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17. March 2015 14:01
by Irene

What now Mr Draghi?

17. March 2015 14:01 by Irene | 0 Comments

The European Quantitative Easing program is finally underway and has begun without any hitches, not something that can be said about the European economy over the last five years and the Greek woes in particular. This makes sense, let’s not forget there would not be a QE program if Europe were in stellar shape. The idea is that QE will boost the European economy and bring inflation back to its target of around but below 2%. History will be the judge. If the ECB can achieve at least one of the two within a year or so, that will be a great accomplishment.

For an investment manager the key question is how will European QE affect the various asset classes; what about European equities (the consensus seems up), the Euro FX rate (the consensus seems down, but how far?) and European interest rates (not such a clear consensus here, the question is how much further can they go down?).

European equities a straight line up?

If history is in fact any judge then previous QE programs in the US, UK and Japan can guide us. In terms of equity returns, it was mainly a one way trade, which is a more or less straight line up. The graph below shows the returns of equities starting from 3 months before the QE program was announced to up to five years thereafter. While the US and the UK started with their QE programs quite early after the financial crisis, the recent QE program in Japan was announced on 4 April 2013. Finally the ECB has followed suit, and not a day too soon, and the doyens of Frankfurt announced their QE program on 22 January this year and it finally started a few days ago. A free lunch may well be on the menu.

Source: Markit, Twenty20 Investments, as of 12 March 2015

Will the Euro weaken much further?

In terms of FX rates, if we take the cue from the US, UK and Japan, there is not such a clear one way picture. The flight to safety made the Dollar stronger not weaker when quantitative easing started. The Yen on the other hand weakened by nearly 25% against the Dollar since QE started in Japan about a year ago. So far the Euro has lost slightly more than 10% against the Dollar since the QE announcement was made by the ECB. Can it weaken as much as the Yen has or is it mean-reverting already?

Source: Bloomberg, Twenty20 Investments, as of 12 March 2015, US Dollar against a basket of FX rates, all other currencies against Dollar

Are negative bond yields here to stay?

Government yields are yet again another mixed bag. For Germany, the question is how much further they can go into negative territory, presumably at some point mean-version must set in. As the balance between supply and demand will mean that there is a shortage for the ECB to buy bunds, this could bring down yields even further.  In the US and the UK, government yields did fall during the first part of QE, but were back at their original level within approximately six months, only to fall again later on with deflation more of a threat than inflation.  

Source: Bloomberg, Twenty20 Investments, as of 12 March 2015

How will these asset class moves help the case for Europe?

So how much will QE help Europe? If the problem with Greece is resolved quickly (and that would be a big if), the results could be stellar. Should Greece leave the Euro, the QE program will probably be needed to resuscitate Europe again. Translating this into investment opportunities, using ETFsas the vehicle of choice, it does suggest QE provides one of those feted opportunities to take advantage of macro-economic policy decisions.  European equities seem a particularly good buy for the moment, although at the time of writing in our rear view mirror we see the Dax close at a record high above 12,000.  How many record trading sessions before that demand for European equities is satiated, remains to be seen. Currency hedging any of these exposures would be no bad thing either. German bunds seem another good trade, but with the risk reward ratio not so high, this does appear to be a lower conviction trade. If one wants to play the currency theme only, there are ETFs available that allow the investor to get exposure to many different currency pairs. All of this is well and good, but does need the Greek odyssey to keep its surprises to a minimum.

QE programs in short:

US: First QE announcement date on 25 November 2008, starting with an aim of $600bn and finally ending up with further QE2 and QE3 at a total of $1.7tn

UK: the announcement for the UK was on 5 March 2009, starting with an aim of raising £175bn, which resulted in a total of £375bn

Japan: announcement on 4 April 2013

ECB: announcement on 22 January 2015 for a total of EUR 1.1tn

6. February 2015 15:56
by Allan

Where did the Sterling Aggregate go?

6. February 2015 15:56 by Allan | 0 Comments

It is official, the numbers are out and according to the consultancy firm, ETFGI, 2014 was a record year for the European ETF industry where inflows burst through the $60bn barrier, far outstripping the figures for 2013. Yet among that cacophony of activity was the very strange decision of State Street to delist their ETF from the London Stock Exchange which tracked the Barclays Sterling Aggregate Bond Index.

Perhaps one of the best kept secrets of the financial adviser community is the power and ubiquity of the aggregate bond indices. As a portfolio manager, this suite of ETFs can do quite a good job for you, well that is if you buy into the commonly held view that diversification is one of the few free lunches left on the table.

Over the years much fire and brimstone has been directed at the financial services industry with its unerring capacity to put the investor last. Remember Lehman Brothers who came to symbolize a generation of over confident investment bankers that took the world over the cliff. If the truth be told that is not exactly true, AIG maybe, but let us not forget that it was Lehman that had built up the world's most impressive fixed income franchise which included their indexing business, the core of which now resides under the banner of Barclays.

The benefit of investing in an ETF that tracks one of these aggregate bond indices is very straightforward to grasp. At the time of writing the iShares Euro Aggregate Bond UCITS ETF has over 2200 EUR denominated bonds in the portfolio and truly represents the Euro bond market. The law of large numbers starts to work in the investor’s favour as this index displays a risk return profile with a relatively high Sharpe ratio (the return per unit of risk). Of course this is only true if one measures the returns in EUR. If one instead manages this investment in GBP, the impact of currency fluctuations eat into the low but reliable returns of the EUR denominated assets.

My understanding is that State Street delisted the SPDR Barclays Sterling Aggregate UCITS ETF due to limited take up since it was first launched. If that is indeed the explanation then that is a pity as this was the only aggregate bond ETF that a UK investor could use without introducing currency risk into their portfolio. It isn't always easy being an ETF provider it seems. The safest of bets is still not enough to have a commercial success on your hands.

10. November 2014 11:08
by Allan

Where are the ETF Market Wizards?

10. November 2014 11:08 by Allan | 0 Comments

In a world where the influence of passive investing continues apace, it is somewhat ironic that 2014 has been the year when the headlines have been dominated by the rock stars of the investing world.  Although Bill Gross and Neil Woodford perform their investment alchemy on opposite sides of the Atlantic, their ability to whip the financial press into a frenzy is not without question.

It will be particularly interesting to see if their ability to gain column inches correlates with the performance of their new ventures?  Indicative of the 'winner takes all' culture that pervades much of investment management, when it decides to make an unscheduled appearance, the law of unintended consequence will eventually add its own twist to the tale.  What I do find striking is that both of these personalities speak out about many aspects of the fund management industry they don’t agree with, yet their tendency to dominate the headlines is itself very unhealthy.

In the old days getting wealthy in the investment management industry meant you either needed to be a rock star or a hedge fund manager.  With absolute returns remaining elusive for an uncomfortably large percentage of wanna be alpha catchers, many hedge funds are mutating themselves into family offices.  In the meantime the world of passive indexing leaves its own indelible mark on the interpretation of where outperformance truly comes from in the first place.

If the future is to be dominated by passive investing, then where should one expect to find today’s and tomorrow’s ETF Market Wizards?  The internet revolution is barely 20 years old, but its impact on many industries is beyond doubt.  Over the last ten years there has been a shift of power as the process of democratization works its way through successive business models and represents the one thing that the incumbents fear the most.  In the world of investment management it seems inevitable that a large slice of that power will move from the professionals to the end investor.   

3. November 2014 09:42
by Allan

Oil price deflation is a game changer for Sweden

3. November 2014 09:42 by Allan | 0 Comments

As Sweden’s central bank lowers interest rates down to zero, now is a good time to get back into the equity market.

As one of the first banks to raise interest rates, Riksbank came out of the traps last week and cut rates all the way down to zero in their quest to stem the spectre of deflation.  In a week that saw the Fed declare an end to QE and the market only expecting a cut of 15bps, it was clear that something was amiss.  Welcome to the world of post-modern economics where the shale oil boom in the US sees some commentators talk of the US becoming a net exporter of oil.

With Brent Crude prices dropping by 23% since June, this appears to be the first sign of a reversal of fortunes for the non-oil producing countries, which incidentally includes most of Europe.  As a result, Sweden, which imports over 90% of its oil, has slowly but surely seen the possibility of entering a deflationary period in the not too distant future.

Source: OECD - 31st October 2014

Since the start of the year, the economic landscape for Sweden has been in rude health. Every month since January, the OECD’s composite leading indicator has increased, regularly topping the list of countries offering the most promising growth prospects. This indicator does come with a two month lag, but GDP growth currently at 1.9% is forecast to increase to 2.7% in 2015 and 3.3% in 2016. Retail sales have been particularly healthy, supporting the case for increasing consumer confidence. Business confidence has undergone some reversals but has also been on the increase as of late. Sweden’s most recent manufacturing PMI number came in at a respectable 52.1, slightly below the forecast number of 52.39 and down from last month’s high of 53.4.

In many instances this positive economic background would have seen the Swedish equity markets flourish. As a Swedish investor, the OMXS30™ index, consisting of the 30 most traded shares on the NASDAQ OMX in Stockholm, has bounced back strongly during the last couple of weeks of October and is up 8.5% year to date. However, as a USD investor the Swedish Kroner is down by 14% since its 2014 high in mid-March and down 13% year to date, resulting in a net loss in US dollar terms.

Source: XACT - 31st October 2014

Since the start of 2014 the large cap country index MSCI Sweden is itself off by 8%, which given that it is denominated in USD is broadly speaking in line with the performance of the OMX index as measured in USD.

As Sweden’s central bank tries to hold back the threat of deflation and with SEK rates now down at zero, currency intervention and asset buying are the two key tools at their disposal. With in-fighting amongst senior members of the bank, nerves definitely appear to be frayed

With a non-negligible probability that this bout of nervousness could result in Sweden’s answer to QE, now looks like a good buying opportunity to invest in the Swedish equity market for which there currently exist two ETFs allowing one to get this equity exposure. The locally traded ETF, XACT OMXS30 ETF, with ticker XACTOMX:SS, trades out of Stockholm denominated in SEK and has $1.28bn AUM as of 31st Oct 2014. The iShares MSCI Sweden ETF, with ticker EWD:US, is denominated in USD, trades out of the US and has $368m AUM as of 31st Oct 2014, which suggests a reasonable size of assets under management in both cases. As one of the stronger economies in the Eurozone, the case for investing does stand on its own merit.

31. October 2014 12:05
by Allan

As the mask slips for European High Yield bonds, post QE, the masquerade is over

31. October 2014 12:05 by Allan | 0 Comments

With the topic of high yield bonds being in the news of late, it is becoming more challenging than ever to detect the signal from the noise. What fate lies in store for this asset class is anyone's guess, and to be honest most people appear to be guessing. However, when the likes of the legendary investor Carl Icahn throws his hat in the ring, as he did recently by declaring high yield was in a bubble, maybe it's time to look at the data again.

Source: Twenty20 Investment, Markit

By their very nature high yield bond indices provide an excellent voting mechanism for the market to express its preference for holding risky assets. For that reason alone, this topic should be filed under behavioural finance rather than technical analysis, but as we all know habits die hard.

Timing one's exit in any asset class is never easy, for one renowned for its high level of jump risk; it becomes the problem best avoided. By looking at the histogram of monthly returns over the full index history, one can at least put a number against the worst case loss.

The tail event dating back to 2008 saw a drop of 22% during a single month, not for the feint hearted. More typically the gap risk on that timescale is in the 6% range. Not a figure that would alarm an investor who specialised is UK supermarket stocks, but drawdowns of this size are still best avoided.

Source: Twenty20 Investment, Markit

If one instead looks at the rolling one year standard deviations of monthly returns, the alarm bells start to ring for many investors. After five years of a historically low interest rate regime, the spread over European Government Bonds isn’t the no brainer ‘indicator’ that it once was. In the absence of a reliable guide as to what the new norm for spreads should be, how can one avoid complacency? Looking at the rolling one year volatility of Euro High Yield Bond index returns should do the trick and very quickly set the alarm bells start ringing. With these risk levels having come off their all-time low of just below 1%, one can see these European high yield bonds have been masquerading as short dated government bonds, which currently are showing risk levels in the 1.5% to 2% range.

With the announcement this week that QE has finally come to an end, albeit with Japan having decided to take its turn holding the stimulus baton, it is only a matter of time before the spread between the 1yr historical volatility of short dated government and high yield bonds reverses sign,
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