particularly within equities, and most of the portfolio’s return is not from being under or overweight different equity regions; it’s the decision to be equities or fixed income or commodities and property and so on. So we spend far more time focusing on the broader overall asset split than we do worrying about sort of regional splits. Most of the portfolio’s return is based on that sort of long term positioning.
Presenter: Now I wanted to go a little bit back towards markets, a bit big where we are in the global economy. I guess the big bet that everyone’s been talking about is: are we facing a world that’s inflationary or deflationary? Nick, you were mentioning earlier having the long, you know, taking this long term view, what’s the Aviva take on where we are?
Nick Samouilhan: Actually, so over that particular horizon we don’t even have a view on inflation/deflation. We just don’t think it’ll be an issue at this particular point of time. We think that the severe capacity out there means that demand from inflation won't be the big driver right now, just talking more in general. We tend to, at the moment right now, spend lots of time thinking about both the underlying economics and where the policy response that will come on top of that. In terms of dealing with inflation, I think that’s a secondary concern to us right now; in two years’ time that might all change. But our worry right now is in terms of where’s the global economy going, and then, in terms of the actual phase of policymakers, how does it impact in terms of underlying portfolios.
Presenter: So it’s sort of a couple of years before you kind of might have to make a call?
Nick Samouilhan: That could change next week, but at the moment, yes. At the moment right now we’re not, our focus isn’t really on worrying about inflation/deflation, trying to proof the portfolio from that; it’s trying to make sure that given that markets essentially right now are managed by policymakers, what does that tell us in terms of the next short term outlook, and how does that tie up with our long term valuation bias.
Presenter: Okay. David, are you similar there or?
David Coombs: Okay, well, it’s quite difficult to tell because of where interest rates are and it is different this time. We say it’s dangerous to say it’s different, but it is. You know, we’re in an interest rate environment we've never been in before; we've got the Eurozone going on, that’s never happened before. So we think the most likely probability next year is actually below trend growth which is not inflationary. Globally, I'm talking about now first of all. And it’s not deflationary either. So if we were looking at scenarios and probability we’d say 50% probability that actually we have neither. In actual fact, we carry on a little bit like we have over the last two years. We would put a 15% probability on deflation, and we’ll have a few long dated gilts just in case that does happen, and then inflation’s probably about 30%. That doesn’t add up to 100 but you can do the maths.
So I think it’s clearly that we think the inflationary risk is greater, and that’s not surprising given the amount of quantitative easing. I think the thing to look out for and the thing that we’re very concerned about is debt cancellation. Because up until now we haven’t really printed money, you know, the Bank of England has bought the gilts off the Treasury Department. It’s if the Bank of England says you don’t have to pay us back then we would be very worried about inflation. And debt cancellation in the States or anywhere else, or Japan, that would then really start to make us nervous about inflation.
Presenter: John.
John Ventre: I think it’s probably instructive to try and understand in a bit more detail what’s actually happening with QE. All that’s really happening is that the Bank of England is owning gilts, and banks have significant deposits with the Bank of England. The inflationary risk comes if the banks start lending out that money, as opposed to effectively keeping it on their balance sheets doing nothing. That’s kind of commonly called velocity: the pace at which that money moves around the financial system, because really that’s the inflationary risk. So, for us, the kind of inflation versus deflation argument boils down to when is that going to actually start to happen; if it happens, what’s the response by policymakers? So if we see that begin to happen and policymakers don’t kind of put QE into reverse to try and address that and begin to put interest rates into reverse, then we are likely facing higher inflation and we’ll have to adapt kind of on the fly as that happens. But for the time being, you know, those deposits aren’t going anywhere, because banks are delevering.
Presenter: So, as long as it’s sort of like the Greenland icecap and it’s just frozen away there, we don’t have to kind of worry about the water level?
John Ventre: Well, it’s something we should watch very carefully to understand what the kind of next move is going to be, but I think that trying to predict what the next move is going to be in that respect is dangerous, because you’ve really very little evidence upon which to make a rational choice.
David Coombs: I think the danger in the UK though which is kind of unique to us is that we've already got inflation above yields, and we are seeing the consumer buffeted by inflation in terms of key things that they have to buy - energy, petrol, train fares - and they are seeing the average household inflation is probably higher than the headline. And I think this is something we do need to worry about and I think it is going to have an impact on the UK economy, which is why I do think we could enter, go back into recession in the UK next year, and we have got inflation actually that’s pretty high already. And I think index linked bonds will become a focus next year in the UK, because I think there will be inflationary fears. It may not actually come about, but I do think the markets will start to worry about it, whether it’s rationally or irrationally.
Presenter: Do you go along with it: a sort of consumer under pressure will lead to inflationary fears?
Nick Samouilhan: Sorry, will lead to inflation itself, or?
Presenter: Well, it will certainly lead to fear of inflation.
Nick Samouilhan: Fear of inflation, I think the point raised earlier is exactly right. Where we are right now is that the conditions for high inflation and the conditions for deflation are all there, and it’s a case of that doesn’t automatically translate into high inflation or deflation, but the conditions are there far more than they’ve been there in the past, and on the idea that inflation’s above yields, never forget that there’s a clear incentive for policymakers to have that happen, because it erodes the real value of the debt. So if you think as a policymaker what you want is you want to have inflation slightly higher than yields, and no one’s really noticed that, and back it up with QE and you’ve got a situation where you could see inflation picking up. At that stage you'd have to look into things like linkers. That could come next year, not sure I think right now we’re all sort of just watching and waiting.
Presenter: Nick, I've had a question in for you from Martin McCudden Smith, of Shepherds Law, he says, and he said this is to be asked in a slightly tongue in cheek fashion, but he said: “If you feel markets are in a seven year cycle, what year are we currently on?”
Nick Samouilhan: It’s not a sort of cycle, so it’s, how we do it is we say that if you look at equity markets, if you look at corporate bonds, the rough period where if you take a valuation bias when markets were returned to that valuation, that’s roughly seven years. And that is the way we manage the fund; we don’t look at it in the sense of an economic cycle. So maybe I can rephrase that question sort of where are we in terms of our valuation outlook? Our valuation outlook is that equities, compared to their long term average of where we think they should be in terms of valuations, not terribly expensive, not terribly cheap. They are exceptionally good value though compared to say government bonds, which are very expensive compared to where they should be, and especially to cash.
Presenter: So the measure you're talking about is an absolute measure of equity values rather than relative to bonds or any other asset class?
Nick Samouilhan: It depends, so yeah, the answer is: are equities cheap? Well in an absolute basis not terribly cheap. Are they cheap versus bonds? Absolutely.
Presenter: Okay. Would you go along with that as well, just while we’re on equities? It’s a bit unfair; it’s a very general question to ask.
David Coombs: Yeah, I wouldn’t disagree with that. I mean we’re talking about reversion to mean theory I think really, and yes I totally support that. Equities don’t look particularly cheap on that theory; they do look cheap versus government bonds. I think they look even cheaper versus corporate bonds actually. I think corporate bonds look far worse value than gilts even.
Presenter: Okay, we’ll come to, sorry, John, you wanted to come in on this.
John Ventre: I might perhaps argue that equities are really cheap on an absolute basis, not necessarily -
Nick Samouilhan: Are you going to?
John Ventre: Yeah, no, I am in fact, yeah. Not necessarily relative to their own valuation history, but equities have a sort of cyclical risk in them. Corporate earnings are linked to an economic cycle. Those cycles are pretty deep, pretty volatile. Actually over the last 50 to 100 years, while the economic cycle seemed to get shorter, they also seemed to get shallower. So the sort of distance from the peak of the cycle in terms of nominal economic growth to the trough gets narrower, and as that gets narrower, corporate earnings should be less volatile. As a result, there is a decent argument to my mind that equities in that environment, if that environment sort of persists, that equities can trade at a higher valuation multiple than they have done historically, and they currently trade at a substantial discount. The great thing is I don’t have to kind of make that call now, because they're so cheap relative to other asset classes that kind of having a bias towards equity is the right thing to do, whether you buy the argument I've just made or not.
David Coombs: So going back to my point earlier, if we do see earnings upgrade surprises in the States for example next year, then the current P/Es will obviously will have looked cheap. So if you buy into the fact, so if you're in the camp that says we’re going to see a recovery in the global economy and we’ll see earnings upgrades, then actually equities will look cheap in an absolute sense as well.
Presenter: Now very quickly, David, just back to inflation/deflation, you said you’ve been buying some long dated gilts, which I presume is your sort of deflation hedge if you like.
David Coombs: Correct.
Presenter: You think there’s twice as much chance of inflation, so what’s your inflation hedge that you're buying?
David Coombs: I hold index linkers, both UK and overseas, including emerging markets, where obviously you’ve got higher levels of inflation in emerging markets, so. So I've got twice as many index linked as, I mean it’s not quite as simple as that, but in terms of duration, you know, I'm buying very long duration gilts, kind of hoping to lose money if I'm being honest, but in there as a hedge. I think we will see higher levels of volatility next year for some of the reasons we've talked about. You know, there will be European buffers, etc. So yes, I have got more inflation hedging in the portfolio than I have deflation hedging. But because we’re kind of in that balance I feel it’s appropriate to have both. It’s not very fashionable to be buying gilts, I know, but I think they're the most effective and cheapest hedge right now for that deflationary risk.
John Ventre: We do still hold a few gilts as well, and in a very similar vein I'd be delighted if I lost money on them. People ask me is it a risk, I'd be delighted if I lost money on them. If we lost money on gilts, the rest of the portfolio would certainly do well enough to compensate.
David Coombs: Well, unless hyperinflation of course.
Presenter: Well, and at the other end of the go, have you got index linked gilts?
Nick Samouilhan: No, actually we find them too expensive. So, while I completely agree with if you like the thesis that David talks about, we’re really valuation sensitive, and accordingly a lot of what we've talked about is reflected in prices, so they're a bit too expensive for us.
Presenter: So more equities would be your inflation -
Nick Samouilhan: Yeah.
Presenter: Okay.
David Coombs: I mean I think they are, I mean I agree they are expensive, but our concern is if we do have inflation above trend, that’s negative for equities, and negative for conventional gilts, so the index linked gilts then come in as a hedge again. But, yes, on a valuation basis, I wouldn’t buy index linked.
Presenter: I thought you were going to say you'd met somebody who’d sold them to you cheap to justify it, and I was going to -
David Coombs: Mr Osborne.
Presenter: Yes. Nick, I know you said that inflation is, and deflation is not, you know, the conditions are there, but you don’t think it’s something that’s going to potentially tip either way. But, given that, do you have a few gilts and a few index linkers in there just at the back?
Nick Samouilhan: We don’t have any index linkers for similar valuation reasons, we do have gilts though, and we hold them because if you look over the last year, the only thing that’s been really protection in the portfolio when you have risk off are these gilts. So we hold them as cheap insurance, not against inflation but just if there isn’t a leg down in markets, the protection you'll get will be from those. You're not going to make terribly lots of money from gilts over ten years; you could easily lose money in real terms. But that’s fine because the rest of the portfolio will give you the return. But, if you are managing volatility, if you're trying to get the risk within a certain band, then you need to have something that gives you protection when you have another leg down, which could come next week or the week after, you're not quite sure. So we hold them purely for protection reasons, not for long term return reasons.
Presenter: Okay, I wanted to move, we've got about five minutes left, so I wanted to move onto the issue of non-correlated assets, everyone’s talking about the importance of being non-correlated and then saying it’s very hard to do. Is it impossible, John Ventre?
John Ventre: Well I think it’s increasingly impossible in liquid assets, and I think the reason correlations are rising, it’s fairly logical. As you start to use more, as the whole industry starts to use more alternative and historically uncorrelated assets, they own more of those assets, and then when the crisis comes they all get very risk averse and sort of delever their portfolio. Obviously they sell a bit of everything and that includes selling the things that are uncorrelated. So things which you kind of don’t trade every day can be uncorrelated, things like property, for example, things like commodities, and particularly agricultural commodities where you get sort of supply shocks, and it’s less just about the demand side, it can be de-correlated. But it is increasingly hard to find, and I think we have to live with the fact that assets are more correlated at least than they have been historically.
Presenter: You almost sound as the only way to get an uncorrelated asset is one that you won't let a human being trade.
John Ventre: Well, not in the extreme, but I'm sort of trying to I suppose analyse the extreme to effectively the more actively things are traded, the more correlated they're going to be.
Presenter: No, I mean I take your point, if I'm feeling depressed about the outlook for markets, that will be expressed. You know, if I could put a price on everything across all the assets I held, not just, I wouldn’t be bullish on equities and bearish on something else.
John Ventre: Yeah, and it could easily happen that professional money managers get significant outflows from the funds that they manage in a very negative outcome and accordingly they kind of become forced sellers of a little bit of everything.
Presenter: And, Nick, I mean do you believe that you can find uncorrelated assets, or is that a bit of?
Nick Samouilhan: Well I'd say the key is adding, as you highlighted, the key here is to separate short term correlations with actual underlying correlations. So, if you have a time when it’s risk off, what is going to happen is that most asset classes will correlate, because as risk off everyone will sell out, and the only reason it properly doesn’t correlate is because we don’t sell it each day - that’s the only reason. Beneath that though there are underlying structural correlations and if you're building a portfolio and you can look past that then there are uncorrelated asset classes out there. You just need to understand the drivers beneath them.
So take gold right now, gold at the moment, everyone highlights that gold and equities are trading very closely together, that’s partly the short term issue. It’s also because behind that what’s driving equities right now, certainly in the last two big markets we've seen, has been expansionary monetary policy. That’s also the big impetus behind gold rallying because that will lead through to inflation. So if you can understand the drivers behind things, you can understand the correlations of those returns over time.
Presenter: And do you take a seven year view on these correlations in the same way that you do on?
Nick Samouilhan: So we do both things, right. We always, our starting point is always what’s the long term view on things, and we then have long term views on returns, volatilities and correlations, and that is a structural correlation. We then also look at what would happen for short term effects, what’s the short term correlation. In which case correlations, they're not 0.4, 0.5; they're 0.8, 0.9 often.
Presenter: But depending on your starting point for say judging a ten, say or, say a seven year period for the correlation between equities and bonds, presuming on the year you picked as the starting point for that, you could come up with a totally different correlation over seven years between these two?
Nick Samouilhan: We tend to use very, very long periods of correlation.
Presenter: You're using rolling?
Nick Samouilhan: Well not for all, well for instance we could easily use 50 years for that data, and then there’s a sense check of that. So you'd sense check what the long term value of correlation you're putting in there, and that could easily have broken down recently, in which case you just need to be careful about which number you're using for that. It’s making sure that you’ve, you need a starting point, and our starting point is always long term valuations, long term drivers. You then need to be careful about short term effects, and we tend to stress test our portfolio for a variety of different outcomes. That doesn’t mean we’re going to make money all the time, but it does mean that we’ll know if certain things happen what the effect will be on the portfolio, and if that’s going to be widely different from what clients expect we take actions to stop that.
Presenter: And, David, I’ll come to you. When John was mentioning property as an uncorrelated asset, a slightly quizzical look, is that a difference between property shares or physical?
David Coombs: I just don’t think there’s any such thing as an uncorrelated asset, because it’s about the situation that you find yourself in. So for example in 2008 commercial property was highly correlated to equities, because commercial property is quite cyclical away from London prime. So I think looking at long term correlations for asset classes is quite dangerous in how you set strategy; you have to look at the here and now and where you're likely to go. And we discussed this just now in terms of everyone says gilts and equities are negatively correlated, well they are until they're not, and when they're not is when you have a significant inflation shock, because it’s bad for both asset classes. And if you only held those two, thinking you had a perfect portfolio, you'd be in for a surprise.
So the point is you’ve got to look at different correlations of different scenarios and the likelihood of them being repeated. There’s no point setting a portfolio that’s been uncorrelated for a layman’s type event when that’s never going to happen again in the future, he said carefully.
Nick Samouilhan: Yeah, the key here is that correlation is sort of the third most important thing you should look at. It’s no use buying ten uncorrelated things if they're all expensive. So you need to generate returns from that, and correlation is just something you look at, as a third point, make sure when you buy things, you're buying it for the correct valuation reasons.
Presenter: And very quickly though because we've just got to finish, what’s the correlation between index linked gilts and 30 year gilts at the moment? You’ve got them for different reasons at either end of your portfolio.
David Coombs: Today, I don’t know, I'm sorry. I think, I mean index linked gilts are expensive because they're break-evens. They are almost perfectly negatively correlated for the last three to four months, because you’ve seen a positive return from conventionals and a negative return from index linked, therefore they're uncorrelated, there you go.
Presenter: Okay, a final quick question for everyone. Nick, if I could start with you first, almost the end of 2012, we’re looking at 2013, should you be bullish on the outlook for markets for 2013, bearish or neutral?
Nick Samouilhan: We’re reasonably bullish. So the way we look at the world is we have our main view, which we think, we call it better days. It means that you're not expecting spectacular growth, but there will be growth. There will be zero growth in Europe, but that’ll feel great. And that’s in general a very positive view. The remainder is that we do see a small chance of another fiscal crisis in Europe, whether that mutates into financial crisis we’re not sure, and there’s another chance of a growth store, principally in the US, and again that feedback between the fiscal cliff and consumer sentiment is key.
Presenter: So reasonably bullish but there are potential rocks out there. David Coombs?
David Coombs: Reasonably bullish, although we think there will be more volatility next year. Actually volatility this year has been pretty low. It hasn’t always felt like it but technically volatility has been low. We think it will be more significant. But that isn’t necessarily a bad thing; that could be an opportunity. But overall things look a lot better than they did 12 months ago.
Presenter: John Ventre.
John Ventre: Yeah, I think a similar view, although I'm the guy who will always say I reserve the right to change my mind next week if different evidence presents itself, so really -
Presenter: If anybody’s watching this on the replay you could have a very different answer.
John Ventre: Well, exactly, so I think what I would say is certainly current view is very constructive. We’re overweight equities; we’re underweight gilts. We’re reflecting I guess a lot of the things that we’ve talked about in this session today, but that doesn’t necessarily represent a 2013 view for me, but rather one that could adapt to different news flow or evidence.
Presenter: Gentlemen, we have to leave it there. Thank you very much indeed for taking part. Thank you for watching Masterclass, from all of us here, for the moment, goodbye.
Information and opinions contained in this interview have been arrived at by Skandia Investment Group. Skandia Investment Group and Asset.tv Ltd. accept no liability for any loss arising from the use here of nor make any representation as to their accuracy or completeness.
Any underlying research of analysis has been procured by Skandia Investment Group for its own purposes and may have been acted on by Skandia Investment Group or an associate for its or their own purposes. Skandia Investment Group is authorised and regulated by the Financial Services Authority.
Information and opinions contained in this interview have been arrived at by Rathbone Unit Trust Management. Rathbone Unit Trust Management and Asset.tv Ltd. accept no liability for any loss arising from the use here of nor make any representation as to their accuracy or completeness.
Any underlying research of analysis has been procured by Rathbone Unit Trust Management for its own purposes and may have been acted on by Rathbone Unit Trust Management or an associate for its or their own purposes. Rathbone Unit Trust Management is authorised and regulated by the Financial Services Authority.
Information and opinions contained in this interview have been arrived at by Aviva Investors. Aviva Investors and Asset.tv Ltd. accept no liability for any loss arising from the use here of nor make any representation as to their accuracy or completeness.
Any underlying research of analysis has been procured by Aviva Investors for its own purposes and may have been acted on by Aviva Investors or an associate for its or their own purposes. Aviva Investors is authorised and regulated by the Financial Services Authority.
Advanced
Slide Mode:
Off
Structured:
Nonstructured
Company info:
Contact: Asset.tv