2021 - The Times They Are a-Changin'
Our convictions, your resolutions.
Pandemic: the game-changer
Vincent Hamelink, Chief Investment Officer
After a year of twists and turns, 2020 is ending in the same funny old way it started.
In early November, in the space of barely a few days, two major events – Joe Biden’s victory in the US presidential campaign and the discovery of anti-Covid vaccines (with, going by the clinical trials, a very high efficacy rate) – are bringing new perspectives to our world and our economy.
Markets were quick to hail these two announcements. Of course, although the vaccines herald a form of normalisation within a given time horizon, the pandemic will leave deep scars, some already visible, others bound to spring up in the long run.
Let’s take a quick look at the short-term consequences, over which a lot of ink has already been spilled, and covering changes not only to our working and consumption habits, of course, but also in the way in which we perceive health, sustainability and the environment.
These new habits have reinforced some highly prevalent trends, such as the development of connectivity, management and data security solutions, as well as online services, and have reiterated, to those whose attention it might have escaped, the pressing need to protect our health, our quality of life and our planet. No surprise, therefore, that firms developing solutions in these areas posted a much better 1H, outperforming, in fact, over the whole of the year.
Beyond these immediate observations and the inevitable market rotations linked to specific events that are likely to occur over the next few months, other, far-reaching changes are underway that will impact society and business models over the next 5-to-10 years.
At sovereign level, first of all, the limits of the indisputably necessary central bank monetary policies are becoming clearer with each passing day. New supportive measures for the economy will only be implementable by means of further fiscal intervention, which will require, for the first time in a long time, governmental intervention in the economy … but not just that. Indeed, governments are being asked to involve themselves in other aspects of our daily lives; for a healthier, safer planet, as a major vector of change for the better, and to manage what is, oddly enough, being referred to as a “return to the new normal”.
Geopolitics, too, has a new face, with China now off the leash and revelling in its status as the new leading global economic powerhouse and in its exiting the pandemic in more radical fashion than elsewhere on the planet. Cathay will henceforth have to deal with a US reconnected with its age-old allies and more fully engaged in international and climate-related business initiatives.
This return of the US to the family of nations will not prevent a degree of de-globalisation. Many countries have experienced this crisis as a serious reminder of the need for available strategic reserves, and to win themselves some degree of autonomous control over health-related or essential goods and services.
To this end, individual States will not wait until the next crisis before reorganising. Certain responses or failures to respond are, these days, frowned upon by the public. The operative word here henceforth is: anticipation … of the challenges and crises to come, with tried-and-tested systems for detecting, monitoring and managing the major domestic and international challenges.
Climate is shortly going to be our primary focus. Governments, lawmakers, central banks, corporates – and, of course, the citizen body – are implementing various steps and actions to counter this, the Next Big Threat to the race.
Climate denial is no longer an option, and the related measures undertaken are often a means of appreciating the quality of a policy, a strategy or a project.
Europe has, here, a card up its sleeve, as the region could assume (already-recognised) leadership in the areas of environmental protection, the fight against global warming, and the circular economy, while rectifying its main decades-long weakness: its dependence on energy and raw materials provided by powers or countries whose vision and values it does not share.
Businesses, too, can draw lessons from this pandemic.
Digitisation, a mega-trend identified well before the crisis, is now rapidly shifting through the gears. Only the fittest will survive, as e-working and e-shopping become the new normal, and indeed are seen as such by clients and collaborators alike.
Process robotisation and optimisation represent no mean challenge for firms keen to remain more agile than the competition. They’re also a challenge to governments, as it’s a trend that could accentuate certain inequalities; the Fed, in respect of this very topic, has made the fight against inequality one of its core strategic objectives.
Sustainability – as governments (see above) have learned – will create opportunities for the most adaptable businesses and – better still – for companies proposing climate and environmental solutions. This is bound to be one of the most powerful mega-trends of the foreseeable future.
It is on this hopeful note that I wish you a very happy 2021. A year of rebirth, a healthier year, with an improved quality of life and – at long last! – of living normally together (again).
The logical disconnection among financial markets
Nadège Dufossé, Deputy Global Head of Multi-Asset
The disconnection between financial markets and the real economy has never seemed as wide as in 2020. Although the year is drawing to a close amid hopes of the second wave of the pandemic regressing in Europe, the hardest-hit of all the continents, the epidemic continues to spread worldwide with almost four million new cases recorded every week. An unprecedented downturn in global production is expected as a result. In October, the IMF was forecasting a 5.9% GDP contraction in the G7 countries, which is far greater than the -3.6% recorded during the 2009 financial crisis. However, the exceptional scale of the Covid-19 health crisis and its lasting repercussions are almost inconceivable judging solely by the performances posted by equity markets (MSCI World indexTM +7.7%), high yield bonds (BofA Merrill Lynch Global High Yield Constrained indexTM +3.5%) and industrial metals (copper future contracts +17%). What factors account for this apparent disconnection between financial markets and the real world?
Financial markets rapidly anticipated a V-shaped recovery during the summer
The economic downturn stemming from the health crisis differs greatly from the 2008-2009 recession. Business activity closed down abruptly but only temporarily. As the chart above illustrates, the ISM manufacturing indexTM in the US slumped from 49 at the end of March to 41.5 at the end of April. The slowdown was even sharper in Europe, with the manufacturing Purchasing Managers' Index (PMI) falling to 33 at the end of April, while the eurozone services PMI plummeted even further to 12. Conversely, a V-shaped recovery during the summer effectively took shape, with business activity bouncing back surprisingly sharply. In the US, the ISM manufacturing index surged back through the 50 level during June and hit 59 in October. The huge monetary and fiscal stimulus measures, which were put in place as early as March, account for the rapid recovery from the unprecedented economic shock. In 2008-2009, the ISM manufacturing index took almost 12 months to breach the 50 level once again.
Equity and bond indices unrepresentative of the real economy
Although the sudden shock triggered by the economic crisis is only temporary, it has had a highly uneven impact across different sectors. Entire swathes of the economy including transport, the tourist sector and the hotel & restaurant industry have been closed down, whereas other segments such as on-line services have profited from accelerated growth this year. The gap between the Covid winners and losers has widened steadily since March and is reflected in spectacularly different performances between companies.
Within the S&P 500TM, the Internet sector (S&P500 Internet RetailTM) posted a positive performance of around +50%, while the hotel sector (S&P500 Hotels Resorts & Cruise linesTM) and aviation (S&P500 AirlinesTM) were down by around 28% and 33% respectively.Companies which have gained from the health crisis are mainly growth stocks, either in the technology sector or in telecoms (social media) and the discretionary consumer segment (on-line sales). Prices among these stocks have been boosted by a positive scissors effect during the crisis, i.e. improved earnings outlook and falling interest rates. The weightings of these mega-cap stocks in the S&P 500 index in the US, which are the undisputed leaders in these sectors, have increased sharply. The combined weight of Google, Apple, Facebook, Amazon and Microsoft now represents over 20% of the index. Amazon’s index weighting has nearly doubled this year to almost 5%. There has been a similar concentration among emerging indices, with four stocks now representing 25% of the MSCI Emerging Markets indexTM. Bond indices are also reflecting the same trend, with 15% of issuers representing 50% of the market cap of the non-financial euro high yield index.
Has there really been a disconnection between financial markets and the real economy or between the market indices and the real economy? The heavy weighting of growth stocks has been amplified by the unprecedented fall in real US interest rates. Growth stock prices rise when interest rates ease, as companies’ future cashflow is discounted at a lower rate. Their weightings in the global indices therefore increase. The impact on the US index is illustrated in the chart below, with the S&P 500 twelve-month forward Price Earnings Ratio tracking the downward trend in real US interest rates (inversed scale on the chart).
Can we expect a partial re-connection over the coming year?
The key question over the next few months will be the pace of the recovery from the health crisis. The trading session on 9 November provided an insight into potential financial market trends for 2021. The interim vaccine test results announced by Pfizer-BioNTech, which demonstrated 90% efficacy, triggered an historic daily outperformance by value stocks over growth stocks.
In the case of the stocks referred to in the example above, Internet sector fell by 4%, while hotel sector rallied 19% and aviation sector gained 15% on the same day. A progressive exit from the health crisis and a recovery in economic activity should enable financial markets to post gains based on a broader spectrum of stocks which more closely represent the real economy. The impression of a disconnection should therefore diminish if similar position rotation continues next year.
However, the Covid-19 pandemic has nonetheless accelerated trends already perceptible before the crisis which were driving medium-term growth themes among tech stocks and in innovative and green sectors. In an environment where real interest rates are unable to steepen significantly, a gap will remain between financial markets and the real economy.
 Source Bloomberg, data on 20 November 2020 in USD
Past performances are not reliable indicators of future performances.Performances expressed in a currency other than that of the investor's country of residence are subject to exchange rate fluctuations, with a negative or positive impact on gains
Source Bloomberg, data on 20 November 2020
 Source Bloomberg, data on 20 November. Top 25% MSCI EM: Alibaba, Tencent, TSMC and Samsung representing 8.8%, 6.7%, 5.7% and 3.7% of the index respectively.
 Source Bloomberg, data on 20 November.
Outlook for Alternative Assets in 2021
Christopher Taylor, Head of New York Life Investments Alternatives
CEO of Madison Capital Funding
Overall Alternative Assets Market
There is no doubt that 2020 has been a tumultuous year with a lot of uncertainty. In addition to the global economic disruption caused by Covid-19, there have been political and social movements that resulted in an up and down environment for investors. As we move into 2021, the outlook for alternatives is strong, with investors looking to allocate more to illiquid, private assets in search of diversification in a volatile market and yield in a “lower for longer” interest rate environment.
Preqin projects global alternatives assets under management to increase to $17 trillion by 2025. The outlook is strong across various segments, with private equity and private debt expecting the highest growth rates. Strong growth is also expected across geographies, including the relatively more developed markets of the U.S. and Europe and very rapid growth for the developing market in Asia.
Outlook for Middle Market Private Equity and Private Credit
New York Life Investments Alternatives has a long history in the middle market, including both private equity and private credit. After a focus on managing portfolio investments this year, both private equity and private debt should see a rebound from low deal volume in 2020, as managers seek to put large amounts of dry powder to work.
Portfolio Focus in 2020: For much of this year, both private equity and private debt firms were inwardly focused as they worked with portfolio companies during an uncertain time. Given the unique economic situation, portfolio performance has been bifurcated, with services companies – such as financial, healthcare, and technology – performing well through the pandemic. Other industries, such as retail, leisure, and manufacturing, have been more economically impacted which could endure until the pandemic has passed. In general, sponsors and lenders have worked together to bridge borrowers through the crisis, keeping defaults at bay except in severe situations. This collaboration is likely to continue, particularly with recent positive news about a vaccine giving hope for a near-term sustained recovery.
Private Equity Outlook: As we have moved into 4Q 2020, private equity new deal volumes have picked up considerably, and while volume may not fully recover until later in 2021, there is a more positive sentiment than earlier in the year. While deal volume is critical for deploying capital, private equity firms will also be looking to realize returns in existing funds after an anemic 2020.
Interest is high in more insulated industries and resilient companies, and add-on acquisitions remain popular to drive growth in a lower risk manner. With large amounts of capital waiting to be deployed, demand for the strongest businesses could support growth in valuation multiples, which have declined from record highs in early 2020.
Private Credit Outlook: Following the private equity trend, private credit deal volume and pipelines have increased in 4Q 2020. Additionally, leverage levels have declined, and yield expectations have widened, positively affecting the risk/return trade-off for private credit. However, significant capital raised and competition among lenders could push leverage, economics, and credit terms back toward pre-pandemic levels, particularly for the most attractive assets.
Within Europe, private debt, which largely developed after the Great Financial Crisis, has faced its first major test. Capital continues to flow to the region, particularly from U.S. managers seeking platform expansion, and private lenders are positioned well to continue taking market share from banks who will likely focus on managing non-performing loans and continue to de-emphasize lending to middle market businesses.
Growing Focus on ESG in Alternatives
Over the past few years, there has been a push by alternative asset managers to incorporate environmental, social, and governance (ESG) factors into their businesses, with the events of 2020 helping accelerate this trend. Europe tends to be ahead of the U.S. in measuring and reporting on ESG factors, but this gap may start to close as global investors require more transparency and consistent reporting so they can compare managers more easily.
From an investing perspective, there is a growing acknowledgment in private markets that companies with better ESG controls can yield better returns and offer better risk management, with a push to better measure and report ESG factors. In our businesses, while we have always weighed many factors that fall into ESG categories, we have formalized that analysis in a way that allows us to evaluate at the initial investment and monitor changes over time.
From a fundraising perspective, managers are being assessed for how they approach ESG factors in the management and governance of their own businesses, including how they serve their communities and build inclusive cultures.
Finally, the growing interest in ESG and sustainable investing is also likely to impact certain asset classes. Private investors can supplement the work of governments in infrastructure investing, including renewable energy.
 Source: Preqin’s The Future of Alternatives 2025, accessed November 2020. https://www.preqin.com/campaign/future-of-alternatives-2025
Exhausted, locked down… or blossoming again: what will the economy look like in 2021?
Florence Pisani, Global Head of Economic Research
Anton Brender, Chief Economist
Hydrogen: energy of the future?
Vincent Compiegne, Deputy Global Head of ESG Investments & Research
Arnaud Peythieu, ESG Analyst
Can the Federal Reserve really combat inequalities?
Emile Gagna, Economist
At the Jackson Hole Economic Symposium in August of this year, Jerome Powell announced a change in the Federal Reserve’s monetary policy strategy. Although the 2% target still remains in place, average inflation targeting has now been adopted. Following a period of low inflation, the US central bank will therefore let inflation drift slightly higher than its target level. In parallel, the Fed has also redefined its full employment objective, now undertaking to drive business activity to a level which not only allows the largest number of Americans to have a job, but also ensures that economic conditions improve for the whole population. The Fed therefore intends to contribute towards more inclusive growth which will benefit all communities more equally. To illustrate this change in strategy, Powell referred to the 10 years preceding the current crisis. By keeping the economy under pressure, monetary policy has enabled the unemployment rate among black and Hispanic Americans to reach all-time lows (chart 1)… and to significantly reduce the employment rate gap between communities.
By redefining its full employment target, the Federal Reserve has clearly implied that interest rates will remain durably low across the entire yield curve. Indeed, low interest rates are the only lever available to the Fed to encourage private and public spending and thus stimulate business activity. There is a risk however that the change in strategy may clash with another of the central bank’s key roles, i.e. maintaining financial stability. If indeed low rate policies encourage higher spending, they do so by pushing private agents to borrow. Overall debt will therefore increase over the next few years in the US and also in other parts of the world where dollar-denominated loans are undertaken. There is therefore a real risk that a new wave of debt will lead either to a crisis, or at least to a period of financial instability.
As regard the new full employment objective, the past few decades have clearly demonstrated that the central bank has not been the main driving force behind any real reduction in inequalities. Targeted education and redistribution policies need to be implemented to achieve this goal. Although the Federal Reserve has periodically succeeded in raising wages among black and Hispanic Americans more rapidly by keeping the economy in full employment for as long as possible, it has never managed to avoid recessions, which have been accompanied by a fall in living standards among the poorest. Only the war on poverty waged by President Johnson under the Great Society programs in the early 1960s durably reduced the income gap between black and white Americans (chart 2). Median incomes among black Americans are still nonetheless 30% lower than among the white population… which is the same disparity as during the early 1970s!
Impact Investing: Entrepreneurial Engagement?
Maia Ferrand, Co-Head of External Multimanagement
Mohadeseh Abdullahi, Investment Analyst, Impact Investments
Is the European green deal, the new deal?
Wim Van Hyfte, Global Head of ESG Investments & Research
Emile Gagna, Economist
Do European Investors pay a "Greenium" for European Sustainable Bonds?
Céline Deroux, Senior Fixed Income Strategist, Global Bonds
Nicolas Forest, Global Head of Fixed Income
Sustainable Bonds are chic!
Green investing is all the fashion, and the growth and diversity in Green Bonds has been phenomenal. Is this a fad? With the European Central Bank discussing the possible inclusion of climate risk to its systemic risk assessment, we could instead be at an inflection point.
The global market for Sustainable Bonds has risen from $50 billion to over $1 trillion in less than five years. More than half of this is denominated in Euros. In 2021, Candriam forecasts $500 billion in new issuance, mostly in European programs, but with US corporations expanding their issuances as well.
Investors seem to eager to help finance societal projects with environmental or social benefits. Is this in addition to the yield – or in lieu of some of the financial return?
Do investors pay a ‘Green’ Premium for being in fashion?
Spoiler alert: Our research shows no 'Greenium'.
With the wave of Green Bond issuance over the last five years, research has intensified from both financial firms and academics – with conflicting results.
Candriam sought to answer the question with a focus on our own investors and on our portfolios. Our Fixed Income Quantitative Team and Global Bonds Management Teams has tailored our research and econometric model to the needs and interests of our particular investing community.
More precisely, we focused on European Sustainable Bonds for two reasons. First, European investors and investments are in the forefront of the green wave, and are some years ahead of the enormous US markets. With sustainable fixed income products accelerating in volume and becoming rapidly more sophisticated, combining a large but younger stock of assets could produce a less-meaningful 'average'. Second, the medium-term supply is likely to still skew towards European issuers.
Our sophisticated econometric model tests the yield differences in European 'sustainable' bonds – green, social, and sustainable, as defined by Bloomberg -- versus European 'brown' or traditional bonds. We control for other factors which may affect yields – duration, liquidity (bid-ask), coupon, emerging vs developed markets, credit rating, maturity, industry sector, and others.
Go for the Green!
We find essentially no 'Greenium', or yield give-up, for investing in sustainable bonds – while as expected, we find significant yield differences among duration, subordination, credit rating and other factors in the model.
Therefore, investors in Sustainable bonds can enjoy both market returns, and the satisfaction of helping finance a social or environmental benefit.
Look out for our full 2020 results and research paper on European Green Bonds and the 'Greenium' in early 2021.
Post-Modern Pandemics – Viral, or Preventable?
Kroum Sourov, Lead ESG Analyst – ESG Sovereign Research
Wim Van Hyfte, Global Head of ESG Investments and Research
Is ‘Pandemic’ Singular, or Plural?
Vaccine trials look promising, and one can almost see the light at the end of the tunnel. We might even forget that there is quite a bit of tunnel left. This period might be especially rocky, with the second wave of COVID-19 in full swing. The new year is likely to start looking no different than the end of this one – it is always darkest just before the dawn.
The big question is what we do next. Do we just 'price in one, or two, or more! pandemics per decade and move on? G4 and other Central Banks have found a magic money tree, but there is no price for lives lost and the suffering of survivors.
Mind-boggling numbers have been thrown at economies, but food lines still stretch for miles even in the US. Some individuals have made profits in the tens of billions, but little has 'trickled down'. Would it not cost us much less to invest a modest amount of the cost of the next pandemic into projects that would treat the 'disease', rather than just symptoms?
The science is clear; these infectious diseases originate in wild animal populations under severe environmental strain from human activity and disruption. Deforestation and associated land use change are major culprits. To save ourselves, the global community must unite to find other sources of income for the local populations, to enforce protection measures, and to invest in re-forestation. This would also be a cost-effective step to slow climate change, which is the tsunami on the horizon. Change is also needed for populations in the developed world. Globalisation and outsourcing have wreaked havoc in the former industrial regions of the West. The grasping at higher profit margins regardless of human cost is endangering social cohesion, and fuelling populist and extremist movements in the developed nations. Investments in ICU beds and hospitals will never be enough if a significant proportion of the population denies the existence of the pandemic. Unfortunately, extremist ideologies, rejection of pandemic protection measures, and climate change denial go hand-in-hand across the globe.
Rejecting the obvious: the new post-modern pandemic
Active campaigns to spread misinformation, outright denial of science, and in some quarters even a complete rejection of evidence-based reasoning, is the other post-modern pandemic. The two intersect when Covid is politicised, and its impact or even its very existence is questioned. While a spring 2021 vaccine might effectively end the current Covid pandemic, the 'ostrich' epidemic is likely to persist. When the next easily-spread virus arrives, rejection of science could prove to be even more deadly than for Covid. In the meantime, social unrest and instability reverberate through society, fuelled by extremist movements of people left behind socially and economically. Some of these movements deliberately seek to cause the breakdown of social order and even civil war.
A Green Marshal Plan is needed for both developed and developing nations to address both health and social pandemics. The neoclassical economic model has proven unable to deal with either, while the green economy offers many opportunities for both the current and the next generation. Anything else is just kicking the can down the road, a road that is a dead-end street.
Vaccine development, if successful, usually takes about ten years. Now we have three with 90% or better efficacy in just a year. With enough funding and a sense of urgency, things happen. We need to apply the same urgency to combat climate change; deforestation is a place to get serious.
As an investor, we have the conviction that environmental preservation and climate change should be at the cornerstone of any sovereign sustainability framework. We are in this together, there’s no “Planet B”. For a sustainable world, we need sustainable finance.
Towards a "healthier" future?
Nadège Dufossé, Deputy Global Head of Multi-Asset
Stefan Keller, Senior Asset Allocation Strategist
Renminbi, the New Dollar?
Julien Fabre, Emerging Debt Portfolio Manager
Is China winning the economic Covid war?
Against both the trade war and the Covid crisis, China has emerged as a domestic economic success. Against the odds it has managed the transition out of the middle income trap where most EM countries founder, climbing up the value-added chain into a consumer-based economy.
A domestic economic success but (not yet) a global economic power, China has become less open economically, and more open financially. But this financial openness remains measured, limited and artificial. Donald Trump dented it seriously, not through tariffs, but by constraining Huawei, the national tech champion.
These developments prompt cosmic questions: How and why does currency becomes dominant? Will the next 'dollar' be a fiat currency? Would investors benefit if the renminbi were to become the next 'almighty dollar'?
Money Printing as a Response to the Covid Crisis
China not only controlled its Covid outbreak early, but also without resorting to printing money. In isolation, this suggests that China is becoming a global currency. Judging by the amount of debt, it is less obvious.
There is only one major currency which did not depreciate vs the US Dollar in March 2020: the Renminbi. Interestingly, the sudden appreciation of the Dollar was caused in part by a liquidity crisis in US interbank markets, dating back to the 2019 unwinding of the Fed's decade of quantitative easing.
The US Dollar: A Lengthy Reign
A currency in the modern sense is nothing more than a government debt which pays no interest and has no physical value. It is a means of exchange and a reserve of value, relying on the network effect and confidence in the issuing state – to some extent, a self-perpetuating characteristic. Even if imbalances accumulate, only a major upheaval will reset the order of things. This has occurred only once in history of fiat currencies, when the British Pound Sterling bowed to the new king, the US Dollar.
Since the end of the gold standard for Sterling, the peak of each national hierarchy of currency has been the central bank. Similarly, one might view the most powerful central bank as the peak of the global system; that is, the Dollar. In normal times the stability of money, or purchasing power, is prioritised, potentially at the expense of the public and of economic growth. During wars and crises the reverse is the case. Governments print money frenetically. During the Covid pandemic, central banks in the US and Europe have thrown themselves into financing the public deficit.
This is how during the early 20th century, Great Britain passed the baton of the leading currency to the United States. The price of the honour was to become a creditor of the world. The Deutsche Mark was a challenger to the Dollar in the decades following the war, but the Euro's built-in frailties meant it could not sustain the inherited momentum towards dominance. Is the Renminbi now in a position to assume a leadership role?
The Hatching of a Global Currency?
China desires to be a global power, but is not unquestionably so. Yet in the face of the worst global pandemic since the Spanish flu, China weathered the pandemic and was the first society to manage a return to a normal life.
The Chinese are known for their steady, painstaking approach. And so 25 years ago China embarked on a journey to open an almost self-sufficient economy towards the deep waters of capitalism. Over the last two years, China has surprised the world, contradicting the view that its growth model relies on high-emission manufacturing, cheap labour, and standardised products.
Becoming a leading currency depends on a nation establishing itself as both the destination and origin of considerable amounts of investment. A leading currency further requires a nation to be a global power, to justify the 'full faith and credit' of the government. To be the dominant currency means that the rest of the world cannot get enough of it. Therefore the underlying superpower will structurally become the debtor of the world, in order to satisfy the demand for the currency.
China remains a decisively closed economy, determined to be an ever-larger creditor. In fact, by recycling their humongous US Dollar reserves, China acknowledges and consolidate the supremacy of the Greenback, and denies a chance to his own currency to become a global means of exchange and reserve.
China is a thing of its own, inspiring awe. But could Xi Jinping have been both the worst and the best thing to happen to China over the last decade? In the twentieth century, the former Soviet Union sent the first man into space, ahead of the US. The Soviet confidence in its own global powers may have strangled any potential openness in Soviet society or economic systems. Might it be because of its lack of openness that the Soviet regime had to bow to he US? For China, could it be that the very political regime upon which its economic success has been built could ultimately prevent it from surpassing the US?
One shivers at China's dystopian use of the most advanced AI technologies to track every individual, social interaction, and small infraction. China is the industrial superpower, well-positioned to become the dominant power in technology.
The development of multiple Covid vaccines in the West is a beacon of hope for the efficiency of non-totalitarian governments. China nevertheless reminds us of a lesson forgotten since the last world war, the need during crises for discipline and efficiency in social and governmental organisation, and the strategic dimension of the manufacturing sector.
Conclusion: Our Money, Your Problem
When the remnants of the dollar-based Bretton Woods system meant the US 'exported' inflation to Europe, Treasury Secretary Connally described the dollar as "our currency, but your problem". Students of economic history will recall the prolonged and painful depreciation which followed. Japan also paid the price of blind faith in the greenback, when years of current account surplus invested in the United States was vaporised. The vicissitudes of history have often forced finance and trade people to turn towards a currency, when other options run out – often through a sudden dramatic crisis.
It is not a rational investment strategy to predict a structural winner in currencies.
Recovery in M&A, a performance driver?
Fabienne Cretin, Head of Risk Arbitrage
Stéphane Dieudonné, Senior Fund Manager
The great lockdown experiment: has the future of real estate arrived early?
Simon Martin, Head of Investment Strategy & Research at Tristan Capital Partners
2020 may prove to be the year when we learnt a huge amount about the future of the real estate sector in a very short space of time. COVID has trampled all over the real estate cycle and to many it will feel like we have lived 7 years of change in 7 months. The Great Lockdown visibly accelerated many pre-existing trends, creating a profound pattern of winners and losers, amplifying dispersion and bolstering the levels of investor conviction around key secular themes.
The biggest beneficiary of this effect have been logistics properties. Investors now have even more appetite for logistics and last mile fulfilment assets facilities. Investors also, understandably, remain bullish about residential for rent assets as the supply of high-quality apartments in European cities remains extremely constrained and demand for affordable spaces remains robust.
We have also all learnt even more about retail assets. Grocery anchored retail parks selling necessity goods have traded their socks off throughout the pandemic, footfall in retail parks has barely skipped a beat during lockdown and rent collections have remained high. After five years of creeping uncertainty, lockdown has helped differentiate what we need in the retail sector from what we do not. Investors are now starting to differentiate and parks that are grocery anchored are diverging from shops and traditional malls. Rising transaction volumes in this new ‘fulfilment’ niche suggests that investors may sense opportunity.
The real estate sectors that have been hit hardest by the downside of the ‘shock’ effect have been those related to tourism, leisure and social discretionary spending. These spaces have been popular with investors playing ‘wealth creation’ thematics. However, the cashflow consequences associated with low visitor numbers are now morphing into capital structure issues. This just shows that strategies with a strong thematic can still be upended but will, of course, be an opportunity for new capital to enter the sector.
Lockdown has also triggered debates over the pace of urbanisation and the role of workplaces. Given the importance of this debate, back in May we set up a study to assess the impact of the lockdown on cities and office users. Our urban workplaces survey spans six European cities and over 6,000 participants. We ran it twice in June and September. The work has yielded some significant insights that is helping guide our perspectives of cities and their office markets.
Firstly, knowledge matters. High knowledge workers and low knowledge workers think differently about cities and workplaces. High knowledge workers want to gather in shared spaces, they want to go back into the office and they see cities and offices as a valuable learning, collaborative and creative environment. They also appreciate management flexibility and space agility. This has implications for design and density of space use – but our numbers clearly show that high knowledge companies need high knowledge cities and high-quality office spaces that they can use flexibly. We view this as a net positive, it will continue to reinforce the urbanisation trend is a major driver of our strategies in high knowledge cities and will help accelerate the process of repositioning urban office assets, creating significant opportunity for investors that have a repurposing skills and the right asset management platform.
Over the last nine months we have had a preview of what the future holds for much of the next decade. This is an extraordinary learning environment for managers and we are focussed on adapting so that our clients can reap the benefits of this change. Tumultuous times are always a great opportunity to make risk adjusted returns and that is what we are focussed on as we head into 2021.
High yield bonds: from liquidity to sustainability?
Nicolas Jullien, Head of High Yield & Credit Arbitrage
In early 2020, a considerable number of corporate issuers had to face severe liquidity issues amid the COVID-19 lockdowns imposed across the world. The subsequent response from governments and central banks has been unprecedented as they provided virtually unlimited support through monetary accommodation and fiscal stimulus. Thanks to massive quantitative easing/bond buying programs that included sovereign, investment grade and even high yield bonds, central banks managed to inject historic levels of liquidity in the market and established themselves as the buyers and lenders of first and last resort.
Compensating for frozen cash flows
As a result of this important back-stop, corporates had the opportunity to raise additional debt – made affordable either by state guarantees or central banks policies – to compensate for the frozen state in their cash flows. Indeed, in the second half of 2020, high yield issuers in the US and Europe successfully issued large amounts of debt irrespective of their fundamentals and their balance sheet status. While this helped flatten the default curve in the short term, it did not prevent from credit deterioration and downgrades. After all, though central banks’ liquidity injections proved very helpful, they cannot guarantee revenues or profits for corporate issuers of debt, especially in a market presenting huge challenges for operational efficiency and productivity amid confinements and social distancing.
As we head into 2021, high yield markets should continue to benefit from the strong liquidity provided by central banks while vaccine developments and fiscal stimulus should allow us to look through near term fundamental deterioration and to focus on the reopening of economies from the second quarter of 2021.
Focus on debt sustainability
However, it is important to note that a portion of this “feel-good”/ positive scenario has been priced, as witnessed by the compression in spreads and yields over the past few months and over the medium term, we do keep in mind that pricing the pain will be just as important as pricing the gain. As the effects of fiscal and government stimulus start declining, fundamentals and idiosyncratic risks are expected to move to the forefront and a liquidity-driven rally is likely to make way for a context where debt sustainability is paramount.
Secular trends such as climate change, digitalisation and de-globalisation, that have been present over the past years, have seen a dramatic acceleration and a greater impact as a result of the Covid crisis. This has resulted in an even more challenging and disruptive environment for corporates as they have been forced to revise their business models and implement structural changes. Companies have had to invest considerable resources in digital transformation, thereby increasing disruption in sectors like retail, commercial real estate and travel. Globalisation has yet again been challenged and companies had to redesign their supply chains creating dispersion among regions and industries like transportation. By making our lives tolerable during the pandemic, technology has confirmed its crucial role for the foreseeable future, and the leadership will undoubtedly be strongly contested by the US and China. Finally, the world’s focus on the climate change will require major alterations in all sphere of consumerism, with the energy, autos and utilities sectors set to literally reinvent themselves over the next decade.
Big opportunities for active managers
We believe these structural mega-trends will have a lasting impact and generate substantial disruption within the corporate universe. We expect the high yield market to be particularly affected considering the higher levels of leverage and greater exposure to bankruptcies, delinquencies and defaults. However, this disruption will result in strong opportunities for those issuers that are able to successfully adapt to the challenges presented. Certain sectors are likely to benefit from key sustainability challenges and regulatory changes that have come about. As a result, we are very likely to see increased dispersion in the market among sectors, regions and issuers, with debt sustainability becoming an issue for many, resulting in a strong separation between winners and losers.
In this challenging environment it will be crucial for investors to exercise a high level of diligence in order to select the right opportunities in a market where dispersion will be omnipresent. Active management and a high level of selectivity based on bottom-up research is vital. Furthermore, traditional analysis will need to be supplemented by greater focus on issues like governance, which will be a key metric while assessing the adaptability of a business model. Analysis of social factors will gain prominence as a company’s interaction with its workforce and with society will be significant amidst the rise of de-globalisation. Finally, the consequences of regulation surround climate change and its impact on sectors/issuers will need strong consideration when analysing the key sustainability challenges that are present. These aspects will have a direct impact on the creditworthiness of issuers and their ability to repay their debt over the medium to long term.
Absolute Return approaches: The Good, the Bad, and the Ugly?
Sébastien de Gendre, Fund Manager
China A-share market: can we see the future?
Vanessa Yichu Zhao, Senior Analyst, Emerging Markets Equities
Jan Boudewijns, Head of Emerging Markets Equity
China A-shares opened a way for international investors to participate in the world’s third largest stock market by market capitalisation (after New York Stock Exchange and Nasdaq) with about 3,800 large, medium-sized and small listed companies. China A-shares are the stock shares of mainland China-based companies, priced in Chinese RMB and traded on the Shanghai (SSE) and Shenzhen (SZSE) Stock Exchanges.
Before A-Shares, non-Chinese investors could invest in H-Shares that gave access only to Hong Kong-listed companies, which included mainly state-owned or private mainland China companies such as China Mobile, China Construction Bank, Tencent and Xiaomi, as well as some very well-known US-listed Chinese ADRs of about 170 Chinese companies, including Alibaba and JD.com. Local China stock markets also offer less active B-shares, which are priced in USD or HKD and listed on SSE and SZSE. A-Shares can offer investors valuable diversification benefits as they give access to a wide range of domestically-oriented Chinese companies which do not depend on overseas revenues for their well-being.
In the past few years, China A-shares were made available to large Western institutional investors through the Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) programmes and the Shanghai & Shenzhen-Hong Kong Stock Connect Schemes. The average daily trading volume on A-shares from HKEX (northbound) has grown by over 14 times from HKD 5.9bn in Q1 2017 to HKD 85bn in Q1 2020 (Source: Hong Kong Exchanges and Clearings as at end of March 2020). In June 2019, SSE and London Stock Exchange (LSE) launched Shanghai-London Connect, a collaboration which can potentially attract more foreign capital inflows to China stock markets in the future.
Starting in 2017, the MSCI™ and FTSE™ global indices have began to include China A-Shares. For example, as of August 2020, China A-shares accounted for 5.1% in the MSCI Emerging Markets Index (please see Chart 2) However, as more A-Share companies are included, this proportion will increase (please see Chart 3)
In the MSCI All Cap World Index, China accounts for only 5.6% (Source: MSCI, 30th November 2020), which we believe under-represents its weight in the global economy as the country’s GDP accounted for 16.3% of the world GDP in 2019 (Source: World Bank, 31th Dec 2019).
A market for active managers
While global indices have started to include China A-Shares, mainland Chinese companies do not have to meet the same high governance standards as those listed on the Hong Kong stock exchange. This, as well as the relatively low research coverage of A-Share companies, points in the direction of active management, rather than index-based investing, as the more profitable way of investing in this market.
In addition, there are other features of A-Shares that makes them particularly attractive to stock pickers. Retail investors currently account for about 80% of the A-Share market turnover and, as the result, it is a fairly well-traded market with higher than average level of volatility. The mispricing created by this volatility is another attractive factor for stock pickers, who can spot valuation-based investment opportunities.
Moreover, while the state owns around a quarter of industries and exercises influence and control in many spheres of the economy, when compared to the Hong Kong-listed H-Shares, the market of China A-Shares of mainland companies provides access to a wider selection of private companies in the IT, Technology, Healthcare and Consumer sectors. And this is where most investment opportunities lie. As an article published by the World Economic Forum in May 2019 stated, “The combination of numbers 60/70/80/90 are frequently used to describe the private sector's contribution to the Chinese economy: they contribute 60% of China’s GDP, and are responsible for 70% of innovation, 80% of urban employment and provide 90% of new jobs. Private wealth is also responsible for 70% of investment and 90% of exports.”
As a pioneering ESG asset manager, we are also encouraged to see that these factors are becoming increasingly important to mainland Chinese companies. This is particularly true for those industry-leading players which have higher levels of foreign investment, although there is still much room for improvement from both company’s and regulation’s sides. This is being driven by the Paris Agreement carbon-neutral objectives for 2060 and the consequent big push for clean energy and electric vehicles, as well as the recently announced anti-trust measures for the internet and e-commerce sector.
We are confident that A-Shares continue to provide a route to an important and growing market for international investors which will improve in quality while providing valuable diversification benefits.
 Source: World Federation of Exchanges, as at May 2020
How to mitigate risks in a low interest rate world?
Charts tell the story.
Steeve Brument, Head of Quantitative Multi-Asset Strategies
Historically, diversified portfolios have been relying on the ability of government bonds to mitigate the impact of equity corrections.
As we can see, government bonds historically provided a positive carry (coupon plus the price appreciation of your bond) during equity bull markets (right part of chart 1) while delivering strong performance during equity corrections (left part of chart 1). In the times of equity market stress, investors tend to reallocate their assets from equities to bonds, which typically translates to attractive price appreciation for fixed income during such periods. This can be seen in the left part of the chart, which shows that reinvesting in fixed income would mitigate the level of risk in your portfolio during the periods when the equity market suffered declines.
Today, with interest rates close to zero or even negative, how likely is it that government bonds will continue to provide this important risk mitigation function going forward?
. Japan can be a good historical example as it experienced long periods of very low interest rates several times in the past. The right part of Chart 2 shows that the coupon is low or close to zero, given that nominal interest rates in Japan are close to zero. On the left side of the chart, we can see a reduced hedging power of Japanese government bonds. In other words, despite very low yields, Japanese government bonds have retained a part of their risk mitigating properties. This ability was partly supported by major central banks, which during the recent crises have been initiating bond purchasing programmes.
However, as shown in Chart 3, government bonds’ risk mitigation powers are reduced when interest rates fall below 2%. In the chart, every point of equity peak just before a market correction of over 15% is indicated by a spot of a different shape and colour – for Japanese, US and Eurozone equities. The vertical axis shows the 10 Year local government bond yield. The chart illustrates that US and Eurozone government bonds have been providing better risk mitigation abilities given that at equity peak government bonds yields where higher that those of their Japanese peers.
Based on the charts we examined, we can conclude that government bonds can still be used to mitigate risks within diversified portfolios but that they do not fill this function as effectively as in the past. However, there are other approaches available that can also be used for risk mitigation.
Solution 1: Flexible strategy
Allocating capital to flexible funds can be a solution for risk mitigation as fund manager can dynamically adjust equity exposure or/and protect portfolio with optional strategies in a timely manner.
Chart 4 shows the performance of the MSCI™ EMU Index (from 31.12.2019 to 30.11.2020) and how being flexible has allowed to reduce the exposure to Eurozone equities (by over a third) during the COVID-19 market shock and to rebuild it as the market recovered later in 2020.
Solution 2: Risk mitigation strategies
In addition of providing uncorrelated performance, risk mitigating strategies such as CTA (Commodity Trading Advisor), Global Macro and Risk Premia can have the ability to deliver Alpha (i.e. outperformance) during the times of market stress.
Chart 5 shows how adding an allocation to CTA wich focuses on following market trends can reduce drawdown and volatility of a diversified portfolio.
Taking a CTA strategy as a separate example, Chart 6 shows how an allocation to this instrument can help mitigate market drawdowns.
Solution 3: True diversifying Strategies: an Equity Market Neutral approach
While the previous two options typically have some correlation to the wider market, equity market neutral strategies aim to neutralise portfolio exposure to the wider market and deliver uncorrelated returns. This is another option to effectively mitigate risk in low interest rate environment. Chart 7 presents the example of how our market neutral strategies performed relative to Eurozone equities since 2016. For reasons of simplification, the data presented in Chart 7 is that of composites managed by Candriam’s investment teams.
In a low interest rate market environment, government bonds can still provide a degree of risk mitigation for diversified portfolios, partly due to the ongoing quantitative easing by central banks during the COVID-19 crisis. However, this mitigation is less effective than in the past.
Integrating other strategies listed below into a diversified portfolio, to complement the added value of your bond manager, could reduce the overall risk of the portfolio.
- either actively monitore the equity exposure through the use of derivatives,
- or have developed tools to analyse and detect market movements in order to position long in the event of an uptrend or short when a downtrend is identified,
- or are supported by tools to detect market inefficiencies in order to set up combinations of complementary arbitrage strategies.
The performance of investments in equities, bonds and alternative strategies are not guaranteed and there is a risk of capital loss.
The risk profile of strategies depends on different underlying risks among the followings: equity risk, interest rate risk, credit risk, foreign exchange risk, risk arising from discretionary management, risk associated with derivative financial instruments, volatility risk.
Recycling – investing in tightening European standards
Monika Kumar, Fund Manager
Quentin Stevenart, ESG Analyst
As the European Union (EU) gets tougher on recycling, investors can look forward to new opportunities in the push on making circular economy happen.
Europe is reading to head full steam ahead in the direction of a circular economy, which the EU hopes will not only help reduce carbon emissions but also boost global competitiveness, foster sustainable economic growth and generate new jobs. Recycling is important in “closing the loop” – creating a circular economy with the recovery of as much resources as possible. Investors will play an important role in making this transition happen.
In 2018, the EU agreed to tighten its targets for recycling waste, aiming to increase the level of recycled municipal waste to 55% by 2025, to 60% by 2030 and to 65% by 2035, while the Packaging and Packaging Waste Directive (94/62/EC) stipulated that EU Member States must recycle at least 70% by 2030.
Earlier in 2020, the European Commission launched its ambitious Circular Economy Package, which includes revised legislative proposals on waste. It had set clear targets for waste reduction as well as an ambitious plan for waste management, supported by a range of measures to address potential and current obstacles to its implementation in different EU member states.
Closing the gaps
As the whole of the EU will be striving to meet these new standards, in the last few years some European countries have made much better progress in building their recycling capabilities than others. For example, the following chart shows how large is the difference in municipal waste recycling performance between different countries. In 2017, rates ranged from 68% in Germany to 0.3% in Serbia. Six countries (Germany, Slovenia, Austria, the Netherlands, Belgium and Switzerland) recycled 50% or more of their municipal waste.
In contrast, another five countries recycled less than 20%, with two countries less than 10 %. Subsequently, some will have to work harder in order to meet the new EU goals and incentives than the top performers, and that is where many investment opportunities will ultimately lie. To close this gap, some countries will likely attract the assistance of companies that are regarded as circular economy enablers.
Note: Recycling rates indicate the percentage of municipal waste generated that is recycled, composted and anaerobically digested, and might also include that prepared for reuse. Changes in reporting methodology mean that 2017 data are not fully comparable with 2004 data for Austria, Belgium, Croatia, Cyprus, Estonia, Lithuania, Italy, Norway, Malta, Poland, Romania, Slovakia, Slovenia and Spain; 2005 data were used instead of 2004 data for Poland because of changes in methodology. On account of limited data availability, instead of 2004 data, 2003 data were used for Iceland, 2007 data for Croatia, 2006 data for Serbia and 2008 data for Bosnia and Herzegovina. For the EU-28, 2004 data were based on 2007 data for Croatia, and 2016 data were used for Iceland and Ireland instead of 2017 data. The 2017 data for Cyprus, Germany, France, Luxembourg, Poland, Slovenia, Spain, Switzerland, Turkey and the EU-28 include estimates.
Source: European Environment Agency, 22 Nov 2019.
More well-known examples of recycling successes have been in the collection of plastic bottles through reverse vending machines. Consumers in some of the “top recyclers”, have grown very familiar with these machines, which act as conduits for “deposit return schemes”. These schemes allow consumers to return their bottles for a reward, usually a monetary voucher which can be spent in store. The machine accepts bottles, optically pre-sorts them depending on plastic type, size and contamination levels, assisting the recycling process further down the chain.
In Germany, which is not only a European but also a global leader in recycling, reverse vending machines had given rise to a sort of national sport, with many teenagers and more grown ups engaged in collection of plastic bottles for money. This has resulted in an impressive 95% collection rate of polyethylene terephthalate (PET) containers nationally. Needles to say, that providers of such machines have done very well, both in terms of their profitability and their share price.
More and more countries are introducing deposit schemes to encourage consumers to recycle. This is a trend that is likely to continue, given the tighter standards introduced in 2019 by the EU Single Use Plastics Directive. The legislation mandates a 90% bottle collection target for all member states by 2029, with all plastic bottles having contain at least 25% recycled plastic (rPET) by 2025. The countries where single plastic recycling rates are not yet high enough, such as France, Portugal and Spain will need to encourage companies-enablers to help them meet the EU expectations in time. As with the municipal waste recycling gap, this will lead new commercial opportunities for providers, which asset managers will help their clients to identify, making the move towards a circular economy profitable for the environment, communities and investors.
 https://www.europarl.europa.eu/RegData/etudes/note/join/2011/457065/IPOL-AFET_NT(2011)457065_EN.pdf , https://www.petcore-europe.org/news-events/202-2017-survey-on-european-pet-recycle-industry-58-2-of-pet-bottles-collected.html
Is there an ESG bubble?
Geoffroy Goenen, Head of Fundamental European Equity
Wim Van Hyfte, Global Head of ESG Investments & Research
COVID-19 vaccine breakthrough: a door to new opportunities in healthcare?
Malgorzata Kluba, Senior Biotechnology Analyst