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LCP investment snapshotA summary of our in-depth quarterly investment update on markets, macroeconomic outlook, topical investment issues and environmental, social and governance issues.
QUARTER TO 31 MARCH 2016 AT A GLANCE
Global growth expectations continue to fall; the IMF warns of the risks of “political isolationism”; Japan follows Europe’s lead on negative interest rates; high quality government bond yields fall across the board; equity markets plunge…but then some recover.
Welcome to our quarterly investment snapshot that provides a short
summary of the markets, macroeconomic environment, topical
investment issues and environmental, social and governance issues.
IMF Findings
Global growth expectations continued to fall, with the IMF’s 2016 and
2017 forecasts trimmed to 3.2% (from 3.4%) and 3.5% (from 3.6%)
respectively – the revised figures represent the fourth downgrade in
12 months. A world of “low numbers” just got lower.
In reporting its findings, the IMF was in sombre mood, warning of “the
risk of political isolationism”, with specific reference to the UK’s looming
EU Referendum, as well as the global economy’s vulnerability “…to
shocks such as sharp currency devaluations and worsening geopolitical
conflicts”.
Brexit
With the UK’s 23 June EU Referendum fast approaching, the IMF has
warned of the “severe regional and global damage” that could be
caused by the disruption of trading relationships. After all, the EU is
the UK’s biggest trading partner – taking around 45% of its exports
and providing 52% of the country’s imports. Volatility in polling results
as well as the impact of day-to-day Referendum “news flow” seems to
have to contributed to a decline in business confidence, a deferral in
some investment decisions as well as Sterling weakness.
Should the UK vote (or look likely) to leave the EU, one might
reasonably anticipate heightened volatility across UK equity, bond,
property and currency markets. In those circumstances, the BoE
would no doubt feel obliged to retain and perhaps expand its current
accommodative monetary stance (anyone for negative rates?). In
the longer term, the response of financial markets to an exit vote will
reflect economic prospects which in turn will depend critically on,
quite literally, the “terms of trade” the UK can secure with its erstwhile
European partners and those further afield.
With most polls suggesting a vote to remain though and perhaps more
importantly, betting markets indicating the same, any upturn in UK
markets would be expected to be modest.
Apart perhaps that is, for Sterling which could see demand rise
following the lifting of uncertainty, renewed appetite from overseas
investors for UK assets and the expectation that the BoE might, at some
stage, but not anytime soon, be free to start the process of normalising
interest rates. ...read more
A world of “low numbers” just got lower....
Continue reading... request a copy of the in-depth LCP investment update here
Sterling seems likely to be the prime winner or loser of the Referendum vote. It therefore makes sense to consider portfolio currency hedging levels to ensure that they are appropriate.
LCP Quarterly Investment Snapshot - 31 March 2016 2
At a glance
Market commentary
BOND PERFORMANCE � Safe haven government bonds were the main beneficiaries of investors’ early quarter blues, with yields on high quality government bonds falling
� Yields finished the period nailed to the floor; in fact, in a number of instances bond yields are now firmly below the floor
� Interest rates rises have had a unicorn-like quality – often talked about, (almost) never seen
BACKGROUND
� Global growth expectations continued to fall – a world of low numbers just got lower.
� The UK economy grew modestly over the quarter. The NIESR’s initial Q1 2016 GDP quarterly growth estimate of +0.3% was the lowest since Q4 2012 due, it believes, to “weakness in production industries, especially manufacturing”.
� Overall, US economic data remained healthy, with Q4 2015 growth figures revised upwards and employment data remaining strong.
� Europe remains a problem child. Following a February fall into deflation, to -0.2%, and sluggish growth expectations, ECB President Mario Draghi announced a new set of financial measures for the region.
� Faced with a similar set of weak economic indicators, BoJ Governor Haruhiko Kuroda took a leaf out of Draghi’s (cheque) book, stating that there was “no limit” to the action he is willing to take which, to investors’ surprise, included cutting interest rates into negative territory.
� Elsewhere, the economic news from emerging markets seemed to stop getting worse, with a weaker US Dollar providing some much welcomed support. Fears over China’s slowing economy abated somewhat; in contrast, Brazil plunged into an ever deepening recession. ...read more
EQUITY PERFORMANCE � Equity markets got off to a terrible start , but then recovered sharply. Investors seem to have remembered Churchill’s observation – “If you’re going through hell, keep going”
� It remains a challenging environment for equity markets – low growth, lots of politics to worry about and some problems that will just not go away – think Greece’s debt burden
� Given all that, there is merit in strategies that are not wholly reliant on “the market”
ALTERNATIVE ASSET PERFORMANCE � Real assets stand out as (relatively) safe havens. Although UK property returns seem to be moderating, supply and demand dynamics remain largely favourable
� Commodities suffered another challenging quarter, with oil plunging below $27 per barrel on two occasions, although it subsequently settled higher
� Diversified growth funds have been less volatile than equities but their performance has been, frankly, disappointing
While China’s ship has steadied, its outstanding stock of debt – as we have noted before – continues to grow. It can’t go on growing indefinitely, but it can probably do so for some time.
Q1 highest returns
9.8% Overseas bonds (unhedged)
Fixed gilts > 15 years8.2%Best
Performers
Q1 highest returns (GBP)
8.8% Emerging markets
Asia Pacific (ex Japan)5.6%
Q1 highest returns (GBP)
12.1% Infrastructure
Property1.1%Best Performers
Best Performers
Data source: Bloomberg, IPD, FTSE, Macquarie, Thomson Reuters Datastream
Mar
ket
com
men
tary
Source: Thomson Reuters Datastream
Equity market volatility
201680
85
90
95
100
105
%
UKEurope (local return)EM (local return)
The broadly flat return on UK equities over the quarter masked the high levels of volatility during the period.
Equity market volatility
Source: Thomson Reuters DatastreamSource: Thomson Reuters Datastream
Equity market volatility
201680
85
90
95
100
105
%
UKEurope (local return)EM (local return)
LCP Quarterly Investment Snapshot - 31 March 2016 3
At a glance
Macroeconomic outlookGROWTH ASSET VIEWS
UPSIDE 5-10%
CENTRAL60-70%
DOWNSIDE 20-30%
Crises, political risks and economic stagnation
Acceleration of global growth as consumer and business confidence returns
The global economy continues on a path of sluggish growth
++ Emerging market multi-asset
Multi-asset credit
+ Absolute return bonds
Commodities (active)
Diversified asset funds
Emerging market bonds
Equities – emerging markets
Equities – global developed markets
Equities – small cap
Equities – UK
High yield debt
Listed infrastructure
Long-lease property
Multi-asset absolute return
Private credit
Property – UK commercial
Property – UK residential*
Secured loans
Timberland*
Unlisted infrastructure
Emerging market multi-asset and multi-asset credit upgraded from + to ++
- Corporate bonds
Insurance-linked securities
Property – European
Protection strategies
-- Fund of hedge funds
Private equity
Emerging market bonds, equities – emerging markets and high yield debt upgraded from - to +
Government bond yields
� German and Japanese yields are at or near their lowest historic levels
� UK yields are historically low but could still fall further towards German and Japanese levels
� Japanese 10 year government bond yields have reached negative territory
Interest rate expectations
� Expectations of UK base rates for the next 1-5 years have fallen further
� Over the last few months, UK base rate rises have been increasingly pushed back
Comparing swap and gilt yields
� At record low yields on both swaps and gilts, clients should consider carefully the timing of hedging implementation programmes
� Where appropriate, we recommend that clients consider an LDI approach that can dynamically switch from one hedging asset to another, selecting from a range of different hedging instruments including swaps and gilts
� Despite the recent volatility, we believe that clients should add hedging to move towards their long-term strategic hedging targets.
0.0%
1.0%
2.0%
3.0%
4.0%
Mar 2016 Mar 2021 Mar 2026 Mar 2031
Market expectations for UK interest rates
March 2015
March 2016
Source: Bank of England
HEDGING ASSET VIEWS
* New asset class – added Q1 2016Rankings of asset classes represent LCP’s views of their attractiveness over a medium-term timeframe (2 to 3 years) informed by our economic scenarios for the next 12-18 months. They do not take account of scheme-specific circumstances. The order within each group is alphabetical.
Mac
roec
onom
ic o
utlo
ok
ECONOMIC SCENARIOS
LCP Quarterly Investment Snapshot - 31 March 2016 4
At a glance
Topical investment issuesTHE POTENTIAL IMPACT OF “BREXIT” ON UK PENSION SCHEMES
See page 1 of this document for comments or read our latest blog by LCP partner Phil Boyle:
Listening to the two sides bashing each other
reminds me of one of my favourite Churchill
quotes: “A fanatic is one who can’t change his
mind and won’t change the subject”.
But trustees should focus on the economics of Brexit because it
could have a significant impact on their pension fund.
Continue reading this blog...
A BUDGET SHAKE-UP FOR PROPERTY INVESTORS
The March 2016 Budget ushered in surprise, and unwelcome, reforms for property investors: a 1% increase in the top rate of commercial property stamp duty, and a 3% increase in tax for investments in (non-main) residential property. Both are clearly detrimental for pension scheme investors.
� The Chancellor’s 2016 Budget reforms delivered two nasty surprises for property investors
� Top rate commercial property stamp duty rises from 4% to 5% while all (non-main) residential property investment now attracts a 3% surcharge
� The 3% residential surcharge runs directly counter to the Government stated desire of institutionalising the rental sector, where mom and pop operations remain the order of the day ...read more
CAN INTEREST RATES GO ANY LOWER?
Er, yes.
While interest rates are at historical lows, as are longer-term yields, it is clear that they could go lower still, exacerbating an already painful position for many pension schemes.
� Many bonds currently trade negative yields which means investors are effectively paying for the privilege of lending money to governments
� With central banks prepared to do “whatever it takes” to stimulate growth, that might actually be a good deal
� Pension schemes yet to hedge (much) may want to adopt a good old
fashioned approach, and do a little bit, often ...read more
CONSOLIDATION IN THE DC MARKET
The Pensions Regulator (tPR) has launched its seventh edition of annual statistics on DC trust-based pension schemes and their memberships. This reveals a trend towards consolidation in DC provision. tPR executive director, Andrew Warwick-Thompson, has welcomed the
concentration of members in larger schemes, such as multi-employer arrangements and mastertrusts, which he believes have the potential to offer “better governance, sustainability and value for members”.
� tPR has launched its seventh edition of annual statistics on DC pension schemes which reveal trends towards larger scale DC provision and sector consolidation.
� Mastertrusts are prime beneficiaries of this development, but they too will face a rationalisation process of their own. For schemes looking at the mastertrust route, it makes sense to choose one of the likely “winners” of this forthcoming Darwinian fight for survival.
� tPR is due to issue a “new and improved” DC code of practice in the summer which should lighten trustees’ governance burden. Hurrah. ...read more
UPS AND DOWNS OF PRIVATE EQUITY INVESTING
A recent report by State Street has revealed that nearly two thirds of investors are planning to increase their private equity allocation over the next five years, while a further 15% propose to reduce it. In an era in which public markets are expected to deliver low returns, an asset class with
the potential for high rewards is attractive for many (larger) schemes.
� According to a State Street survey, nearly two thirds of institutional investors (big ones we think) are planning to invest more in private equity in the next five years…
� …but transparency is a key issue and a failure to improve disclosure would affect investors’ intentions
� … and greater transparency would probably stop some of them have
the wool pulled over their eyes by private equity firms ...read more
THE INTRODUCTION OF LIFETIME ISAs
Arguably the biggest surprise in the 2016 Budget was the announcement of the new Lifetime ISA product, which will be available from April 2017. The Lifetime ISA will be a separate product to the normal ISA, with the increased £20,000 contribution limit applying across both.
� The introduction of the Lifetime ISA could be attractive to many self-employed as an alternative to pension schemes ...read more
Top
ical
inve
stm
ent
issu
es
LCP Quarterly Investment Snapshot - 31 March 2016 5
THE TASK FORCE ON CLIMATE-RELATED DISCLOSURES
At a glance
Environmental, social and governance issues
� Investors have had a sorry time of it in emerging markets recently. Not so Martin Gilbert, CEO of EM asset manager Aberdeen. He still trousered £4.3m even as £34bn flowed out of Aberdeen’s door and the share price fell by 45% over the year to its AGM. Admittedly, his remuneration is down from last year – but with only a 10% fall, it would be hard for him to suggest to his firm’s investors that “I feel your pain”, at least with a straight face.
� Thomas Cook shareholders revolt over executive pay
� Shell takeover of BG Group was confirmed by shareholders, although a substantial minority voiced concerns that the current low oil price make the takeover unviable
� Around a third of investors in social house contractor Lakehouse showed a distinct lack of confidence in the company’s governance, voting against 10 of the 18 resolutions proposed by the company’s management at its first AGM. It would be hard to describe that as a good start to life as a public company.
� Since all these stocks are listed on the major world indices, they will all be held by passive managers ...read more
CORPORATE ENGAGEMENT – FIRST QUARTER 2016
� Climate change is, shall we say, a hot topic. The Financial Stability Board has established a Task Force to produce recommendations for enhancing company-specific climate-related disclosures
� The first phase of the project, completed in Q1 2016, involved setting objectives for the project and identified seven fundamental principles for effective disclosures
� Improved disclosures will of benefit to all investors, including pension schemes, and make it easier to assess climate-related risks ...read more
LAUNCH OF LCP INVESTING RESPONSIBLY
Environmental, social and corporate governance (ESG) issues are
relevant to all investors, not just those with an ethical focus. Our
Investing Responsibly magazine caters for our clients’ growing
interest in this area.
It covers a diverse range of topics from identifying your investment
beliefs to selecting fund managers to exercising oversight of your
investments. A common theme is that focusing on long-term
sustainable returns may deliver better financial outcomes. It is
increasingly seen as best practice for DB pension schemes, DC
pension arrangements and charity endowments.
GET YOUR COPY HERE
ESG
issu
es
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No 2315442) and in the EU (Regd. TM No 002935583). All partners are members of Lane Clark & Peacock LLP. A list of members’ names is available for inspection at 95 Wigmore Street, London W1U 1DQ, the firm’s principal place of business
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have been engaged to provide. © Lane Clark & Peacock LLP 2016.
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Natalie BrainAssociate Investment Consultantnatalie [email protected]
Contact us to discuss the work we have been doing and how we can help you identify opportunities for your pension scheme.
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@LCP_Actuaries
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