Views on the year to come
We asked ten CIOs and other senior figures at international assset management firms: ‘Where will investment opportunities lie in 2009?’
Anne Richards, CIO, Aberdeen Asset Management, London
The coming year will be another ex-tremely tough one for investors, but market anomalies will continue to offer long-term opportunities.
Deteriorating company earnings and the prospect of tightening regulation will continue to weigh on credit and equity markets alike, while economic woes will also hamper commercial property returns.
Those regions of the world that entered the downturn without any significant degree of leverage will be best placed to capitalise on any global recovery. Asian countries in particular fit this bill, having learned from the 1997 banking-precipitated Asian crisis. We therefore expect global economic power to continue its shift towards the East.
Our bias is to increase risk incrementally across our portfolios, given that overly despondent investor sentiment is leading to irrational securities pricing and undervaluation - and to some attractive long-term investment opportunities.
Thanks to our strong disciplines and meticulous stock selection process, we believe we are well placed to identify undervalued securities that will outperform in the long term.
For our multi-asset portfolios, we prefer equities over government bonds and property, seeing better value there. Although our equity asset allocation continues to be driven by where we find quality and value, we continue to favour Asian companies, given the region’s strong foundations. Among fixed income markets, we see most potential in credit, where current prices are already discounting a lot of bad news about the global economy. Finally, we believe that yields in certain former ‘bubble’ commercial property markets, such as the UK, could start to become attractive.
Michael O’Brien, head of distribution business, EMEA, Barclays Global Investors, London
Short-maturity distressed debt is attractive as we expect all types of these issues (including credit and structures) to start to pull back to par as they approach maturity. Short government bonds look appealing as the yield on long government bonds falls due to high levels of new issuance. Opportunities exist in private equity funds given heavy discounting in the secondary market for these vehicles.
For equity beta, we could see a strong rally if there is a material improvement in credit conditions. Where more equity beta is required in a portfolio, a prudent approach might be to gradually build exposure while keeping an eye on US consumers and the ability of banks to deal with bad debt and recapitalise. An overweight to quality stocks (ie companies with low leverage and strong cash flows) will remain a dominant theme in 2009. Value strategies are likely to continue to underperform until we see greater earnings visibility.
In the quantitative versus fundamental space, the increased emphasis on value and quality themes might work in favour of some quantitative managers. Add to this the sharply reduced competitive landscape and quantitative investors might experience strong returns in 2009. In general, earn income wherever you can find it - high quality spread products, especially with shorter duration, and taking account of liquidity risk should prove profitable.
Pascal Blanqué, CIO, Crédit Agricole Asset Management, Paris
The crisis has now been going on for a year and a half, but it is not because we are starting a new year that the world will change. It is reasonable to think that 2009 will resemble 2008, at least during its early stages. The aggressive response of governments and central banks has been reassuring and should both avoid the systemic risk of a chain reaction of defaults and pave the way towards a gradual return to normalised market liquidity and risk premiums. The crisis has thus entered a new phase, one that is more reassuring for the financial sector but also more uncertain for the real economy. In the 12 months ahead, the environment will be fragile and, at best, convalescent.
It is still too early to take an aggressive stance on most risky asset classes. While liquidity, security and prudence will remain the investment guidelines for the CAAM group in 2009, we will also be discerning and quick to pounce on opportunities resulting from the many discrepancies caused by the crisis. On the one hand, certain very attractive valuations in the credit and equity markets are already providing a wealth of opportunities on a long-term investment horizon. In addition, the aftermath of the crisis offers investors the opportunity to profit from inefficiencies that have appeared in government debt markets and deeply discounted indexed bonds. Finally, equity portfolios selecting the least volatile and most decorrelated shares should allow clients to benefit from minimised risk and volatility.
Chris Cheetham, CIO and CEO, Halbis, London, the active management specialist of HSBC Global Asset Management
Current and leading indicators of economic activity have recently taken a dramatic leg down and it is now clear that the global economy is on the brink of recession. The real question is how deep. The good news is that the policy response has been very decisive and unprecedented in its scale. This will not solve the problem and nor will it prevent a prolonged period of subdued growth in the developed economies, but it should head off a Japan style scenario.
What does this mean for investment strategy? For those with a longer horizon and no concern about short-term volatility, there are opportunities. Perhaps the most attractive asset class today is corporate debt. Spreads are at multi-year highs and a diversified portfolio should deliver attractive returns even as defaults rise.
In the long term, inflation might be an issue for bonds, but not on a three to five-year view. However, the market is likely to remain illiquid so that needs to be factored in. Equity valuations are much better than they have been for most of the last 20 years. Whilst still not very cheap, equities ought to do better than bonds on a 10-year view and they beat the inflation risk. The price for this potentially attractive long-term outcome is likely continuing high volatility. Long-term investors can still win, but there will be no free lunch.
David Jacob, CIO, Henderson Global Investors, London
Institutional investors are entering 2009 bruised and battered from the last couple of years. The massive unwinding of debt across the global economies has led to forced selling, adding downward pressure on nearly all asset classes.
We have seen indiscriminate mark downs across assets as negative sentiment and this forced selling has overtaken fundamental valuations, making some assets cheap. However, this has thrown up some potential opportunities for pension funds and other long-term investors who will be able to access returns over the next three to five years, particularly in some areas of fixed income. We currently see potential opportunities in investment grade debt, secured loans, and AAA-rated asset backed securities. These markets may get worse before they get better; for investors who have an intermediate to long-term perspective, we see excellent opportunities for good returns.
The outlook for equities remains trickier to ascertain. We do not expect there to be an end to the bad news for the economy for some time to come, and we expect more companies will fall by the wayside during 2009. Governments have made it clear that they will use fiscal stimulus in an attempt to support the economy and prevent recession from becoming depression. Success in this will depend upon how rapidly spending can be deployed and how it is used.
To the extent that it builds infrastructure and improves productive capabilities within an economy, it will have long-term benefits for growth as well as near-term ones. Regardless of how it is spent, it will have longer-term impacts on budget deficits and tax burdens that will need to be managed in the future.
That said, for those optimists who think the recovery could arrive sooner than expected, Asia could deliver higher rates of return, through a combination of equity growth and currency uplift. The US, being the largest and most flexible market in the world, should not be ignored and any recovery may be led by US assets in the first instance.
One thing is key though: with economic risk high and corporates continuing to struggle to survive, now is not the time for passive investment. A skilled manager actively sifting through the opportunities will be the one to find returns.
Joe McDonnell’s, head of global portfolio solutions EMEA & Asia, Morgan Stanley Investment Management, London, and a trustee director of the Morgan Stanley UK pension fund
While 2008 has seen an unprecedented spike in the correlation between various asset classes and the true benefits of diversification have consequently been muted, 2009 is likely to see strong performance from certain market segments while others will remain in the doldrums.
A low-growth, low-inflation backdrop will make a sustainable rally in global equity markets a challenge while those asset classes with considerable ‘latent value’ will likely make a great deal of progress. With the falling attraction of cash, investors will look to extract value where they see a clear investment thesis. Credit markets, hit badly in the fourth quarter of 2008, are increasingly looking attractive and a classic ‘recovery’ pattern could see improvements in credit markets well before equity markets. We believe four main themes will emerge:
Latent value investing, the idea that prospective gains can be calculated from certain market segments that have experienced a considerable and steep decline in value and that this decline is large on a historical basis Economic factor portfolios, a new ‘balanced’ portfolio less dependent on strong global growth Defensive equity portfolios that invest in sectors and companies that offer strong and stable dividends and with more emphasis on the franchise value of a business Long-term real asset portfolios where corrections in real estate, commodities and other real assets provide the opportunity to build a well-constructed long-term inflation hedging portfolio
Investment solutions that tackle these themes include diversified credit portfolios (investment grade); dedicated senior loan and high yield portfolios; dedicated distressed hedge fund portfolios; equity franchise; diversified alternative portfolios that look to combine alpha and betas sources; the Long Term Real Asset Portfolio (LTRAP); and mandates that address funding gaps and the necessity to build diversified portfolios to bridge those gaps.
George Muzinich, president, Muzinich & Co, New York
“A rising tide lifts all ships” is a saying that perhaps aptly characterises the investment mood of bull markets. The general or macro trend transports us away from careful analysis, and rigorous questioning of investment assumptions. The stronger the market, the more this macro sentiment becomes pronounced. It leads to speculative behaviour that results in market bubbles. We do not want to be accused of underperformance relative to our peers.
We are now living, however, in a time of sober assessment of our economic realities. We need to focus on cash flow to meet our commitments. We are living in a period that demands an in-depth understanding of the merits of individual investments. It is a time of harsher economic realities where fundamental analysis will show its worth.
In this period of low tide, it is essential that we return to basics, to core principles of fundamental analysis and risk conscious thinking. It is vital that we pay attention to microeconomic fundamentals. Corporate credit is a sector that promises very generous double-digit returns for those who concentrate on fundamentals.
Corporate credit has been punished for the follies of structured products, of untrammeled leverage. High yield bonds already discount a depression scenario. They have priced in 20% default rates, a rate considerably higher then the 15.4% default rate of 1933. Credit will be the place to be in 2009 and very likely for years to come. But its rewards will come to those who do the laborious work of serious fundamental analysis.
Joe McDevitt -managing director, PIMCO Europe, London
As deleveraging is not yet complete and the performance of the real economy continues to surprise on the downside, investors should not try to be heroic but rather focus carefully on the relationship between return and risk. Governments have had to insert themselves into the middle of financial markets in order to prevent a complete breakdown in the provision of credit to consumers and companies. It is here, in those segments of the capital markets, where governments have provided their balance sheets, where investors can find relatively attractive risk/return investment opportunities: agency debt, agency pass-through securities, and the senior debt of major ‘national champion’ banks should all provide attractive spread and return over ‘risk-free’ rates while minimising risk to capital.
For those investors prepared to take more risk for more return, investment grade corporate debt represents a very interesting opportunity, with current global spreads averaging over 5% above government bonds. These spreads give the equity risk premium a run for its money and imply a default level well in excess of any scenario short of Armageddon.
Rick Lacaille, CIO, State Street Global Advisors, London
Securities markets have responded to the worsening economic outlook and higher risk aversion during 2008. We believe that the economic news and company level results will continue to be very challenging throughout 2009, but risk aversion may decrease as investors compare the longer-term prospects for risky assets against the extremely low yields we expect to see in government bonds.
The credit and equity markets continue to behave differently, with the effect of distressed sales being more pronounced in credit. As a medium-term prospect, credit appears to be more undervalued, but we expect that the spread could widen further in the near term. Meanwhile, equities offer good value, with US being preferred to non-US.
Michael Gran, managing director and co-deputy head of quantitative asset management, TOBAM, Paris
Diversification tops the ‘to-do’ list in 2009. Beta rather than alpha is the most important investment opportunity. There is so much volatility in the markets now, that strategies which spread risks cannot possibly be at a disadvantage to concentrated risk-taking. Dispersion of returns within any asset class is likely to be extreme, and those getting it wrong will suffer dearly.
TOBAM research indicates that focusing on efficient beta construction, without making ‘big bets’, is a way to achieve higher returns with less risk. Capturing beta efficiently is often overlooked as a path to superior investment results. Substantial interest in efficient beta strategies followed the dot-com boom and bust, since many market cap index investors began to question the logic of maximum allocation to a price bubble at its peak.
Since then, concentrations built up in financials and materials, again emphasising the problem with price levels dictating your asset allocation. There has been a trend towards non-market cap solutions, and one of the more efficient approaches for beta construction is known as anti-benchmark.
Anti-benchmark uses a mathematical approach to create the ‘most diversified portfolio’. Anti-benchmark does not use return predictions, but rather spreads risk more evenly across all the currently identifiable market risk factors. Diversification is the strategy, or the absence of strategy, which is worth paying attention to at all times. Perhaps during this period of exceptionally high volatility, a focus on maintaining superior diversification can provide investors who lack a crystal ball, the best possible edge for 2009.