<p>Low interest rates and high equity valuations are putting the squeeze on investors. Join three panelists from Natixis Global Asset Management for a discussion on topics including:</p>
<ul>
<li>Weak growth and central bank policies</li>
<li>Global megatrends and opportunities</li>
<li>Worries and wild cards</li>
</ul>
Video Image:
Duration:
0000 - 00:54
Recorded Date:
Thursday, June 16, 2016
Transcript:
Gillian: Welcome to Asset TV, I am Gillian Kemmerer and we are here live at the Morningstar conference in Chicago, welcome to our Master Class, with high evaluations, lower rates and volatility, the new normal. How do you position in this market, and where do the opportunities lie? Well, luckily we’re here with three panelists who are [inaudible] global asset management, who are going to share their expertise on where the opportunities and challenges are ahead for the rest of 2016. Please submit your questions because this is a live taping, we’d love to hear from you. There is a question box at the bottom, underneath your video screen, so please send your questions and we will review them and pose them to our panelists. So without further ado, let me introduce them. To my immediate right is David Lafferty, the Chief Market Strategist at Natixis who will talk to us about capital market and portfolio construction. Next to him is Dawn Mangerson of McDonnell Investment Management, she’s our US taxable and municipal bond specialist. And finally we have [inaudible] who will bring us up to speed on global trends and sustainable equity investing. Thank you all so much for joining us here today. So, Dave, I’m going to start with you. Can you give us your take on the market and what the environment looks like for investors right now?
David Lafferty: [0:01:10] You know, I think if you take a step back and look really big picture, the global macro economy is really stuck in kind of a rut. And I guess it’s not a surprise, the big trends that are out there, we need population growth. We don’t have a lot of that in the developed world. The workforce in China is not growing very fast; they have plenty of population but not a lot of workforce. Japan has demographic problems, Europe, the US, so we’re not getting a lot of population growth, that’s one of the long term drivers of economic growth. If you don’t have that, you need productivity growth, that’s been a bit of a mystery, we can’t seem to find that anywhere. And so as a result without a lot of population growth and a lot of productivity growth, we’re stuck in a very low nominal and real growth environment, without a lot of catalyst to sort of get us to break out of that environment. We don’t see anything on the horizon right now that sort of spawns us out of that environment. So I think we’re sort of stuck in a rut, neither of those things, productivity or population growth can be solved overnight. They’re very long term problems. So I think we’re going to be in sort of the status quo at least for a little bit while longer.
Gillian: [0:02:21] So we’re seeing sluggish fundamentals but valuations are high?
David Lafferty: [0:02:24] Yeah. I mean this is ultimately the problem that the asset allocator has today is interest rates have been low for a while, that’s sort of the beginning of a whole bunch of asset allocation problems. But at least we had decent fundamentals on the equity side. After the crisis, you know, we were down at 10/11 times earnings. Now we’re at 18 times earnings, while interest rates have been low for a while, at least equities weren’t overpriced. We don’t think equities are overpriced now but they’re elevated, they’re not cheap anymore. So for the asset allocator, that combination of low interest rates and elevated valuations is a bit new. And that forces some really hard choices on investors today.
Gillian: [0:03:01] Sure. Dawn, what about you, what are you seeing broad strokes?
Dawn Mangerson: [0:03:03] Well, I’m a little bit more happy than Dave seems to be from a global perspective. Actually when you look at the domestic economy and where interest rates are here, it’s much more attractive than globally. However, you know, we still have to take into account what is going on globally. You know, everybody’s eyes have been on what The Fed is going to do. And I think right now our bigger risk is for lower yield as opposed to higher yield, whereas last year, you know, everybody in the fixed income goes, “Well, are they going to raise rates? They’re going to raise rates.” You know, everybody’s worried about it. And I think right now it might be a little bit more a welcome to have some higher rates, maybe a little more inflation. So I think domestically we should be a little happier about our status within the global context.
Gillian: [0:03:48] Sure. And we have an FOMC meeting a few days from this particular taping. But broadly speaking for the rest of the year rates will continue to be on investors’ minds. And I think it seems like the rise may not happen in June, what are you thinking?
Dawn Mangerson: [0:04:00] Well, the market’s pricing in definitely later in the year now, after the Jobs Report came out was a little disappointing. I think that’s what we were thinking could happen, it’s a little difficult to raise rates in an environment where the global economy, like Dave mentioned is pretty weak.
Gillian: [0:04:20] Right. [Inaudible] what about you?
?: [0:04:21] Yeah. Well, Dave touched on a few points already, some of the valuation and global economic growth. I think on top of that in the next couple of weeks and months, volatility will actually remain quite high linked to more macro or political type events. You know, there’s the big Brexit debate in Europe, there’s the US elections coming up, earlier this year and it continues there’s a lot of discussions about Chinese economic growth and that all has an impact on equity markets in general. So when Dave touched on economic growth that also has an impact on earnings growth. We still think that from an earnings growth point of view this year, you’re pretty much looking at max flat numbers. But that’s for the market as a whole. There are pockets of value and of opportunities elsewhere. When Dave talked about population growth for instance linked to the political situation. And then in Europe they have migration as a big topic today as one of the solutions as well. So if we have a bit of a longer term view on some of those demographic trends, there are actually good valuation opportunities as well.
Gillian: [0:05:23] Interesting. You’re saying the exact opposite perhaps of demographics in Europe, with populations rising due to the refugee crisis. But it also may introduce its own set of challenges in macroeconomic growth.
?: [0:05:35] Sure, sure. And specifically over the short run it will really cause a lot of stress in Europe. And that’s something that will continue I think to [inaudible] markets in the next couple of months.
Gillian: [0:05:44] Right. So, Dave, coming back to you, you’ve mentioned some of the challenges that investors are facing right now. And it seems like traditional [inaudible] may not be working as well as they used to, so can you talk us through that a bit?
David Lafferty: [0:05:55] So I think traditional portfolio construction is very tough right now. At the end of the day I like to think that beta has kind of gone into hibernation, is the way that I think about it, interest rates are very low as Dawn mentioned, not so low in the US, but very low around the rest of the world. We kind of know what we’re going to get from our bond portfolios. It might be a positive number but it won’t be a very high number. And stocks broadly speaking, I agree with [inaudible] point, I think there’s a lot of interesting pockets of valuation in the indexes. But the overall value of the equity indexes is not that great. And so I think returns in the broad global equity markets will be constrained, won’t be terrible. But I think that they’ll be constrained. So those two key beta drivers, those big index returns on your return that comes from interest rate risk or the bond market or from equity risk premium and the stock market, those two numbers don’t look that great today. So you really have to kind of stretch your wings a little bit. And I think the world has become a bit more in the current environment, more about finding alpha, those dislocations that [inaudible] mentioned in the market, instead of relying on the returns of the overall market.
Gillian: [0:07:05] And what are some of those opportunities or pockets that you’re seeing right now?
David Lafferty: [0:07:09] Well, I think they certainly have struggled more recently. I think it’s been a very tough environment for alternative investments, broadly speaking that’s a big catch all. There’s been some pockets of strength, some pockets of weakness. But I think managers that can take advantage of the dislocation, that’s one way to find it. If you can find a manager that can generate 100 or 200 basis points of alpha in a world where a lot of the bond market only gives you one 1 or 2% total return, then if you can find a manager that can find some of those pockets and sort of extract that value from the dislocations, there’s something to be seen there. I also think there’s some value in the credit markets. We don’t love super high quality sovereign bonds. But there’s parts of the credit markets, whether it’s bank loans, high yield or the lower end of investment grade, they don’t offer fantastic value. But when everything is sub 2%, they’ll offer decent value. So I think there’s a little bit of some leeway that the asset allocator can have on the bond side as well.
Gillian: [0:08:09] Sure. And we’re going to come back to the bond market in a second. But, [inaudible], I want to direct to you as we’re on equities right now. Are you seeing the same dispersions?
?: [0:08:15] Yeah, sure. And I agree with, David, he said that the days of beta are over. And in a low growth environment, it’s really important we believe to find transparent growth because there are areas in the market that are growing, specifically if we’re looking at a rising middle class in emerging countries. If we look at the annual trends, like in an aging population where we actually see baby boomers retiring now with more needs on healthcare in the next couple of years. We see millennials taking over as well in the economy in general. And they have a different mindset to, you know, what we have seen in the last couple of years. And that’s all providing a lot of opportunities. We also see valuation opportunities linked to areas that have underperformed in the last couple of years. Think about energy, and specifically when you bring into account or into the debate the recent agreement in Paris that we’ve seen on climate change, where the world has really taken an important step towards lower carbon economy with the big financing needs for solutions going to energy efficiency and renewables. We also see more opportunities in water and in agriculture going forward as well. So from a growth point of view and a valuation point of view, there are really pockets of interest in the market today.
Gillian: [0:09:25] And it appears that many of those are related to sustainable and long term growth measures?
?: [0:09:31] That is true, that’s specifically on the opportunity side, when you take a long term view in terms of how we believe or how you believe that the world is going to evolve over the next 10 years, it is geared up. And there’s a lot of unsustainability in the way we organize our economy today. And moving to a more sustainable low carbon model for instance from an energy point of view, a bigger focus on healthcare and education is definitely going to drive a lot of investments going forward as well. But at the same time we’ve seen a lot of the negatives about unsustainable behavior in the more recent years as well. And think about Volkswagen for instance, think about British Petroleum in the Gulf of Mexico, think Electric Power to Toshiba etc. And from that point of view, companies are actually taking action as well, partly linked to new regulation, to change their behavior and partly because the investors are driving them to actually change their models.
Gillian: [0:10:24] So they are responding to investor demand for this focus on sustainability as well?
?: [0:10:27] We certainly do, yes.
Gillian: [0:10:29] Dawn, talk us through some of the trends, are you seeing some of these similar trends or issues echoing throughout the bond market too?
Dawn Mangerson: [0:10:37] Especially in the muni market, the one place I want to touch on demographics like [inaudible] mentioned, also with some other sustainability type issues going on, working on a lot of green bonds being talked about in the muni market. And I’ve been in the muni market for over 20 years. And I’ve always been of the mind that a lot of what’s in the muni market is good for communities and the economy. We’re investing in clean water projects. There’s all kinds of things they can be invested, hospitals, schools, wind power, a number of different things in those sectors. But the other thing with demographics is the aging of America, the people, the investors. And traditionally, when you mention traditional investing, traditional investors are high net worth, you know, when they retire they want some tax exempt income. They want more income as they retire. And they’re concerned, like I mentioned earlier, the fear or the risk for them is that rates stay low. And the income component needs to be built up. So munis though are attractive, we’re actually seeing foreign investors saying, “Hey, I can get positive yield going into the muni market.” So right now in the muni market one of the biggest issues might be that we’re going to see too much demand come into the muni market. You know, you can buy munis at a 100% of treasuries, where historically they’ve traded at a lower yield, so there’s no give up to treasuries, to go out of a [inaudible], you know, sector into a municipal sector. And you know, negative yields in the foreign, you know, to foreigners or foreign investors or positive yield. It’s a good story.
?: [0:12:17] Yeah. And those demographics are not really going to change, on the contrary, they’re going to continue to be stronger. And then that demand for higher income I believe will actually continue to put pressure on yields globally.
Gillian: [0:12:30] Interesting. And kind of building on this, you’ve mentioned that demand is skyrocketing for munis, but it seems that supply was a little bit depressed going into this year. Do you see a pick up coming and what will drive it?
Dawn Mangerson: [0:12:40] We would love to see a pick up in supply. Right now it’s a little bit of a technical issue. Munis rely on a lot of refunding issuance, just like when you see rates fall, people refinance their home. There’s a lot of issuers that can refinance their debt. But right now they need to be able to get enough yield to put in an Escrow in order to pay off their debt when it’s called. And there’s negative arbitrage is what it’s called, they just can’t get enough in the treasury market to call that, refund that issuance. So we’re relying on that to increase the supply of the muni market.
Gillian: [0:13:17] Now, and Dave, kind of bringing it back to you. What funds are you focused on and what are the implications for the way that you construct portfolios?
David Lafferty: [0:13:23] Well, I think these guys have hit on some big ones. From a portfolio construction standpoint, I think Dawn has really hit on some of the opportunities in the bond market. We don’t love low yielding interest rate sensitive sovereign stuff, high quality bonds, just not attractive. But that’s not a reality for most clients; they need ballast in a portfolio. So within a high quality bond portfolio what’s the best stuff that you can find? Munis would be one of our favorite areas. Again, we don’t like … I think of munis as being a high quality asset class. We don’t love high quality because we think low yield’s an interest rate sensitive. But if I have to be in that space, munis is one of the places we think we should emphasize as Dawn mentioned, they’re basically trading in line with treasuries. So you’re picking up the tax advantage for free. Another place in the bond market might be TIPS, again treasuries; we don’t love high quality stuff. But if you have two risks in the bond market, one is higher real growth, higher real rates and one is inflation, at least something that’s inflation protected takes one of those two risks off the table. I don’t know that inflation is going to go through the roof. But at break even rates of 1½% out 5 and 10 years, inflation looks a little underpriced to me. So again, we don’t love treasuries, but if you had to force me, I like Munis and TIPS more than I like anything else in that space.
Gillian: [0:14:41] Sure. And [inaudible] have been piling into 10 year treasuries, despite the risk that they’ve been taking on, particularly the duration risk, so [inaudible].
David Lafferty: [0:14:48] Yeah. It’s amazing that people are willing to take on 8½ years of duration risk for a 160 basis points. I know clients and investors will tend to follow past performance. But the fact that the US Aggregate Index has a 4 or 5% return over the last 5 or 10 years, doesn’t look anything like what it’s going to be going forward. People have to remember that basic bond math. And again you need high quality in a portfolio, so you’ve got to sort of pick your poison. And right now I think TIPS and munis are two of the best places to find that kind of ballast in a portfolio.
Dawn Mangerson: [0:15:24] And I would just add on to what Dave’s saying is basically, you know, with munis, they’re a really nice complement to some of the riskier asset classes that Dave likes. And as far as treasuries go, I mean typically if we do see rising rates, which would be nice, munis are defensive. They typically in a rising rate environment are going to outperform treasuries. So if in 10 years you can get a muni at the same yield you can get a treasury, and we do see rising rates, you should be pleasantly surprised if they would outperform in that rising rate environment.
Gillian: [0:15:55] It would be a good thing to keep in mind because a lot of investors are trying to play defense, but many of them it seems are looking for treasury instead. So we actually have a question in from the audience, so I wanted to quickly direct that to you. I’m not surprised that this is one of the first, so let’s talk about energy and oil prices. Dave, I’ll start with you, broadly what is your outlook for the commodities market?
David Lafferty: [0:16:14] Well, broadly, I mean we don’t follow all commodities the same. We certainly spend a lot of time on oil. We sort of have to at this point, given the volatility that it’s created in portfolios. Our longer term view which is played out much faster than I thought was that oil would eventually normalize, when the price of West Texas Intermediate get down to around $30 a barrel we were saying, “Look, the normalized long run price of oil should probably be 50/55, maybe just over $60 a barrel.” That turned out to be a pretty good guess as we backed up towards 50. But what I do like to point out is that was our view over the next few years, and had happened almost right away. I was very surprised at how quickly the price normalized. I think we’ve seen some supply shocks, Nigeria, Iraq, Libya, there’s some places where the wildfires in Texas … excuse me, in Canada. So there’s been some supply shocks, but it’s probably goosed the price a little bit more than we would have expected. But we think in the long run it probably normalizes in that $55-65 a barrel. We just think that the ability of the US to put on what’s often referred to as this short cycle supply, the fact that horizontal drilling and fracking can come online so quickly. It’s hard to imagine oil going back to $80/90/100 a barrel unless there’s some macro shock. But on an equilibrium basis, 55-60 is sort of where we think it’ll level out over time.
Gillian: [0:17:49] Sure. I’m always seeing some interesting developments that would cut supply, we also have [inaudible] not to do so. So there’s definitely a pull and a push in that respect.
David Lafferty: [0:17:57] Absolutely. And it’s tough because in the long run what we’re leaving out of this discussion is demand, and we don’t really know where that demand is going to fall in the long run for many of the things that [inaudible] is looking at in terms of macro trends around energy conservation and alternative energy. We have a sense of what the supply curves look like, I don’t think necessarily we have a great idea of what the demand curve looks like out, you know, maybe in the next year or two. But out 5 or 10 years I think it’s a lot harder to figure out what’s going to happen with demand for high drill carbon. So I think it’s a tough picture to analyze.
Gillian: [0:18:32] And we have questions flowing in [inaudible], I want to quickly direct to you to give you the opportunity to tell us about energy from your point of view, the sustainable.
?: [0:18:39] Yeah. So obviously when people talk about energy and in most cases talk about fossil fuels. But we see a lot of interesting developments mainly on the demand side as well but also on the supply side. So energy efficiency is actually on the demand side, really, you know, gaining a lot more traction. So getting more output with the same or with lower input ideally. And we see that in building efficiency, in transport efficiency, industrial efficiency. And companies are changing their business models to actually make opportunities, consumer products, industrial products that are more efficient. And that’s actually been one of the main reasons why demand has actually not increased as much as what a lot of people thought over the last couple of years because, you know, we are a lot more efficient than what we used to be, and that will continue. At the same time there are risks involved for traditional utility companies, mainly because of the carbon content of the fossil fuels, mainly coal that they use to generate the electricity. And in regions like Europe where renewables always get priority, but more and more in the States and in emerging countries as well. But they’re actually looking at, you know, their assets and they find them stranded, they don’t yield the returns anymore that they thought they would yield. And because of new technology mainly, you know, price decreases, and technology advancements in renewable energy mainly on the solar side, combine that with battery storage that is actually decreasing in price as well. And that trend we believe is going to continue as well. So there’s not just opportunities, but I think when you take a traditional benchmark approach and invests in utilities, I think this is definitely a risk you have to take into account.
Gillian: [0:20:18] Interesting. So Dawn we actually have a question specifically for you from Santos, Santos asks, since we are almost at negative interest rates, why has the muni NAV not gone up?
Dawn Mangerson: [0:20:27] I’m sorry, could you repeat that?
Gillian: [0:20:28] Of course. Since we’re almost at negative interest rates, why has muni NAV not gone up?
Dawn Mangerson: [0:20:34] I don’t know if I can answer that question. Negative interest rates, we’re not at negative interest rates in the muni market. I’d say right now in the 10 year space we can still get a yield of 2% or more. What I look at for the muni market is it’s an asset class, it’s a high quality asset class, positive valuations, attractive versus other asset classes. It’s a nice place to invest as far as when you have the socially responsible investment, when you’re looking at demographics, it’s somewhere where people can put their money and like Dave mentioned, it’s a nice foundation so that you can add, if you need a little bit more risk in your portfolios, it’s a great complement to put, you know, just to have that muni component in there. Do you have a better answer, Dave? I need maybe a little help on this one?
David Lafferty: [0:21:25] I don’t know if I’ve a better answer, maybe I’ll add a little bit to it because I think you hit the nail on the head, you talk about when rates back up that munis tend to be a little bit more defensive. The flipside of that is when rates rallies, munis don’t rally as much because they’re not a flight to quality asset, you know. So people … so what we’ve seen and Dawn sort of summed this up when she said, “Yeah, there are negative interest rates out there but that’s not what we see in the muni market.” Sovereign rates have plunged into negative rates and the question was about, I assume, NAV funds. Yeah, your funds rise. In the muni market interest rates have come down a little bit. But they’re not plunging like we’ve seen in the sovereign market. So the same way that munis can be a bit more defensive when rates back up, you also don’t get as much of the risk off trade when interest rates fall in munis. And that’s sort of the good, you know, what hasn’t worked is interest rates have fallen, it’s likely to play out in your favor when rates start to back up in the muni market.
Gillian: [0:22:19] Sure. We have another question from David which I’m going to address to all of you. He wants to know if there’s anything unusual happening in the markets or any opinions being expressed [inaudible] nearing presidential election? Who would like to take that first?
David Lafferty: [0:22:32] Well, it’s dangerous but I’ll go first I guess.
Gillian: [0:22:35] [Inaudible].
David Lafferty: [0:22:36] Yeah. I don’t have a particular interest necessarily, or a routing interest in whoever wins. I think we, as I started this by talking about, I think there are some real structural issues that I’m not sure either of the presumptive nominees is going to solve overnight. So I don’t … and I think it’s far too early to begin building an investment plan around who might win and what policies they might implement. I think it’s far too early to get wrapped up in the geopoliticals aspects of the, you know, we don’t have running mates yet. We don’t have, you know, any good polling day to going into the fall. And so I think there’s just a lot of unknowns out there. I don’t think investors can be building an asset allocation or a portfolio around the US election. I will say though, so I don’t have a lot of confidence about how it all plays out. I have a lot of confidence that Mr. Trump brings more volatility to the election season. And people will argue about Mrs. Clinton’s policies versus Trump’s policies. But I think what people really miss is that what Wall Street doesn’t like is the unknown, the uncertainty. And you may love Mrs. Clinton, you may hate Mrs. Clinton but you can’t say you don’t know Mrs. Clinton. She was in the White House for 8 years. She was in the Senate for 8 years. She was Secretary of State for 4 years. The market knows her, love her or hate her, we know her. We just don’t know about Donald yet. And what we do know might change tomorrow. So he hasn’t laid out a lot of policies. I don’t know that the market will dislike him, but I think volatility will not be your friend as we move into the fall.
Gillian: [0:24:13] Sure. And volatility it appears shall become the new normal with or without the US presidential election playing in. So it certainly may augment some of those swings.
David Lafferty: [0:24:20] Yeah, absolutely.
Gillian: [0:24:22] Would you like to add anything else?
?: [0:24:24] No, just I agree in this volatility, I think that the uncertainty is going to drive the markets. And then volatility may actually, you know, lead to opportunities over the long run. So whoever’s going to win, they always have to work with Congress as well and they have a team around them. And eventually whatever extreme or however extreme the opinions may be going into the election, it’s never really going to work out exactly in that way. So if there is increased volatility and there’s specifically a, you know, a pullback in markets probably we’ll see it more as an opportunity to strengthen the [inaudible] possessions in the portfolio than to do anything else.
Gillian: [0:24:58] Sure. And Dawn?
Dawn Mangerson: [0:25:00] I don’t have an opinion either way. But basically what I would like to see out of Washington is a little less austerity. I would like to see a little bit more investment in America and infrastructure in particular. It falls into what [inaudible] talking about. But also in the muni market, it’s one of the things that we finance, you know, their projects, you know, 70% or more of these infrastructure projects, they’re financed through the municipal market. So it’s a great way to invest in America and to loosen up the purse strings a little might encourage a little bit more growth in the economy.
David Lafferty: [0:25:34] I think just the potential for after the election regardless of who gets in there might be a little bit about the … the two things that I think when we talk to our colleagues in Washington of what might be on the political agenda, corporate tax reform isn’t a high probability but it’s somewhat of a probability. That I think would be very helpful for the economy and the capital markets. And I think some type of infrastructure as Dawn said, not holding the, you know, you can’t live on austerity forever. I don’t know how it will play out but I think post election, those two things while they’re not high probabilities, are at least something that might create some positive benefit after the election.
?: [0:26:16] Just on the infrastructure side, I think there’s great opportunities here that should not be missed. Because in some cases there’s actually no choice, you know, we need water for instance and if you look at the structure of the water…
Gillian: [0:26:26] [Inaudible].
?: [0:26:26] Yeah, we do. And then there’s no alternative for it. Then if you look at the quality of the infrastructure in the United States, knowing that 14% of all the water they pump in the system gets lost. And that’s treated water; you pay for that, you know, the electricity that is used for that etc. And at the current pace of investment they’re going to get to 20% or more by 2020 already. So there’s opportunities to invest, specifically to create the more sustainable infrastructure here in the States. Think about water, think about sustainable energy, rollout, I don’t know, charging stations for electric vehicles for instance, train connections, fast speed trains. And I’m living in France, it’s a great country from that point of view, you can get anywhere with a fast speed train. But here in the States it’s just, you know, not possible to take a train that can then have a connection between big cities like let’s say Boston and New York or New York and Washington DC, you could cut down the travel time to one hour for instance with a very, you know, easy connection. And those would be investments that are long term in nature that will help the economy. But that would really also kind of fill the short term spark for economic growth.
David Lafferty: [0:27:33] So [inaudible] brings up a good point that I think is missed which is a lot of the infrastructure spending that we’re talking about doing has to be done, fixing bridges, roads, tunnels, airports, etc. It’s going to be financed at some point anyway, so we might as well do it sooner when interest rates are at rock bottom. This idea that we’re going to add a lot of debt, we’re going to add a lot of debt regardless when we have to go make these investments. We might as well be financing it at long … very low long rates if we have to do it anyways. So hopefully Washington will come around to pushing a little bit harder on the fiscal side after the election.
Gillian: [0:28:10] And I know that all of you look globally so I’m going to direct this question first to you [inaudible] because you’re based on Paris. But then we’ll open it up, this is from Jack, one of our viewers. He wants to know what catalysts you would look for that signal a pick up or lessening of economic activity in developed Europe?
?: [0:28:25] Well, we see some of those catalysts already happening if you look at construction activity for instance in Europe and the specific, also results of construction companies. We’ve seen a stabilization and actually a small pick up on that side as well. That basically means that European consumers are ready to invest, they don’t consume but they start to invest bit by bit. And a lot of that is driven also by investments in energy efficiency. So to some extent it’s driven by regulation and by incentives given by the government, that’s definitely a good indication. But at the same time a bit of political stability would really help.
Gillian: [0:29:00] [Inaudible] as well?
David Lafferty: [0:29:01] I mean what I would look at is sort of the balance between fiscal and monetary policy. It might be a bit counterintuitive. But I think we’ve reached a point where the more extreme monetary policy becomes, particularly from the European Central Bank but also from the Bank of Japan. The more that restrains growth I think, you know, I talk to our clients every day, they don’t understand the technical nuances of what negative interest rates mean. But they know it sounds bad. And it doesn’t make them want to go to the mall. And it doesn’t make CEOs want to invest in people, plant and equipment. So what I would love to see, it’s not a specific signal, but the trend I would like to see is more of a recognition that more has to be done on the fiscal side. And that maybe getting more and more extraordinary in our monetary policies is actually probably sending us in the wrong direction. I’d like to see Draghi and Kuroda and Yellen say, “We’re going to keep interest rates low and accommodative. But stop looking to us to solve the world’s problems.” I think that would be a healthy change in the investors’ mindset that maybe breaks us out of this low growth world we’re in.
Gillian: [0:30:07] So breaks us out of the dependency on monetary policy?
David Lafferty: [0:30:10] Yeah, and a very unhealthy addiction to thinking that Central Banks can save, you know, save all … save us from all of our problems.
Gillian: [0:30:18] Sure.
?: [0:30:19] It is in that respect, I mean what we’ve seen the last couple of years is really a disconnect between the financial world and the real world. But in the real world, I mean if we look at financial returns over the last couple of years they’ve been really good in reality. But the underlying feeling of the economy has not been really good. And that’s where we really want to see a signal from governments all over the world that they really want to start investing again, but really invest for the long term in infrastructure that will help us all to actually, you know, give us the visibility that … and the transparency that, you know, we have an economy that we can use as well to make our investments.
Gillian: [0:30:52] Dawn, what about you, I mean you’re trading assets that are directly linked to government decisions at least in the muni bond space. So what are some of the catalysts you’re looking for in the US market? Let me direct it that way.
Dawn Mangerson: [0:31:02] Well, with regard to investments in the different projects, I think the federal government like I said, needs less austerity. They need to partner with the municipalities, because right now a lot of these projects have been put on hold. A lot of municipalities actually have been deleveraging because they’re addressing their pension and [inaudible] liabilities. So because this is becoming such a big portion of their budget, they just can’t take that money and put it towards projects, especially if they’re not getting any partnership with the federal government to do so, because fixing roads and stores, like you said water, different things like that, it’s very expensive and it needs to have a partnership which it has historically. And the federal government finally I think last year came up with the Federal Transportation Highway Fund. But they finally figured out a way of financing that. It used to be just on fuel tax, and it wasn’t enough to pay the debt service and outstanding debt for fixing roads. And they had to appropriate that money and they didn’t like that. So since they have now a 5 year plan we might see more issuance and more projects come to the market, which would be refreshing.
Gillian: [0:32:10] Interesting. So I’d like to go to China briefly because we recently heard that George Soros has stepped back into actively trading in his family office, one of the things that he’s been most vocally bearish about is China. He believes it’s one of the biggest risks that we face. I’m curious to know what are the fundamentals you’re looking at when you’re evaluating China? And just how big of a risk is it posing? Is it something that we’ve overblown or is it something that you think we’ve evaluated properly and should be focused on? Do you want to start with that?
David Lafferty: [0:32:38] Yeah. I mean I think about two risks in China, one of them does not bother me and one of them bothers me quite a bit, so, and one is the opposite side of the coin is the first one. And the first one is the growth rate. And everybody’s worried about the growth rate slowing, or we had 7½ GDP or we had 5½ or we had 2½. No one seems to know, it’s probably not what the official number is. It’s probably a bit lower than that. I don’t worry about that so much, you know, this is … someone said earlier today, you know, angels on the head of a pin. I’m not sure that it really matters if we’re 6½ or 7. I do worry quite a bit about the flipside of that which is the amount of debt that’s being accumulated to finance those growth rates. And total social financing is probably 250% of GDP. I think the real question isn’t when does China have some type of debt bubble implosion? But do they have the ammunition and the wherewithal to deal with it when it happens? Will they be able to clear out the banks? Will they be able to separate the good banks from the bad banks? Do they have enough foreign currency reserves to sort of paper over some of these problems? I’m much more worried about the accumulation of debt that’s funding the growth in China than the actual growth rate in China, which seems to get more news.
Gillian: [0:33:55] Sure. So focus on the debt issuance and whether or not it’s sustainable [inaudible].
?: [0:33:59] Yeah. And [inaudible] companies individually more than the Chinese economy as a whole, because on the economy as a whole I’m reasonably worried, the correction will happen. It is not a sustainable, you know, financial bubble. I really just think [inaudible] to some extent as well, and that correction will happen over time hopefully, not too fast, but it will happen. But at the same time that our specific needs for investments recognized by the government mainly linked to environmental quality, water quality, air quality and the soil quality. There are areas that are really high up in the 5 year plan and investments are being made and a lot of money is actually been spent on that. And to bring it back to what we said earlier on about the US or Europe investing in the infrastructure. Well, China is doing that as well. And part of that infrastructure is linked to, you know, environmental quality. And it’s really necessary because you cannot walk around in Beijing or in Shanghai without, you know, a filter, without a mask, which is obviously horrendous. And it’s going to cost of them a lot of economic growth there in the future as well. So you can get direct access, but there’s also a lot of companies that have, you know, exposed to China, you know, directly because they’re selling there, but they’re not [inaudible] in China. So those two areas are really important.
Also if you look at the rising middle class for instance in China, there’s a lot more demands now for basic healthcare products, hospitals, but also access to better schooling, to medical equipment, to even simple things like glasses, a lot more demand. Because people can now afford to go to the doctor, they know that they can actually improve their life quality a lot better by wearing glasses. So there’s a lot more demand for those basic products as well, a lot of basic products like insurance products, basic financial products etc. So no matter what the general economy is going to do, that’s a trend that has so much [inaudible] and that will continue. And there are opportunities on that side. But at the same time as the economy is actually facing challenges, they will react too, and specifically on the production side, they will create more competition for some of the producers in the western world as well. And [inaudible] being a lot lower in China that can actually be a shorter term challenge, a lot more than direct exposure to China.
Gillian: [0:36:16] Interesting. So we see certainly pressures on the debt side, but some opportunities on demographics and then a question of Chinese production, whether or not it will ramp up, so a lot of interesting forces there.
David Lafferty: [0:36:26] I think one of the tough things about China is we can talk about the risks, but they’re not easily hedgeable. I think that’s one of the, you know, you’ve got the second largest economy in the world and as a marginal contributor to global growth, the biggest part of global growth, so not the biggest economy but the biggest component of where growth comes from. If there is some type of, you know, really bad scenario, first of all we don’t know when it’s going to happen so you can’t sit around and hedge it away forever, there’s a cost to that. And it would be so pervasive that I’m not sure it’s something that can be hedged away. So I think when I’d put on my asset allocation hat, I worry about the accumulation of debt and a lot of the trends that [0:37:05] mentioned, but I’m not sure the average investor should be sitting at home worrying about that because I’m not sure there’s a ton that they can … maybe George Soros can come up with a hedge to it or a way to make money. But the average investor is going to be affected by that if it happens. There’s not a lot we can do about that.
Gillian: [0:37:21] [Inaudible]. We actually have a viewer question that’s sort of [inaudible] to this point and Olivia, she said, when you look at the global market situation now like China, Japan and Europe, when do you expect that the downward market cycle will end? So another market timing question.
David Lafferty: [0:37:39] Yeah, the downward cycle, I don’t know again. I’m of the camp that there aren’t a lot of catalysts out there right now. So I don’t know, that is really the $64,000 question is what breaks this cycle? As I mentioned, bad demographics and very questionable productivity and very difficult geopolitics I think makes it very hard to break out of this cycle. I think one of the most interesting asset allocation by-products of this is, you know, [inaudible] and Dawn are talking about sort of these megatrends around demographics, might be healthcare, migration and population, energy efficiency. In a world where in aggregate there’s not a lot that’s attractive. As I mentioned, I think beta’s kind of gone into hibernation. Playing some of these megatrends that fit into the ESG space are probably going to be the best way to make money because those are going to be one of the few places where you do have a secular tailwind. Because I think the global economy right now without a catalyst to shock us out of this low real rate and low nominal rate world, I think it’s very hard to say, “Hey, we think we’ll break out of this next year or the year after.” It’s probably going to be some exogenous shock that we can’t see coming that breaks out of it. I don’t know that there’s a silver bullet on the policy or economic side that fixes what ails the developed world today.
Gillian: [0:39:05] Sure. Now, [inaudible] do you want to add something?
?: [0:39:07] No, just I’m just wondering if it’s going to happen in the foreseeable future anyway. And from that point of view I think it is really important to understand that you cannot just buy the market anymore. And just as you said like beta is pretty much dead or hibernation as you call it, you stated maybe before that … or stated before that. But you cannot just buy the market. So I think you really need to look for pockets of value and opportunities. And that may mean moving away from index type thinking and constructing a portfolio completely differently than what you’ve done before.
Gillian: [0:39:37] [Inaudible].
Dawn Mangerson: [0:39:40] Well, I think that’s true, I think that they’re … and I think the trend has been more that people are investing in things that they want to invest in and, you know, [inaudible] socially responsible or impact investing. So I think they’re not looking as much at the yield anymore, they’re not getting much. And saying, “Okay. Okay, if I can’t get the yield that I need I’m going to get the yield that the market’s going to offer. But I’m also going to get something out of it or give back to the economy, give back to the community.”
Gillian: [0:40:11] Sure. It feels like we’ve finally entered a time where this long term focus of sustainable investing which has been popular let’s say in the political and social world is now translating into the financial world. So we’ve been talking a lot about long term trends. But I want to shift our focus actually to the short term. Dawn, we’ll start with you, are you worried about the short term market volatility? And if so, what are you doing to kind of hedge against it?
Dawn Mangerson: [0:40:33] No, I don’t think that, we’ve seen a lot of volatility in the treasury market, just like we were talking about earlier, the flight to quality. And we’ve also seen some volatility on the shorter end of the treasury curve. And that has to do more with what people anticipate is going to happen with The Fed. But I think that curve actually has been a big driver of returns this year because we’ve seen a much flatter curve. We’ve seen more demand on the longer end of the curve. And it’s shifting, so people are looking a bit further out the curve for some income and actually a little bit of carry yield, believe it or not. So the curve has been a very good part of the investment strategy this year. So volatility, you know, volatility can be your friend, you know, if you’re confident in what you’re buying and what you’re investing in, when you do see those spikes up in yield, those are opportunities. So we welcome it.
Gillian: [0:41:27] Okay. And David, what about you?
David Lafferty: [0:41:28] Yeah. I would agree, I mean we largely think of volatility as being an opportunity. The disconnect there is I’m not sure the investors think that way. You know, we teach them to sort of mitigate – try to mitigate their losses. And so maybe we’re talking out of both sides of our mouth. But I do think that investors when they talk to their advisor, whoever they’re consulting with really needs to have a plan for volatility. Too many investors just let it happen to them, and they make decisions retroactively instead of proactively. So if I was worried about short term volatility and I think we all should be, I would be talking to my advisor or consultant about, “Okay, when this happens and assets get cheaper, which assets do we want to go out and buy?” I think it’s very hard to say to an investor, “Hey, this asset or this asset class has fallen by 20%. Hey, buy it now that it looks terrible.” That’s probably the best time to buy it but they won’t think that. And so I think getting their buy in, getting your clients’ buy in ahead of time that when volatility comes let’s be proactive about putting it to work. I think it’s easier to get clients to buy into that because if you wait until the negative consequence occurs, they’re going to be very, you know, we’re going to scream low P’s and higher yields and wider spreads and tell everybody to buy this stuff. But they’re just going to see the negative returns on their statement. So get their buy in ahead of time because it’s tough to get it afterwards.
Gillian: [0:42:53] Sure. And [inaudible], what about you, how do you think about volatility in the short term?
?: [0:42:56] Yeah. Well, we … well, we expect higher volatility to last for a bit longer. So we mitigate that by focusing a lot more on quality, so quality management, quality balance sheets, quality margins etc. And also diversification across themes, sectors and geographies a lot more, then volatility when it happens, specifically on the downside when there are some high quality names that actually underperform or where we have still a very, very good, you know, conviction for the longer term, well, we use that volatility then to strengthen those positions.
Gillian: [0:43:29] Now, I want to talk a little bit broadly, we’ve spoken on a number of risks, number that have been kind of keeping up with all of our headlines lately, so whether it’s China or whether it’s the US election. But do you think that there’s any risk in the market right now that’s underappreciated or not getting the kind of airtime that let’s say some of the more popular topics to talk about are?
David Lafferty: [0:43:51] I sort of mentioned mine earlier. I think the most underappreciated risk is that we’ve become too reliant on central banks. And this has both a good by-product and a bad by-product, depending upon if you’re short term thinking or long term thinking. If you’re short term thinking, when we all wake up and realize that all this extraordinary policy isn’t getting us much and central bankers are not infallible capital market gods, that they can’t fix these problems. I think the market is in for a rude awakening. And I think that short term volatility, I think that’s a risk that is probably mispriced. We see it almost every day. When there’s bad economic news the market tends to rally because people think The Fed will ride to the rescue. So there’s still this unhealthy reliance on central banks. I think the underappreciated risk is that we wake-up one day, we realize that isn’t true and we have a real nasty selloff. For the long term investor that might be the shock that makes the markets more attractive, maybe yields go up, spreads widen, PEs go down, then we’ll have more things to buy. But I think we’re going to have to go through some pain that underappreciated risk that central banks can’t solve the problem right now. That’s a good thing in the long run, it’s probably a bad thing in the short run when we finally recognize that limitation.
Gillian: [0:45:10] Sure. And I can’t think of one thing that’s been focused on more than central bank activity, whether it’s The Fed wait watch or everyone listening to Draghi’s press conference just a few weeks ago. There’s been a huge amount of focus there. Dawn, what about you, is there any risk in your part of the world that you feel is underappreciated?
Dawn Mangerson: [0:45:27] I think I mentioned it earlier, I think lower yield as opposed to higher yield’s the biggest risk, the reinvestment risks. You know, when we see portfolios, it’s a fixed income, you buy bonds for the income. And if those roll down and they mature, you know, we have portfolios that we’ve invested 3 or 4% yield that are starting to mature and then you have to go back and reinvest it at a lower yield. I think with the aging of America, with more people retiring and they need that income component, both taxable and tax exempt, I think negative interest rates would be a very big risk to investors.
Gillian: [0:46:06] [Inaudible] what about you?
?: [0:46:06] Yeah, probably no surprise but I’ll say environmental, social and governance risks. And you know, more lately we’ve seen a lot of evidence of that as well, [inaudible] already, some utility companies are significantly underperforming because they are facing a situation that, you know, is difficult to manage. They have these assets are [inaudible] nothing there today. We’ve talked Volkswagen and talked Electric Power. A lot of investors are looking at probabilities and, you know, take Fukushima now for instance, [inaudible] electric power, there may have been a 1% probability of an earthquake hitting Fukushima in the way it did, and the cost of that will be a 100 billion and then you multiply the 1% by the 100 billion, that’s an impact of 1 billion, okay, find a company who can take that. But when the accident actually happens, because [inaudible], well, because of an earthquake and then [inaudible] what we believe is poorer environmental and safety management. But then it’s actually a 100 billion hit, and those risks are not really factored into the market. And one link to governance I suppose is pensions, look at the funding of pension funds on the corporate balance sheets and on, you know, also the way insurance companies look at their liabilities. A lot of those pension plans and insurance companies are relying or need a 7½% on average discount rate to calculate the liabilities. But they also need that investment return going forward. And most of those are actually invested quite heavily in bonds. So that’s been fine over the last couple of years because that’s the return they actually got. For the next 10 years, you’re looking … there’s no way you can get anywhere near the 7½%. So I think the pension problems actually will come back [inaudible], they did in the early 2000s.
Gillian: [0:47:45] And it plays into your demographics point perfectly.
Dawn Mangerson: [0:47:47] It’s exactly another factor for coming for municipalities, for cities and states that are having trouble where they’ve been getting returns much higher than what they can get in the market right now.
Gillian: [0:47:59] Interesting. So I appreciate that we’ve talked a lot about risks in those conversations. But as we come to the end of our conversation I’d like to talk about what positive forces you think will have the most interesting impact in 2016.
David Lafferty: [0:48:11] They’re difficult to find. I do think to some degree, you know, everybody says, you know, bull markets don’t end of old age. That’s probably true but the passage of time can be a bit helpful. We mentioned the US presidential election, I think getting past the election may be is a mild positive. There are geopolitical events around Europe that we’d like to get past. I mentioned it’d be nice to get past some of the issues around monetary policy. We keep getting more and more extraordinary in our policies and I don’t think that’s helpful. And I think from an asset allocator standpoint, I do think there are pockets of relative value. So I think as we mentioned, credit, we’ve talked about munis. There are parts of the equity markets that are demonstrably cheap. There are parts that are expensive. There is some relative value out there even if the broad markets aren’t fantastically priced. I mention that because when you build a portfolio, you have a 100% of your assets, it has to go somewhere, just putting it in cash probably isn’t a great option, people think because inflation is low, that cash is an option, but it’s still a negative real return asset. So I think there are some positive stories within the global capital markets, even if the overall averages won’t look great in the near term.
Gillian: [0:49:26] Sure.
Dawn Mangerson: [0:49:28] I would definitely agree. I think, you know, when you look at things on a relative basis, like I think I started out being, I think we look pretty good here, you know, domestically, you know, we still have decent yields, relative to other parts of the world, the economy’s still chugging along, not at a great pace but it’s still strong. I think I do like the trend of the socially responsible investing. I think that’s a great way to go about looking at some investments, if yield is not your ultimate goal and if it’s actually investing in the US. And I think that could be a great driver for growth.
Gillian: [0:50:04] That’s very positive, and [inaudible] what are you seeing as well?
?: [0:50:06] I just think it’s a great time for active investments, if you just invest in the index, the index is [inaudible] to risks. And on the risk side, for every risk there’s probably an opportunity as well. So if you’re on the wrong side, you know, you have an issue, but if you’re on the right side you can generate some good performance. And if you look at the disruption that we’re seeing in some business models, with newer technology putting business models, you know, on the question … or how to say that, with new regulation coming to the market as well and, you know, creating costs for some companies, that cost is a revenue for another company. So if you look at index composition today there will be some that will actually lose out on that side, but there’s also a lot of companies that will win on that debate, so active investment we believe is definitely, you know, it should [inaudible] in this environment.
Gillian: [0:50:56] Right. Well, we’ve actually come to the end of our discussion, so I just want to give you each the opportunity to give us maybe one quick final takeaway that we should think about moving into the second half of this year.
David Lafferty: [0:51:06] Well, my big takeaway might just be around the confusion in the marketplace. I think that, you know, [inaudible] mentioned regulation. In the US we’ve been dealing with the Department of Labor and the fiduciary rule. And my big macro takeaway is that it’s very confusing out there, from both a regulatory standpoint, macroeconomic, where are the opportunities in the capital markets? I think the value of advice has skyrocketed, I think whether it’s an institutional consultant or your financial advisor, I’m not sure that the markets were ever a do it yourself market. But I think as the world grows more interconnected and more complex and more regulated and the opportunities are more spotty, having a sounding board to talk about your investments with, I think, you know, there’s been a lot of talk about pushing advice down. I think there’s a perfect opportunity to raise advice up given the complexity that … the increasing complexity of the capital markets.
Gillian: [0:52:03] Interesting, Dawn?
Dawn Mangerson: [0:52:04] I would just say that I do think that like we’ve talked about fixed income domestically. And I do think that it has some value, not only treasuries, corporates, municipals, taxable munis, even structured product, relative to other types of investments are very solid right now. And I think that it should be a core part of your portfolio and it should offset some risks elsewhere.
Gillian: [0:52:27] [Inaudible] have you some final thoughts?
?: [0:52:29] Yeah. Well, from my point of view, I think it’s important to understand still that people have to think differently about their portfolio construction in general. There are opportunities out there, so for every risk there’s an opportunity, risk management will become more important than ever. But people need to understand where that risk is coming from, [inaudible] opportunities. But more than ever I believe integrating environmental, social and governance risks, you know, we see that more than ever it has impact on performance. People need to be aware of that.
Gillian: [0:53:02] Wonderful. Well, thank you all so much for joining us, and thank you for tuning in. From Morningstar in Chicago I’m Gillian Kemmerer for Asset TV.
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