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Global view

2019 outlook: active selection is essential

The global economy – which has been doing fairly well – is likely to become even less synchronised and more fragmented. This would continue a trend that began in earnest in 2018 as market returns turned negative. As the effect of US tax cuts wears off, the economy will likely slow, but we don’t expect a US recession yet. However, around the world, trade tensions and political uncertainty are set to be primary drags on performance. High oil prices and tight labour markets in the US, UK, Germany and Japan could also heighten fears of rising rates and inflation.

Neil DwaneGlobal Strategist

(continued on next page)

3 Alternatives Selectivity may pay off in Latin American infrastructure debt

4 Grassroots® Research What the drop in Turkey’s lira means for consumer spending

Active is: Exploring new ideas

Allianz Global Investors Insights

DECEMBER 2018

Key takeaways

– As the global economy becomes less synchronised, investors should aim to be more active and selective

– The US economy will likely slow after the effect of the tax cuts wear off, but no US recession is expected yet

– China may be hampered by trade frictions and the emerging “tech cold war” with the US

– With QE mispricing many asset classes, diversification alone may not be sufficient; contrarian ideas may come into favour

Highlights from our outlookHigher interest rates in the US – and less quantitative easing from the US Federal Reserve and European Central Bank – will likely reduce liquidity and create higher market volatility for investors in 2019. Because navigating the markets successfully may take greater skill, we believe investors should consider actively selecting where to invest, rather than passively accept market returns – understanding that there is no guarantee that any type of strategy will outperform.


that manage their ESG profiles well – focusing on areas such as strong governance, climate change and board diversity – are likely to strengthen their positions in the coming years. Investors who examine these ESG factors can gain an additional layer of insight for identifying opportunities in a marketplace that increasingly demands selectivity.

4. Rising inequality is hurting economies and transforming politics The economic inequality that has been growing in societies around the world is a significant factor in driving anti-globalisation sentiment, and it looks like the trend could get even worse. Inequality is a political issue that has helped spur the rise of nationalist and populist parties. It can also drag down growth, destabilise social systems and stress government budgets.

Five investment ideas for 2019

1. Don’t write off entire regions or markets based on one event – Brexit, for example. It’s important to understand which stocks/sectors might be favoured based on specific scenarios.

2. Globally, inflation pressures are rising as consumer prices increase; investors should consider equities, commodities and real estate as natural inflation hedges. Global equities and commodities still look well-positioned as a whole.

3. The hunt for income remains pressing in a world still experiencing low interest rates.

Investment-grade and high-yield bonds in the US and Europe may be challenged in the coming year, though credit fundamentals are stable globally.

4. Diversification as a strategy is not working as well, as quantitative easing has mispriced many asset classes; contrarian ideas and out-of-consensus themes may come into favour.

5. Disruption in politics and technology is creating clear winners and losers globally; active research and analysis seeks to improve the chances of finding alpha.

Global view(continued from page 1)

2

ESG investing is on the rise US total assets (1995-2018)

1995 1999 2003 2007 2010 2014 2018

ESG Incorporation

Overlapping Strategies

Shareholder Advocacy

$14,000

$12,000

$10,000

$8,000

$6,000

$4,000

$2,000

$0To

tal A

sset

s (in

Bill

ions

)

Source: US SIF Foundation. This chart is illustrative in nature and should not be considered a recommendation to purchase a specific security, strategy or product.

In recent years, investors have been able to follow the herd as markets have risen, but continuing that approach now will likely destroy value rather than create it. As we enter into a period of lower cross-asset correlations, higher volatility and lower returns – particularly for equities – active asset allocation and active security selection are likely to become increasingly important.

Four key themes for 2019

1. A new “tech cold war” could disrupt global supply chains

During 2018, the Trump administration identified China as a strategic technological threat. This has led to fears in China that American technology may ultimately become unavailable, which would be a strategic threat to China’s own economic security. This may prompt both the US and China to build their own discrete tech ecosystems. The result could be a “tech cold war” that lowers profit margins, inhibits innovation and disrupts the global supply chains of tech companies in Asia and the US.

2. Quantitative tightening could mean less growth and higher volatility Central banks have finally started easing back on the stimulus they pumped into the global economy in the wake of the financial crisis. In the US, the Federal Reserve is raising interest rates and beginning “quantitative tightening” by reducing its bond holdings. As this approach is replicated around the world, we expect to see higher volatility.

As central banks ease back on the stimulus they pumped into the post-crisis global economy, we expect to see higher volatility

3. ESG is becoming mainstream, as investors recognise the potential for managing risk and driving performance

Environmental, social and governance (ESG) factors have become a primary concern for investors. Companies


Alternatives

Selectivity may pay off in Latin American infrastructure debt

3

Many investors consider investments in Latin America as relatively risky parts of their “core plus” allocations – the traditional home for investments with higher risk profiles. That would be understandable for countries such as Argentina, whose sovereign debt is rated B plus, or Brazil, with its BB minus credit rating.

However, we believe that tarring an entire region with the same brush isn’t the right approach – particularly when it comes to infrastructure-debt investments. Actively selecting among projects and countries in Latin America may provide enhanced return potential at levels of risk that

Key takeaways

– Investors are increasingly looking to infrastructure investments as a way to balance their portfolios – and actively selecting among Latin American infrastructure-debt projects can be particularly attractive

– Focusing on essential infrastructure projects in investment-grade countries may help minimise the market, currency and political risk associated with this asset class

– With careful portfolio construction, Latin American infrastructure debt can sit within a traditional core allocation even as it offers enhanced return potential

are comparable to similarly rated US issues – which can help Latin American infrastructure investments fit within a portfolio’s core allocation.

Being selective can help reduce a range of risks

The first step to mitigating risk in this asset class involves focusing exclusively on the six countries in the region that have investment-grade credit ratings: Mexico, Chile, Peru, Colombia, Uruguay and Panama. These countries have all demonstrated strong track records for developing their infrastructure with foreign capital. And crucially,

Paul DavidHead of Americas, Infrastructure Debt

they all also will require significant inflows of foreign investment in the coming years.

Mexico, Chile, Peru, Colombia, Uruguay and Panama have strong track records for developing their infrastructure with foreign capital

Risk in this region can be further mitigated by selecting a mix of infrastructure-debt investments across various sectors – particularly in critical areas that have what we believe to be minimal market risk, such as electricity distribution and transmission; water pipelines and desalination systems; renewable energy; and established transportation projects such as airports and toll roads. Moreover, focusing a greater share of investment on the large economies of Mexico, Chile and Peru – with smaller allocations to Colombia, Uruguay and Panama – could help manage market risk even more.

Careful selection may be able to help manage other types of risk as well:


Latin America’s investment-grade countries have a BBB+ weighted average credit rating

Mexico Peru Chile Colombia Uruguay Panama

Weighted average/

total

Credit rating BBB+ BBB+ A+ BBB BBB BBB BBB+

2017 GDP growth 2.00% 2.50% 1.50% 1.80% 2.70% 5.40% 2.10%

Population (millions) 127 31.9 18 48.2 3.4 4 232

Infrastructure index 4.3 3.8 4.8 3.8 4.7 4.9 4.3

Source: Credit rating based on average long-term foreign currency ratings provided by S&P, Moody’s or Fitch, where available. Ratings are adjusted to the Standard & Poor’s rating tiers shown above. GDP growth from Bloomberg Economic Forecast Function, as at 29/11/2018. Infrastructure index from The Global Competitiveness Index 2017-2018 (World Economic Forum) as at 29/11/2018; scale is from 1 (worst) to 7 (best). Weighted average calculation is based on infrastructure-debt activity over the last five years, as at 31/12/2017. The above chart is illustrative in nature and should not be considered a recommendation to purchase or sell a specific security, strategy or investment product.


4


– The currency risk associated with this asset class can be managed – particularly for US investors. Many projects – especially in the energy and power sectors – have US dollar cash flows and prefer to borrow in dollars. The same doesn’t apply across all sectors, however, underscoring the need for careful asset selection.

– Political risk can be managed by investing in the highest-profile infrastructure projects – such as regulated companies and projects – where the winning bids are chosen through an open-procurement process.

Improved yield potential and favourable ESG profiles

Infrastructure-debt assets in Latin America also offer a host of other potential benefits:

Alternatives(continued from page 3)

– They typically have credit ratings close to the sovereign-debt credit ratings in their relevant countries, but with a pick-up in spread. For example, Mexico and Peru have sovereign credit ratings of BBB plus and Chile is rated A plus – and infrastructure deals in those three countries are typically close behind, with ratings of BBB or BBB minus.

– They currently offer long-term yields that we believe can persist through the economic cycle. While every infrastructure-debt deal is unique, our analysis shows that infrastructure debt in Latin America offers about 100 basis points of additional yield potential compared with similarly rated US public corporate debt.

– Since a significant proportion of the investment opportunities in this area are in renewables (such as hydro, wind and solar power) or in lower-carbon natural gas, this asset class can also be attractive

from an environmental, social and governance (ESG) perspective.

Latin American infrastructure debt can be a core holding

For years, investors have increasingly looked to infrastructure investments as a way to balance their portfolios. In fact, the total amount of infrastructure assets under management has more than quadrupled in the last decade, according to Preqin.

Of course, infrastructure investing is not without its risks, but we believe being active and selective in this space may provide attractive return potential. By focusing on essential infrastructure projects in strategic countries in Latin America, investors can help ease some of the concerns that are associated with investments in the region – including market, currency and political risk. This can help Latin American infrastructure debt sit within a traditional core allocation even as it offers significantly enhanced return potential.

In recent years, Turkey’s economy was one of the fastest-growing among emerging-market nations, growing at a pace comparable to India and China. But fundamental problems such as high levels of foreign-currency debt lurked under the surface. So when US-Turkey trade tensions made headlines in the summer of 2018, the Turkish lira suffered a steep selloff – and the country’s economy started a sharp decline.

Grassroots® Research

What the drop in Turkey’s lira means for consumer spending

Key takeaways

– Although Turkey’s economic growth was recently on par with China and India’s, the value of Turkey’s currency – and its consumer confidence – has plunged

– According to our new research, approximately 3/4 of Turkey’s consumers plan to spend less on homes, vacations and cars – and even more are worried about inflation’s effect on food and petrol prices

– More than 60% said their optimism about the country’s economy decreased in the previous six months, and more than half believed the economy would deteriorate further in the next six months

Grassroots® Research – Allianz Global Investors’ proprietary in-house research division – sought to assess the impact of new economic developments on Turkish consumers’ spending habits by surveying approximately 800 consumers in September 2018. This work informs our investment outlook for clients.

Consumer optimism has dropped along with the lira The survey confirmed our investment analysts’ observations about Turkey’s weakening economy. Six out of 10 respondents said their optimism about the country’s economic developments

Oleksandr PidlubnyyGrassroots® Research Analyst



5


fuel and food. More than half were already planning to curtail or stop their purchases of convenience food and prepared food.

A strong link between consumer sentiment and economic growthAlexandra Richter, Head of the Emerging Europe Equity team at Allianz Global Investors, found the outcome of this survey of particular interest because Turkey’s economy is traditionally a domestically driven one: “The combination of a weak Turkish lira, increased inflation and high interest rates are weighing on

Grassroots® Research(continued from page 4)

consumer confidence and overall growth. As a result, Turkey’s consumers are in the process of either postponing some purchases or at least trading down. It will be interesting to conduct this survey again in a few months to see how consumer confidence has evolved in a low-growth – but probably still high-inflation and high-interest-rate – environment.”

A weaker currency, increased inflation and high interest rates have started to weigh on consumer confidence and overall growth

Almost three-fourths of respondents will cut or delay spending on big-ticket items Question: Will the latest economic developments affect your personal spending habits for the following?

12%

9%

9%

10%

8%

8%

8%

8%

9%

10%

8%

7%

7%

9%

15%

13%

34%

13%

14%

13%

17%

36%

22%

32%

29%

26%

19%

33%

29%

48%

14%

41%

45%

54%

33%

Apparel & accessories

Car purchases

Dining expenses

Electronic goods

Holidays/travels

House purchase/rental

Household appliances

I will spend significantly more I will spend slightly more It will not affect my spending habitsI will spend slightly less I will spend significantly less

Source: Grassroots® Research. Data as at September 2018.

had decreased in the previous six months. Looking to the future, more than half said they believed the economy would deteriorate in the next six months.

Yet our respondents’ biggest worry was the lira’s depreciation, with 92% citing concern that Turkey’s weaker currency would negatively affect their overall financial situation. In fact, more than half told us their financial situation was already worse than it had been six months ago.

92% are concerned that a weaker lira will negatively affect their overall financial situation

Big-ticket purchases get sidelined as the price of consumer staples rise

The volatility of the lira, and the overall financial insecurity of Turkish consumers, has caused a predictable pullback in consumer confidence and spending. Almost three-quarters of respondents said they plan to spend less on major purchases:

– 73% will spend slightly or significantly less on home purchases and/or rentals

– 71% will spend slightly or significantly less on vacations and/or travel

– 70% will spend less on car purchases

Our respondents also told us they expected the biggest price increases over the next six months to hit gas/

Inflation expectations focus on fuel and food Question: For which consumption categories do you expect the biggest price increases in the next six months?

77%

77%

59%

56%

46%

42%

40%

39%

37%

34%

34%

29%

21%

5%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Gasoline or fuel

Food

Motor vehicles & parts

Utility costs

Consumer electronics

Rent or mortgage

Transportation

Health-care spending

Apparel

Telecom, internet and media

Education

Entertainment

Other discretionary spending

Other

Source: Grassroots® Research. Data as at September 2018.



Source: Allianz Global Investors Insights, Volume 10, Issue 12

Grassroots® Research is a division of Allianz Global Investors that commissions investigative market research for asset-management professionals. Research data used to generate Grassroots® Research reports are received from independent, third-party contractors who supply research that, subject to applicable laws and regulations, may be paid for by commissions generated by trades executed on behalf of clients. Information herein is based on sources we believe to be accurate and reliable as at the date it was made. We reserve the right to revise any information herein at any time without notice. No offer or solicitation to buy or sell securities, nor investment advice or recommendation is made herein. In making investment decisions, investors should not rely solely on this material but should seek independent professional advice. Investment involves risks, in particular, risks associated with investment in emerging and less developed markets. Past performance is not indicative of future performance. This material has not been reviewed by the Securities and Futures Commission of Hong Kong and the Monetary Authority of Singapore, and is published for information only. Issued by Allianz Global Investors Asia Pacific Limited. Allianz Global Investors Singapore Limited (12 Marina View, #13-02 Asia Square Tower 2, Singapore 018 961 (Co. Reg. No. 199907169Z)) is the Singapore representative and supervised by the Monetary Authority of Singapore.

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