When looks deceive
equity outlook
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As the world waits for an end to the pandemic, equity markets are positioning for the aftermath
Chapter one
Can Asia’s new economic drivers be the symbols of hope equity investors are looking for?
Chapter TWO
The sectors that have weathered the coronavirus storm the best
Chapter THREE
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content by: WELLS FARGO ASSET MANAGEMENT
Money managers are recommending that investors use periods of market volatility in the coming months as a tactical opportunity to add to stocks and other risk assets. For Asian stock markets, UBS believes a Joe Biden win would be a more positive outcome of the US presidential election. Initial reactions from the US equity market to a Biden presidency would likely be more negative given his plan to raise corporate income taxes, UOB Private Bank said. Indosuez Wealth Management has a preference for quality firms and a long-term constructive view of technology, environmental and societal themes. BNP Paribas Wealth Management is betting on Covid-19 vaccine developments, robust liquidity and improving earnings to support the equity market. Some wealth managers have started to include select travel names within airlines, as well as leaders in the mining and materials sectors. A focus on the recovery of domestic travel and consumption in countries such as China and South Korea are also on the cards. One investable theme that Newton Investment Management believes has been underappreciated is China’s ageing population. Read on to find more!
audrey raj, editor, citywire asia
Positioning for the aftermath
How investment managers have been tweaking their portfolios in these tumultuous times
Chapter FOUR
Will the Asian consumer continue to dictate the path of future global growth?
Chapter FIVE
content by: ABERDEEN STANDARD INVESTMENTS
welcome
chapter one: what lies beyond?
chapter two: new economy lifeline
chapter three: a tale of two peaks
chapter four: the value of a new horizon
chapter five: what lies beyond?
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content from: allianz global investors
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Chapter two
Chapter three
Chapter four
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What lies beyond?
chapter one
As the world watches and waits for an end to the coronavirus crisis, equity markets are positioning for the aftermath. If history is any indicator, global stock markets are primed for a rotation from growth to value. Markets plunged following the Covid-19 outbreak to levels last seen decades ago. The aftermath is especially sobering – while the world awaits a vaccine, many economies battered by lockdowns are unlikely to reset this year. The stage seems set for value stocks that have traditionally shone in gloom. They had a prolonged outperformance against growth stocks after the 1991 and 2001 recessions. But their edge after the 2008-2009 recession was ‘very brief’, said Norman Villamin, chief investment officer for wealth management at UBP. This is because the banking sector faced structural headwinds and a cyclical decline from 2011 to 2012. ‘Given the secular headwinds facing those sectors again in the current environment, investors might expect a similar outcome. ‘As a result, investors should take a stock-picking, quality-biased approach to stock selection looking ahead,’ Villamin said. Villamin is among money managers cautioning against fleeing to value, even as coronavirus infections start to climb again. Instead, he recommends repositioning into secular growth themes such as financial technology, green energy and healthcare. ‘The challenge for investors in the value segment is that a number of sectors are facing structural rather than just cyclical challenges.
words by Annabelle Liang, Senior reporter
The challenge for investors in the value segment is that a number of sectors are facing structural rather than just cyclical challenges
Norman Villamin, CIO, UBP
‘The traditional energy sector is facing a multi-year shift to green alternatives, which may leave some countries with effectively stranded assets. Banks and traditional financial institutions are ceding market share to technology driven new entrants,’ he said. UBP believes the bright spots in the space are high quality industry leaders in the mining and materials sectors. However, HSBC Global Asset Management prefers the insurance sector, given Asia’s ageing population and rising income levels. Life insurance penetration in markets such as China, Indonesia and India were below 3% as of 2019, said Bill Maldonado, CIO for Asia Pacific and global equities. Further still, the low-interest-rate environment – which is set to persist for another four to five years – tips the scales for growth.
Maldonado believes the environment reduces the likelihood of a financials earnings rebound. It could support the consumer sector and widen the difference in valuation between growth and value stocks. ‘We are also in the age of high uncertainty driven by geopolitics, technology disruption and pandemic concerns. These factors may lead to both short- and long-term impacts,’ the HSBC stalwart said. ‘For instance, while some may argue Covid-19 is only a temporary disruption to the economy, we have seen changes in consumption patterns and people’s lifestyles, including more online consumption and increased health consciousness. ‘As a result, some sectors have outperformed, including the sportswear sector and online education. These may well become a longer-term trend than the pandemic itself.’
Valuing value Looking at September, there were instances where value outperformed growth. UBS observed a period where the S&P 500, with its comparatively high proportion of growth stocks, retreated just over 9%, while markets like the UK and Singapore lost about 3%. The Swiss giant prefers industrials and recently turned bullish on materials within the value space. It also likes the consumer discretionary sector, which has a mix of value and growth stocks. Even so, it sees bigger opportunities in growth. ‘We do not recommend selling entire positions of the popular internet platforms,’ said Hartmut Issel, head of Asia Pacific equities at UBS Global Wealth Management. Issel instead encourages investors to ‘lock in some of the profits and redeploy the funds either in other pockets of IT or growth sectors that have not performed as well, or otherwise also include value stocks’. Federated Hermes similarly expects growth stocks to maintain their market leadership, across broad sectors and regions. There has yet to be a sustained value rally. While it has outperformed growth, the magnitude is tame compared to the quarterly trend, said global equities portfolio manager Louise Dudley.
Those looking for where to go next will need to balance long-term ambitions and short-term realities
Louise Dudley, global equities portfolio manager, Federated Hermes
‘Those looking for where to go next will need to balance long-term ambitions and short-term realities. ‘The rebound and cyclical names will benefit once we have turned a corner on the infection rate, though in the short term, the growth stocks offer not just growth but greater certainty on earnings, given their robust quality features even in the wake of a global pandemic,’ Dudley said. The $628.8bn manager is separately reducing positions in some staples and work-from-home names. These have delivered since March’s selloff and valuations are currently looking less attractive. Inflation is a concern for some retailers. There are also expectations of consumer confidence weakening after government support eases, Dudley said.
One divide There was one division of opinion: travel plays. Federated Hermes and UBP felt that recovery for the sector was a distance away and recommended limiting exposure. On the other hand, HSBC said its small and large cap teams were focusing on the recovery of domestic travel and consumption in countries such as China and South Korea. ‘Some of the metrics our macro team tracks have confirmed our thesis. For example in China, cinema box office revenue has rebounded quickly, while domestic tourism and air traffic is back to near pre-pandemic levels as of September,’ Maldonado said. UBS has also started to include select travel names. Within airlines, it is looking at those with a big home market that can bring back large parts of their business, even as cross-border restrictions persist. Alternatively, plane makers can serve as a proxy. The prospect of phase three vaccine approvals has also raised hopes for fewer global travel restrictions, Issel said. ‘What is different in this crisis are the following factors: a pandemic and the subsequent lockdowns leading to economic loss. Thus, the market divided stocks into winners, like work-from-home beneficiaries, and those who suffer. ‘Given the unusually extreme performance divide, it is quite conceivable that the gap closes rapidly. ‘We do not encourage giving up diversification, but it works both ways – only focusing on a few stocks because they have proven popular over several months could be detrimental once the rally broadens out the way we expect it,’ Issel added.
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chapter TWO
With 2019 and 2020 challenging investor flows, Asia’s new economic drivers might be the symbol of promise equity investors are looking for. Asian equities must have been hoping 2020 would bring some respite after 2019’s market selloffs. However, little relief has come in the pandemic-hit year, with investors forced into rebalancing to get the best out of their portfolios. To this end, investors should look to ‘new economy’ stocks, with sectors like the internet, technology and healthcare clearly diverging and outperforming older sectors, such as financials and energy, Credit Suisse said. Equity inflows in Asia fell by $100bn to a record $37bn in 2019, while global flows also fell flat, Morningstar’s annual fund flow report showed. Despite this, Asian equities are shaping up for better times ahead, after the region’s comparably swift containment of Covid-19 and a robust economic recovery in China. ‘As valuations seem to have already largely priced-in good economic prospects, a continued recovery in earnings will be key to drive the market higher,’ said Credit Suisse’s Suresh Tantia, senior investment strategist.
words by Andrew Wong, REPORTER
New economy lifeline
The region is also significantly exposed to new economic trends, such as digitalisation, the cloud and artificial intelligence, which will support Asian equities structurally. Meanwhile, easing monetary policy globally and a weaker US dollar should benefit the asset class, the strategist added. Hong Kong’s Value Partners shares the sentiment, with the manager indicating Chinese equities remain on track as a constructive medium- to long-term investment. ‘Market corrections would present buying opportunities for long-term Chinese equity investors, as a positive outlook is still in place,’ said Frank Tsui, senior fund manager. Ongoing trends such as China’s growing domestic consumption, supported by a rising middle class and urbanisation factors, come into play. However, Tsui cautions against wildly investing as the world’s second-largest economy begins to recover ahead of the curve, and the surplus of global liquidity helps to attract capital flows. ‘We expect diverging sector performance to continue amid the new norms of the pandemic, and an uneven road to recovery for different sectors,’ he said. To that end, investors still need to engage in bottom-up stock picking to generate outperformance in China.
Uneven recovery Looking deeper, the recovery on a regional basis has also been uneven, with Southeast Asian economies taking a bigger hit during the pandemic. While most losses have been recovered since the MSCI Asia Pacific ex Japan index sunk in March, the outperformers have come from North Asian markets like China, Taiwan and South Korea. ‘Southeast Asia is a different story, with markets like Singapore, Thailand, Indonesia and the Philippines delivering double-digit losses of around 20% to 30%,’ Eastspring Investments’ Sarah Lien, director and client portfolio manager, pointed out. Singapore, unexpectedly, has lagged in its recovery compared to its regional peers. The island had been widely praised over its initial virus-containment efforts, but fell to a surge in Covid-19 cases in early April. With its traditionally heavy exposure to banking and real estate sectors, Singapore's economy has missed out on the gains being made in sectors related to healthcare, technology and the consumer, which have been the biggest beneficiaries amid the ‘new normal’. It is not all bad for the city state, however, as its strong business qualities and regulatory backdrop will continue to attract investors to the market, Lien said.
Southeast Asia is a different story, with markets like Singapore, Thailand, Indonesia and the Philippines delivering double digit losses of around 20% to 30%
Sarah Lien, director and client portfolio manager, Eastspring Investments
‘We remain overweight Singapore equities in our dividend income-focused equity strategies,’ she said, given the attractive dividend yields and valuation support from the selloff in 2020. Meanwhile, India found its economy crippled by the pandemic later than many countries in the region, crushing investment sentiment as the number of infected surged to nearly seven million. The latest forecast from the country’s central bank signals an economic contraction of 9.5% in 2020, which could force even looser monetary policy. UTI Mutual Fund, an India-based asset manager, expects the government to introduce complementary fiscal policies to support the Reserve Bank of India. ‘While visibility of growth in the near term remains elusive, we take comfort from the fact that a significant amount of capital has been raised to repair and strengthen balance sheets by the corporate sector in general, and the financial sector in particular,’ the manager said in an October report. Beyond the economics and policies, India has also had back-to-back years of above normal monsoon seasons, UTI said, which will be a key driver for growth of the agricultural and rural economy.
Strategic changes For Credit Suisse, the pandemic forced the bank to progressively rethink its allocations and investment strategies in equities to avoid underperformance and engage with outperformers. In May, the bank upgraded Taiwan equities to outperform as the country remained the only Asian market to avoid strict lockdowns given its virus-containment success. ‘Furthermore, its tech sector strongly benefits from the work-from-home dynamic and 5G demand,’ said Tantia. Technology makes up around 60% of the island’s benchmark index. From the start of the year to 9 October, the index climbed 6.5%. At the same time, Credit Suisse gave an underperform view to Malaysian equities, which tend to struggle as global equities rally. Most recently, in June, the bank turned positive on Chinese equities after anticipating stronger outperformance driven by economic recovery, superior earnings, reasonable valuations and currency strength. ‘Nearly three months on, the catalysts remain relevant and credible, and as such, we reaffirm our view on China equities,’ Tantia said.
Meanwhile, Value Partners’ Tsui is focused on domestically driven firms including those rooted in consumption upgrades, e-commerce, education and healthcare. ‘Overall, the market has been efficient and rewarding to the strength of respective sectors, which is why we are seeing performance divergence,’ he said. On the flipside, the recovery for sectors like retailers, landlords, banks and utilities will face more challenges. Eastspring has not altered strategies significantly, although it has concentrated exposures in its Singapore portfolio. With banks facing headwinds from interest rates and the credit cost cycle, Lien is instead looking to those that are backed by the strongest digital platforms. Similarly, the manager streamlined her view in real estate to properties with solid balance sheets, unique portfolios of mall properties and strong management teams. For the manager, retail shopping malls in Singapore are past the worst as the risk of additional lockdowns or ‘circuit breakers’ remains low. ‘We are active in the real estate space and believe that Singapore will retain its status as an attractive destination for investors seeking to invest in property in the region,’ she said.
We expect diverging sector performance to continue amid the new norms of the pandemic and an uneven road to recovery for different sectors
frank Tsui, senior fund manager, Value Partners
Nearly three months on, the catalysts remain relevant and credible, and as such, we reaffirm our view on China equities
Suresh Tantia, senior investment strategist, Credit Suisse
A tale of two peaks
chapter THREE
words by Shu Le Han, Senior Researcher
The high-low-high of markets over the last year has been breathless, with some sectors revelling in the voyage and others finding the drama all too much. 2020’s markets have been thrilling to say the least – the S&P 500 plummeted 30% in a matter of 22 trading days in March and rose back up to its February record highs merely five months later in August. We explore how sentiments have changed in the swing between the two peaks. Fund flows The analysis is based on global fund flows experienced by funds available for sale in Singapore and/or Hong Kong. All flow figures are in US dollars. Source: Morningstar ‘Average monthly flows before March’ refers to the average monthly net flows into/out of the sector from 1 October 2019 to 29 February 2020. ‘Average monthly flows after March’ refers to the average monthly net flows into/out of the sector from 1 April 2020 to 31 August 2020. Pre-crash Average monthly flows before March (USD, millions)
Post-crash Average monthly flows after March (USD, millions)
Inflows Fixed income continues to be at the top of investors’ minds even after the March crash. Net new money into the global fixed income sector more than doubled (2.1 times), with investors pumping $5.0bn into the sector post-March. Within global fixed income, investors injected the most into global corporate bonds - USD hedged funds, with $1.8bn of average net flows post-March compared with $290.7m pre-March. Confidence for Greater China equity funds strengthened after March’s plunge. The sector raked in 13.8 times more average monthly net inflows post-March ($1.4bn) than pre-March ($98.9m). It was also one of the sectors that managed to garner net positive flows during the March tumble. In March, the sector took in $26.2m from investors.
Outflows European large caps and Asia ex-Japan equities continue to lose favour with investors even after the March market crash. In particular, the Asia ex-Japan equity sector saw 34.1% more net outflows than before the crash. Investors removed an average of $709.8m from the sector in the months leading up to and including August. This is in comparison to the average of $529.2m of net redemptions in the months leading up to and including February. Japan equities have failed to inspire confidence following the March lows. The sector bled 10.8 times more after the crash. On average, investors removed $329.4m from the sector from April onwards as opposed to a net removal of $27.9m before March. Japan saw a change in leadership following the resignation of long-serving Prime Minister Shinzo Abe in late August, where net outflows from the sector during the month were $262.5m. Its peak net outflows were recorded in April when the sector lost $676.4m.
European large caps and Asia ex-Japan equities continue to lose favour with investors following the March market crash
Changing tides Sectors with a change in flow (>$100m per month)
Confidence for the cautious and moderate mixed assets sectors waned after the March lows. Investors removed $137.7m and $43m monthly from the sectors respectively. This is in comparison to the average monthly net inflows of $497.4m and $387.5m before the March crash. Investors also seemed spooked by global emerging markets equity, removing $381.6m on average from the sector as opposed to the $51.2m it pumped in before the crash. On the flipside, despite being one of the hardest hit regions from the coronavirus pandemic, Latin American equities have been in favour, gathering $62.9m monthly net flows compared with its net negative monthly flows of $107.5m before March.
Performance The analysis is based on funds available for sale in Singapore and/or Hong Kong. The performance is measured by total returns in USD terms. Pre-crash period: one year to 29 February 2020. Post-crash period: one year to 31 August 2020. Source: Morningstar Pre-crash: one year to February 20
Post-crash: one year to August 20
Best-performing sectors The precious metals, technology and US large cap growth equity sectors held their ground, continuing to be among the top-performing sectors before and after the market crash in March. Average total returns from funds in these three sectors more than doubled over one year to August compared with the year to February. New entrants to the scene post-crash are the Greater China equity and consumer goods and services sector equities. Prior to the crash, funds in the Greater China equity sector had an average one-year return of 6.4%. In the year to August, funds on average achieved five times the total return compared with one year to February. On the other hand, the average one year total return to August for funds in the consumer goods and services equity sector was 8.7 times that of February. Average return per fund in the sector over one year to February was 3.3%, compared with 28.6% over one year to August. Meanwhile, the UK mid/small cap equity and US fixed income sectors fell off the charts. While funds in the UK mid/small cap equity sector made 2.1 times more over one year to August (28.0%) than that of February, total return for funds in the US fixed income sectors fell to 4.9% over one year to August.
The precious metals, technology and US large cap growth equity sectors held their ground, continuing to be among the top-performing sectors before and after the market crash in March
Worst-performing sectors The energy and Thailand equity sectors continue to be hit hard even after the market nosedived. However, both sectors saw a fall in losses. Negative returns fell by two thirds for the energy equity sector. On average, funds in the sector recorded one year total returns of -8.0% to August compared with -24.2% over the year to February. Meanwhile, returns in the Latin America, real estate and Africa equity sectors detracted further after the plunge. Latin American and African equities were pulled further into minus territory, both recording negative returns before the stock market crash in March. Positive total return of 4.3% was recorded for funds in the real estate equities sector one year to February. However, the sector had trouble recovering from the March lows, recording a -3.3% total return one year over to August.
Fresh exuberance Monthly return (%)
Korean equity, natural resources equity and Malaysian equity sectors were among the worst-performing sectors before the March market tumble. They have since propelled into positive territory over one year to August. Korean equity funds experienced the largest change in one year returns to August compared with February. Funds in the sector on average returned 23.3% over one year to August compared with -17.5% to February. The global equity mid/small cap sector saw the largest decline during the March crash when funds on average lost 255.8% during the month. Nonetheless, funds in the sector jumped back up to 175.4% on average in monthly returns in April.
Time will tell Investors have not only stood their ground but have also strengthened their convictions after the market crash in March. Technology equity, US fixed income and global fixed income sectors continued to achieve strong net inflows. On the other hand, the Europe large cap and Asia ex-Japan equity sectors have continued falling out of favour. Meanwhile, both the cautious and moderate allocation sectors, as well as the global emerging markets equity sector, experienced the largest change in tide. Confidence for these sectors has waned the most after the March crash in terms of net flows. On the performance front, precious metals, technology and US large cap growth equity sectors have continued shining in the midst of the pandemic, while headwinds have been unforgiving for the energy and Thai equity sectors. Korean equity, natural resources equity and Asian equity sectors made the biggest comeback leading up to the second market peak. Six months after the WHO declared Covid-19 a pandemic, the markets have seemingly shrugged off its dramatic crash in March, reaching record highs for the second time in 2020 in August. With the pandemic unrelenting, will markets continue charging higher or will confidence wane? Only time will tell.
Source: Morningstar
The value of a new horizon
chapter FOUR
Asia-based fund selectors have not been easily swayed by the growth-driven equity rally and view a potential move to value in 2021.
Equities have been on a wild ride in 2020. The S&P 500 fell 30% within 22 trading days in March, only to jump back up to its February highs within six months. How have you tweaked your asset allocation in light of tumultuous equity markets? In particular, in which equity sectors do you find pockets of opportunities amid this volatility?
Arjan de Boer Head of markets, investments & structuring, Asia Indosuez Wealth Management
CONTENT BY
Global equity markets have been volatile given persistent headwinds on several fronts. For one, geopolitical factors such as US-China tensions, which started in 2018, have kept investors on edge. Fast forward to 2020 and the prolonged Covid-19 pandemic and global recession have kept global equity markets in a state of flux. For instance, we witnessed the fastest market correction in history in February and March 2020, during which the US equity market lost $4.3tn. This was followed by an aggressive recovery in the global stock market, seeing the Nasdaq Composite up 77% from its low on 23 March to its peak on 2 September. Most of the gains in the stock markets year-to-date have been driven by large cap technology stocks. Buoyed by the year-on-year growth of their second quarter earnings, driven by higher demand for digital tools and solutions as more people worked remotely, the technology sector has seen an increase in investor interest. This surge in demand has resulted in gains in technology stocks, driven by multiple re-ratings. However, we do not expect the re-rating to continue as the global pandemic eases. With the impending US presidential election, volatility is expected to rise as the outcome will have material consequences for US equities. Overall, notwithstanding a tactically cautious stance, UOB Private Bank is maintaining its neutral view on equities over the medium to long term, predicated on an eventual earnings recovery and supportive central bank policies. Our view on asset allocation is that the current valuations of cyclical and value stocks in sectors such as financial, industrials, materials and energy are very attractive. This is because they have not priced in the forecast of strong year-on-year gains arising from the expectations of a global or US economic recovery in the second quarter of 2021. We recommend our clients who have a longer investment horizon to reallocate the US stocks in their portfolio from the growth sectors, such as technology, to value stocks. While we have downgraded US equities from neutral to underweight on a tactical basis, we note that the current market correction in the US technology sector is healthy. US technology stocks will remain an attractive investment as the technology sector, which is a cyclical industry, is likely to perform better when the economy recovers and we do not rule out upgrading our call on the technology sector in the future.
Dr Neo Teng Hwee Chief investment officer UOB Private Bank
Grace Tam Chief investment advisor BNP Paribas Wealth Management
The strong equity rally after the March lows was led by growth stocks (technology and healthcare). If we observe the Faang (Facebook, Apple, Amazon, Netflix and Google) stocks alone, the gain of 124% since March 2020 to the recent peak dwarfs that of the S&P 500 index. In fact, when we look at the equal weighted S&P 500 index, it has just barely climbed back to pre-Covid-19 levels. This indicates that the rally has yet to give a considerable boost to the broader market. Vaccine development, robust liquidity and improving earnings are supportive to the equity market. However, at the same time, Covid-19, the US election and geopolitical tensions remain the key risks investors can’t ignore. Hence, we continue to recommend a ‘barbell’ strategy. On one hand, to maintain some exposure to growth stocks and buy on dips, we are in favour of the long-term outperformance of growth stocks. On the other hand, to diversify into value/cyclicals, such as selected energy, materials, financial and consumer discretionary stocks. We expect to see some rotation into value/cyclicals, particularly given the likely increase in positive vaccine news in the coming months, which signifies that the end of Covid-19 is in sight and ultimately points towards a return to normalcy.
At this stage, looking at the valuation multiples, the upside for equity markets is limited. Forward price-to-earnings (P/Es) for the MSCI World index have moved to the highest level since the late-1990s, leaving equities with limited upside. The US equity market stands close to 21x 2021 earnings, but 18x excluding the technology giants that made the summer market acceleration. European equities stand at 16x 2021 earnings, in line with the 20% traditional discount to the US market. Currently, elevated P/Es are sustained by central banks’ low rates and quantitative easing policies, but offer less upside from here onwards, although they do provide a buffer on the downside. Any market upswing will rely on macroeconomic recovery and earnings momentum, but no longer on central banks. As such, our house view is slightly underweight equities, close to neutrality. We maintain a preference in US and Chinese markets and have lowered our underweight in Europe, which could benefit from the successful outcome of the European Summit and a potential reversal of US dollar weakening. We have a preference for quality firms, but there is a potential rebound of value shares due to rates steepening. We have a long-term constructive view on technology, environmental and societal themes.
chapter five
Source source source source
1
Where there’s a will, there’s a way for consumers amid the pandemic, as they boost and evolve key themes and trends. Money managers are keeping a close eye on several long-term themes that are set to benefit from changing consumption trends. Schroders is backing e-commerce, wellbeing and energy transition, whereas Newton Investment Management is betting on renewables, electric vehicle manufacturers and smart building solutions. DBS Private Bank is bullish on e-commerce ecosystems, the cloud and semiconductors, while Aberdeen Standard Investments likes 5G, autonomous driving, artificial intelligence and automation. David Docherty, investment director of thematic equities at Schroders, said consumers are being predictably ingenious and resourceful in adapting to their new realities. Online shopping, for example, was already gaining popularity even among slower adaptors, boosting the merits for e-commerce platforms focused on home deliveries. Similarly, the focus on wellbeing was already well established before the Covid-19 outbreak and Docherty expects this trend to further intensify. He said the virus has even accelerated several existing trends in urban land use, such as future development of medical research campuses and data centres. ‘Consumers’ desire for experiences, such as tourism and live events, has clearly been halted by coronavirus, but we believe these activities will quickly resume when normality returns,’ he said. Both Docherty and Newton CIO Curt Custard believe the long-term investment theme of energy transition remains firmly on track, because ‘policymakers have used the pandemic to increase fiscal expenditure on projects aimed at promoting a green recovery’, Custard said. ‘The broad-based digitalisation trend, which captures everything from online education and video streaming to e-gaming and tele-medicine, also looks equally well placed to benefit from the shift in demand brought about by the pandemic.’
Rising above it all
words by Audrey Raj, editor
Be very cautious At the same time, Custard warned that valuations can be problematic. He said as themes become better appreciated by the market, securities can get bid up and become overvalued. The text-book example of this was during the dotcom bubble. While the rise of the internet was unquestionably a major global trend, as rigorous analysis of companies gave way to speculation, when the bubble burst it took more than 20 years for investors to recoup losses. ‘Thematic investing, like all forms of equity investment, can go wrong if the research underpinning the analysis is not rigorous and geared towards longer-term sustainable returns. Themes by their very nature take time to materialise. Investors should be very cautious about thematic products that are geared too much to the short term,’ he said. ‘We reckon that some 30% of market capitalisation is being disrupted, mainly from the old economy sectors. We recommend avoiding sectors that are seeing long-term disruption,’ added Hou Wey Fook, CIO of DBS Private Bank.
Thematic investing, like all forms of equity investment, can go wrong if the research underpinning the analysis is not rigorous and geared towards longer-term sustainable returns
Curt Custard, CIO, Newton
When comparing cyclical and structural themes, Aberdeen Standard’s Flavia Cheong believes investors should pay particular heed to structural trends in Asia’s favour, notably the consumption power of an increasingly wealthy middle class. The head of Asia Pacific equities sees the brightest prospects for quality Asian stocks with strong balance sheets, low levels of debt and sustainable competitive advantages operating in sectors with structural growth prospects. ‘They tend to be more resilient during downturns. Areas of interest include segments such as healthcare, wealth management and insurance; adoption of technology services such as the cloud and rollout of 5G; and the region’s growing urbanisation and infrastructure needs,’ Cheong said.
Chinese trends There are numerous investable themes in China as well. The US-China trade tensions is seeing multiple implications for investors, but that has not stopped most wealth managers from placing bets in the country. This is partly due to the strong returns from China A-share markets over the last 18 months despite rising trade tensions. Compared to 10 years ago, the world’s second-largest economy has become a lot more self-sufficient on the back of domestic growth. The nation is reducing its reliance on the US in areas like technology by encouraging local investment in the sector. ‘A self-reliant or self-sustaining China is also a far more sustainable and balanced economic model,’ Cheong said, adding ‘we believe higher disposable incomes will spur demand for healthcare products, wealth management services, insurance and luxury goods and services. ‘Structural growth drivers such as the adoption of cloud applications, 5G and artificial intelligence also remain intact.’
China’s internet sector is another evolving industry. Jose Pun, an equity analyst at Schroders, refers to the sector as ‘the driving seat of global innovation’. According to Pun’s research, there are now 904 million connected internet users who spend an average of around 31 hours a week online. ‘This represents a penetration rate of 65% of the population, up from 34% in 2010. By comparison, connected internet users in the US number around 312 million and market penetration is already close to 90%,’ he said. Schroders has identified new trends contributing to the emerging Chinese internet space. While social media apps still capture the greatest proportion of user time on mobiles, the rapid increase in the use of short form videos is a major growth trend, Docherty said. ‘A new trend within e-commerce in China, and which is not seen in Western markets to the same extent, is the rise in live streaming using a “key opinion leader” (or KOL) as a host. This concept is a blend of social media influencer and home-shopping on TV.
A self-reliant or self-sustaining China is also a far more sustainable and balanced economic model
Flavia Cheong, Head of Asia Pacific equities, Aberdeen Standard
‘But now, with mobile video, there are KOLs to cater for all needs, providing recommendations for a range of tastes. Major e-commerce players such as Alibaba have successfully adopted this approach,’ he said. Meanwhile, one investable theme that Newton believes has been underappreciated is China’s ageing population. ‘When we think of ageing, our minds are typically drawn to Japan or the US. But if we look at how this trend will play out over the next decade, China’s over-60-year-old population in 2030 will be larger than the entire population of the US,’ Custard said. Chinese companies are also becoming more engaged with ESG issues, though many would argue that the ‘G’ is still an area that needs to be closely monitored. According to Morningstar, Chinese investors pulled $1bn from sustainable equity funds in the second quarter of 2020, indicating lesser interest for such strategies.
Unmasking the dividend opportunity
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After all, companies worldwide slashed their dividend pay-outs in the second quarter of this year to their lowest level in more than a decade. Expectations for aggregate dividend pay-outs over the next 12 months have dropped recently by about 15% (see chart 1).
words by Patricia Holburn
But investors should look beyond alarmist headlines and focus on the facts: companies still paid shareholders US$382 billion[1] in dividends in the second quarter despite a global economic shutdown. It underlines how the vast majority of stocks continued to pay dividends even during a crisis. The worst-hit markets for cutbacks were those where a dividend culture is most deeply embedded: Europe and the UK. On average, European firms allocate a higher percentage of their free cash flows to dividends than anywhere else in the world[2]. It follows, then, that cuts were correspondingly higher. But analysis of the data reveals that banks alone accounted for more than 40% of dividend cutbacks across Europe in the second quarter[3]. That was after the European Central Bank ordered banks to freeze pay-outs to preserve capital and support businesses and households during the pandemic. Subsequently the UK’s top financial regulator – the Prudential Regulation Authority – also applied pressure on banks under its purview to follow suit. Each of Barclays, Santander, Lloyds, NatWest, Standard Chartered and HSBC has confirmed they will not be paying dividends in 2020[1]. But it’s important for investors to distinguish between companies cutting dividends due to cash-flow difficulties, and those compelled to do so by regulators and governments. Many of the latter were in a position to continue paying dividends, and will surely resume when permitted. At the same time, the pandemic has not impacted all companies equally. Firms operating in sectors such as travel, leisure and construction have been among the hardest hit. Yet others are benefitting from changes in work and consumption patterns in areas such as cloud computing and online services. Investors can actively reduce their direct exposure to the virus’ impact and to stocks where they anticipate unwanted tail risks. Inevitably it means some companies will be better placed to sustain their earnings and dividend payments than others. When it comes to dividend investing, investors can actively reduce their direct exposure to the virus’ impact and to stocks where they anticipate unwanted tail risks. At the same time, they can target companies with the strongest balance sheets and competitive positioning to sustain their pay-outs. In many cases, payment of a dividend can act a good proxy for the quality of a company’s management and governance. Research from financial services firm Jefferies shows how quality stocks tend to avoid the worst of the dividend cuts, with a strong correlation between board independence and dividend pay-out.[2] In the US, where board independence is deeply ingrained, companies with less than 60% of independent board members average a 17% dividend pay-out, versus a 33% pay-out for firms with more than 90% of independent board members, the research finds.
Recent headlines may highlight cutbacks in pay-outs, but the global universe of dividend-paying stocks is vast and diversified with a long track record of growth. The harsh economic fallout of a global coronavirus pandemic may seem a perverse time to highlight the benefits that dividend income can bring to investment portfolios.
Senior Investment Specialist, Equities, Asia Pacific
Ben Sheehan
Chart 1: MSCI AC World Index, Bloomberg 12M forward dividend per share estimates
Source: MSCI AC World Index, Bloomberg, September 2020. Past performance is not a guide to future results.
2. Microstrategy – Dividend Playbook 2020, Jefferies
3. The Global Income Investor, SG Cross Asset Research/Equity Quant/Bloomberg
Global context Another critical factor substantiating the sustainability of dividend income is the size and diversity of the global equity universe. We maintain a buy-list of 1,100 companies globally at Aberdeen Standard Investments, including dividend-paying stocks. We believe this provides us with a sufficient pipeline from which to choose. Moreover, while dividends from companies on Europe’s EuroSTOXX and the UK’s FTSE100 indices are forecast to be cut by over 30% in 2020, for Japan’s Topix500 Index the figure was 8% and for the S&P500 it is projected to be flat, according to Bloomberg’s dividend projections as at the end of June. On the upside, more than 30% of companies in the UK, Europe and Japan are expected to raise dividends in 2020, while in the US that figure is projected to be more than 60% (see chart 2).
Chart 2: Companies projected to raise dividends
Source: SG Cross Asset Research/Equity Quant, Bloomberg, 6 July 2020
Data also shows that the market with the most sustainable dividends is the US. Just 30% of US firms cut dividends during the 2008 financial crisis, notes research from Jefferies. It has been a similar story during the Covid-19 pandemic, with US dividends the most resilient in the world so far. Jefferies attributes this to the fact that US companies spend more on buying back their own shares – another way to return capital to shareholders – than any other market. During periods of stress, US firms have a history of suspending buybacks rather than dividend payments. In Asia, meanwhile, almost 90% of companies pay dividends now, according to data from Jefferies and Factset. Moreover, they also have far lower levels of leverage on average than elsewhere. This is a region that already accounts for more than 50% of global economic growth. With low net gearing and consistently high free-cash flow, we expect companies in Asia to drive continued global growth in dividend pay-outs.
Chart 3: Trend of global dividend growth over the past quarter century
Source: Bloomberg, MSCI AC World Index, May 2020. Estimates are not guaranteed and actual events or results may differ materially.
Investor opportunity More than just sustainability, investors should also be mindful of the opportunity that the global universe of dividend-paying stocks presents. Due to the sharp compression in bond yields, equities have offered a higher average yield than bonds since 2011 (see chart 4). We expect no let-up in this trend given the enormous pool of low and negatively yielding bonds, which now stands US$15 trillion globally.
Chart 4: Equities offered higher average yield than bonds since 2011
Source: SG Cross Asset Research/Equity Quant, Bloomberg, September 2020. Past performance is not a guide to future results
Ageing global demographics also point to continued strong demand for income as people increasingly look to save for their retirement. This growing pool of capital seeking income provides a strong incentive for companies to continue paying dividends. So despite all the headlines about cutbacks in dividend pay-outs, investors should take heart that there remains a broad base of dividend-paying companies to choose from, particularly when they search on a diversified global basis. Aberdeen Standard Investments offers a unique proposition to fulfil your clients’ income needs. The Aberdeen Standard SICAV I – Global Dynamic Dividend Fund aims to provide a premium monthly dividend payout as well as benefit from capital appreciation via our high conviction global equities portfolio. Speak to your local Aberdeen Standard Investments’ representative or visit www.aberdeenstandard.com.sg/ for more information.
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Seizing opportunities in China
1. What trends are currently shaping the Chinese market? Where do you see growth opportunities? From a fundamental perspective, we believe the following trends should help generate interesting investment opportunities within the Chinese equity market: • • •
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 and no investment advice or recommendation is made herein. In making investment decisions, investors should not rely solely on this advertisement but should seek independent professional advice. However, if you choose not to seek professional advice, you should consider the suitability of the product for yourself. Past performance of the fund manager(s) and the fund is not indicative of future performance. Prices of units in the Fund and the income from them, if any, may fall as well as rise and cannot be guaranteed. Distribution payments of the Fund, where applicable, may at the sole discretion of the Manager, be made out of either income and/or net capital gains or capital of the Fund. As a result of the payment, the Fund’s net asset value is expected to be immediately reduced. The dividend yields and payouts are not guaranteed and might change depending on the market conditions or at the Manager’s discretion; past payout yields and payments do not represent future payout yields and payments. Investment involves risks including the possible loss of principal amount invested and risks associated with investment in emerging and less developed markets. The Fund may invest in financial derivative instruments and/or structured products and be subject to various risks (including counterparty, liquidity, credit and market risks etc.). Past performance, or any prediction, projection or forecast, is not indicative of future performance. Investors should read the Prospectus obtainable from Allianz Global Investors Singapore Limited or any of its appointed distributors for further details including the risk factors, before investing. This advertisement has not been reviewed by the Monetary Authority of Singapore (MAS). MAS authorization/recognition is not a recommendation or endorsement. The issuer of this advertisement is Allianz Global Investors Singapore Limited (12 Marina View, #13-02 Asia Square Tower 2, Singapore 018961, Company Registration No. 199907169Z).
Portfolio Manager Director
aNTHONY WONG
Domestic innovation replacing foreign brands: Increasingly we are seeing Chinese companies climbing the value-added chain and competing with foreign brands within domestic Chinese markets. Very often these Chinese companies not only provide good quality products at competitive prices, they also have better local knowledge, shorter turnaround times, strong after-sales support and good distribution channels. Consumption upgrade: This is not a new trend in China, but quick control of the pandemic in China and resilience of China’s middle class have helped support the performance of companies with strong brand name. In particular, consumer staple companies including white liquor brands, food ingredient companies, food flavouring brands have generally performed well. Increasingly, we are seeing a recovery in domestic discretionary spending post Covid-19, including in areas such as tourism and entertainment. Technology advancement: Though the tech war between US and China has led to increasing uncertainties for tech companies around the world, China remains one of the key players along the tech supply chain. One outcome of the tech war has been the acceleration of domestic innovation as China looks to reduce its strategic reliance on external providers of key components along the supply chain. Over the long term, companies with strong R&D capability and execution are likely to gain market share, while those relying on imported technologies may struggle.
2. What role does ESG play? Compared to developed markets such as Europe, ESG is still a relatively new concept within the Chinese equity market, albeit developing at a fast pace. While there are many ways to include ESG as part of the investment process, at Allianz Global Investors, we take an integrated ESG approach. This means we examine the Environmental, Social and Governance aspects of investment candidates, and pay particular attention to potential tail risks that might trigger significant financial loss in the future. With rising participation from international investors and improving ESG awareness from Chinese domestic investors, we believe ESG may over time become more mainstream in the China equity space. This means companies with strong environmental discipline, social responsibility and better corporate governance may enjoy a lower risk premium over the longer term, in general.
1. Bloomberg, as at 30 September 2020.
3. Will we ever reach a point where global investors will consider China as a standalone asset class? The short answer is yes. With MSCI’s inclusion of China A-Shares into its flagship indices, we believe China equities, including onshore and offshore stocks, may potentially come to represent up to 50% of the MSCI Emerging Market Index if all China A-Shares are fully included into the index.. By that time, we would not be surprised to see many investors separating China from the rest of their Emerging Market portfolio as a standalone asset class. In fact, even now we are seeing early movers into this direction. We see a number of asset allocators with a longer term investment horizon considering investments into a holistic China portfolio that combines investment ideas from onshore and offshore China equities, thus gaining exposure to China as a stand-alone asset class.
4. How can foreign investors access the Chinese equity market? In terms of investment channels, there is no capital control for offshore China equities, i.e. Chinese companies listed in Hong Kong and the US. For China A-Shares, investors can participate through the Stock Connect, RQFII and QFII schemes. For retail investors who may not be very familiar with the dynamics of the local China markets, actively managed mutual funds can be a good choice, as these products are typically managed by experienced investment professionals, with strong research resources and disciplined investment process. There is also a growing range of ETFs that can provide access.
5. Why is China the perfect hunting ground for active investors? We believe there are major inefficiencies in the China equity market. Turnover is dominated by retail investors, who have a very different mentality from institutional participants. Retail investors generally have a very short-term outlook, with a bias towards momentum and small cap stocks with the expectation of high earnings growth. This creates situations in which share prices diverge significantly from underlying long-term fundamentals. We believe that fundamental, bottom-up stock selection is the best way of exploiting these inefficiencies. Stock selection is our core area of expertise, hence we have designed our strategy so that stock selection is the key driver of its risk and return. The China A-Share market is volatile, and there can be large, unpredictable deviations in the performance of different sectors. We believe market inefficiencies in Chinese equities can be best captured through a combination of stock picking overlaid with effective risk management. The separation of the onshore and offshore China equity markets results in further inefficiencies. The different shareholder bases can lead to different valuations for onshore and offshore listings of the same company. By investing across the A-share and H-share markets, we believe there may be potential opportunities to capture the differential pricing of dual-listed stocks.
6. What's your long-term outlook for the market? Fundamentally, China has been “first-in and first-out” of the Covid-19 outbreak. The number of new daily confirmed cases in mainland China reached its peak in mid-February, and has been on a declining trend since. The effective containment of mini outbreaks in Beijing, Dalian and Xinjiang has also demonstrated China’s preparedness and ability to manage the situation in a way that minimizes economic disruption. The result has been a gradual lifting of nationwide lockdowns and a visible recovery of economic activity. China’s Q2 real GDP came in well above expectations at +3.2% year-on-year, rebounding sharply from the negative Q1 reading.[1] Into Q3 we are seeing a strong recovery in exports, industry output as well as a recovery in consumer spending. Echoing this macro response, recent corporate earnings in China have been stronger than expected. Over the longer term, we may observe continuous improvement of the Chinese equity markets in terms of the quantity and quality of investment opportunities, thanks to the continuous efforts to develop more institutional and transparent capital markets. This should, in turn, facilitate the development of domestic innovation, especially for companies related to the “new infrastructure” space. The buildout of the next generation of infrastructure should not only help mitigate short-term economic pain, but also lay the foundation of a fundamental transformation of China’s manufacturing supply chain and the competitiveness of many Chinese corporates.
Moreover, technology stocks (thought to be beneficiaries of the lockdowns) soared in value, other sectors such as industrials, travel and leisure, and retail slumped – even if tech valuations have since fallen from the highs reached in August. We believe the disparities in terms of performance underline the value of our approach of seeking out quality companies with a sustainable competitive advantage that are able to continually grow their earnings above the market and are not themselves reliant on economic growth.
Global equities have enjoyed a strong recovery from the lows to which they plummeted earlier this year. By the end of August, the MSCI All Country World Index was up by 1.8 per cent in US dollar terms year to date [1]. Yet these gains mask a highly divergent performance in terms of markets, sectors and stocks. The UK has been one of the worst performers, while US equities and Asian emerging markets have stormed ahead. Meanwhile, Japanese, European and emerging markets broadly remain in negative territory.
Equity performance highlights the importance of a quality approach
Portfolio Manager, Global Equities
David Dudding
1. Bloomberg, 30/9/2020
Hunting for quality We look for companies that achieve high returns on assets or capital employed and benefit from low levels of financial gearing. These companies tend to deliver solid profit growth year in year out and are highly stable, reflecting their low levels of debt. Certainly, such companies have performed excellently this year, allowing us to generate solid returns for investors. Generally, around 70 to 80 per cent of our portfolio is invested in companies that already display these characteristics, with a further 20 to 30 per cent focused on companies that are improving, which we believe can become the quality businesses of tomorrow.
Exploiting the explosion of technological disruption across economies The term “technology sector” is something of a misnomer in 2020 because new technologies are disrupting the entire economy and the distinctions between technology and other areas is increasingly blurry. While some of our biggest holdings are payments companies, such as MasterCard and Visa that are exploiting technological advances to boost profits growth, it's debatable whether they are financial or technology companies. Moreover, while Alphabet and Amazon are not formally within the technology sector, semiconductor businesses are. Many of the latter started as hardware companies, but are increasingly becoming software companies. Therefore, we target companies that exploit new technology to their advantage to become tomorrow’s winners. The Covid-19 pandemic has accelerated the process of technological disruption across economies as increasing numbers of people work from home, and turn to online shopping and entertainment. In the retail sector, for example, retail businesses that have most successfully weathered the pandemic have been those with physical stores as well as an online offer. Meanwhile department stores, such as Macy’s, have come under increased pressure as shoppers shun the high street.
Value investing doesn’t necessarily offer value The pandemic has also focused the spotlight even more on value investing, an approach that often involves the search for undervalued companies on the assumption that their share price might at some point revert to average levels. The problem is that, as a result of Covid-19, nobody knows when or even if we will go back to pre-virus days, so it is difficult to know where that average lies. In addition, technology is also disrupting many industries. Take the auto sector, for example: electric cars seem to be the future, so investing in businesses that still focus on the internal combustion engine (that may be replaced by electric sooner rather than later) could prove a costly mistake – even though the stock currently appears cheap.
A week in the life While we are a stock-picking team, we also ensure our portfolio is diversified in terms of geography and sector and we are constantly monitoring the portfolio whilst looking for new opportunities. As an example, during a typical recent week we reviewed UK and European stocks, undertook analysis of technology, media and telecoms stocks in Europe, India, China and the US, and discussed current and potential holdings in the semiconductor sector. That gives you an idea of how much ground we cover in any one week.
Important Information: For use by Professional and/or Qualified Investors only (not to be used with or passed on to retail clients). This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority. In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act and relies on Class Order 03/1102 in marketing and providing financial services to Australian wholesale clients as defined in Section 761G of the Corporations Act 2001. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws. In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore. In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the ce (Chapter 622), No. 1173058. Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.
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Uncovering innovation on the right side of change
What does it mean for a company to be on the right side of change in 2020? Put yourself in the shoes of a respected entertainment brand that’s given the magical gift of flight to cars, caretakers, and elephants. You’re known for innovation, but to make your next act work—creating a wearable technology to enhance the guest experience at your theme parks—you need the gift of top-flight software talent. But that type of talent can be as elusive as the rightful owner of a glass slipper. This story is emblematic of a digital transformation happening on a massive scale across corporate America. As companies embrace new technologies and strive to meet evolving consumer demands, they must find the talent to manage an array of new digital complexities. Increasingly and across industries, these firms are struggling to do so due to a scarcity of skilled software developers. Two forces are at play:
The company’s highly skilled software engineers have done work for a wide variety of businesses, such as American Express, Southwest Airlines, Zynga, and Google. Globant’s share price at the time did not reflect the growth opportunity we expected to see from owning it when we purchased the stock. This is where our example of a storied entertainment brand comes back into the picture. Globant also helped gaming brand Electronic Arts develop its FIFA soccer game franchise and partnered with London’s Metropolitan Police to develop a digital platform for accessing police services digitally. In conclusion, we believe 2020 will be a year where the pace of change continues to accelerate. Technological disruption will become even more pervasive. In order to thrive, companies will require a far greater amount of digital capabilities than they have in the past. We believe businesses on the right side of change that can meet the changing demands of consumers—such as the acute shortage of software developer talent—can be poised to produce strong excess returns. Just as major entertainment brands can revolutionize the consumer experience by bringing the right minds together, our team is using a uniquely designed process to capture these opportunities.
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1. As reported on Investors.Globant.com: “Globant—We Are Ready”
Ozo Jaculewicz, CFA
Digital transformation is of strategic importance to many global companies.
Trillions of dollars in market cap are resting on the shoulders of the search for software developer talent.
This is leading companies to turn to external service providers to meet their needs. And they are hunting in all corners of the globe to find this talent. While conducting bottom-up research, we on the Fundamental Growth Equity team identified a compelling theme around this growing supply-and-demand imbalance for software developers. Our research analysts met with multiple management teams from companies of all sizes that noted over and over again how hard it was to find talent. Following our process to “surround the company,” the search for a solution to the developer shortage led our analysts to companies that recruited and developed skilled labor pools outside the U.S. A chance conversation we had with a software management team at an industry conference added to our conviction, as the executive sang the praises of some select outsourced developers. Through the execution of our investment process, the team developed an investment thesis that Globant—an information technology (IT) services company in Latin America with 6,000+ IT professionals—has the potential to be a key beneficiary of the demand for software talent.
2
1 million
Number of IT jobs unfilled in the U.S.
Tech-hiring decision-makers at U.S. firms who identified lack of IT talent as a key challenge
80% of about 2,800
Sources: IT trade group CompTIA and Robert Half
Can you recall a time in your family history of taking young children to a theme park?
Amid the joyful memories, you may remember a certain amount of chaos. The hours of waiting in line for rides. The constant juggling of food, balloons, and at least one child while you fumbled for your wallet to pay for it all. And finally, after a long day, near the point of collapse from exhaustion, you’ve arrived at your hotel room door only to realize you have lost your key. Globant—as reported on its website [1] —helped Disney create a next-generation online experience for its parks and resorts. Perhaps you’ve heard of the MagicBand, a sensor- enabled wristband that — as reported by Wired [2] — allows wearers to avoid lines, pay for meals, and even unlock their hotel room doors. In our conversations with Globant, we learned it provided talent to help the entertainment brand achieve its innovative vision.
2. As reported on Wired.com: “Disney’s $1 Billion Bet on a Magical Wristband
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Associate Portfolio Manager and Senior Portfolio Specialist, Fundamental Growth Equity Team
Senior Portfolio Manager, Fundamental Growth Equity Team
Michael Smith, CFA
Headline Headline
What are we looking for? Put simply, we understand ‘sustainability’ to mean the durability of a company’s business model over the long term. To put it more succinctly: ‘what makes a great company stay great?’. The combination of empirical research and our own experience as investors has led us to believe that sustainability hinges on two key features. Only companies that are run a) for the long term, and b) with regard to all stakeholders, will be able to maintain above average growth and returns. However, the market tends to be poor at long-term forecasting, rarely looking more than a few years out. Analysts also struggle to make sense of and value non-financial factors because they do not fit neatly into an Excel model. This means the market often fails to identify or appropriately value those companies that can consistently deliver “supernormal” growth and returns. This offers an opportunity for investors such as ourselves. But finding these special companies, and deciding which ones to invest in, is not as simple as using third party sustainability ratings. Third-party reports can be a useful input for our analysis, but there are serious shortcomings that mean they should be used with caution. Three problems with third party ratings 1) Third-party scores are backward-looking. Our Sustainable Investment Team has produced studies showing that scores are a poor predictor of future controversies, instead tending to change after the event. Scores may also be infrequently updated. 2) Problem two is that third party ratings are inconsistent. Each provider uses a different methodology – which are generally very opaque - and so come up with different answers, as the chart below shows (AAA-CCC are the different ratings given to companies with AAA being the highest).
Click to read more about: Why “corporate karma” is crucial for your investment returns
3) These third party scoring systems can only be based on reported metrics and policies, given they need to be deployed across a wide range of companies. A lot of the ultimate score relies on whether a company has certain policies or targets in place, regardless of how well they are implemented or achieved. This also means they inevitably reward disclosure rather than a genuine commitment to sustainability. This structure tends to favour larger companies, often in Europe, as these are more likely to have resources dedicated to sustainability reporting and are legally required to have certain policies. What do we do instead? Introducing the SQ framework. Given the limitations described above, we created our own framework – SQ – for assessing sustainability in a more holistic and unashamedly qualitative fashion. The framework comprises 20 questions framed around four broad pillars: 1) Respect for the environment. Here we’re thinking about the company’s impact not just in terms of its products but also its operations – i.e. how it makes those products, runs its facilities etc. We look at whether suppliers are held to high environmental standards, so that a company cannot get a pass just by outsourcing all its dirty work. We also consider any environmental controversies the company has been involved in. 2) Fair and equitable treatment of employees, suppliers and customers. This covers questions around pay, working conditions, discrimination, and safety. As regards suppliers, we’re looking for evidence of a constructive relationship alongside good visibility and human rights standards down the supply chain. And for customers, product safety and value for money are key areas for consideration, as is the use/protection of any customer data. 3) Good corporate citizens. We look at the benefits or harm to wider society created by the company’s activities, as well as relationships with regulators and the local community and whether they pay their fair share of tax. We make use of our proprietary SustainEx tool to quantify this aspect of the assessment. 4) Prudent allocation of capital. This covers aspects such as shareholder returns, governance standards, and transparency. The purpose of basing the framework around open questions is to move away from simply ticking boxes. These are complex issues that require us to consult a wide range of resources and interact directly with companies. We want to get really ‘into the weeds’ of how a company is run to gain a deep understanding of its corporate culture and stakeholder relationships before we invest. SQ in practice – high bar for inclusion Using the SQ framework helps to identify issues and open up different dimensions to the analysis that might not come to the fore in third party reports. We frequently come across companies where we fundamentally disagree with external ratings providers. For example, our forward-looking analysis might take account of the fact that something has fundamentally changed at the company since a historic controversy, to prevent it from happening again. Or our use of unconventional data and direct company engagement may have given us insight beyond what is disclosed in official reporting – especially in the case of smaller companies or those listed in emerging markets. Clearly no company is perfect and our SQ framework also helps us to identify areas of relative weakness where we can engage with the company to try and improve their behaviour or practices in the future. Truth lies in the eye of the beholder As the examples above show, any assessment of sustainability is going to be subjective. There is no “absolute truth” that can be revealed just by crunching enough data. Our SQ framework means we ask the same 20 questions for every company, regardless of industry or geography. This keeps our approach consistent. However, we recognise that, for a given company, certain questions will be more material than others for the future sustainability of the business. Looking at a bank, for example, we will pay more attention to assessing their customer relationship management, prudent capital allocation, and their relationship with the regulator – rather than their (modest) environmental footprint. For a food producer, on the other hand, their resource use and sourcing is paramount. However, there is still value in answering the seemingly less relevant questions for every candidate, as it gives an indication of how seriously the company takes sustainability across the organisation. Ultimately, we are trying to assess how a company’s management of its stakeholder relationships might translate into its prospects for future growth and returns. The SQ framework provides the lens through which we can do this. Relying on third parties would be like trying to wear someone else’s glasses – we wouldn’t see a clear picture. This information is a marketing communication. The views and opinions contained herein are those of Katherine Davidson, and may not necessarily represent views expressed or reflected in other communications, strategies or funds. This information is not an offer, solicitation or recommendation to buy or sell any financial instrument or to adopt any investment strategy. Information herein is believed to be reliable but we do not warrant its completeness or accuracy. Any data has been sourced by us and is provided without any warranties of any kind. It should be independently verified before further publication or use. Third party data is owned or licenced by the data provider and may not be reproduced, extracted or used for any other purpose without the data provider’s consent. Neither we, nor the data provider, will have any liability in connection with the third party data. The material is not intended to provide, and should not be relied on for accounting, legal or tax advice. Reliance should not be placed on any views or information in the material when taking individual investment and/or strategic decisions. Any references to securities, sectors, regions and/or countries are for illustrative purposes only. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
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There are a multitude of sources available to investors who want to assess a company’s sustainability. Some of the most commonly used are MSCI, Sustainalytics, and Thomson Reuters. These can be useful for highlighting issues and sourcing data, but I believe in doing my own homework. My team and I therefore use our proprietary framework, developed and implemented with the help of the Schroders Sustainability Team, to analyse a company’s ‘Sustainability Quotient’, or SQ.
Issued by Schroders Investment Management Ltd registration number: 01893220 (Incorporated in England and Wales) is authorised and regulated in the UK by the Financial Conduct Authority and an authorised financial services provider in South Africa FSP No: 48998
Click to read more about: Managing corporate controversies: the role of ESG ratings
Source: Schroders, December 2017
EQUITY OUTLOOK
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At the beginning of this year, most global market forecasts were for modest returns. There was no sense of the impact that a global pandemic might have. ‘Our view was that equity valuations were full and our expectations were for modest, positive returns,’ said Murray Winckler, portfolio manager and co-founder of Laurium Capital. Then came Covid-19 and in March, equity markets ‘fell off a cliff,’ as George Herman, director and CIO at Citadel, noted. ‘The 34% decline in the MSCI World Index in over a month was the sharpest and quickest ever in 100 years,’ Winckler said. ‘It was the magnitude and speed of the declines of some of the asset classes that really shocked the markets. Volatility went through the roof with the VIX rising to 80. There was massive uncertainty.’Support came in the form of stimulus packages, notably in the US, Europe and – to a lesser degree – China, and a huge rally followed. The fall was felt equally, but the rally was more discerning. Winckler said the MSCI World Index return, which is down around 5% for the first six months of the year, includes positive returns of 14% from information technology (IT) and 4% from healthcare. There were negative returns from energy (-34%), financials (-15%) and broad industrials (-13%). Adrian Saville, chief executive of Cannon Asset Managers, said countries with good policy responses to the pandemic, strong economies and high contributions from technology-oriented sectors have performed well. US equity markets recovered well after a dramatic fall, with the S&P 500 posting a 0.6% return (in US dollars). Whilst the country might not have had an ideal response to the health crisis, it has an unmatched ability to deliver stimulus packages. Winckler said the US acted very quickly to the pandemic with huge monetary and fiscal stimuli that propped up the market. Markets in Europe haven’t fared as well. ‘Equities in the eurozone delivered -12.4% (in euros) for the first half of 2020,’ said Pierluigi Ansuinelli, portfolio manager, Franklin Templeton Multi-Asset Solutions. ‘Different European countries are characterised by different sectors and different concentrations,’ he said. According to Ansuinelli, the top three sectors in Germany, according to MSCI index methodology, are consumer discretionary, financials and IT. ‘The equity market in France is concentrated on industrials, consumer discretionary and consumer staples, (accounting for 52% of the total weight).’
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The CAC 40 was down -13.6% and the German Dax was down -3.9%. Saville highlighted the Spanish market, which is export-oriented and heavily reliant on tourism. ‘Spain’s IBEX is down 16% year-to-date,’ Saville said. There are outliers such as Estonia, which, according to Saville, has shown exceptional turning speed, underpinned by a strong social fabric and highly digitised economy. ‘The Estonian TALSE index has recovered most of its 2020 losses.’ However, the pandemic has not been kind to emerging markets. ‘Emerging markets other than China have not done well,’ Winckler said. South America in particular had a bad six months, down 30% (in US dollars). ‘The region is heavily dependent on global growth, was suffering across various regions pre-Covid-19 and had little in the way of stimulatory room,” said Nishlen Govender, portfolio manager at Citadel. ‘Given the nature of the crisis, industries that were essential or allowed us to communicate and work in isolation performed exceptionally well. Stocks benefiting from open economies, travel and business such as financials, energy and utilities struggled,’ Govender said. Technology has been a winner, in most cases, across the board. The Nasdaq hit record highs early in July. Winckler said the tech index in China, the Krane Index, is also up – around 30%. There is a story behind this boom. ‘The post-Covid-19 working-from-home theme grabbed the narrative and technology stocks soared. In fact, this was one of the most concentrated rallies ever, with only a small proportion of the index performing well,’ Govender said. Those stocks include Amazon, Apple, Alphabet and Microsoft. Poor performers include hotel and tourism businesses listed on the Nasdaq. Investment styles haven’t escaped the diversity in returns either. ‘Year-to-date global growth stocks are up 6.6%, while value stocks are down 17.4%,’ Saville said. ‘Global large-cap stocks are down 4.7%, but momentum stocks are in positive territory.’ It’s been a tough start to the year for investors. Winckler has spent more than 30 years in the market and can remember not only the shocks in the current century – the dot-com crash and the great financial crisis – but also some from the late ’80s and ’90s. The severity and speed of this one surprised him. ‘2020 has been frightening,’ Winckler said. ‘The volatility and changes at the margin have been radical.’ Citadel’s Herman agreed with Winckler’s sentiment. ‘2020 is proving to be the hardest year ever to analyse by far,’ he said. But a more rapid move to digital has had one benefit – access to companies and management teams is easier, even if physical visits aren’t possible.