Saturday 26th July 2014
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FRIDAY ANALYSTS TICKER: July 25th 2014 - According to Adam Cordery, global head of European fixed income, Santander Asset Management, and fund manager for the Santander Euro Corporate Short Term and Euro Corporate bond funds, “Pricing of risk assets doesn’t offer much of a margin for error at the moment. And now Europe is starting to go on holiday, market liquidity may get poorer than normal, and any buys today may well have to be holds until September. It is always interesting to note what yields are required to attract clients to financial products. Twenty years ago, bond funds offering yields of 10%+ could generally attract lots of client interest very quickly. However as rates have come down over the years, so the yields clients demand have fallen. Now 4% seems to be the new 10%, he say. Cordery thinks that unfortunately, investors often want today the yield/risk mix that was available last year, so the products that get launched, sold and bought in size may be more risky than people think. “Products with 4% yield will sell well today, but to get to a 4% yield in Euro you need to invest in a portfolio with an average rating of single-B, and that is far from being risk-free. I get the impression the conventional wisdom today is to think that interest rates must surely go up soon and the main risk to bond portfolios is an increase in bund yields. Because of this many investors are buying short-duration products and floating rate notes, perhaps viewing them as a safe choice, almost like cash. It is possible however that these products may yet prove to have a considerable sensitivity to changes in credit market spreads and/or bond market liquidity, and may prove to be no protection at all.” - Commenting on the RBS share price jump, Dr Pete Hahn of Cass Business School, says “It's hard to tell whether the RBS share price jump today is more about relief or optimism. The former is about fewer fines, fewer losses on loans, and fewer costs in a shrinking business and possibly dividends for shareholders. And there's the rub, owning shares (as opposed to interest bearing debt) should be about optimism and long-term growth in dividends. But from a shrinking business? Few would argue that RBS' retail and corporate bank had efficiencies to be gained and cash flow that might be converted to dividends; yet like most banks, RBS' cost of equity remains stubbornly and appropriately above its ability to provide a return on that equity. For shareholders, current improvements should mean dividends in the medium term but a recognition that RBS may lack any merit for new investment and delivering any long-term dividend growth - not good. While many large retail banks are getting safer, in some aspects, and we often speak of them in terms of moving toward utility type models, banks take risks, are cyclical, face competition, have new business challengers, and are simply are not utilities. Investors shouldn't get ahead of themselves here.” - According to the monthly survey held by the central bank of Turkey, the country’s capacity utilization (CU) rate declined slightly to 74.9% in July from 75.3% in June. Meanwhile, seasonally adjusted (SA) CU also declined to 74.3% from 74.7% in June, writes Mehmet Besimoglu at Oyak Yatirim Research. As for manufacturing confidence, the index declined to 109 from 110.7 in May. On SA basis, the index also edged down slightly to 106.4 from 107.2. SA capacity utilisation was broadly stable in 1H14, averaging at 74.7%. This is the same level with the 2013 average. Despite the political turmoil and volatility in financial markets, activity has been relatively resilient. Export recovery & government spending supported production in 1H. Following the elections, public spending relatively decelerated. The turmoil in Iraq also decelerated export recovery from June. Nevertheless, we still expect 3.5% GDP growth in 2014, writes Besimoglu.

Are there rational causes for “home bias”?

Wednesday, 02 May 2012 Written by 
Are there rational causes for “home bias”? Savers and investors in every country hold an excessive quantity of domestic securities relative to foreign securities, so-called “home bias”. In the euro-zone, home bias has been growing sharply of late. http://www.ftseglobalmarkets.com/

Savers and investors in every country hold an excessive quantity of domestic securities relative to foreign securities, so-called “home bias”. In the euro-zone, home bias has been growing sharply of late.

Suggested causes for home bias include:

  • holding domestic assets can protect domestic investors against domestic risks such as inflation or exchange-rate depreciation;
  • the benefits of international diversification are small relative to the transaction costs involved in buying foreign assets;
  • and information on domestic assets is of better quality than that on foreign assets.

The scale of the home bias
“Home bias” characterises an excessively high weight of domestic assets in portfolios, relative to what would be optimal, and therefore results in an excessively low weight of foreign assets.

Using Germany and France as examples, 65% of French and German institutional investors’ stock portfolio is in domestic equities while German institutional investors have 53% of their bond portfolio in German bonds. Indeed, French savers as a whole hold three times more French equities than foreign equities while German savers hold almost four times more German equities than they do foreign equities and more German bonds than foreign bonds. And in September 2011, German and French banks held respectively 75% and 42% of their own government’s securities.

Is it possible to find rational explanations of home bias?
There may be irrational explanations for home bias i.e. investors are not penalised by losses on domestic assets as much as by losses on foreign assets and they have a "patriotic" attitude etc. But there may also be rational explanations for home bias such as hedging domestic risks, small benefits of international diversification, and quality of information.

1. Hedging of domestic risks

Investors will hold large portfolios of domestic assets if these assets provide a better hedge against specific domestic risks than foreign assets do.

Exchange rates

Holding euro-zone equities is unlikely to protect investors in the euro-zone against a depreciation of the euro. Indeed, this much is evident when comparing the European stock market with the US stock market. Over the period 2008 to 2012, the European stock market declined relative to the US stock market and the euro depreciated.

Inflation

Certainly, this argument cannot apply to bonds since countries that experience an unexpected increase in inflation normally experience a rise in long-term interest rates, which generates losses for domestic investors – meaning that an internationally diversified bond portfolio would actually be preferable.

In the case of equities, one could think that this is an asset indexed to prices, which therefore provides a hedge against domestic inflation. However, in the case of France and Germany it is quite the opposite as the Price Earnings Ratio is negatively correlated to inflation. Indeed, equities do not provide any protection against domestic inflation, and the reverse is in fact true.

2. Small benefits from international diversification

The idea is that if the benefits of international diversification are smaller than the adjustment costs (transaction costs) incurred when buying foreign assets, investors will abstain from international diversification. If we take the example of euro-zone bond portfolios, one would see that diversification to the euro-zone as a whole in the period 1999-2012 reduces the return and the risk slightly, but in a very limited way.

3. Advantage in terms of information

It is an often-heard argument that the information available for investors is better for domestic assets than for foreign assets – largely because investors have better contacts with company management and their own government.

If this is true, this bias is likely to be far larger for small and mid-sized companies than for large companies that have better information resources. As a result, we should expect larger unexpected (news) shocks for small and mid-caps than for large-caps, and subsequently higher volatility in small and mid-cap indices. Indeed, this appears to be the case. The volatility of large-cap indices has been lower since 2003 than that of small and mid-cap indices.

Patrick Artus

A graduate of Ecole Polytechnique, of Ecole Nationale de la Statistique et de l'Adminstration Economique and of Institut d'Etudes Politiques de Paris, Patrick Artus is today the Chief Economist at Natixis. He began his career in 1975 where his work included economic forecasting and modelisation. He then worked at the Economics Department of the OECD (1980), before becoming Head of Research at the ENSAE. Thereafter, Patrick taught seminars on research at Paris Dauphine (1982) and was Professor at a number of Universities (including Dauphine, ENSAE, Centre des Hautes Etudes de l'Armement, Ecole Nationale des Ponts et Chaussées and HEC Lausanne).

Patrick is now Professor of Economics at University Paris I Panthéon-Sorbonne. He combines these responsibilities with his research work at Natixis. Patrick was awarded "Best Economist of the year 1996" by the "Nouvel Economiste", and today is a member of the council of economic advisors to the French Prime Minister. He is also a board member at Total and Ipsos.

Website: cib.natixis.com/research/economic.aspx

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