The capital group inc singapore: Improving fundamentals boost emerging market debt

Emerging market (EM) debt has seen a sharp sell-off since the US elections. What is your outlook for the asset class? EM debt needs growth, and in theory strong US growth (i.e. fiscal expansion) should be positive for the asset class. The uncertainties around a Donald Trump presidency are well known, especially on the global trade front, and this explains some of the sell-off that we’ve seen in EMs since the US elections. However, I think the markets may be overestimating the extent of trade protectionism by pricing in potential moves such as the North American Free Trade Agreement (NAFTA) being cancelled, but the important thing to note is the fact that EMs benefit from strong global growth and we should see this in 2017, especially with stabilising commodity prices.


This is particularly good news for local yields, which are around 6.5%-7%, and in some of the higher yielding dollar universe, for example Argentinian US dollar-denominated debt. EM debt is also less affected by rising bond yields than traditional fixed income. Another concern is that if US interest rates move significantly higher, then EM debt won’t look as attractive as an asset class. Finally, higher US interest rates will also directly increase borrowing costs for EM countries – although US dollar debt is becoming a smaller portion of overall EM borrowing and dollar debt levels are in general more manageable now.


Despite all this uncertainty, it is important to note that EM countries are actually in pretty good shape. Overall fundamentals for EM as an asset class are stabilising, and this is after a number of years when fundamentals were deteriorating. This has been driven by external factors, such as the dissipation of the commodity price shock and the improving global growth picture. It has also been driven by the improving credit stories of countries like Brazil, Argentina and Russia.


Overall, I am quite optimistic and I think 2017 will be a year where we can take more opportunities and less of a defensive stance, with the p


What could be the impact of fiscal expansion in the US?


President-elect Trump intends to give the US economy a shock of fiscal stimulus that I do not think it needs at its current point in the financial cycle. There could be a boost to growth, from around 2% to 2.5%-3%, but because of the tight labour market there is an inflation risk. However, the hope is there will be enough global spare capacity that prevents this from becoming an issue – if not, the US Federal Reserve (Fed) would have to raise rates faster than the markets anticipate.


How do you see current valuations in EM debt?


Local yields are, in absolute terms and relative to developed market yields, attractive. Inflation is coming down, which should also support EM bonds. This is because EM central banks can now ease monetary conditions; something they haven’t been able to do in a long time.


With hard currency bonds, we’re seeing more of a bifurcated market. You have the high-quality investment-grade countries, like Mexico and Brazil, where you get very little yield. If the US Treasury curve normalises further, these countries will have very little yield cushion to protect against a rise in US interest rates, which is not particularly attractive. However, in the dollar space, there are some higher yielding bonds, such as Argentina and some Sub-Saharan African countries, where yields are significantly higher. We see these as more attractive because you take a lot more credit risk, or spread risk, rather than underlying US interest rate duration risk.


What is your outlook on EM currencies?


If we look at our fundamental equilibrium value exchange rate (our internal fair value exchange rate model), overall, EM currencies still appear undervalued, and they have very attractive carries because of high inflation rates. Even those fair valued currencies like the Brazilian real have large carries, which provide lots of cushion, even if the currencies depreciate slightly. Whether or not we see EM currencies appreciate from here, however, will again depend on what a Trump presidency looks like. We may see the dollar move higher if we have meaningful fiscal expansion in the US, but I think it will be different from when the Fed was withdrawing quantitative easing or planning its first rate hike. At that time, this was done in an environment of disinflation and a lack of growth in the rest of the world. Now we have a recovery in Japan and Europe, with strong employment growth. I do believe that EM currencies are cheap enough to allow for some uncertainty.


What’s your view on commodity prices?


Based on the views of our commodity specialists, I would expect commodity prices to be well-supported and rangebound. There is still a lot of supply, but with a better growth picture, demand should not only stabilise but also increase somewhat.


Could you share your outlook for China?


There are several interesting things happening in China. Firstly, the government is working to depreciate the renminbi because it does not want the currency to appreciate any further against the Japanese yen, which the Japanese government is also trying to weaken. Plus, there is a slightly stronger US dollar outlook, at least for the next 6-12 months.


Secondly, Chinese growth received another artificial boost earlier in 2016 through fiscal stimulus, but this is now beginning to run out, meaning growth is coming down to its structural run rate of around 4%-5%.


Finally, the very positive news is that China has come out of its deflation trap – producer prices have been positive for the first time in three and a half years – which has increased its nominal GDP growth. So, yes, there is a structural slowdown, partially due to poor demographics, and we don’t expect any further stimulus, but the presiden


What about the problem of nonperforming loans in China?


There are lots of non-performing loans in China, which could be problematic, but because the country has a closed capital account and a banking system that is state-owned, then it should take a lot longer to become a problem, if at all. With time and money, you can defer those issues or just remove them through inflation; if your economy is growing well in nominal terms, these non-performing loans become a lot less of a problem.


What are your most compelling investment opportunities right now?


Brazil and Argentina are both examples of countries where, following a decade or so of economic mismanagement, we are finally seeing some change. Brazil has a strong technocratic caretaker government, with a president that is not planning to run for re-election.


This means that President Michel Temer can do the hard work and put the country on a much better footing, including cutting the budget deficit, which should also allow for lower interest rates. Hopefully, by the time of the next election in 2018, the economy should be doing better and the population might be in a better position to elect a government that will have a mandate to really improve the country’s economy


Argentina is in a similar position. After 12 years of Kirchner governments, the country finally has a conservative, orthodox centre-right government in place, which is looking to undo the distortions in the economy (although this will take time).


With Russia, while the political landscape has not changed much, the government has at least been very pragmatic in its economic approach by letting the rouble fall to compensate for declining oil prices. India is also delivering nicely on some reforms. Growth has been good and inflation is coming down.


Capital group intermediaries consultants Hong Kong: Municipal and Global Bonds

Revenue bonds tend to offer higher yields and entail risks that are typically more straightforward than general obligation bonds (GOs) for research-driven investors to analyze.


  • Local government issuers face practical constraints on raising revenue, while large pension liabilities put a heavy strain on their balance sheets. These represent significant and sometimes difficult-to-assess risks for investors in local GOs.


  • This has led yields offered by local GOs to now often match or exceed those of the broader municipal bond market — a sea change in muni bond pricing.


The muni market seemed to take Donald Trump’s victory in stride in the days following the November 8 presidential election. We’ll see what happens down the road, but the president-elect’s agenda for tax reform and infrastructure — by itself — appear unlikely to have a dramatic nearterm impact on munis. Understandably, the focus on how the environment for munis may develop under the next president is quite intense. However, today’s spotlight on possible longer term changes makes it all the more surprising that a recent structural change has received little fanfare. Not so long ago, general obligation bonds were viewed as the “safer” part of the U.S. muni market. Because of a state or local government issuer’s ability to increase revenues by raising taxes or fees, the argument went, many bond investors assumed that there would be little problem for these issuers to make coupon payments and return bond principal. For many years, investors were willing to receive about 10% less income, because they viewed local GOs as less risky than most other comparably rated muni bonds. From the end of 2008 to the start of 2014, for example, the average yield for investment-grade (rated BBB/Baa and above) local GOs was about 2.8% — roughly 30 basis points below the broader investment-grade muni market.


What a Difference Two Years Make Gradually, this benign perception has given way to a harsher reality. Starting in 2014, the market began to question whether local GOs actually entailed more risk than previously thought. Recent concerns over Chicago’s stability and bankruptcies associated with Detroit and Puerto Rico have helped crystallize a more unforgiving view. As a result, the yield discount of local GOs to the broader market has largely disappeared. What explains the dramatic repricing of local GOs, which account for 17% of the total issues and about 58% of the GOs in the investment-grade Bloomberg Barclays Municipal Index? Investors may be demanding greater return potential from local GOs, because they have recognized that local governments have:


  • Potentially limited flexibility to increase revenues


  • Large fixed costs


  • Insufficient political will to address substantial and growing pension liabilities


For Local Governments, Reality Bites Although these risk factors have become more widely appreciated and better reflected in bond prices, they are not actually new. The extent to which specific issuers suffer these vulnerabilities also varies widely. For example, cost cutting may prove difficult to implement due to contractual arrangements and fixed costs in some municipalities, while others may face far fewer impediments. Similarly, the ability of local governments to increase revenues in a challenging fiscal environment may be severely limited in some cases but not others. Flexibility is dependent on the overall health of the local economy and the nature of the revenue sources in place. Additionally, the political will to seek greater revenues through taxation or fees may be lacking — particularly in challenging times when increasing the financial burden on individuals and businesses could prove highly contentious. Many local governments also have to clear another major political and legal hurdle, in that they must first gain state approval before enacting any changes.


Pensions Are the Elephant in the Room For muni bond investors, local government pension liabilities are a major risk that shouldn’t be ignored. Pensions for municipal workers are often the largest liabilities on local government balance sheets, and the health of many plans has deteriorated over the past decade. At the end of 2015, local and state governments had an overall funding gap of 28%. Depending on the discount rates used, recent estimates suggest US$1 trillion to US$3 trillion in unfunded commitments need to be addressed (through additional contributions and investment returns) in order for these plans to meet their financial obligations to current and future retirees.


Forward investment return expectations play a critical role in determining whether or not a plan has a funding gap. Therefore, it’s important to note that many local and state pension plans still assume investment returns in excess of 7%, but are likely to moderate those expectations over time. As a consequence, lower return expectations could cause widespread increases in pension funding gaps among local and state governments.


Another Good Reason to Focus on Revenue Bonds Clearly, local and state GOs entail some significant risks, and bond prices have begun to better reflect this reality. However, in many cases, assessing whether or not a bond investor is being adequately compensated for these risks can be quite tricky. For GOs, an issuer’s willingness to repay its debt is a key variable in the investment decision. On the other hand, the situation with revenue bonds is quite different. Revenue bonds (which account for 60% of issuers in the investment-grade muni market) are backed by specific revenue streams from various entities such as water and sewage plants, toll roads, airports and toll bridges. Credit research can provide a well informed assessment of what a revenue stream for a toll bridge could be, whether the project will be successful and whether the associated bond represents an attractive investment.


Revenue bonds typically offer a yield advantage over local and state GOs, without the aforementioned funding, political and pension-related vulnerabilities. Assessing the ability of an issuer to pay on a revenue bond is a straightforward analytical problem for an experienced, research-driven muni investor like Capital Group. These factors have often influenced our portfolio managers to steer their muni-focused investments toward revenue bonds.


Global Bonds Can Help Investors Meet Varying Goals


  • One way to protect purchasing power is through exposure to foreign currencies.
  • Although the U.S. dollar’s value has risen in recent years, it could be poised to fall if the U.S. is in the late stage of its economic cycle.
  • A global bond fund can help investors diversify away from U.S. credit risk, as well as protect purchasing power through foreign currency exposure.


Of the many objectives investors establish for their portfolios, capital preservation and protection of purchasing power typically sit alongside requirements for income and growth of assets. Purchasing power protection basically means generating returns at least equal to the rate of inflation. Bonds such as Treasury Inflation-Protected Securities (TIPS) offer a direct hedge against inflation. Yet a portfolio of TIPS may not address the income and growth objectives of many investors. Meeting these various goals may be possible through a more diversified portfolio that includes an exposure to assets denominated in currencies other than the U.S. dollar. Such assets, like global bonds, not only help to diversify income and returns, but also provide some protection for purchasing power against currency-related volatility.


Why Exchange Rates Matter When a country’s currency exchange rate rises or falls, there can be a direct impact on the price of imported goods in that country. That so-called pass-through rate will vary from country to country, but some studies indicate that the long-term pass-through rate for the U.S. dollar is around 40%. That means if the dollar’s value fell by 10%, then prices of imported goods would broadly rise by about 4%.


In today’s global economy, much of what we consume is produced in whole or in part in other countries. Our foreign consumption basket might include things as expensive as a car or as cheap as a T-shirt. If we want to maintain purchasing power relative to our future consumption basket — the things we expect to buy in the future — then an allocation to assets denominated in foreign currencies makes sense.


Is Now the Right Time to Initiate or Add to Non-dollar Holdings? Over the past few years, the U.S. dollar has strengthened broadly against other currencies and now looks relatively overvalued. The chart on page 3 looks at the trade-weighted dollar index, which is the weighted average of the dollar’s exchange rates with its trading partners, against our internal estimate of its fair value. Since 2012, we have seen the dollar move from being very cheap to fair value to expensive. Currencies tend to be volatile and can diverge significantly from their fair values. However, ultimately they tend to revert to the mean: as relative valuations become extreme, they tend to move back toward fair value.


Today, there are indications that the dollar could be poised to turn. Historically, we have seen turns in the trade-weighted dollar precede turns in the financial cycle. Momentum loss is driven by a halt in the acceleration of house price inflation and private credit growth.


Financial cycle models, which are very slow moving, effectively reflect leveraging and deleveraging stages in the economic cycle. Our model indicates that we are now seeing late-cycle behavior as house price inflation and private credit growth are both decelerating. Typically the deleveraging part of the cycle is characterized by slowing growth, improving external balances and a weaker currency. If the U.S. cycle loses momentum, the U.S. dollar should fall.


Look to a Global Bond Fund Whether or not the dollar turns in the near term, relative valuations suggest that this could be a good time to initiate or add to non-dollar-denominated assets. Actively managed global bond funds can help. They enable investors to gain discrete exposure while relying on the fund’s managers to assess the risk and return opportunities across global bond and currency markets.

Capital group emerging market tokyo japan: Global Currencies Outlook, The Strong Dollar Is Losing Steam

Currency movements often produce a wild ride for investors, but 2016 was a year for the ages. The pound sterling tumbled to a 30-year low, the euro declined sharply in the fourth quarter, and the U.S. dollar staged a remarkable bull run.


What’s in store for 2017? In my view, the roller coaster won’t stop, but the ride should be less bumpy. That’s important because currency fluctuations can have a big impact on investment results. In 2016, for instance, European stocks enjoyed a robust 7% gain in local currency terms. But for dollar-based investors, currency movements eliminated all of those gains, producing a loss of –0.4%.


Here are my thoughts on the outlook for select global currencies this year:


U.S. Dollar Nearing a Peak


A strong acceleration in U.S. economic growth — perhaps influenced by the policies of the new U.S. president — could drive the dollar a bit higher, but probably not by more than 5% or so. The dollar is on the last legs of a multiyear bull run, in my opinion, after rising more than 30% since 2011. Calling a peak is always difficult, but it’s obvious that a lot of good news on the U.S. economy is already baked in to the current dollar price. The dollar is overvalued by about 10%, in my estimation, so there are limits to how much further this bull can run. I think the dollar entering a consolidation phase this year would not be surprising.


Euro Recovery on the Horizon


If one accepts the premise that the dollar is expensive, then that means some other currencies are undervalued. The euro has been cheap for several years, in my view, but the stage is set for a recovery. Growth in the euro-area economy is starting to firm up. And inflation is beginning to rise, albeit from very low, deflationary levels. If these trends continue, then the European Central Bank is likely to start reducing its bond-buying program, which should allow the euro to appreciate. However, I think this won’t happen until the second half of 2017, after the French and German elections. Once the political uncertainty declines, the euro will be in a good position to rise.


Pound Sterling Bottoming Out


There is still a high degree of uncertainty surrounding the U.K.’s departure from the European Union, a process that is expected to take two years. The current value of the pound, which is down 15% against the dollar since last summer, already incorporates some “hard Brexit” risks. As long as this uncertainty continues, there isn’t much reason for the pound to move a lot higher, but I also don’t see it falling much more from here. The pound’s valuation is attractive today, but there is little reason to be optimistic until we know how the U.K. will be treated outside the EU.


Yen Remains Undervalued for Now


The yen experienced a true roller-coaster ride in 2016, essentially making a round trip and ending up close to where it started. The yen’s valuation is cheap, but it is trading at such levels due to the Bank of Japan’s very aggressive asset purchase program, combined with yield curve control measures. Given the upward pressure on global interest rates, the risk is that markets will test the central bank’s ability to keep Japanese interest rates low. Any sign that the BOJ’s willingness and ability to keep rates low is fading will quickly trigger a stronger yen.

Capital group financial advisor Tokyo japan: Markets Can Take Time Adjusting to the Policy Fog

Key Takeaways


There is an interesting disconnect these days between political uncertainty and market volatility.

When history seems to offer little guidance, financial markets take time to adjust and have a bias toward not changing.

The key to successful investing in these times is for active managers to maintain enough portfolio flexibility to respond rapidly when the uncertainty starts to resolve.


In the short time since the new U.S. presidential administration was installed, there has been a flurry of policy announcements, and even more policy speculation, spanning a multitude of areas. In the process, an interesting disconnect has emerged between the political and financial worlds.


Much of the political news gives an impression of chaos and uncertainty, whereas financial markets have remained liquid and orderly, risky asset prices have remained well supported — and in most cases have actually strengthened — and market-based measures of uncertainty, such as the VIX, have remained low. (The Chicago Board Options Exchange Volatility Index, or VIX, measures the implied volatility of the Standard & Poor’s 500.)


This disconnect exists at a more granular level, as well. For example, the so-called “border adjustment tax,” which in effect subsidizes exports and penalizes imports, should play a central role in a revenue-neutral corporate tax reform package, and would in theory have a significant impact. It should lead to a substantial appreciation of the U.S. dollar, it should be detrimental to low-end retailers who rely heavily on global supply chains, and so on.


The Role of Active Management


But financial markets do not incorporate these expectations. Equity prices reflect a high probability of corporate tax reform, yet forward exchange rates have not adjusted much, and retail stocks have not underperformed a great deal either. There are several other examples of the market’s underreaction to policy announcements that should in theory have a significant impact on specific groups of companies.


It would not be quite right to conclude that markets are not efficient. Rather, in periods of high policy uncertainty, and when history seems to offer little guidance, markets take time to adjust. In the meantime, they have a bias toward not changing until uncertainty is resolved – either because policy is clarified, or because an adverse shock materializes.


This tendency toward inertia is exacerbated by the inclination of many active managers to focus on peer risk rather than absolute risk. There is little incentive to take large portfolio positions with limited information, which may be hard to justify to clients, when the costs of being wrong are potentially high.


In other words, especially in an environment of regime change and high policy uncertainty, market efficiency is not instantaneous, but a process. This creates room for active management to add value. However, that should not imply that all active managers will succeed. In fact, there has been a gradual rise in the dispersion between active managers since mid-2015.


Investment Implications


The key to successful active management in periods of elevated uncertainty is not to stake everything on single-point forecasts. Rather, it is the ability to apply detailed policy analysis to a range of scenarios, and to maintain enough portfolio flexibility to respond rapidly and with high conviction as soon as uncertainty starts to resolve itself toward a specific outcome. Furthermore, the ability to populate the portfolio with diversified investment ideas, rather than a few macro positions, is essential if managers hope to generate alpha while keeping active risk under control.


Market liquidity has been good. Investor flows can be invested rapidly and efficiently. But can they be invested wisely when we know so little about the future? They can – but only through an investment process that is solidly grounded in fundamentals, granular enough to generate diversified ideas, forward- rather than backward-looking, and not too strongly anchored to preconceptions about how economic policy and financial markets must function. Investors should ensure that they have exposure to a broadly diversified set of investment themes and can benefit from active management that can respond with agility and flexibility to a rapidly changing policy environment.

The capital group inc Singapore: Adding our voice to the indexing dialogue

In recent years, the idea that investment managers can’t beat the index has become something of a truism within investing circles. The latest to weigh in is legendary investor Warren Buffett. In his 2017 letter to Berkshire Hathaway shareholders, he effectively endorsed that view by advocating low-fee indexing as the best approach for most individual investors. Here, Tim Armour, chairman and chief executive officer of Capital Group, discusses Mr. Buffett’s views and offers his perspective on the indexing discussion.


What are your thoughts on Warren Buffett’s recent comments that seem to endorse index investing?


Mr. Buffett’s approach at Berkshire Hathaway has many similarities to how we invest at Capital Group — through bottom-up investing, rigorously analyzing companies and building durable portfolios. This research-driven, long term, buy-and-hold approach typically means less trading, lower expenses and with it better results. And we wholeheartedly agree with Mr. Buffett’s all important message that most people need to save more for retirement — and to get invested and stay invested.


Mr. Buffett is not the only indexing proponent. Why do you think this view is so prevalent?


It’s important to say that we don’t dispute the data that has led Mr. Buffett and others to form their views. Namely, we agree that the average investment manager does not outpace the market over meaningful time horizons. However, a fairly simple fact has gotten lost in the debate. Simply put, not all investment managers are average. As we like to say, “Just because the average person can’t dunk a basketball doesn’t mean that no one can dunk a basketball.”

Mr. Buffett and others acknowledge that there are exceptions. We are one of them. And selecting a manager whose track record suggests it has the potential to deliver better outcomes can make a very meaningful difference in an investor’s life. For example, investors in an index fund will generate market returns. On the other hand, by investing in certain select funds, investors had an opportunity to outpace the index. For today’s investors, the difference between the market average and even slightly better returns over the long term can mean a much larger nest egg for a retirement that could last decades.


Do funds from certain managers offer something beyond the possibility of higher returns?


Index funds allow the opportunity to benefit when the markets are going up. However, by investing in index funds, you are also locking in all the market’s losses. Index funds may have their place, but they provide no buffer against down markets. Despite the trillions of dollars that have flowed into them, only about half of investors we surveyed last year are aware that index funds expose them to 100% of the volatility and losses during market downturns. Perhaps that’s unsurprising given the historic length of the US bull market. But markets turn. And doing better than the crowd in bad times is critical for investors seeking to grow their nest egg over the long term. Actively managed investments can offer the potential to lose less than index-tracking investments during market declines.


What’s your view on the value of professional advice?


Capital Group has long believed in the value that good financial advice can bring to help investors pursue their long-term investment goals. We believe advisors help motivate people to save and, perhaps most importantly, they can serve as a steadying hand during volatile times when human nature often drives investors to make decisions that wind up being counterproductive. In most cases, investors need to save more and stay invested, and advisors play a pivotal role in helping people do both of those things.