Saturday 25th June 2016
NEWS and COMMENT ROUNDUP - June 24th – The UK has voted to leave the European Union – Prime Minister David Cameron has resigned, saying he will leave office in October, following an orderly management of the run up to the declaration of Article 50, which will precipitate the UK’s exit from the Union. The question is whether the incoming leader of the Conservatives will be the next prime minister and can take up the post without an electoral mandate – will the country have to vote again before the end of the year? – EU President Donald Tusk says that the remaining 27 members of the EU have recommitted to the European project and that if the UK wants to leave, it should do so quickly; a view reiterated by Martin Schultz, the president of the European Parliament – Nicola Sturgeon says she will begin talks with the EU on possible Scottish membership and that a second referendum on the Union is now likely – Sinn Fein’s Martin McGuinness has called for a border poll on union with a United Ireland, resurrecting potential secession from the Union by part of Northern Ireland as well - Jeremy Leach, Chief Executive Officer at Managing Partners Group, believes Brexit will have little long term impact on the UK financial services industry. He says: “Financial services will continue to be the UK’s biggest export for the same reasons it has been for the last 100 years, which is its pragmatism, innovation and desire to trade. Nor will the UK necessarily be excluded from the European Union’s pass-porting regime for financial products. Most of the EU’s regulatory processes were adapted from those of the UK’s Financial Conduct Authority anyway so negotiating a workable agreement will be more straightforward than for other EEC members that are still evolving on their regulatory framework.” With regards to Sterling, Jeremy Leach believes it will settle down and strengthen in the longer term: “As much as sterling has fallen today, the market will gravitate back to pre-referendum levels within a few days. In the longer term, sterling will strengthen against the Euro because the UK’s economy is in much better shape than many of its European peers.” - Steve Davies, fund manager, Jupiter UK Growth Fund says, “The UK domestic economy held up surprisingly well in the run up to the referendum, aided by the fact that disposable incomes are still rising by some 7% year-on-year (according to ASDA’s income tracker). The uncertainty of ‘Brexit’ clearly poses some threat to this: business investment is likely to be put on hold during the negotiation process and there is also likely to be a hit to consumer confidence, while a weaker pound may lead to higher imported inflation. Some offset may occur if the Bank of England chooses to reduce interest rates from here or introduce a further round of quantitative easing. Commodity prices may well weaken too in response to a stronger dollar – the fund remains zero weighted in the oil and mining sectors … One final thought: a falling pound combined with a hit to the share prices of UK domestic assets is likely to reignite M&A interest in the UK market from overseas players and I would expect Chinese investors to be right at the front of that queue” -- Mark Burgess, CIO EMEA and Global Head of Equities at Columbia Threadneedle says, “Not surprisingly, equity markets are going to be quite weak today, with sterling assets more broadly quite weak. The thing that markets hate most is uncertainty and with the prime minister resigning we’ve got political uncertainty thrown in on top of economic uncertainty and we don’t know what shape the UK economic arrangement with Europe is going to take. That is going to take quite some time to negotiate and we are going to have to negotiate any bilateral trade agreements with the rest of the world as well. The real issue is about what it means for Europe. We’re likely to see calls for referendums in some of the other European countries and members of the Eurozone and the single currency, and I think the market is going to worry about the implications of that. We’re a single trading nation and clearly what the nature of our trading arrangements with rest of the world looks like is going to be uncertain and I think that will naturally slow activity. The uncertainty as well as what this means for Europe will also slow European equities unequivocally so this is a negative event for global GDP.” Richard Colwell, head of UK Equities at Columbia Threadneedle adds: “Certainly in the short term the Leave vote will be a negative for both Sterling and the UK economy. In the longer term the consequences are much less clear. However, given the FTSE 100 is comprised of around 70% overseas earnings, the implications for the UK equity market may not be as great as some people fear. There may be further opportunities in UK domestic stocks that have been sold off aggressively, in particular those stocks that were in the various ‘Brexit Baskets’ created by investment banks as they tried to exploit concerns about leaving the EU. Clearly, any exposure to overseas earnings is positive for investments as they are considered less exposed to the domestic economy and can benefit from a weaker sterling.UK stocks (excluding financials) are also, to a degree, cushioned by the current market yield (at time of writing) of 3.95%, which is three times that of gilts and attractive in a global context. Indeed, gilt yields are already at their lowest level since records began in 1729.” Meanwhile, Jim Cielinski, global head of fixed income at the firm says, “ This outcome was very different to what the markets expected and certainly to that which was priced into the market as recently as yesterday. Consequently, the market reaction has been as immediate as it has been extreme. Core bond markets have rallied sharply – as market yields have plunged to record lows in many developed markets. The benchmark 10-year US Treasury bond, for example, is lower in yield by around 20 basis points. This takes that yield to around 1.5%, the lowest in recent decades. German 10 year bonds have fallen by a similar amount to -0.10%. Peripheral European bond markets are being hit hard (Italian government bonds are wider in spread by around 30 basis points) and this should continue. Within currencies, sterling is around 9% weaker to the US Dollar (1.35), the weakest level since 1985 and the euro is also weaker by around 3% (1.09). Meanwhile, the yen has surged, strengthening to 101.5. Credit markets are weaker. The widely watched Main index opened 26 basis points wider (around 25% wider of actual spread) and is at the widest level this year. Meanwhile, the Crossover index opened wider by 100 basis points (in percentage terms a similar amount). Financials, higher beta and cyclical credit have been harder hit with spreads around 30% wider over the last day. Commodity prices have been marked down with the exception of gold which has rallied. We believe that a number of central banks (Bank of England, European Central Bank and Bank of Japan) will need to ease policy. A weaker UK currency will produce higher inflation in the year ahead but this will ultimately prove to be transitory. Hence, although the decision to ease may be a close call - growth and stability concerns will dominate policy maker’s thinking. Core government bond yields have plunged to record lows and will be supported as long as risk aversion prevails but further declines in yield should be limited. The price of so-called safe havens is now extreme. Corporate issuers have become well-accustomed to operating in a low growth, weak revenue environment and for such companies it will be the extent of economic weakness that matters most. Our central case is for slow growth, no credit improvement but no sharp rise in defaults. Demand for income remains and this will continue to support spread markets as will a policy response (for example, corporate bond purchases) that provides a ‘back stop’ and cushions losses in corporate bonds. As such, we remain modestly constructive of corporate credit” - Howard Cunningham, fixed income portfolio manager, Newton Investment Management says, “The leave result is likely to be supportive of shorter dated gilts as activity slows and the prospect of interest rate increases recedes even further into the future. The gilt curve may steepen as investors demand more compensation for the longer term uncertainties, but overall yields should not necessarily be higher. It is worth bearing in mind that, to the extent investors initially view the leave vote negatively and want to dump sterling assets, we doubt gilts will be top of their sell lists. Sterling corporate bonds face conflicting forces and greater uncertainty may ultimately lead to risk premia, i.e. higher credit spreads (particularly for UK domiciled issuers). It is important to point out that with yields on euro denominated bonds already low, sterling corporate bond yields might look more attractive. Particularly if, as we expect, ECB intervention has unintended negative effects on liquidity in the euro corporate bond market.” -- Paul Hatfield, Chief Investment Officer, Alcentra says, “We think the short-term impact will definitely be negative for the UK economy, with the uncertainty delaying investment decisions and stalling spending all round. Longer term, it is possible the UK can renegotiate a good outcome with the EU but it hasn’t said how, or on what basis. You could see the other EU countries making life difficult for the UK after Brexit, partly out of pique and partly to deter other countries from doing the same.” -- Mark Bogar, European Smaller Companies Manager, The Boston Company Asset Management “Follow-on risk is now a major factor and we have to think about potential knock-on effects; for example, other countries voting on their membership of the EU. If this leads to an unravelling of the EU the hit to economic activity over the immediate term will be significant. I like to think over the longer term countries will figure it out – and will continue to trade with one another – but it could take up to three years to iron out the ‘new order’ and in the meantime economic activity and GDP growth in European countries will feel the impact. In my opinion the Eurozone will go into recession again during that time.”

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Eastern European funds face reality Photograph ©Soldeandalusia/ Dreamstime.com, supplied March 2013.

Eastern European funds face reality

Tuesday, 19 March 2013
Eastern European funds face reality The range of investment options available to local and foreign institutional investors across central and Eastern Europe (CEE) is matched by the disparity in performance and development of individual markets. Writing in UniCredit’s CEE report for Q1 2013, the bank’s chief Eastern Europe, Middle East and Africa economist Gillian Edgeworth says the predominant theme across CEE last year was the influx of foreign liquidity via portfolio flows. Part of this inflow was structural in nature, reflecting a shift in asset allocation from developed to developing markets, but the remainder was cyclical as investors searched for yield in the face of record amounts of G7 central bank liquidity. Paul Golden reports. http://www.ftseglobalmarkets.com/media/k2/items/cache/2a9ceb674dd25489978c3ffc90b75279_XL.jpg

The range of investment options available to local and foreign institutional investors across central and Eastern Europe (CEE) is matched by the disparity in performance and development of individual markets. Writing in UniCredit’s CEE report for Q1 2013, the bank’s chief Eastern Europe, Middle East and Africa economist Gillian Edgeworth says the predominant theme across CEE last year was the influx of foreign liquidity via portfolio flows. Part of this inflow was structural in nature, reflecting a shift in asset allocation from developed to developing markets, but the remainder was cyclical as investors searched for yield in the face of record amounts of G7 central bank liquidity. Paul Golden reports.

The danger of viewing central and eastern Europe (CEE) as a homogenous market was highlighted in the aftermath of the global financial crisis, when Poland emerged as the only country in the region whose economy expanded during 2009 while its Baltic neighbours experienced significant falls in GDP. Professor Krzysztof Rybinski of Warsaw’s Vistula University refers to the degree of fiscal easing, the scope of public investment and the degree of cross-border financial leverage available to individual countries to explain this disparity. However, with EU guidelines on public debt levels limiting the scope for fiscal stimulus and investment moving away from large scale construction projects, he warns that no part of region will be immune from the effects of economic turmoil in the European Union in 2013.


Various funds are more than aware of the continuing impact of macro trends on the performance of local funds. Even so, the growing diversity of fund investment strategies is a clear indication of the deepening of the asset management industry across the sub-region.




Schroders manages the ISF Emerging Europe fund, which is mainly invested in Russia, Poland and Turkey but also in Hungary, Slovakia and the Czech Republic. The fund has been in existence since 2000, is in the first quartile for its peer group and is one of the five largest funds in the region at around €500m. Lydia Malakis, the firm’s director for central and Eastern Europe says there are no local restrictions around investment in liquid securities. Many CEE asset managers still tend to focus on their local market, mainly because they can generate strong performance for their clients by staying purely domestic, particularly in the larger markets of Poland, Russia and Turkey.


“They don’t see the need to look outside their own markets for capital growth because these markets are still growing and there is a pool of IPOs and corporate bond issuance yet to come to the market,” she explains.


The sophistication of the CEE institutional investor base varies significantly. For example, Poland has a well-developed pension fund system, whereas Russia pension funds are virtually non-existent. Institutional investors generally identify investment opportunities in the region by doing their own research, analysing economic and company specific data and meeting with finance ministers, central bankers and prominent local businessmen to gain an understanding of local regulations and political dynamics, says Andrey Popel, director Greylock Capital Management.


“CEE offers opportunities for index trackers, pension funds, insurance companies, corporate bonds managers and hedge funds. In the Russian bonds market, for instance, there is a wide selection of liquid investable assets in the sovereign, quasi-sovereign and corporate space, although in some jurisdictions—most notably Hungary, Serbia, Croatia, Georgia and even Ukraine—corporate bond supply is quite limited.”


Despite these limitations, Popel says his firm continues to identify interesting distressed and high yielding opportunities in Kazakhstan, Hungary, Russia and Ukraine. These opportunities are often company or country specific event-driven investments (a hedge fund investment strategy that seeks to exploit pricing inefficiencies that may occur before or after a specific corporate event) and have lower correlation with the broader market.


Dainius Bloze, fund manager at Bank Finasta observes that some international investors choose to rely on publicly available company information and make investments from outside via bourses, while other are brought into the market by investment bankers. “Value investing and strategies that combine tenets of both growth investing and value investing (known as ‘growth at a reasonable price’ or GARP) are employed, but in general there is little discrepancy between strategies in this region compared to developed markets,” he observes. “CEE markets are smaller and less liquid than developed markets so strategies have to be adjusted and generally require more involvement from investment managers, since publicly available information is scarce and imperfect. Russia stands out as a market that is very much event driven and dependent on commodities.”


Stefano PregnolatoStefano Pregnolato, head of portfolio management EMEA at Pioneer Investments.While having local expertise is important, it is also possible to tap into investment opportunities through global asset managers. That is the view of Stefano Pregnolato, head of portfolio management EMEA at Pioneer Investments, whose equity and fixed income products are managed in London and Vienna while its emerging markets analysts leverage portfolio managers and analysts based in the region.


“Foreign investors usually prefer internationally available funds when they invest in CEE, whereas investors from within the region tend to prefer local domiciled products,” he states. “Fixed income strategies are much more popular than equities, but that is not unique to this region. Different interest rate environments and risk levels in each country affect the structure of institutional investor mandates.”


Albin RosengrenAlbin Rosengren, partner East Capital. There are fewer specialised managers focusing on Russia or CEE than on other emerging markets such as China according to Albin Rosengren, partner East Capital, who describes a broad eastern European or in some cases a Russia fund as the most common ways of accessing the market.


“There are around 100 funds that focus on Eastern Europe, very few of which are run by independent specialist asset managers and most of which are based outside the region. In addition there are perhaps 20-30 focusing purely on Russia. Many of these funds belong to banks and are run by smaller and often non-specialised teams.”


There are a few investment houses in Russia and other parts of Eastern Europe, but most assets come from outside the region, he continues, “These assets come mainly from western Europe, although some US endowments have invested and pension funds in Latin America and Middle East sovereign funds are increasingly looking at opportunities in central and Eastern Europe.”


Rosengren points out that some institutional investors have opted for passive alternatives and that ETF exposure to the region has increased. He believes this can be explained at least in part by two years of ‘risk-on-risk-off’ where political decisions and macroeconomic events have almost been more important than the performance of individual companies.


Rosengren reckons that most investors are not overly concerned about falling commodity prices but still want exposure to CEE that is not driven by commodities, which is why his firm launched a Russia domestic fund last year that excludes investments in commodities or companies reliant on exports.


“Central and Eastern Europe is still mostly a general broad strategy equity play, but we are seeing the emergence of some plays on different parts of the economy (such as consumer funds) and there are also a few fixed income funds emerging. However, regionally specialised bond funds have not yet generated a large volume of transactions.”


Rosengren suggests that very narrow country funds have struggled to raise assets compared to wider regional funds. “Turkey was a major theme in 2012 on the back of its credit rating upgrade and better than expected economic development. Growth this year is again looking strong and the market is not expensive.”


Paul SeverinPaul Severin, managing director at Erste Asset Management.Erste Asset Management managing director Paul Severin estimates foreign participation in the Polish bond market has risen above 40% compared to approximately 30% this time last year. “Assets managed by local investors (pension funds, insurance, investment funds) have also grown and local market participants have become much more sophisticated, although local fund managers usually cover only one country. There are also some large domestic players in the shape of real money accounts, banks and hedge funds.”


In general, foreign investors are comparing different countries from a fundamental perspective, analysing structural and cyclical issues and trying to find under- and over-valued markets/securities, he explains. Severin refers to increased interest in local FX bonds (both sovereign and corporate) with the Russian local fixed income market being opened to foreign investors, but adds that private equity is still a very small part of the market.


“Global emerging market funds dominated investments last year and emerging Europe accounts for 10-15% of these portfolios. ETF funds captured flow in 2012. Investors use a wide range of investment strategies, from relative country comparison to single name relative value trades, depending on the asset class and assets under management.”


Miroslav KubenkaMiroslav Kub˘enka, head of equity research at Generali PPF Asset Management.Miroslav Kub˘enka, Generali PPF Asset Management head of equity research says foreign investors account for roughly half of total equities turnover on each of the CE3 (Czech Republic, Poland, Hungary) stock markets but that this includes institutional investors from other CE3 countries who view these three nations as almost a single ‘domestic’ market. “Over the last couple of years, the attractiveness of the CE3 equity market region has been decreasing for outside investors. These countries do not enjoy superior growth compared to Western Europe anymore.”


Generali PPF Asset Management considers low liquidity to be a major drag on foreign institutional investment, adds Kub˘enka. “The Prague stock market is a great example. Its equities turnover last year fell to the lowest level since 2003 and several international banks have already closed their equity trading departments in the city.”


Radomir Jac Radomír Já˘c chief analyst at Generali PPF Asset Management.His colleague and chief analyst Radomír Já˘c says that in contrast, participation of foreign investors in the government bond market has risen over the last three years although they still account for less than 50% of outstanding bonds in the CE3 countries with the majority held by domestic banks and pension funds.


“In Q4 2012 non-residents held just over 46% of all Hungarian government bonds, with domestic banks holding around 30% and pension funds the remainder. In Poland, foreign investors control between one third and half of government bonds, compared to 23% by domestic pension funds, 17% by banks and just over 10% by domestic insurance funds.”


According to Kub˘enka it is relatively easy to identify investment opportunities in central and eastern Europe without going through local fund managers. “Foreign institutional investors can choose from a wide range of local brokers and banks, whose support includes research conducted by local analysts. Also, many international banks cover blue chip firms in the CE3 countries and are able to arrange calls with analysts, investor visits, etc.”


He sees little variance in the investment strategies and objectives of institutional investors located outside CEE and those based within the region. The biggest difference between the two is that CE3 equities represent a significant part of the total equity exposure for domestic institutions.


CEE sovereigns have taken advantage of the liquidity window created by low government bond yields in many developed economies to raise cheap funding to finance post-crisis budget deficits and improve maturity profiles. Ukraine, Hungary and Serbia in particular have significantly increased their reliance on international bond funding and have been able to postpone fiscal and structural adjustments.


Lydia MalakisLydia Malakis, Schroders’ director for central and Eastern Europe.Malakis reckons there are about 60 emerging Europe equity funds and agrees that emerging market debt has received a lot of attention from fixed income funds in recent years. “One notable difference from the rest of Europe is that you have a lot of smaller companies that cannot raise finance through the capital markets, which encourages private equity structures.” Property structures are another non-listed option, although she acknowledges that real estate investment performance in CEE is a “mixed bag”.


According to Malakis, local investors in Turkey have been favouring hedge fund-type absolute return strategies investing in local fixed income, equities and money markets. Closed ended, tax optimised strategies were well received in Poland last year, whereas in Russia there is much interest in FX-type strategies and commodities.


“Local deposit rates are also a factor in terms of what you recommend to clients because they may need to hedge their currency risk,” she adds. “Many of our CEE clients are asking for hedged strategies back into their local currency.”


It is clear that CEE is not a ‘one size fits all’ market when it comes to investor preferences. However, for all the region-specific recommendations and warnings, Rosengren concludes that CEE allocation decisions are based on the same factors as for any other region—growth prospects, risk and valuations.

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