Global Investing

Buying back into emerging markets

After almost a year of selling emerging markets, investors seem to be returning in force. The latest to turn positive on the asset class is asset and wealth manager Pictet Group (AUM: 265 billion pounds) which said on Tuesday its asset management division (clarifies division of Pictet) was starting to build positions on emerging equities and local currency debt. It has an overweight position on the latter for the first time since it went underweight last July.

Local emerging debt has been out of favour with investors because of how volatile currencies have been since last May, For an investor who is funding an emerging market investments from dollars or euros, a fast-falling rand can wipe out any gains he makes on a South African bond. But the rand and its peers such as the Turkish lira, Indian rupee, Indonesian rupiah and Brazilan real — at the forefront of last year’s selloff –  have stabilised from the lows hit in recent months.  According to Pictet Asset Management:

Valuations of emerging market currencies have fallen to a point where they are now starkly at odds with such economies’ fundamentals. Emerging currencies are, on average, trading at almost two standard deviations below their equilibrium level (which takes into account a country’s net foreign asset holdings, inflation rate and its relative productivity).

What’s more, interest rates in all these countries have risen since the selloff kicked off last May, in some cases by hundreds of basis points. That makes running short positions on emerging currencies and local debt too costly, analysts say.  What’s also helping is the sharp volatility decline across broader currency markets, with Reuters data showing one-month euro/dollar implied volatility near its lowest since the third quarter of 2007. That has helped revive carry trades — the practice of selling low-yield currencies in favour of higher-yield assets  Low volatility and high carry – that’s a great backdrop for emerging markets. No wonder that last week saw cash return to emerging debt funds after first quarter outflows of over $17 billion. Pictet again:

Local currency bond yields have climbed in recent months – quite steeply in some cases – hence, the asset class has acquired some extremely positive characteristics. Such yields are now among the highest of all global fixed income classes, yet their duration is among the lowest. In a period likely to see higher U.S. bond yields, that makes for an attractive combination.

Weekly Radar: Elections and housing in last big week of 2012

So an extra dose of medicine from the Fed on Wednesday helps smother global market volatility further into the yearend — even though naming an explicit 6.5% unemployment rate could well send Treasury bond volatility soaring as the current 7.7% rate likely approaches that level in 2014 just as the Fed low-rate pledge expires. Not a story for early next year maybe, but…

More nose-against-the-windshield, the busy end to this week – with the EU Summit today and December’s flash PMIs tomorrow – makes it difficult to clear the decks yet for yearend — at least not as much as market pricing and volumes would suggest. Moves to some form of EU banking union are already in the mix from Brussels, however, so another plus at the margins perhaps.

And looking back over the past week — who’d have thought we could still be surprised by an upset in Italian politics? It was the only real significant pre-Fed news of the past week and maybe packed more of a initial punch that it warranted as a result. But for all the interest in Monti stepping aside and Silvio’s attempt to return, there was no really big shift in picture already in front of investors. Ok, so the election is now likely in February not March/April and no one wants to write off Berlusconi completely. But he’s still more than 10 points adrift in polls and Monti himself may well stand for PM in the election too. In short, it adds some political risk at the edges, but if you were happy to hold or buy more Italian bonds before this (still a big ‘if’), then all that really changed for investors is they got a better yield at this week’s relatively successful auction.

Frontier markets: safe haven for stability seekers

Frontier markets have an air of adventure and unpredictability about them. One is tempted to ask: Who knows what will happen next?

The figures tell a different story.

In fact, emerging markets overtook frontier markets in terms of volatility of returns as long ago as June 2006, as a recent HSBC report shows. And a more significant milestone was passed a year later, in June 2007, when even developed markets overtook frontier markets in terms of volatility of returns.

Since then, frontier markets have without fail stayed more stable than developed and emerging markets. In 2012, the gap between the closely-correlated developed/emerging markets bloc and frontier markets widened even further as returns in the latter seem to be becoming even more stable. According to David Wickham, EM investment director at HSBC Global Asset Management:

Weekly Radar: Leadership change in DC and Beijing?

Any hope of figuring out a new market trend before next week’s U.S. election were well and truly parked by the onset of Hurricane Sandy. Friday’s payrolls may add some impetus, but Tuesday’s Presidential poll is now front and centre of everyone’s minds. With the protracted process of Chinese leadership change starting next Thursday as well, then there are some significant long-term political issues at stake in the world’s two biggest economies.  Not only is the political horizon as clear as mud then, but Sandy will only add to the macro data fog for next few months as U.S. east coast demand will take an inevitable if temporary hit — something oil prices are already building in.

Across the Atlantic, the EU Commission’s autumn forecasts next week for 2012-14 GDP and deficits will likely make for uncomfortable reading, as will a fractious EU debate on fixing the blocs overall budget next year. But the euro zone crisis at least seems to have been smothered for now. Spain seems in no rush seek a formal bailout, will only likely seek a precautionary credit line rather than new monies anyway and needs neither right now in any case given a still robust level of market access at historically reasonable rates and with 95% of its 2012 funding done. According to our latest poll, more than 60% of global fund managers think Spanish yields have peaked for the crisis. Greece’s deep and painful debt problems, shaky political consensus and EU negotiations are all as nervy as usual. But tyhe assumption is all will avoid another major make-and-break standoff for now. More than three quarters of funds now expect Greece to remain in the euro right through next year at least.

The extent to which the relative calm is related to today’s introduction of a wave of EU regulation on short-selling of bonds and equities and, in particular, rules against ‘naked’ credit default swap positions on sovereign debt is a moot point. This may well have reined in the most extreme speculative activity for now and it has certainly hit liquidity and volumes.

Weekly Radar: Earnings wobble as payrolls, BOJ, G20 eyed

Easy come, easy go. A choppy October prepares to exit on a downer – just like it arrived. World equities lost about 3 percent over the past seven, mostly on Tuesday, and reversed the previous week’s surge to slither back to early September levels. Just for the record, Tuesday was a poor imitation of the lunge this week 25 years ago – it only the worst single-day percentage loss since July and only the 10th biggest drop of the past year alone. But it was a reminder how fragile sentiment remains despite an unusually bullish, if policy-driven year.

Why the wobble? t’s hard to square the still fairly rum, or at best equivocal, incoming macro data and earnings numbers alongside year-to-date western stock market gains of 10-25%. There’s more than enough room to pare back some more of that and still leave a fairly decent year given the macro activity backdrop and we now only have about 6 full trading weeks left of 2012. So it will likely remain bumpy – not least with U.S. and Chinese leadership changes into the mix as mood music. The sheer weight of a gloomy Q3 earnings season seems to have hit home this week, with revenue declines or downgraded outlooks  – particularly in “real economy” firms such as Caterpillar, Dupont,  Intel and IBM etc – worrying many despite more decent bottom line earnings. As some investors pointed out, earnings can’t continue to beat expectations if revenues continue to wither and there are still precious few signs of an convincing economic turnaround worldwide to draw a line under the latter.

The policy-driven equity boom of the past couple of months has also been suspect to many strategists given the lack of rotation from defensive stocks to cyclicals, showing little conviction in central bank reflation policies succeeding soon even though ever more ZIRP/QE has seen something of an indiscriminate dash to any fixed income yields you care to mention – from junk to ailing sovs and now even CLOs! The bond rush has swept up an awful lot of odd stuff –  not least 10-year dollar debt from countries such as Bolivia and Zambia, whatever about Spain, and corporate junk with CCC ratings and current default rates of almost 30%! As some other funds have pointed out, another weird aspect of this has been the appetite for long duration – which doesn’t fit with any belief that reflationary policies will work on a reasonable timeframe. So, is that it? Central banks will continue to wrap everything in cotton wool for the next decade without ever succeeding in boosting growth or even inflation? Hmmm. The various U.S. growth signals are not ultra-convincing, not yet at least, but they’re not to be ignored either. Thursday’s news of a bounceback in the UK economy in Q3 also shows the prevailing stagnation narrative is not without question. And everyone seems convinced Chinese growth has troughed in Q3 –and  just look at the 66% rise in Baltic Freight prices in little over a month. The rebound in super-low equity volatility in the U.S. and Europe this week is also worth watching – though it has to be said, these gauges remain historically low about 20%.

GUEST BLOG: Is Your Global Bond Fund Riskier than You Thought?

This is a guest post from Douglas J. Peebles, Head of Fixed Income at AllianceBernstein. The piece reflects his own opinion and is not endorsed by Reuters. The views expressed  do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.


Global bond funds continue to attract strong inflows as near-zero interest rates lead many investors to look abroad for assets with attractive yields. As we’ve argued before, global bonds provide many important benefits, but it’s crucial that investors select the right type of fund.

Not all global bond funds are cut from the same cloth. One key consideration that investors often overlook is the extent to which the fund elects to hedge its currency exposure. When a domestic currency depreciates – as it did for US-dollar–based investors during most of the period between 2002 and 2008 – foreign currency exposure can help boost returns from holding global bonds.

Pension funds cover the table

As gloomy first paragraphs go, you’d have to go some to top Schroders’ Jonathan Smith’s introduction to a report touting his firm’s momentum investing offering.

“As the global economy continues to de-leverage, the next decade looks likely to be a period of weak growth and low interest rates, punctuated by bouts of heightened instability and crisis.”

Oh but hang on!, here’s Legal & General Investment Management having a go.

Time for a slice of vol?

As the global markets consensus shifts toward a “basically bullish, but enough for now” stance — at least before Fed chief Bernanke on Monday was read as rekindling Fed easing hopes — more than a few investment strategists are examining the cost and wisdom of hedging against it all going pear-shaped again. At least two of the main equity hedges, core government bonds and volatility indices, have certainly got cheaper during the first quarter. But volatility (where Wall St’s Vix index has hit its lowest since before the credit crisis blew up in 2007!) looks to many to be the most attractive option. Triple-A bond yields, on the other hand, are also higher but have already backed off recent highs and bond prices remain in the stratosphere historically.  And so if Bernanke was slightly “overinterpreted” on Monday — and even optimistic houses such as Barclays reckon the U.S. economy, inflation and risk appetite would have to weaken markedly from here to trigger “QE3″ while further monetary stimuli in the run-up to November’s U.S. election will be politically controversial at least — then there are plenty of investors who may seek some market protection.

Societe Generale’s asset allocation team, for one, highlights the equity volatility hedge instead of bonds for those fearful of a correction to the 20% Wall St equity gains since November.

A remarkable string of positive economic surprises has boosted risky assets and driven macro expectations higher but has also created material scope for disappointment from now on. We recommend hedging risky asset exposure (Equity, Credit and Commodities) by adding Equity Volatility to portfolios.

Retreat of Tail-Risk Trinity

Until this week at least, one of the big puzzles of the year for many investors was squaring a 10-15% surge in equity indices with little or no movement in rock-bottom U.S., German and UK government bond yields. To the extent that both markets reflect expectations for future economic activity, then one of them looks wrong. The pessimists, emboldened by the superior predictive powers of the bond market over recent decades, claim the persistence of super low U.S. Treasury, German bund and British gilt yields reveals a deep and pervasive pessimism about global growth for many years to come. Those preferring the sunny side up reckon super-low yields are merely a function of central bank bond buying and money printing — and if those policies are indeed successful in reflating economies, then equity bulls will be proved correct in time. A market rethink on the chances for another bout of U.S. Federal Reserve bond-buying after upbeat Fed statements and buoyant U.S. economic numbers over the past week also nods to the latter argument.

But as we approach the final fortnight of the first quarter,  more seems to be going on. Much of the whoosh of Q1 so far has merely been a reversal of the renewed systemic fears that emerged in the second half of last year. In fact, gains in world equity indices of circa 13% are an exact reversal of the net losses suffered between last June and the end of 2011.  And if those gains are justified, then much of the extreme “tail risks” that scared the horses back then must have been put to rest too, no? Well, the two mains tail risks — a euro zone breakup or collapse and a lapse of the U.S. economy into another recesssion or depression — do look to have been been put to bed for now at least. The ECB’s mega 3-year cash floods in December and February and the “orderly” Greek debt default and restructuring last week have certainly eased the euro strain. The remarkable stabilisation of U.S. labour markets, factory activity, household credit and even retail sales has also silenced the double-dippers there for now too.

The net result seems to have been this week’s synchronised retreat in three of the main “catastrophe hedges” — gold, AAA-government bonds and equity volatility indices — and this move could well mark a critical juncture. Gold is down 8% since its 2012 peak on Leap Day,  10-year U.S., UK and German government bond yields are up 25/30 basis points since Monday alone, and equity volatility gauges such as Wall St’s ViX have dropped to levels not seen since before the whole credit crisis exploded in the summer of 2007.  If extreme systemic fears are genuinely abating and the prevalence of even marginal positioning like this in investment portfolios is being unwound, then there may well be some seismic flows ahead that could add another leg to the equity rally.  The U.S. bias in all this is obvious with the rise of the dollar exchange rate index to its highest since January. That has its own investment ramifications — not least in emerging markets. But the questions for many will remain. Is the coast really clear? Are elections over the coming weeks in France and Greece and an Irish referendum on the euro fiscal pact just sideshows? Is the global economy sufficiently repaired to bet on renewed growth from here and will corporate earnings follow suit? Has bank and household deleveraging across the western world halted? Are the oil price surge and geopolitical risks in the Middle East no longer a concern? And if you’ve made 10-15% already this year, are you going to go double or quits?  The chances are there will not be 10-15% equity gains in every quarter this year.

Currency hedging — should we bother?

Currency hedging — should we bother?

Maybe not as much as you think, if we are talking purely from a equity return point of view — according to the new research that analysed 112 years of the financial assets history released by Credit Suisse and London Business School this week.

Exchange rates are volatile and can significantly impact portfolios — but one can never predict if currency moves erode or enhance returns. Moreover, hedging costs (think about FX overlay managers, transaction costs, etcetc).

For example, the average annualised return for investors in 19 countries between 1972 (post-Bretton Woods) to 2011 is 5.5%, hedged or unhedged. For a U.S. investor, the figures were 6.1% unhedged or 4.7% hedged (this may be largely because only two currencies — Swiss franc and Dutch guilder/euro — were stronger than the U.S. dollar since 1900).