Fri, 09/11/2012 - 06:50
Earlier this week, Ewen Cameron Watt (pictured), Chief Investment Strategist, BlackRock Investment Institute, presided over a panel discussion on how investors should think about their long-term allocation needs.
Speakers included: Tim Webb, Head of EMEA/APAC and Global Alpha Fixed Income Group; Stuart Reeve, portfolio manager, Global Equities, and Steve Cohen, Head of Investment Strategies and Insight, iShares EMEA.
Discussing fixed income opportunities, Webb commented that investment-grade credit still offered value to investors but sounded a word of caution with respect to the high yield bond market: “This is one area that we’re a bit wary of. Everybody is looking for yield and it’s a space that we feel is becoming a little bit too crowded.”
For government bonds, it’s a bit of a catch-22 situation this year. Yields in safe haven markets like the US, UK and Switzerland have continued to fall, with US 10-year treasuries trading at a 5-month low of 1.64 per cent on the back of Obama’s victory last night.
Webb said that even though 10-year yields were grossly overpriced “on a Taylor Rule basis”, it was clear that the US Federal Reserve “wants rates to stay low for a long time and are not likely to rise anytime soon”.
This might seem counter-intuitive and lead some to ask, ‘Why not just short government bonds on the threat of eventual interest rate hikes?’ Webb, though, used Japan to illustrate his point, whose government bond market in the 1990s gave many an investment manager nightmares.
In 1994, JGB yields went through 3 per cent, prompting a lot of fund managers to decide that the time was now ripe to short the market. “Yields then went through 2 per cent and then 1 per cent, so we’re keeping that very firmly in the back of our mind,” said Webb.
On value opportunities, Webb said that emerging market credit still looked attractive, “although we prefer Asia Pacific emerging markets to Latin America”.
To help bring some added clarity to investors, BlackRock has developed its own index for rating sovereign risk. Named the BlackRock Sovereign Risk Index, a pool of financial and survey data are used to assess the government debt of 48 countries in both developed and emerging markets, and rank each country based on relative fundamental risk.
As Cameron Watt explained: “The BRSI uses more than 30 quantitative measures, complemented by qualitative insights from independent third party sources. It helps investors understand the risks and opportunities present in sovereigns, and provides another viewpoint for asset allocation.”
Discussing dividend yield stocks, Stuart Reeve noted that at 3 per cent, absolute levels of yield, globally, haven’t changed that much. Nevertheless, in today’s yield-chasing environment, even yields of three per cent make for a relatively “attractive area of investment in a zero rate world”.
Investors should not, however, focus on just the yield potential when investing in such stocks. As Reeve explained: “Buying the highest yielding dividend stocks and expecting high income returns is not the key to success.”
Over the medium term, the vast majority of equity returns are explained by a combination of both yield and growth. Continued Reeve: “In today’s challenging growth environment we are looking for companies that provide an attractive level of yield income, but which are also capable of growing their cash-flows in a sustainable way over time.”
The goal, then, is to focus on companies with fortress balance sheets, exposure to fast growing emerging markets, and a demonstrable track record of dividend growth.
Utilities stocks have the most to lose, having gained the most in the wake of recent US tax cuts. Consumer staples and healthcare stocks, however, are attractive sectors for finding companies able to grow their dividends over time said Reeve.
Diagio in the UK and Finland-based Kone, the elevator constructor, were two examples given by Reeve. Rather than reinvesting 100 per cent of their cash flow, these companies, on average, “reinvest less than 20 per cent of their cash flow back into the company. That gives them discretion over whether to reinvest the rest in M&A deals, or give it back to their shareholders,” said Reeve.
Steve Cohen said that growth in fixed income ETFs would likely accelerate over the next few years. “In the last few months we’ve continued to see inflows in investment-grade bonds as they become a relative safe haven asset class for investors,” said Cohen, noting that the search for yield was one of three catalysts helping drive growth in ETF assets. “October was the biggest month yet for EM debt, attracting USD1.9billion in net inflows.
Also driving demand was a changing shift in investor perception towards systemic risk, particularly in Europe. With markets there having settled since the ECB announced its bond-buying program, Cohen said that investors are starting to consider reallocating into European equities again.
Cohen highlighted, however, how clearly things have shifted from quarter to quarter this year. In Q1 and Q2 the focus was on emerging markets. Then in Q3 there was a rotation back into Europe. Now, in Q4, investors are rotating back into EM equities.
The final driver, said Cohen, was government policy. With macro headlines dominating market behaviour Cohen said: “Gold has been a huge driver of ETF inflows on the back of further quantitative easing, even though we now think it’s in a consolidation phase. Industrial metals are removing some growth risk concerns and we’ve seen some short-term reallocation back into this space recently.”
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