EFG Quarterly Review_Q3 2013_lo Res
-
Upload
reader1453 -
Category
Documents
-
view
216 -
download
0
Transcript of EFG Quarterly Review_Q3 2013_lo Res
-
8/14/2019 EFG Quarterly Review_Q3 2013_lo Res
1/12
Summer 2013
QUARTERLY REVIEW
This issue:
Flows and fundamentals
US:Data dependency
Europe:ECB activism
Asia:Chinas shadow banks
Special focus:Active fixed incomemanagement
-
8/14/2019 EFG Quarterly Review_Q3 2013_lo Res
2/12
EFG International
Comment
If anyone doubted the importance of central banks to the worldsfinancial markets, events of the early summer should lay theirdoubts to rest. The hint that the US Federal Reserve would taperits programme of asset purchases assuming that the US economy particularly jobs growth was strong enough sent markets intoa tailspin in June. Japan, however, is keenly embracing US-stylequantitative easing (QE) policies. And, in early July, the ECB
adopted the US approach of giving forward guidance on short-term interest rates. The Bank of England is thought likely to adopta similar approach.
So, although the precise details vary, the US model of post-crisismonetary policy seems to have been effectively exported to therest of the world.
Comparisons with the US, of a less favourable nature, are alsobeing made in China. Concerns about its shadow banking systemare being likened to the conditions which preceded the US sub-prime crisis. There are important differences, and we do not thinkthis is Chinas Lehman moment, but clearly Chinas bankingsystem will remain a source of concern for some time. Fixingbanks, the last five years tells us, is a slow process. For investors,however, much bad news already seems discounted in the Chineseequity market.
-
8/14/2019 EFG Quarterly Review_Q3 2013_lo Res
3/12
Quarterly Review Summer 2013
Overview
Contents
03Asset market
performance
04US: Datadependent QEtapering
05UK:Double dipdisappears
06Europe:ECB activism
08Asia:Chinas shadowbanks
09Special focus:
Active fixed
income
management
After more than four years of very easy monetary conditions in the US, financial markets arestarting to adjust to a different environment. However, the phasing out of expansionary policiesin the US will be a long, slow process and will be conditional on the strength of the economy itwill be data-dependent. Furthermore, other countries are only now embracing US-stylemonetary policies (QE in Japan and forward guidance on rates in Europe).
Expected changes in policy have led to some large fund flows, out of assets previouslyconsidered safe, such as gold, core government bonds and inflation-protected securities. Recentcapital losses on such assets have challenged the notion of their safety.
The summer is often a volatile time in financial markets and in that context such uncertainconditions may be expected to continue. This, however, is an environment in which a carefulassessment of fundamentals needs to be set alongside the short-term vagaries of fund flows.
Figure 1
2007 2008 2009 2010 2011 2012 2013
-120
-100
-80
-60
-40
-20
0
20
40
60
Index,
+=better/-=worsethanexpected
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
%
Citigroup Economic Surprises Index for major economies (lh axis)
US 10-year government bond yield (rh axis)
Economic
data better
than expected
Source: Thomson Reuters Datastream. Data as at 2 July 2013.
Economic
data weaker
than expected
Economic surprises and bonds
What sort of growth?
It is commonplace to describe economies as being at various
positions in their economic cycle recovery, recession and so on.
Such an analysis is, however, somewhat inappropriate in current
circumstances: different economies are better described as being
at varying stages in their post-crisis and structural adjustment.
In these circumstances there is a heightened sensitivity to data
releases. Better than expected data has typically seen the price of
safe haven assets, such as US government bonds, fall with their
yield rising.
The US is making a good recovery from its credit and housingcrises. Even so, economic growth still remains weaker than long-
run historic averages and the labour market is not yet strong
enough to support an early withdrawal of monetary stimulus. The
UK recovery lags that of the US but data revisions have seen the
double dip disappear and growth seems to have recovered well in
mid-2013. Japan has posted strong growth so far in 2013: probably
helped by Abenomics, at the very least with regard to the positive
influence on confidence. However, the jury is still out on whether
or not that set of policies will ultimately succeed in boosting
growth and eliminating deflation.
In the Eurozone, many structural challenges remain to be
addressed, austerity fatigue can be seen in some countries andthere is slow progress on the structural reforms which were
designed to bolster the Eurozone. Economic activity has, at best,
stabilised. China, meanwhile, continues to strive for a rebalancing
of its economy away from export and investment dependence and
toward more consumer-orientated growth. Growth is firm but the
perennial fears of a hard landing have not been dispelled.
-
8/14/2019 EFG Quarterly Review_Q3 2013_lo Res
4/12
EFG International
02
Figure 4Figure 2
2009 2010 2011 2012 2013
99
100
101
102
103
104
105
106
107
108
109
Index,
Q12009=
100
EurozoneUSJapan
Source: Thomson Reuters Datastream. Data as at 2 July 2013.
GDP: Japan vs US and Eurozone
Figure 3
Source: JP Morgan, Thomson Reuters Datastream. Data as at 2 July 2013.
03 04 05 06 07 08 09 10 11 12 13
70
80
90
100
110
120
130
140
150
Index,
January
2003=100
BRIC Eurozone JapanUSN11*
Less competitive
*Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, Philippines, Turkey, South Korea, and Vietnam
Real exchange rates
Source: IMF World Economic Outlook database. Data as at 2 July 2013.
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
-10
-8
-6
-4
-2
0
2
%o
fGDP
Brazil India Turkey South Africa
Forecast
Current account balance: ten-year downtrend
Flows and fundamentals
Perhaps because economic growth does not yet seem to be
on a secure footing, indications that the US Fed may taper its
quantitative easing (QE) programme (that is, reduce then stop
its programme of asset purchases) have caused a number of
dislocations in financial markets.
As well as the impact on safe-haven bonds, fears of tighter
global liquidity have adversely impacted emerging market bonds,
currencies and equities that had been favoured in the hunt for
yield. Fund outflows from many of these previously-popular assets
have been substantial and, at times, disorderly. The drawbacks
of passive, index tracking investing for such assets have been
highlighted (see Special Focus on page 9).
Changing perceptions
In that context, a changed perception is, in some cases warranted.
Japan has long been regarded as a structurally weak economy with
entrenched deflation and poor demographics. We are cautiously
optimistic that the aggressive set of policy measures introduced by
the new government will have a positive short term impact on the
economy although the longer term implications are less clear. It is
notable that, even before these measures were introduced, the
Japanese economy had made a respectable recovery from early
2009 the trough of global activity.
In the emerging economies, we need to be mindful of the fact that
fund flows into these economies in recent years have had, in some
cases, a very distortionary effect. Notably, they have driven up
real exchange rates in a number of countries (for example Brazil,
India, Turkey and South Africa), impairing their competitiveness and
bringing a deterioration in their current account balances. Other
emerging economies have not been as adversely affected.
Although the importance of the emerging economies in driving
global growth on a long-term basis remains intact. Variations
around that theme also need to be considered.
We return to these themes after a discussion of recent asset
market performance.
-
8/14/2019 EFG Quarterly Review_Q3 2013_lo Res
5/12
Quarterly Review Summer 2013
US Europe Japan Emerging World
-15
-10
-5
0
5
10
15
20
%
Bonds, total return US$ terms
Equities, total return, US$ terms
Source: Citigroup (bonds); MSCI (equities). Data as at 2 July 2013.
Six months to end-June 2013
Figure 5
Asset market performance
03
Asset market performance
In all of the main developed markets, equitiesproduced positive, and government bondsnegative, returns in the first half of 2013. In themain emerging markets, both bonds and equitiesposted losses in US dollar terms.
Asset market performance
Overall world equities produced total returns in the first half of
2013 of 8.8% in US$ terms. The strongest performing countries
were Japan, with a gain of 16.6% in US$ terms and the US (up
13.7%).
Japans equity market the starperformer in the first semester
Equity markets
The four main emerging equity markets Brazil, Russia, India and
China all recorded losses in US dollar terms in the first half of the
year. In contrast, all the main developed equity markets returned
positive local currency returns, with Japans gains amounting to 34%.
Currency weakness against the US dollar undermined theperformance of almost all markets in dollar terms. That was most
notable in Japan, with a sharp fall in the yens value. Even so,
Japan still produced the strongest dollar-terms returns in the first
half. Australias gains in local currency terms were transformed
into losses in US-dollar terms as the currency weakened sharply.
Concerns about slowing Chinese growth and commodity prices
weighed on the Australian dollar.
Figure 6
Source: Citigroup. Data as at 2 July 2013.
Japan Australia UK Switzerland US Eurozone
-15
-10
-5
0
5
%
US$ terms
Local currency terms
Six months to end-June 2013
Bond market returns
Figure 7
Equity market returns
Source: MSCI. Data as at 2 July 2013.
Brazil
Russia
China
India
Australia
UK
Taiwan
Germany
Switzerland
US
Japan
-20
-10
0
10
20
30
40
%
US$ terms
Local currency terms
Six months to end-June 2013
Past performance is not an indicator of future performance.
Past performance is not an indicator of future performance.
Past performance is not an indicator of future performance.
Bond markets
Most developed world government bond markets recorded
negative total returns in local currency terms in the first half of
the year. Losses in capital value, as yields rose, outweighedcoupon income. In US dollar terms, as the dollar appreciated
against most currencies in the period, returns were further into
negative territory: losses in the Japanese government bond market
amounted to 12.4%.
Behind the back-up in bond yields was a concern about the effects
of a tapering of the US QE programme, which would entail a
slower pace of Fed purchases of government and mortgage bonds.
-
8/14/2019 EFG Quarterly Review_Q3 2013_lo Res
6/12
EFG International
04
United States
The health of the US economy will be carefullymonitored during the summer as the US FederalReserve has outlined that various economic criteriawill be carefully assessed when judging the timingand pace of the exit from ultra-low interest ratesand the scaling back and ending of quantitativeeasing (QE).
Tapering decisions
The importance of the US economy and monetary policy decisions
to the entire world was underscored by the fact that all globalfinancial markets were affected by recent Fed comments that it
would start to taper its QE programme.
Tapering refers to scaling back the Feds monthly asset purchases
from the current pace of $85bn. That is, the Fed will still continue
to buy government and mortgage bonds but at a slower rate.
Growth recovery
The fact that US GDP growth has recovered sufficiently well
enables such a step to be considered. In particular, the private
sector is regaining momentum, offsetting the drag on overall GDP
growth from lower government spending. As a result of the wayGDP growth data are reported - quarter on quarter annualised
changes - growth could well appear stronger in the third quarter
as comparisons are made with the second quarter (in which the
effects of government spending cuts were greatest).
Figure 8
Source: Thomson Reuters Datastream. Data as at 2 July 2013.
2007 2008 2009 2010 2011 2012 2013
-6
-4
-2
0
2
4
6
Overall GDP growth
Federal, State and local government spending
Private sector spending
%c
hangeonyear
US GDP: government and private sector
Labour market is key
However, the most important economic information behind the
tapering decision will be labour market data and, more specifically,
the monthly change in non-farm payroll data. Over the first six
months of 2013, the increase averaged 190,000 jobs per month.
If that pace in maintained, we think it will justify a gentle taper in
asset purchases. If gains are above 200,000 per month a more
rapid taper would be warranted, but less than 140,000 per month
would signal no tapering. Importantly, gains at that rate are unlikely
to absorb all the new workers entering the labour market and theunemployment rate is likely to rise. However, the link between job
creation and the unemployment rate is far from direct as there has
recently been a steady fall in the participation rate (the share of the
population in work or actively seeking work).
The exit route from the USs unorthodox policies will certainly take
a long time and require a delicate balancing act.
Figure 9
Source: Thomson Reuters Datastream. Data as at 2 July 2013.
2010 2011 2012 2013
63.0
63.5
64.0
64.5
65.0
65.5
%
7.5
8.0
8.5
9.0
9.5
10.0
%
Participation rate (lh axis)
Unemployment rate (rh axis)
US labour market
Trends in the labourmarket will be thekey factor behindthe tapering of theFeds assetpurchases.
Fed moves on monetary policyare data dependent
-
8/14/2019 EFG Quarterly Review_Q3 2013_lo Res
7/12
Quarterly Review Summer 2013
05
United Kingdom
There are some brighter signs with regard to the UKeconomy allowing the Chancellor of the Exchequerto claim recently that it is out of intensive care.
Economic surprises
In financial markets it is so often the case that economic data
are judged not in an absolute sense whether growth is positive
or negative, for example but relative to expectations. It is the
surprise element which influences financial markets. In the UK
recently those surprises have been generally favourable, with data
better than market expectations.
Revisions to past data on GDP have also helped dispel some of
the gloom. The double-dip recession the renewed drop in output
in late 2011/early 2012 after the recession in 2008/9 no longer
exists, thanks to such revisions.
Even so, UK GDP in the first quarter of 2012 was still 4% lower
than at its peak four years earlier.
Figure 10
2007 2008 2009 2010 2011 2012 2013
-80
-60
-40
-20
0
20
40
60
80
100
120
Index,+=better/-=worsethanexpected
UK Citigroup Economic Surprises Index
Source: Thomson Reuters Datastream. Data as at 2 July 2013.
Economic
data weaker
than expected
Economic
data better
than expected
UK economic surprises
Figure 11
Source: Thomson Reuters Datastream. Data as at 2 July 2013.
1980 1985 1990 1995 2000 2005 2010
25
26
27
28
29
30
31
32
33
Millions
UK total employment (millions) Recessions
UK employment
The UK produces more jobs,even in hard economicconditions
Labour market
Nevertheless, the UK economy has been good at creating jobs.
Numbers in employment reached a new peak of 32.3million in
the first quarter of 2012. The unemployment rate of 7.8% is similar
to that in the US. Employment levels fell only modestly in the
recession by 2.5%, compared with 7% in both the early 1980s
and early 1990s recessions.
It is true that many of the jobs created are part time and lower-paid,
but there is no doubt that conditions in the UK labour market are
much better than almost everywhere in the Eurozone.
Policy change?
This all means that when Mark Carney took over as Governor
of the Bank of England on 1 July, conditions were better than at
the time his appointment was announced in November 2012.
Nevertheless, his first comments highlighted that the back-up in
government bond yields could threaten continued growth and that
they were unwarranted by prospects for short-term rates. That, in
effect, amounts to forward guidance on policy interest rates.
UK equities
Although UK 10-year gilt yields have risen to 2.5%, they are still
low in a long-term historic context. UK equities, with a dividend
yield of 3.5% (on the FTSE All-Share index), continue to provide
attractive yield and total return prospects for longer-term
investors.
Double dipdisappears as dataturn more positive.
-
8/14/2019 EFG Quarterly Review_Q3 2013_lo Res
8/12
EFG International
06
Europe
In mid-2012 it was seen as essential to develop anew framework to strengthen the operation of theEurozone. Moves towards banking union and theuse of a common fund for bank recapitalisationwere deemed urgent. One year on, little progresshas been made on these issues.
Slow progress on structural issues
Perhaps most disappointing is the case of the ESM (European
Stability Mechanism), the eurozones 500bn rescue fund. This
was designed to be able to recapitalise banks directly. So far, that
has not happened: concerns about the collateral requirements
have been the main stumbling block and it is thought unlikely to be
operational for another 18 months.
Progress has been made on plans for banking union, entailing
common supervision of large European banks, but concrete
structures are unlikely to be in place for some time.
Some see the German general elections on 22 September,
because they distract German policy makers attention, as one
reason for the delay. Although President Angela Merkel is widely
thought likely to win, a new German government is unlikely to be
in place much before end-2013. By that time the direct elections to
the European Parliament (in late May 2014) will be looming. There
is a realistic chance that parties broadly opposed to current EU
policies will have a majority in that new parliament.
Source: Thomson Reuters Datastream. Data as at 2 July 2013.
Germany France Italy Ireland Portugal Spain Greece
0
5
10
15
20
25
30
%
Unemployment rate, latest
Previous peak (since 1990)
Figure 13
Eurozone unemployment
EU leaders have
decidedthat when it
comes to fiscal and
economic integration
within the eurozone,
the decisions will be
taken at a later date.
Decision makingstalled
Figure 12
Eurozone economic surprises
2007 2008 2009 2010 2011 2012 2013
-200
-150
-100
-50
0
50
100
150
Index,+=better/-=
worsethanexpected
Eurozone Citigroup Economic Surprises Index
Source: Thomson Reuters Datastream. Data as at 2 July 2013.
Economic
data better
than expected
Economic
data weaker
than expected
There are three main reasons for that. First, economic data have
been no worse than (admittedly low) expectations. Second, current
account deficits in the peripheral countries have narrowed sharply
or moved into surplus (to a large extent because of weak domestic
demand, which has curbed imports). Third, and most important,the ECBs pledge to do whatever it takes to save the euro last
July, the announcement of Outright Monetary Transactions (OMTs)
last September and the commitment to maintain interest rates
at present or lower levels for an extended period of time in July
have calmed markets. Mario Draghi has described the OMT as
probably the most successful monetary policy measure in recent
times, despite (or because of?) the fact that it has never been
used.
Although Eurozone equity markets have recovered since their
trough last June, valuations are still, overall, low and there are
many interesting stock-specific opportunities.
but a more active ECB
Despite these concerns, tensions in the Eurozone have subsided
and break-up risk is now considered a low probability.
Peter Spiegel,Financial
Times, 28 June 2013.
-
8/14/2019 EFG Quarterly Review_Q3 2013_lo Res
9/12
Quarterly Review Summer 2013
07
Could problems with Chinasshadow banks result in a hardlanding for the economy?
with limited transparency so cleaning up any problems posed
for the regulated banks by the shadow banks can be done more
quietly. Second, China still has strong economic growth, so to
some extent it can grow out of its problems. Third, savings levels
are high and banks themselves have not lent excessively the loan
to deposit ratio is only 75% whereas it was well above 100% for
US banks before the crisis.
For investors, the other major difference is that an equity market
bubble has not gone hand in hand with the growth of lending.
Indeed, the domestic Chinese equity market (the Shanghai Stock
Exchange A share index) is no higher than it was ten years ago.
In China, as in some of the other more export-orientated Asian
markets, we still see good value in equities.
Asia
Chinas shadow banks have been known to pose apotential problem for some time. Events in late June,however, propelled the sector into the spotlight.
Chinas shadow banks
The term shadow banking refers to three main types of financial
activity: off-balance sheet activity by the banks themselves;
activities of non-bank financial institutions such as trust and
leasing companies; and lending by retail money lenders to small
companies and individuals.
The expansion of credit by the Chinese shadow banking sector hasbeen rapid, trebling in size to RMB23 trillion in the four years to
the end of 2012.1The expansion of lending by the shadow banking
system has magnified the expansion of credit by the banks
themselves. The consequence has been that overall lending to the
private sector, which was stable at about 120% of GDP from 2003-
2009, has risen by a third since then.
Many see echoes of the USs credit crisis in Chinas current
problems. Growth of lending has financed construction spending
(infrastructure as well as housing); it has helped drive a surge in
property prices; some of the investment has been excessive
(building roads to nowhere) and, most recently, financial
institutions stopped lending to each other, with interbank interest
rates briefly soaring to 25%.
Even so, the parallels go only so far and we do not see this as
Chinas Lehman moment. First, banks are already state-owned,
Figure 14
China: bank lending to the private sector
Source: Thomson Reuters Datastream; Joe Zhang 'Inside China's shadow banking', Enrich Professional Publishing (2013).
2000 2002 2004 2006 2008 2010 2012 2014
90
100
110
120
130
140
150
160
170
%o
fGDP
Bank lending to the private sector
Bank plus 'shadow' bank lending to the private sector
Shadowbanking
Spotlight falls onChinas shadowbanks. But this isnot a Lehmanmoment.
Figure 15
China & Hong Kong: stockmarket indices
Source: Thomson Reuters Datastream; Hang Seng Indices (www.hsi.com.hk). Data as at 2 July 2013.
00 01 02 03 04 05 06 07 08 09 10 11 12 13
0
200
400
600
800
1000
1200
Index,
1
January
2000
=1
00
Shanghai Stock Exchange 'A' share index
(restricted to mainland China domestic investors and qualified foreign investors)
Hang Seng China Enterprises 'H' shares index
(mainland China enterprises with H-share listings in Hong Kong)
Hang Seng (main Hong Kong index)
1See Jo Zhang Inside Chinas shadow banking; the next subprime crisis? Enrich Professional Publishing (2013).
-
8/14/2019 EFG Quarterly Review_Q3 2013_lo Res
10/12
EFG International
08
Japan
Figure 17
Source: Thomson Reuters Datastream; EFG forecasts. Data as at 2 July 2013.
Corporate profits and forecast (Yen trillions)
2000 peak
2007 peak
2000 2002 2004 2006 2008 2010 2012 2014
2
4
6
8
10
12
14
16
18
20
Yen
trillions
Forecast
...but higher highs for profits
Figure 16
Japan: lower highs for the stockmarket
Source: Thomson Reuters Datastream. Data as at 2 July 2013
00 01 02 03 04 05 06 07 08 09 10 11 12 13
6000
8000
10000
12000
14000
16000
18000
20000
22000
Index
points
Nikkei 225 index
2000 peak
2007 peak
Japans stockmarket
has risen sharply
since Abenomics was
launched in late 2012
but it still offers good
value.
Strong profit growthin prospect
Although there has been a setback in the Japanesestockmarket after the initial sharp rise whichaccompanied the launch of Abenomics, we still seeit as cheaply valued relative to the trend in profits.
Abenomics and the stockmarket
It will be many years before the success or otherwise of the
set of policies known as Abenomics can be assessed. The three
arrows of the policy are: renewed fiscal stimulus, amounting to
13 trillion ($150 billion, about 2.7% of GDP); a 2-2-2 monetary
policy a doubling of the monetary base in 2 years to reach a 2%
inflation target; and a series of structural reforms to help improve
competitiveness. As a by-product of that set of policies, the yen
has weakened sharply.
The pass-through from a weaker yen to higher imported goods
cost has improved the outlook for inflation but reaching the 2%
target remains some distance away.
Furthermore, as noted above, Japans GDP growth since 2009 has
been on a par with the US and strong 2012 first quarter growth
was recorded.
The stockmarket has responded well to the measures with theJapanese equity market being the best performing developed
market in the first half of 2013, despite a setback after its initial
surge. It still remains, however, below the previous peaks recorded
in 2000 and 2007.
Corporate profits rebound
Corporate profits, however, have already risen and are generally
expected to grow strongly this year, to some extent as a result
of the yens more competitive level. A new peak level for profits
in 2013/14 looks a realistic prospect. Indeed, on the basis of
consensus twelve month forward earnings expectations, Japans
equity market is no more expensive now than it was in late 2012.
Scepticism questioned
Perhaps because Japans equity market has been such a poor
performer for such a long period of time, and because Japans
economy has repeatedly disappointed, scepticism about Japans
prospects is widespread. For the short term at least, we are taking
a more optimistic view with regard to the outlook for Japanese
equities.
-
8/14/2019 EFG Quarterly Review_Q3 2013_lo Res
11/12
Quarterly Review Summer 2013
09
At the start of the year we were concerned that there was little
value in many government bond markets that were viewed as
safe. We were concerned that many investors in such bonds were
not paying adequate regard to the risk of a rise in yields and the
consequent decline in capital values.2 That risk has materialized,
with 10-year US Treasury yields rising from 1.72% in late-December
2012 to 2.50% in early July 2013. That has brought an almost 7%
fall in the price of such bonds. Safe bonds have been far from
safe.
The sell-off in government bonds has seen other bond markets,
such as emerging market bonds, weaken as well. That is
unsurprising given that such bonds typically trade on the basis of a
yield spread over Treasury bonds, which act as the benchmark.
The announcement that the US Federal Reservewould start tapering its purchases of fixed incomesecurities under its Quantitative Easing programmeled to a sharp sell-off in many fixed incomeinstruments around the world. Flows out of manybond funds were substantial. The experienceemphasises to us the importance of active fixedincome management and underscores the problems
of passive, index-tracking investing in this market.
The advantagesof active, ratherthan passive,fixed incomemanagement.
Special focus:
Active fixed income management
Figure 18
Emerging market bond spreads
Source: EFG. Data as at 2 July 2013.
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
0
2
4
6
8
10
12
14
16
Emerging market bonds yield spread over US Treasuries
(based on actual historic weights in Emerging Markets Bond Index)
Spread based on current weights in EMBI index
Basis
points
The sell-off demonstrates to us one technical drawback of
investing in fixed income instruments via a passive fund. Such
passive funds seek to replicate the behavior of one of the widely-
used fixed income indices, but they failed to do so. The outflow
of funds was so substantial that, on an intra-day basis, they often
traded at a discount to the underlying value of the bonds held inthe funds. Essentially, the problem is that the liquidity offered to
investors in the passive fund was greater than in the underlying
investments. Funds tracking the index failed to do so with the
precision that investors expected.
Additionally, and more fundamentally, we remain skeptical of the
merits of such passive investing in fixed income markets. In bond
indices, a government or corporate issuer has a larger weight the
more debt that is outstanding. That means a greater amount is
invested in poorer credits.
Our approach to active fixed income investing is to focus on
fundamental value. That is the philosophy behind our EFG NewCapital Wealthy Nations Bond Fund*, for example. The emphasis
is on investing in bonds issued by countries which have strong
national balance sheets and external asset positions. In turbulent
conditions, as seen recently, our active management allows us
to reposition toward bonds that have underperformed due to
technical, liquidity and flow-related developments. Investors, such
as ourselves, with the focus on longer-term structural factors can
benefit from such an environment.
2See EFGs Quarterly Review, 2013 Q1Investing in safe government bonds.
* The value of your investment may fall as well as rise and you may not get back your original investment.
-
8/14/2019 EFG Quarterly Review_Q3 2013_lo Res
12/12