Tim Love, Investment Director – Emerging Market Equities
50 years from now, we believe it is likely that the MSCI emerging markets (EM) weighting will become more equally aligned with developed markets (DM) across the broader global indices, possibly reaching a weighting of 50% which would close the historical gap. To us, this reflects their growing economic status given collectively EM makes up more than 50% of global GDP and 80% of output, yet account for a mere 11% of the MSCI All Country World index (ACWI) currently.
So why is this the case? The arguments are broad and are strongly influenced by ESG factors, ie EMs can be poor in terms of corporate governance. But essentially we are looking at a multi-decade anomaly which we believe is a major distortion but should continue to abate.
Things are slowly changing. Historically, the MSCI China index has been related to Hong Kong only and currently has no major recognition of mainland China A-shares, despite the fact they account for a larger market cap than the whole of Europe. MSCI has announced plans to increase the China A-shares exposure across its indices next year, following the first stage of implementation at a 5% weighting, which has been promising.
In our view, EM equities present a great opportunity – they are under-owned, undervalued and under-rated. The relative risk/return profile of EM versus that of DM is favourable on the basis of the former's positive currency-adjusted returns. EM equity valuations have de-rated heavily year-to-date and are well below those of the S&P 500 index from a current and historical perspective. The bulk of the countries are investment grade and have a positive / neutral outlook. Debt profiles – bar China – have been held in check and GDP per capitas continue to rise. In our opinion the biggest risk in the EM space remains the possibility of a widespread health pandemic rather than a further impulsive rally in the US dollar or major trade war.
Larry Hatheway, Group Head of GAM Investment Solutions and Group Chief Economist
The Federal Reserve (Fed) has been a major factor for investors over the last three years as it has normalised monetary policy. Recently Fed Chairman Powell acknowledged that the Fed’s current monetary policy is approaching the so-called neutral rate. Investors have taken that with sigh of relief thinking that the Fed’s tightening policy is coming to an end. In our view, the truth is that the Fed probably does not need to move monetary policy into a restrictive stance insofar as inflation is unlikely to overshoot its policy stance.
Nevertheless, investors may still underestimate the Fed’s next steps. Markets are discounting one rate hike at the end of this year and a further hike in 2019. We believe it is very likely, however, that the Fed will lift rates several times next year. At some point, therefore, investors will likely realise that monetary policy will become somewhat more restrictive than is now priced.
Finally, as inflation approaches and even slightly exceeds the Fed’s target we believe there will be some risk of an overshoot. In that scenario, markets are likely to be unsettled by the prospect of a more hawkish and less predictable Fed. Accordingly, we believe monetary policy uncertainty will be part of the investment backdrop for much of 2019.
Reiko Mito, Fund Manager, Japanese Equities
Prime Minister Shinzo Abe has confirmed plans to hike Japan’s VAT rate from 8% to 10% in October 2019, marking the second leg of a sales tax increase, the first of which was initiated in April 2014.
Market observers fear that that the upcoming hike could dent purchases, having seen consumption tank after the first hike in 2014, when VAT was increased to 8% from 5%. However, we are more optimistic this time around, as the government has unveiled its fiscal agenda to boost Japan’s economy after the tax increase next year. The agenda includes tax credits for car and housing purchases, reduced rates on food as well as rebates on certain cashless purchases. As a result, we feel that the overall impact of the second tax hike will have a negligible effect on consumer confidence compared to the first one in 2014.
Increasing the sales tax, in our opinion, is essential for the Japanese government’s credibility in addressing its major debt issues. For this reason, we believe that ceasing quantitative easing (QE) will not be a priority for the Japanese government next year as it is fully committed to the VAT rate hike while change in accommodative monetary policy could disrupt market dynamics.
Gregoire Mivelaz, fund manager, developed market credit
Everyone has been waiting for the ECB to announce its first rate hike, which has now been postponed to 2019, specifically September 2019 according to the latest indications. Rising rates tend to be good for profits of financials and as we approach next September we expect investor attention to start to look favourably on the likelihood of improvement in balance sheet strength from such a move. This is particularly the case for those of the national champions we tend to favour. Since we are already positioned for rising rates, with about 50% weighting in our strategies invested in fixed to floaters and floating rate notes, we are aiming to benefit both from better credit metrics and a rising rate environment.
During 2018 the theme among investors has been one of de-risking. For 2019 we believe central banks will increasingly move towards quantitative tightening (QT). One question we are often asked is how this will affect us. QT is only tangential for us since there was no buying of financials via quantitative easing (QE), so there will be no direct unwinding in our areas.
Charles Hepworth, Investment Director, Managed Portfolio Services
Now we have the first stage of the finalised agreement on the Brexit deal it is worth considering the likely outcomes, as in our view there are still many different paths and rabbit holes we can go down – in our view, some of them more likely than others.
The tortuous negotiating work of the government over the last two years has produced the withdrawal agreement, which has now been signed off by the 27 EU countries, but it meets one final hurdle – approval by the UK parliament. If it is going to go through, which at the time of writing looks a very low probability, we believe there are currently only two ways this could happen:
Either the European Research Group (led by Jacob Rees-Mogg) would have to win some concessions / amendments to the current deal that are more in keeping with their desire for the UK to be unshackled from the EU and resulting in a hard-ish Brexit, or enough Labour remain-supporting MPs break with party lines and vote with Prime Minister May to approve the current deal, thus ensuring a soft-ish Brexit. In our view, both of these probabilities look very slim, given the EU’s insistence that the agreed deal is not for amending.
Our other scenarios are based around the prospect of parliament voting against the deal – which we believe would increase the likelihood of a second referendum, although how this could be phrased is open to huge debate. If it was along the same lines as the original EU referendum in 2016, current polls suggest this would favour a “remain” outcome, but the same polls implied that outcome last time around. Alternatively an embattled May could stage a surprise vote by the people on her deal in the form of a snap election, thereby bypassing parliament approval and moving for a proxy endorsement of her deal by the electorate. This may be just too risky a strategy given the disastrous outcome she achieved in the last snap election, but it should not be ruled out entirely.
One other eventuality which could emerge is a transition extension that goes on ad infinitum. In this scenario, while the deal is agreed, it is not in time for the March deadline next year, so extension after extension is required meaning the current status quo effectively remains in place. In our view, this is perhaps now the lowest likelihood probability for the end state of Brexit – BINO (Brexit in name only); it was one that the EU could have used as its trump card and wait out until the UK electorate is pacified into remaining, but that ship now looks like it has sailed.
John Seo, Co-Founder and Managing Director of Fermat Capital Management LLC
We believe the catastrophe bond and insurance-linked securities (ILS) market will likely surpass in 2019 the USD 100 billion mark of total outstanding issuance – a major milestone for the market.
Breaking past USD 100 billion is important because in the early days of the market many observers said they would have been happy if we could just get past USD 5 billion, and that was only fifteen years ago. Significant energy will be released by reaching this milestone, which should be beneficial for our market and the insurance industry as a whole.
With strong investor demand for ILS, we believe that the opportunities for further growth are inevitable. There is a greater realisation that this market will continue to grow and one day will go to USD 300 billion and beyond. We believe we are going to get there, but of course, there are numerous paths to achieving this result. It could be achieved through natural growth or by expanding further into protection gaps. We also feel that there is a significant opportunity for expansion outside the US market, especially in China, and to non-natural catastrophes like cyber and casualty.