major passive engagement gap - kl-communications.com · would do well to remember you get what you...

WWW.KL-COMMUNICATIONS.COM MAY 18

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Major passive engagement gap

P3CAN THE US DOLLAR'S

SURGE CONTINUE?

P4WHAT IRAN DEAL EXIT

MEANS FOR OIL

P6EVOLVING IN AN AGE

OF DISRUPTION

Engagement is one of the areas where active managers can add long-term value, explains Neuberger Berman's Joe Amato (page 2)

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Joe AmatoNeuberger Berman

uch has been said about active and passive management

in the past few years.The debate has largely focused

on relative performance. One important aspect of this debate less discussed is engagement. It is a big hole in the debate, because engagement is one of the areas where active management can add value and drive long-term outperformance.

Engagement matters. Genuine engagement requires informed judgement and experience is vital in making such judgements.

Passive investors say they are long term, due to the inability to sell – often pointing out active managers can simply sell if they do not like a company's direction.

This is not true for many investors. At Neuberger Berman, we invest in a company because we recognise its quality and we know it entails continual evaluation. We do not start scrutinising things only when we become aware something might be amiss. If we see management wavering from delivering long-term value, we engage. Selling is potentially leaving unrealised value on the table.

Passive investors are along for the ride. The big managers lack experienced resources to engage genuinely or make judgements about the quality and success of management. Relatively small teams are in 'stewardship' roles, most often focused on the proxy-voting. While necessary, this generally only happens once a year and is often focused on relatively immaterial issues.

Compare this to the hundreds of managers and analysts at a firm like ours, many with decades of experience in analysing companies and industries.

What about other issues such as a company's ESG responsibilities? Assessing whether a company is well governed – and holding management accountable – requires judgement, not box-checking. Good active managers harness decades of experience and expertise and are among the few market participants genuinely informed about those aspects of a company.

Any investor hoping a manager will hold corporates to account on both shareholder value and ESG would do well to remember you get what you pay for.

Major passive engagement gap

ermes Investment Management, the £33bn

manager, has launched the Hermes European Direct Lending Fund.

Managed by Patrick Marshall, head of private debt & CLOs, the European Fund follows the successful launch of the UK Direct Lending Fund in 2016.

The Fund offers access to the stable, low-correlated returns from high-quality, senior-secured loans to a diverse range of middle-market businesses in the UK and Europe – with a focus on Scandinavia, Germany, Benelux and Ireland.

Senior-secured transactions are originated through co-lending partnerships with Danske Bank, DZ Bank and KBC Bank – which sit alongside the existing UK mid-market agreement in place with Royal Bank of Scotland.

"The strength of our partnerships with Europe's leading banks, combined with our own origination skills, sustain a strong pipeline of high-quality loans for our investors," Marshall says.

"By focusing on attractive, senior-secured loans in the mid-market space, we can ensure there are strong creditor protections in place. Our aim will be to consistently outperform by lending to quality, growing businesses on terms seeking capital preservation and yield capture."

Hermes launches European Direct Lending Fund

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"Good active managers harness decades of experience and expertise"

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Witold BahrkeNordea

Arno LawrenzAshburton

Fabrizio QuirighettiSYZ

he US dollar should strengthen further towards

year-end. First, inflation divergence is here to stay.

Chinese inflation, in particular, has room to fall further. Also, it seems to us the ECB will have to tone down its tapering ambitions, weakening the euro. Secondly, desynchronised growth is supported by Trump's tax cuts lifting US growth, while at the same time the eurozone is

he dollar will likely weaken in the second half of the year,

with a target of 1.30 against the euro by the end of 2018.

However, a trend of a weakening currency rarely develops in a straight line and corrections can stimulate significant rebounds. The Fed's path to tighter financial conditions is now largely priced-in by the markets, while the BoJ and ECB are still deploying QE.

eading into April, short positions of the US dollar

against G10 currencies were at seven-year extremes.

Once it became apparent a number of key global indicators were rolling over or topping out, the relative strength of the US counted in its favour – with the dollar appreciating by almost 5% against a basket of currencies since mid-April. Likewise, the rising US treasury yields over this

suffering from last year's euro strength. In addition, slower Chinese credit growth is a headwind to the world's second biggest economy.

Thirdly, while we do not see treasury yields rising much more, the relative yield argument pro US dollar is unlikely to weaken. It is hard to see the ECB taking the lid off euro rates through QE when growth slows and inflation is miles away from its target.

The cost of hedging is perhaps a less considered, but important, factor. Hedging US dollar risk has increased meaningfully since Q4 2017, which makes investments in US treasuries by European or Japanese investors costly and makes the diversification benefit less interesting.

This will continue to become less attractive when bunds – and one day Japanese government bonds – offer positive yields.

period also formed a positive backdrop for the dollar.

We are cautiously optimistic on the global economy and do not expect deep-rooted weakness. On a longer-term valuation basis, the US dollar appears expensive as a result of an extensive global dollar asset accumulation phase over the past few years. This trend has not yet reversed, suggesting a somewhat negative long-term outlook.

"The relative yield argument in favour of the US dollar is unlikely to weaken"

"Hedging US dollar risk has increased meaningfully since Q4 2017"

"On a longer-term valuation basis, the US dollar appears expensive"

Can the dollar's surge continue?T

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Richard RobinsonAshburton

ollowing years of criticism, US President Donald Trump ripped up what he referred

to as a 'decaying and rotten deal', pulling out of the Joint Comprehensive Plan of Action between Iran and the P5+1.

This decision was no major surprise considering the rhetoric and conduct of the President – who replaced Secretary of State Rex Tillerson and National Security Advisor H R McMaster with Iranian hardliners Mike Pompeo and John Bolton. However, on the face of it, the announcement went much farther than was expected and was essentially a full pull-out – with no room for negotiations.

What does this mean for the oil market? The worst-case scenario, involving strict adherence and policing of sanctions, could see as much as 700k bbld removed from the market. A less disciplined approach, with ambiguous US guidance, could remove less

than 200k bbld. Trump’s rhetoric sounded fairly unambiguous.

The market can hardly afford yet more oil to be removed from an already tight and tightening outlook. We are and have been bullish in relation to the oil price, even before the prospect of Iranian crude being removed. The rate of decline in inventories over the last 12 months has been unprecedented, despite the phenomenal growth in supply from the US onshore market. This supply growth has been eclipsed by a combination of strong demand growth, which was far above the IEA forecast at the beginning of the year. Supply is being driven lower in a number of countries, most notably Venezuela.

Next year, we will also see the start of a sequence of years where the number of projects delivering first-oil declines significantly, thanks to the precipitous drop in spending between 2014 and 2017.

What Iran deal exit means for oil

Rowe Price has added the US High Yield Bond Fund,

run by experienced portfolio manager Kevin Loome, to its Luxembourg-domiciled SICAV.

Loome and his investment team of five, joined T. Rowe Price Group Inc. last year from Henderson Global Investors (North America) Inc. The US mutual fund managed by Loome was also acquired.

Loome is familiar with T. Rowe Price, with the manager spending more than a decade at the group between 1996 and 2007.

The manager relies on credit selection as the main alpha generator, utilising flexibility to invest across the full capital structure spectrum.

"US high yield bonds continue to be a fertile hunting ground for income-seeking investors, but there are a number of more crowded areas of the market. Active managers with the ability to dig into the smaller and less-trafficked segments have the ability to significantly outperform the herd over the coming years," Loome says.

"In addition, it is also important for investors today to have a heightened focus on credit risk, as we are at the latter stages of an expansive credit cycle. With interest rates continuing to rise, defaults are likely to increase from the current low levels. Active security selection to avoid weak issuers will be as crucial as ever."

T. Rowe Price unveils US High Yield Bond Fund

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"The market can hardly afford yet more oil to be removed"

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T

Mike ConeliusT. Rowe Price

Phil HarrisEdenTree

he supportive environment of attractive yields and improving

economic fundamentals in emerging debt markets looks set to continue over the coming year.

EM bonds – including hard and local currency sovereign and corporate debt – in general, are currently offering a premium of between 3% and 5% over equivalent-maturity US treasuries, with local currency bonds in particular offering some of the highest yields.

The prospect of monetary policy tightening in developed markets, particularly the US Federal Reserve, might be regarded by some observers as a headwind to EM bonds. However, returns on EM debt have historically been relatively

nvestors in UK markets are once again faced with complex economic, political

and financial cross currents.Domestically, the key issue is

clearly Brexit and the economic and political matrix accompanying the continuing negotiations. Upcoming talks on trade are likely to be more difficult than the elements already agreed, while the government’s minority status leaves it vulnerable. Indeed, a forced general election, resulting in a decidedly business-unfriendly administration, is the largest risk.

While heightened political risk does not inspire much confidence, the underlying economic picture, supported by a strong global growth backdrop, offers hope. Investors will need to keep a close eye on

resilient during previous periods of rising rates in the US.

Currently, we are particularly focusing on select local currency markets with a lower beta to US duration, as that can improve diversification and also help to offset the risk of US rates rising at a faster-than-anticipated rate.

Meanwhile, EM fundamentals remain strong, too. The global growth outlook remains positive, synchronised across both developed and emerging markets, which should, in turn, fuel growth in global trade. Current account balances have improved dramatically over recent years, with deficits generally much reduced, while the level of indebtedness among EM countries has also declined noticeably from 2015 peak levels.

consumer spending, which is a key determinant of UK growth. The past year or so has proved challenging for consumers; we witnessed real wages decline as currency-induced inflation came to the fore. If inflation has peaked, there may be some real wage gains coming to the aid of the beleaguered UK consumer.

While we are generally optimistic over UK economic prospects, some sectors – particularly retail and large-ticket consumer areas – will continue to suffer cost pressures and deferred orders. The housing market remains robust, supported by continued low mortgage rates, as well as the 'Help to Buy' programme and recent stamp duty changes for first-time buyers.

The opportunity in EMD

The mixed UK outlook

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Hermes adds two managers to fixed income team

"Focusing on markets with a lower beta to US duration"

"The past year has proved challenging for the consumer"

ermes Investment Management has

expanded its fixed income team with two new hires.

The appointments are representative of the group's approach to providing clients with access to all areas of global credit markets. The team is now 26-strong, providing solutions across both public and private debt.

Stephane Michel has been appointed as senior portfolio manager, assisting in the build out of the group's asset-based lending platform, as well as the wider multi-asset credit capability. He is responsible for identifying opportunities, trends and strong risk-adjusted relative value across illiquid markets, as well as making portfolio composition recommendations.

Andrew Lennox has been appointed as asset-backed securities portfolio manager and will make investment recommendations within the European ABS universe. His role will also include building and developing systems and infrastructure to analyse, risk manage, report on and monitor European ABS assets.

Andrew Jackson, head of fixed income, says: "The wealth of experience that Stephane and Andrew bring will strengthen what is an already highly-skilled team, allowing us to develop our offering to pension funds and other long-term institutional clients."

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T: +44 (0) 203 137 [email protected]

Ben PetersEvenlode

s the second decade of the twenty first century rolls on, innovation in

products, services and pricing models is crucial to engineering company growth.

The winners will be the companies where adaptation is embedded in the DNA. This is evidenced by expenditure on R&D, marketing, as well as cultural attitudes towards investing in the long-term success of the company.

The IT sector is reshaping the world by leading the data revolution. Once start-ups, like Apple, have now matured into market-defining behemoths. But these beasts have also kept on their toes by reaping some of the rewards for years of investment in the next phase of technologies.

Microsoft’s business is now driven by its Azure cloud platform, which allows companies and developers to host applications in a constantly accessible environment. Intel has focused its research and development efforts on data centre-focused processors, and invested capital in the capacity to produce them, again to facilitate cloud-based applications. Both have used the resources generated from dominance in the first wave of the information era to develop the next.

As for media, it is an industry fundamentally affected by the advent of personal computing and the internet. It is no longer sufficient to simply create content

and pump it out to consumers. In the world of B2B media, companies like Wolters Kluwer and Relx have transformed offerings into a hybrid of content and tech, providing data and analytics to support decision making. This has led to steady growth in recurring revenues.

Healthcare companies have to evolve product offerings, as the IP protections afforded through patents expire. This is an acute problem in pharma, where generic drugs lead to rapid price declines. It is a fundamental requirement innovative new therapies are developed.

Even the world of shampoo and shaving has been put on alert of being disrupted. The narrative suggests incumbent consumer staple dinosaurs are being doubly impacted by young upstarts and Amazon. However, large consumer groups are grinding

Evolving in an age of disruption

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out low-to-mid single digit sales growth and improving profit margins. It is not the go-go years, but it is not too bad all the same.

Although it is still a minority sport, online is the fastest-growing method of day-to-day shopping. On the web, perhaps counterintuitively, people search around less for options. Groups with dominant brands, like PepsiCo, have higher market shares online than in-store.

And the upstarts? Some do nibble at the heels of the big boys. Dollar Shave Club forced P&G to examine its Gillette business after the former’s novel subscription-based offering started to take US market share. Dollar Shave Club is now owned by Unilever, having been bought in 2017. In addition to ongoing innovation, well-resourced consumer goods companies can also buy ready-made invention.


"The winners will be the companies where adaptation is embedded in the DNA"

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