The recovery in global markets continues to evolve, with ramifications for a number of areas and, by implication, for multi-asset funds.
Interest rates – lower for longer
Interest rates in the UK-US world are on the rise. You may be bullish on the recovery or sceptical but quantitative easing is finished in the UK and will end soon in the US. The emergency is over. Interest rate rises are next on the agenda.
One reason for not expecting rates to rise far, however, is central bankers seem to be losing the taste for it. Increasingly, they prefer ‘macro-prudential regulation’, which involves constraining lending. Banks are required to hold more capital relative to their loan books and carry out greater scrutiny of borrowers.
The outcome is called ‘tight but cheap’ money, where the availability of money is constrained while suppressing interest rates.
For us the bond market seems mispriced. Growth and inflation look sustainable so long-dated bonds are too expensive, but rates will not rise as far as many think so shorter-dated bonds look too cheap. We have positioned accordingly, hedging long-dated interest rate risk while embracing the shorter end of the curve.
UK commercial property – just too cheap
What is fair value as a commercial property investor? When we think about our exposures we get very similar outcomes to an inflation-linked corporate bond, that is:
1) A rising cashflow through upward-only rent reviews;
2) The risk that tenants do not pay their rent – the bond equivalent would be missing a coupon;
3) The risk that the property is unrentable and loses its value – in bonds that would equate to a default.
In property markets, we get paid about a 3 per cent real yield for owning a supermarket rented to Tesco. In fixed interest markets, we get paid a real return of less than 1 per cent for the same risks. Many buildings yield more just as many bonds yield more depending on their quality and void risks. With average lease lengths of quality property portfolios around 10 years, being 2 per cent cheaper in yield terms means being about 20 per cent undervalued in capital terms. Thus UK commercial property is a compelling opportunity which we are exploiting in our multi-asset funds.
“Emerged” and cheap markets
The phrase “emerging markets” implies growth markets, indeed Goldman Sachs recently suggested they be named exactly that. The trouble is lots of emerging markets have now “emerged” and their growth rate is slowing – exactly what is supposed to happen.
Investors have become distracted by this slowing growth and are missing the compelling value opportunity that some of these markets now offer. Equity markets in north Asia, eastern Europe and Brazil are much cheaper than those anywhere in the developed world and while their expansion is slowing, there is still much more growth than in developed markets at what is now, we believe, a far more attractive price.
Because the return we get as equity investors is overwhelmingly the result of the price we pay, in our funds we are buying these emerged and cheap markets, with a particular focus on Chinese large caps and Brazil.
John Ventre is head of multi-manager at Old Mutual Global Investors