Portfolio Adviser • November Guide 2016 • Overview

The theme behind Portfolio Adviser Autumn Congress was whether or not macro is still king when it comes to asset allocation and portfolio construction, or are company fundamentals the principle driver?

In June, we hosted Portfolio Adviser Summer Congress, held exactly one week ahead of the EU referendum. We now know the result; we may not like it but the voting has finished, the result is in and Brexit means Brexit, so the conversations at the autumn event turned to an examination of what we do now from an investment point of view.

Bearing in mind we do not yet know the rules, a potentially more pressing question for the fund groups present is whether they will need a presence in the UK and in Europe, with Dublin and Luxembourg the favourites.

To paraphrase a classic cricketing put-down, Brexit is not even the biggest problem in Europe, so what came out of the various discussions was a sense of the complexity of the low-yielding world in which we are all operating.

One welcome addition to the conversation was Danny Blanchflower, a member of the Bank of England’s Monetary Policy Committee between 2006-09. He knows a thing or two about surprises, and his keynote speech (p8-11) was an insight into how central bankers think, what they are thinking right now and the potential impacts on investment opportunities of the surprises that could be coming our way. “The reality is that for a central banker, there are shocks coming,” he said.

“The economy is being hit, but you haven’t adjusted to the last shock. You are sitting there now in a very difficult situation. You had a chance to rebuild and a chance to make these structural reforms, and you didn’t make them.

“Your problem now is that you are really vulnerable. At least in 2008 we could cut interest rates from 5.5% to 0. 5% and start buying assets, but now the assets to buy are running out. What assets is the ECB going to buy?

“As investors we have to be cautious, but the benefit of all the quantitative easing is that it will push up asset prices. It will push up equities, bonds and the price of corporate bonds. There are places to go, but there are nasty surprises coming. I’ll put my money on it.”

Blanchflower was the keynote speaker at our first ever Portfolio Adviser Congress, in Benahavis in southern Spain.

His words then hold true now: “People say to me all the time that QE hasn’t worked. I don’t agree with that. Bernanke doesn’t agree with that either. When asked to tell people what the counterfactual is, he says if we hadn’t rescued the banks, done QE or cut rates, what would the world have looked like?

“He says unemployment would be much, much higher; something like it was in the depression, 25%. We saw what happened when one or two large financial firms came close to failure. Imagine if 10, 12 or 15 firms had failed, which almost happened during the fall of 2008. It would have brought down the entire financial system and would have had enormous, long-lasting implications for the global economy, not just the US economy.”

We are in a stronger position now because of QE but what future indicators should we be looking at?

The answer, according to Blanchflower, is the same now as it was then: wages. “Wage growth is the crucial thing to focus on because it will tell you when stimulus is going to stop,” he said.

Blanchflower also discussed whether or not monetary policy has had its day, the attraction of a post-Brexit UK to overseas investors and the future direction of asset prices (see p8-11).

It is no coincidence Blanchflower is the first keynote speaker PA has invited back, now economics and top-down considerations are the main drivers of asset allocation and portfolio construction.

On the morning of the first day at the congress, Portfolio Adviser’s group digital editor Geoff Candy hosted a panel debate that asked if macro is still king.

Panellists included Neil Williams, Hermes Investment management’s group chief economist; Caroline Shaw, head of fund and asset management at Courtiers; Amanda Sillars, a multi-manager fund manager at Jupiter; and John Roe, head of multi-asset funds at Legal & General Investment Management.

Contrary to Blanchflower’s view, Sillars said: “It is abundantly apparent that QE isn’t working. It is not creating the growth that was the reason for it having been created in the first place.”

On the other hand, Roe was more in agreement with our keynote speaker: “The problem globally is inflation, not growth. I think that is why QE has gone on for as long as it has. The reality is that if we had more positive wage inflation in the US, they could normalise the economy. But they can’t because they are petrified about the fact they are nowhere near their inflation target. Their inflation expectations are well below their anchor over a 10-year period.

“The problem is much more acute in Japan and Europe. The UK probably has the least issue because it has control of its own currency and, historically, has created its own inflation.” (See p12-15.)

The whole ethos of our congress events is to encourage debate between fund selectors and fund managers. As each event takes place, the topics covered are a good indication of the buying behaviour of the former and the positive outlook of the latter.

Given how low yields have gone, it is no surprise then that the topics included a liberal serving of bond funds – a subject that has been absent from the multi-strategy discussion table in the past year or so. Emerging market debt made a welcome return, with at least one fund manager describing it as “the oasis in the yield desert”.

Emerging markets, both equity and fixed income, are in huge demand from fund selectors. Proprietary data from Last Word Research shows that among UK fund selectors giving a 12-month forward-looking view, global emerging market equity is the most favoured asset class. In fact, more than 53% of fund selectors indicate they will be increasing their allocation to the asset class in the coming year.

Asia Pacific ex Japan equities (47%) and emerging market corporate bonds (28%) make up the top three asset classes of choice in the next year. Meanwhile, at the other end of the spectrum are UK gilts. Forty-seven per cent said They will decrease their allocation to the asset class, while 31% are likely to decrease exposure to developed market government bonds.

We conducted a straw poll at the congress and 40% plus of the invited fund selector experts said they were likely to increase their allocation to both emerging market equities and debt.

Interestingly, alongside UK corporate bonds, a table of the top five net sellers among UK-based fund selectors would also include US and UK equities.

That made the conversations slightly harder for two of our invited speakers: Richard Buxton, head of UK equities at Old Mutual Global Investors, and John Bailer, a senior managing director at the Boston Company Asset Management, which is part of the Bank of New York Mellon.

One event looming over the event – and as you read this it is either just about to happen or has just taken place – was the US presidential election.

Blanchflower is a Brit living and and teaching in Boston (he is currently the Bruce V Rauner professor of economics at Dartmouth College, the Boston- based Ivy Leaguer) so I will leave the last word to this on him.

Throughout the whole of the primaries Trump was ahead, and in this general election he has always been behind. It would be a surprise, I think, if he was to get in. But the reality is people see that it’s close and is within the margins of error right now. We have a Brexit-type vote, and the similarities are strong.

“You probably need to hedge a Trump win. The big issue is not whether people say they’ll vote for Clinton, it’s whether they will show up. This is really about turnout and it is hard to predict what will happen.

“If the turnout is big among African Americans in places like Philadelphia, Clinton will win Pennsylvania. If it’s not, Trump will win. It’s a toss-up. The odds with the bookmakers are 70/30 right now; they were about 80/20 for a Brexit remain.” A two-way street As I wrote earlier, the format of the congress event is designed to encourage debate, discussion and conversation between fund managers and buyers on investment strategies.

Our research and ongoing conversations with our readers and delegates meant we had the right topics covered by the speakers: investment strategies from emerging market debt to highyield bonds, from small-cap specialists to large-cap advocates, as well as experts in generating your clients an income, fixed or otherwise.

For those who attended the event, thanks again for getting stuck in and challenging preconceptions, for taking on the herd and giving alternative theories to an attentive audience. To those who were not, read on to get a flavour of the views expressed.

‘THERE ARE PLACES TO GO, BUT THERE ARE NASTY SURPRISES COMING. I’LL PUT MY MONEY ON IT’

‘THROUGHOUT THE WHOLE OF THE PRIMARIES TRUMP WAS AHEAD, AND IN THIS GENERAL ELECTION HE HAS ALWAYS BEEN BEHIND. IT WOULD BE A SURPRISE, I THINK, IF HE WAS TO GET IN’

Jerry Devlin, head of UK distribution, Amundi The Portfolio Adviser Congress has been the key event on our marketing calendar for the past three years. It is an excellent opportunity to get close to our important clients in an interactive and informal manner. The setting and organisation are first class and the format of small breakout sessions allows for the free exchange of information and ideas. Our fund managers often comment on the high level of client engagement and articulate questions. The itinerary allows ample time for casual conversation and the more structured format of the Fund Labs is an ideal one-on-one introduction. Finally, the quality of the keynote speakers and their subject matter is unparalleled, leading to informative and at time very lively debate.

James Gavin, managing director, UK, Ireland and Channel Islands, MFS Portfolio Adviser Autumn Congress is one of the key events in which MFS looks to participate on an annual basis. MFS has now taken part in the past three of these events, and the Last Word team has not failed to deliver on the high standard of delegates and also the professional manner in how the event is run. We were able to cover a great deal over the course of two and half days, with intimate seminar groups, one-on-ones and discussions over the lunches and dinners. I look forward to participating again in 2017.

Never mind the passing of summer and onset of autumn, Richard Buxton, head of UK equities at Old Mutual Global Investors and manager of the Old Mutual UK Alpha Fund, detects a distinct change in investor mindset

Has anyone else noticed it? I am, of course, referring to the beginnings of a change in mood music for the UK equity market. We may have been here before, where time has been called on the near 30-year bull-run in bond markets, resulting in yields grinding gently upwards, only to be compressed once more.

I am becoming increasingly convinced that monetary policy, in all of its guises, has reached the end of its useful life. Negative interest rates may help companies to borrow cheaply, but if the money is used for share buybacks or overseas acquisitions that merely exacerbates the divisive nature of quantitative easing.

It boosts asset prices for those who own them but the vote to leave the EU was, in part, a warning shot across the bows of institutions from Joe Public flagging that not enough has been done to help those in the ‘real’ economy who aren’t rich in assets.

What is to be done? The smart money is on the use of fiscal stimulus. Hopes are rising that come the Autumn Statement, chancellor Philip Hammond will announce major spending plans for boosting Britain’s network of roads, railways and a myriad other things.

This, surely, will alleviate some of the pain and economic uncertainty of a ‘hard’ Brexit.

Of course, this change in the mood music may be played out over many years but if the baton finally passes from monetary to fiscal stimulus, it has significant implications for leadership in equity and bond markets. The aforementioned infrastructure projects will need to be financed somehow.

The most obvious way would be a massive sale of billions of pounds worth of UK gilts, flooding the market and, at long last, depressing bond prices and lifting yields in the process.

Rising bond yields would be good news for a number of reasons, not least helping to restore much-needed profitability to our unloved banking system through an improvement in banking margins.

A further consequence could be the negative impact on ‘bond proxy’ stocks, the likes of which have become way too overcrowded a trade in my view, particularly in the consumer staples sector.

Investors might finally wake up to the realisation that Barclays, which trades on a 50% discount to book value, isn’t that bad value compared with British American Tobacco, which sits on a 12x price/earnings multiple – for 2020.

Given increased government borrowings the pound will have to continue to take the strain. But that is not all bad news for the 75% or so UK-listed companies with large overseas earnings that are listed on the FTSE 100 index. Does this mean, at long last, larger companies might even unwind years of outperformance registered by their smaller and medium-sized peers?

The market-moving events investors face during the final months of the year – the Autumn Statement, a bitterly contested US election and an Italian referendum which could see a further rise in populist parties – means investors will need to be confident of their respective fund positioning.

‘RISING BOND YIELDS WOULD HELP RESTORE MUCH-NEEDED PROFITABILITY TO OUR UNLOVED BANKING SYSTEM’