Taking “Smart Risk” to Achieve Active Return

Taking “Smart Risk” to
Achieve Active Return
Investment
Forum
Andreas E. F.
Utermann
Global CIO of Allianz
Global Investors
Hong Kong, January 2014
Since its inception in San Francisco in 2011, our Investment Forum
has established itself as a highlight in the AllianzGI calendar, serving
as a source of inspiration and testing ground for our medium to long
term investment outlook and thematic hypotheses. At our gathering
in Hong Kong for our meeting this January, where the air was mild and
sky was particularly clear, we were able to reflect on the bold decisions
taken since we last held our forum there and to discuss the future
investment horizon.
Understand
It was at the preceding Investment Forum in Hong
Kong, back in June 2012, that our chief investment
officers first discussed in detail the “Financial Repression” phenomenon, which to this day offers an
important means of understanding – and ultimately
acting on – the low-yield capital market environment.
It is an environment in which the biggest risk is not to
take any risk.
At that Forum, we also concluded that measures
would be taken to bring the Eurozone more closely
together and that a breakup would be avoided. We
identified three conditions for a stabilization of the
European Monetary Union.1 While Europe is not out
of the woods yet, policy makers have made sufficient
See: Allianz Global Investors, “European Monetary Union
(EMU): Break-Up or Closer Integration?”, 2013
2
Source: Mercer Database, calculations by Allianz Global
Investors; data as of December 2013.
1
progress in each of these areas – most notably Mario
Draghi’s de facto “lender of last resort” statement in
summer 2012 – to ensure that bond markets in the
Eurozone enjoyed a significant spread tightening.
Political risks remain significant, however, and should
not be underestimated.
The relative stability of our macro scenario- an environment of low growth and still low inflation – gave
us the opportunity this January to explore more specific trends that have been shaping capital markets
and to consider how investments should be made in
the future.
For us as an active asset manager, one of the most
important, if somewhat insidious, trends in the industry is that it is becoming more and more difficult to
deliver an active return for clients, in particular in
equity investments. This challenge can be charted
over the last two decades using the Mercer database 2. In effect, lower volatility has driven down
Understand. Act.
Investment Forum
tracking errors and active returns, as has the increase
in stock correlations that coincided with the increase
in institutional share ownership and the secular rise
of indexing. The empirical evidence confirms, however, that, the more active managers are, the better
the expected performance. Research shows 3 that
there seem to be two distinct but related approaches
for managers to generate alpha:
(i) focused stock pickers, whose portfolios have a
smaller set of conviction investments and generate a higher active share and higher tracking
errors; and
(ii) diversified stock pickers taking advantage of a
wider range of alpha sources; these strategies are
characterized by lower tracking errors, seeking to
maximise the information ratio.
Distinguishing between future winners and losers is
at the heart of active investment when it comes to
stock picking. This is particularly true in light of what
economist Joseph Schumpeter termed “creative
destruction”, and particularly pertinent given the
application of Moore’s Law when we consider the
rate of technological change. Hence, with input from
McKinsey 4 and our San Francisco-based global head
of research, we devoted a session to the “disruptive
technologies” that could shape our future.
The development and applications of advanced
robotics, advanced materials and next-generation
genomics are among the new technologies we are
paying closer attention to as we scrutinize corporates’
business models, sector developments and economic
growth drivers.
In our discussion about ongoing macroeconomic
trends we started to review the inflation outlook,
understanding that inflation – or, more precisely, its
opposite: deflation – can have a significant impact on
all asset classes.
Inflation has, if anything, surprised to the downside
in recent months, and it is the threat of deflation
rather than inflation that commands the attention
of the latest generation of central bankers. Never-
theless, we believe that inflation will stabilize and
not turn into the type of deflation that has plagued
Japan until recently. In this context, it is important to
distinguish between “deflation” and “disinflation”.
Whereas deflation is a period with falling prices usually accompanied by at least stagnation, disinflation
is a period when inflation rates come down, but do
not turn negative. We see that emerging markets
and commodity exporters are putting pressure on
traded-goods prices including commodities, that
the deleveraging in the private sector is unlikely to
be completed any time soon and that trend growth
should therefore remain moderate, while global
unit labor cost growth continues to be muted. Taken
together with our scenario of moderate, but sustainable growth, which gained further support during the
last few quarters, the price levels in the developed
markets should stabilize before edging up in the next
two to three years. In parts of Europe where we have
seen deflation, this is part of a painful adjustment
process to re-establish competitiveness.
We do not expect a widespread repeat of the
Japanese experience in the developed world for
the following three reasons:
1. The current level of private-sector leverage is far
lower than it was in Japan in the 1990s;
2. Monetary policy, be it that of the Federal Reserve
(Fed) or that of the European Central Bank, is much
more accommodative than in Japan at the beginning of what we now call the “lost decades”; and
3. The housing markets in the US and the peripheral
countries of the Eurozone stabilized sooner.
While not as obvious a pressure, an uptick in inflation
should not be discounted by investors. Long-term
inflation expectations are still well anchored, but
the output gap in the US is closing after years of
under-investment in the developed world and global
broad money growth behaved well in relationship to
nominal growth. With broad money growth being
stable at 6 to 7 %, year-on-year growth is at average
levels – so both significant inflation and deflation are
unlikely in the coming quarters.
Source: Cremers, Martijn and Petajisto, Antti 2007, “How Active is
Your Fund Manager?”; in 2010 Petajisto published an updated analysis with data through to 2009 and found that the most focused
funds underperformed during the latter part of the decade.
4
See McKinsey Global Institute “Disruptive technologies: Advances
that will transform life, business and the global economy“, 2013
3
2
Act
As at every Investment Forum, we have discussed the
investment implications and how best to act on our
insights.
To start with our own investment processes, the
evolution in active management needs to continue:
With the support of our “Grassroots” teams and our
buy-side company research, we need to continue
to pick stocks and capture the big trends, including
in, but not limited to, technology, which will reach
far beyond the technology sector. The quality of our
analysis and the conviction this gives us in our investments is what sets us apart.
Opportunities for outperformance need to be captured by judiciously increasing the active share in a
portfolio, expanding the investment universe (e. g.
including small and mid caps instead of sticking to
large-cap investments) and increasing operational
excellence through alpha extensions, for example the
130 / 30 type, which permits to leverage 100 % convictions into 130 % investments.
Our conviction is: the more active managers are,
the more successful they should be.
Taking our macro-economic scenario into account,
the chase for active return needs to be combined
with the willingness to take smart risk. As we have
previously stated, we believe there is no alternative to
taking risk:
• Income solutions with a low duration risk might
be the first choice for investors.
• A next step might be corporate bonds, including
high yields. There is still a huge demand for credit
risk, and economic developments and earnings
growth should continue to support the improvement of corporate balance sheets.
• Notwithstanding their strong run so far, equities,
notably dividend strategies, should remain in the
focus. Developed-market equities have already
enjoyed re-ratings, leading to an expansion in
multiples; further share price growth will likely
need to be underpinned by earnings growth, and
will therefore be more selective.
• Institutional investors would be well advised to
go into more illiquid assets, which, in addition to
generating steady cash flows, should command
illiquidity premia in return for longer holding
periods.
In a low-yield, low-inflation environment there should
be opportunities for active return for those who are
willing to take smart risk.
Andreas Utermann
Imprint
Allianz Global Investors Europe GmbH
Bockenheimer Landstr. 42 – 44
60323 Frankfurt am Main
Global Capital Markets & Thematic Research
Hans-Jörg Naumer (hjn), Dennis Nacken (dn),
Stefan Scheurer (st)
Data origin – if not otherwise noted:
Thomson Financial Datastream.
Calendar date of data – if not otherwise noted:
January 2014
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