New York roundtable: Moving up

Our New York panel discusses the mainstreaming of ESG, the shift towards passive investing, trade tensions and the outlook for 2019.

Bev Hendry (chairman – Americas, Aberdeen Standard Investments)
John Panagakis (head of international advisory services, Nuveen)
Thomas Darnowski (head of product development, Schroders)
Jan Van Eck (chief executive, VanEck)

Funds Europe – Which have been the most in-demand products and solutions for US investors in 2018?

Bev Hendry, Aberdeen Standard Investments – We’re primarily active managers, and active has been out of favour. There has been a lot of passive, fixed income, ultra-short bond recently. But it’s been very tough – even though the markets until very recently have been generally favourable, it’s not been a great time for active investors, and hopefully the volatility we’re seeing right now will mean that active investors like us will do better. However, what we’ve seen is mostly passive and fixed income.

Thomas Darnowski, Schroders – The one area I would add to Bev’s comments would be that in active, we’ve seen an uptick in the international equity space too, whether that’s developed or emerging, specifically in the first seven or eight months of the year. I think that’s another area where there’s been some manager churn happening, and in aggregate, net flows have been positive in the international space.

Jan Van Eck, Van Eck – It’s not really a new story. It’s sort of been the same, that US equities on the active side have been the toughest, and fixed income, active and international active are OK and are gaining net inflows. That was the same this year, and the passive continues to grow. I wouldn’t use this term, but just to summarise, our business is smart beta passive, so it’s kind of different exposure to market cap, and that’s been OK, it’s always a story that you have to go and explain. I think a lot of investors are open to that, although I have to say a lot of people are looking at the price first and never going beyond the price in their exposures. I hope that will reverse, because that’s in some cases just crazy.

John Panagakis, Nuveen – We’re seeing interest more on the alternative side – private debt, real estate debt, as well as corporate debt. Differentiation strategies like equity market neutral are also gaining interest. With investors cautious about volatility returning, many are hedging their bets in more hedge strategies.

Funds Europe – What impact have trade tensions had, if any, on the state of investment funds? Has the issue been an inhibitor for portfolio diversification?

Hendry – I think investors are taking a lot of money out of the equity market, and they’re going into fixed income, and cash. We’ve also seen some diversification into alternatives, infrastructure and even real estate where there’s a ten-year horizon of income coming in. The trade tensions are just part of the whole scenario, and there’s not too many positives, apart from the fact that companies are better run, I think, than they’ve ever been. Every one of us is looking at how to improve productivity, whether it’s with artificial intelligence or just getting more out of your technology. Another thing we are seeing is pressure on fees. Now there’s only certain things where we can cut costs. People is the main area, and then there’s subscriptions, information technology and property. You’re seeing asset managers moving to Tennessee or they’re moving large parts of their business, because they’re getting great incentives. We’re moving across the street in Philadelphia because we’ve got a better deal and we’re all going to be on one floor, which will improve productivity and efficiency. I think everybody is getting better at managing their businesses, but certainly there are headwinds out there right now.

Darnowski – I was going to actually say, from an investor perspective in the US, especially in retail, that they’re still very complacent with their investments as well. Even though the headlines on trade point to concern in the markets, many US investors have stayed the course in their investments. We have done a lot of educating on why looking at some solutions to protect yourself on the equity side, or think of alternative credit strategies on the fixed income side, could be beneficial when markets become more uncertain. With trade wars, political banter and discussions of the end of a bull market in the US, you have to believe we are in an uncertain time. The last couple of weeks, the market has given us some more volatility, and investors need more education for them to make sure they’re realising the risks in what’s inherent and what’s coming up.

Panagakis – On the institutional side, many are saying, “Everything looks expensive in this environment.” With yields increasing, we’re finding people are more interested in debt instruments that don’t have a lot of volatility, so if it’s a floating-rate vehicle or something along those lines, short term, on a risk-adjusted return basis, then debt does look more attractive than equity, whether it’s public debt and private debt, or real estate debt across the broad spectrum. However, there is also the fear factor of rising interest rates and the volatility associated with that, so I think there is a preference for shorter-dated investments; anything that has a floating rate component is much more attractive.

I think tweets move markets these days: for example, there was a comment recently about talks with China and it caused widespread murmurings. Investors are looking for any little titbit of information at this point in time, especially around trade tensions. I think, for the most part, if you look at the current administration, it’s a negotiation from an extreme. Trump is essentially a real estate person and always looking at the art of the deal (we’re one of the largest real estate managers); you’re always going to create your negotiating position over here, your opponent over there, and that’s the way you look at it; you look to settle somewhere in the middle. That’s what’s going on right now, it’s that mentality.

Van Eck – We were constructive on emerging markets coming into the year, looking at global economic growth being positive and earnings growth of our portfolio companies, including our Chinese companies, being in the 15%-20% range. I think what we got wrong, which is regrettable for our shop because we’re into gold and money supply, is that we missed the monetary policy of China, which two years ago started a big, aggressive deleveraging and regulation or straightening out, whatever you want to call it, of their financial system, and that obviously impacted Chinese financial assets this year. That’s what we got wrong. I think they’re re-stimulating now, and that should kick in in Q1/Q2 of 2019, so I think that’s what we focus on, not so much the tweets and the trade policy and short-term politics, but the monetary cycle in China.

The second thing I would say – I was just there last week, and having travelled there extensively since 1993 – is that China is transitioning. It’s gone from the high growth, catching up to the rest of the world to “Now what do we do?” Xi Jinping’s economic policy is relatively pro-SOE [state-owned enterprise], and that negatively affects foreign businesses doing business in China, but also negatively affects the private sector in China. He’s sort of reversed that in the last month or two, but that’s a big thing to watch. If you’re looking forward to the next ten years, China’s a middle-income country. Maybe it goes for 5% growth – we’re just trying to feel ourselves out, I think, for what the new China is as well, which hurts valuations.

Funds Europe – How much is ESG becoming mainstream in the US?

Hendry – If investors see that it’s profitable to invest in ESG companies, I think that will trump the fact that it’s ESG, but so far there’s been more talk in the US than action. In Europe, we find that we actually sell a lot of it. It’s caught on in the conferences and as a buzzword, and we see a lot of institutional pension funds being very interested in it, but we also saw with many of these pension funds, their aim is for their pensioners to grow savings or to have funds that perform well, so if your ESG fund is outperforming a traditional fund, then I think it will definitely catch on. We’re maybe ten years behind Europe and Australia over here, I’d think.

Panagakis – I do think it’s regional, even within Europe. You go to the Nordics or to the Netherlands, very much so. Southern Europe, not so much. The UK is kind of interested a little bit, and then Australia and Canada, much more so than the US. TIAA, Nuveen’s parent company, has been a big ESG investor for the past, I think it’s got to be over 40 years. I think it depends on the generation and the sector: millennials are much more interested than baby boomers. The money is with the baby boomers right now, so everybody’s putting in ESG portfolios or offerings within a portfolio; whether I’m a wire house or a bank, I have an ESG portfolio, and if I’m on a DC [defined contribution] plan, I have an ESG option. The options are there, the money’s just not flowing there at this point in time. As millennials get a bigger piece of the economic benefit, you’ll see that change. Public plans, much more so than private plans on the DB [defined benefit] side, are moving slowly in that direction.

I think it’s an evolution, not a revolution, because the government’s never going to mandate it as a requirement in the US the way some countries do within Europe.

Van Eck – I would look at ESG two ways. One is an investment strategy which can be dominated by ESG screens, let’s call it. The second is, do you have the tests, the ESG questions, embedded in your investment process? You always cared about governance, but do you have a checklist or some other way of analysing all the ESG factors? It’s something like a form of ‘risk management 2.0’, embedded in the investment process. Institutions are starting to expect this.

Darnowski – The talk about ESG has become mainstream, but flows have not. With that said, we have seen that it depends on the channel, client type, as well as the demographic of the end investor. We have worked with some institutional public plans that decided to search out investors who have a history of having sustainability embedded in their process and where we were awarded a mandate because of the length of time we have been investing in this way.

We have worked with some consultants that are starting to pick up more coverage and ratings in specific areas where we have established long-term track records, like environmental or climate change. I believe this is another area of education and discussion to see where we end up. The key question will be, what does it actually mean in a portfolio? Is it embedded in all aspects of a portfolio, is it another alpha tool, and is your manager fully equipped in the area?

Funds Europe – ETFs in the US continue to grow. Are active managers managing to distinguish themselves in the asset management marketplace?

Van Eck – It’s extremely competitive and ETFs, I would say, are not immune at all from the price competition that the whole industry is seeing. Actually, this year I would say I felt more price competition in the ETF world than in the active world, partly because there are several players that just want to grow market share and use price to do so. Their perception is that if they have no assets in their competing ETF and they cut their fees by half, they haven’t given up anything, but of course, collectively that’s not true, and if it happens to them it’s not true. That’s what I would say about 2018: that price competition was tougher in ETFs than in active.

The other point is that everyone’s at the ETF party, but it’s not really clear how core ETFs are to their business or how much momentum they intend to have with those ETFs.

Panagakis – I think that the pricing thing is just like on the passive side, people are trying to say, “It’s only going to be a handful of big players in ETFs” – that’s the thought, and so firms are saying: “I want to be one of those big ETF players.” Is it a party where everybody’s invited or is it trying to become a club where very few players dominate?

Van Eck – Yes, there’s the top three or four ETF issuers that are everywhere, and then the position that we’re trying to achieve is being one of the top-ten players. We’ve expanded our Ucits offering this year through an acquisition and that’s always our conversation. “We’ve got our top five, and we’re asking to be in the top ten,” and because we offer diversified exposure, meaning not really this market cap, that’s the discussion we have. I’ll let you know in three years how it’s going. We’ll see.

Hendry – You want to give your clients the ability, if they feel that they still want to invest with you because they like your service and everything else but your price for active is too high, for us it was just too big a market not to be in. We bought a series of ETFs that are all in commodities, which was something that we weren’t in either, but it was the platform really that we were interested in, and then the ability to come up with new products – active, things that we can see might be able to capture some of the retirement market without really diluting the fact that if they want active emerging markets, they can still go to Aberdeen Standard,. There’s such a wide range of ETFs, as you know, there are funds that just invest in robotics and sectors like that, so it’s amazing. Some of these are very large funds, billions of dollars for something you would think was really niche, but again the fees are very low. So even where we came into the ETF market, we still had to cut our fees because we were told that “you’re not going to get any assets”, which is tough for active managers who might be used to getting 100 basis points.

Darnowski – We have made the active choice not to be in passive ETFs. At the same time, we do believe that this could be an advantageous wrapper of choice for actively managed strategies for some investors moving forward with advantages over mutual funds in the US, assuming the strategy can be delivered in the ETF wrapper. That is why we have launched an actively managed ETF (HTAB) in our partnership with Hartford Funds. We believe that there are numerous wrappers or delivery mechanisms for investors going forward, and we want to make sure we are fit for purpose in all relevant areas.

Funds Europe – At the end of 2018 there has been significant market volatility. How does that affect your outlook and how do you think it will affect investor demand for 2019?

Panagakis – I do think we were constructive on 2018; for 2019, our global investment committee is now gathering, amongst our 13 investment affiliates, and collaborating on the outlook. We probably have a few more concerns about ’19 than ’18.

I think you’ll get some market-neutral or equity long-short strategies and pretty market-neutral strategies that people may be looking at on the equity side of things. For anything with a floating rate or a transitional shorter term, I think the trend will probably continue in the short term.

Hendry – I think short term, we’re very cautious, maybe through the winter, but we think it will pick up post-March when we’ll have something on Brexit, which again is a big uncertainty. Hopefully US and China tensions will have eased by then, but at least we’ll have maybe some more clarity on it. Certainly we’d be very cautious at the moment. There are definitely some opportunities, we’re seeing some big movements in individual companies that are dropping 20%-30% that are now very realistically valued. For the long term, we’re optimistic, short term I think there’s going to be some more volatile and nervous days ahead.

Darnowski – Our view on ’19 is still cautiously optimistic. Cautious because of the headline risks, fed tightening and late-stage market cycle. Optimistic due to the strength of corporate earnings. As we look out over the next few years, our multi-asset team is viewing a potential US market slowdown into 2020, but can easily move forward with resolutions or lack thereof to some of the broader political and economic issues. Looking further out, there are certain inescapable truths of the next decade of the investment landscape that we are speaking with investors about, including some disruptive forces. This includes investment factors such as a lower rate environment, low inflation, ageing populations, a growing role for China, as well as disruptive factors such as environmental issues and technological disruption.

Van Eck – As far as market dynamics are concerned, 2018 was just a return to normal volatility. The real outlier was 2017, which I still don’t understand, and probably never will in my career – why volatility in Trump’s first year in office was so low, but that was a fact. So, now it’s just back to normal. The other thing I’m looking at closely is the shift from growth to value. Growth performance relative to value performance this year we’re approaching, if you look at it on a Russell basis, the 1999 levels. Now, how you define those two always gets into nuances, but I just think that was an interesting thing to watch, when were the FANG stocks ever going to roll over? So, those are two internal market dynamic questions that I would expect to stay normal, meaning higher volatility and a reduction in growth’s outperformance over value in 2019.

Funds Europe – Over the next couple of years, are you positive, and what needs to be done to take us into a better position? What would you like to see changed that would help transform the industry to make you optimistic?

Panagakis – I think investors are simply looking at the length of the cycle and saying something’s got to give, because we’re so long into this recovery and so long into the cycle. But that, in and of itself, is not a reason to make a decision one way or the other. Obviously, a reduction of the trade tensions would be very valuable in addition to bringing down the level of debt across the globe. I do think Brexit remains a big question, and it’s not only the Brits that will be impacted. I think nationalism around the globe and the trends in and around that are playing a big effect. If we get rid of the national sentiment, bring the level of indebtedness down and reduce the trade tensions, then it will be a more optimistic outlook.

Hendry – The political climate is pretty toxic, and it’s not good for the country, so I’d love to see, in the second half of Trump’s first term, some coming together. Generally, I find in the US that businesses are thriving despite all the external factors.

The other thing is, there’s such a focus on price, and people tend to forget about the other things – performance and service, for example. You know, it’s the race to zero, but that’s not good for everybody. As asset managers, we probably had it too good for too long. We made a lot of money, we built up big cash balances and we’re now going to see more consolidation in the industry. I think there’s going to be fewer players – it’s either going to be very small boutiques offering just one or two strategies, or mega-firms offering everything.

Darnowski – Yes, economic and fee transparency is where I was also going to go. I know that waving a political wand will never work. Specifically to our industry would be to cut through the current regulatory environment and get to a place where investors have full transparency across the value chain of their investment choices.

There is an appropriate price for the value that you bring and the alpha that is added for clients. But what we have to be careful about is that we are entering into a new round of consolidation efforts within the investment community, and even seeing it within asset management and consultant firms. We need to be careful of fully bundled offerings for investors unless there is an appreciation for the value that is tied to those offerings. This type of transparency is good for investors and good for the investment system.

Van Eck – I think there are a lot of reasons for our clients to celebrate. Fees are lower, that’s great for the clients. Also, investors have been longer-term oriented. You used to find in the financial adviser channel people really chasing hot dots, and we got good positive inflows into our active emerging markets equity strategy this year, and I’m sure it wasn’t easy for those financial advisers to have client conversations, but I think they’re positioning themselves more as bundling a solution and less having to defend every line item on the client statement.

The last thing that we don’t talk about enough is the reduction of conflict of interest in our industry. We’re not perfect when it comes to disclosure of the value chain payment, but I’ve been thinking a little bit about healthcare, and almost every actor in the healthcare system is conflicted. Even if you’re looking for a long-term care facility, the people that give you consulting advice get kickbacks from the care facilities. So, we’ve come a long way in our industry over the last 25 years, and I think we have a lot for clients to be excited about.

I don’t know about 2019 but I look forward with a five-year lens or so, and I’m with you on the debt bubble. It’s just a concern, our deficits next year are going to be super-high. At some time, the US will not be able to get away with it. The question for our industry, to me, is asset allocation, because your safe fixed income part of your portfolio could not be so safe. We haven’t, I’ll speak for ourselves, totally answered the questions around that. I think more radical asset allocation solutions may be more appropriate than some that are built into our product set.

The last thing I would just note is having spent a little time in crypto, I really think there’s going to be massive disruption on the payment side and foreign exchange and things like that for our partners, the banks, our distributors. I can’t really fully articulate how this will develop, but it is a potential risk.

©2018 funds europe



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