Kempen Insight July 2016 by Kempen publications

Kempen Insight /// July 2016

KLIK VOOR NEDERLANDSE VERSIE

KEMPEN

INSIGHT THE NETHERLANDS Focusing on the long term Silly season? US presidential elections The role of yields and transparency

Table OF of CONTENTS contents TABLE ‘There is no substitute for active investors who develop a deep understanding of businesses’ /// Interview with Dominic Barton, Global Managing Director at McKinsey & Company

4 GOV

ERN

KEMPEN EUROPEAN PROPERTY STRATEGY TRACK RECORD*

2015

2014

2013

2012

GTE

O HO

ND Quick visitPLto AFOEdinburgh

2 /// Meet the Kempen European small-cap team

2016

4,5jr

ANC

BER

EIKB

AAR

HEID

Looking right through real estate

/// New modus operandi yields greater insight

Among professors /// Inaugural speech of chief strategist – and professor – Roelof Salomons in words and pictures

Kempen Insight, July 2016

* Bron: KCM juni 2016

What explains the low volatility anomaly’?

Foreword

At the start of this year we anticipated a year of high volatility and little direction on the financial markets. So far, our predictions have proved to be highly accurate. As Ruth van de Belt rightly notes in her column, we are witnessing Brexit upheaval in the United Kingdom and presidential elections in the United States. The summer promises to be anything but dull for news. At Kempen Capital Management we are monitoring current events closely, and as always we look beyond our own national borders when it comes to economic trends. Yet we also take a good look at the Netherlands. Dominic Barton, Global Managing Director of McKinsey & Company and one of the people behind Focusing

If the price is right

Capital on the Long Term, says in our interview with

/// Relevance of cost transparency for UK and Dutch pension funds

him: ‘The Netherlands has a proud tradition of leadership on long-term investing and incorporation of environmental, social and governance.’ We are very pleased that he is participating in SHIFT TO Long-term

Books that inspire /// As selected by Evert Waterlander

Volatility on the horizon /// Politics could cause turbulence

Column Ruth van de Belt /// US summer spectacle

investing, the English-language newsroom where you will find the latest research and opinions on long-term investing. Someone else who intends to conduct a

lot of research into the long term and the effects on investment is our chief strategist Roelof Salomons. He was recently appointed Professor of

Investment Theory and Asset Management at the University of Groningen. This edition of Kempen Insight includes a report on his inauguration in

/// COLOPHON

pictures and words.

Juli 2016 ©Kempen Capital Management

In short: together with you, we

Editorial address Kempen Capital Management to: Secretariaat KCM Postbus 75666 1070 AR Amsterdam T + 31 20 348 8700 redactie@kempen.nl

Editors Ruth van de Belt, Lars Dijkstra, Anja Corbijn van Willenswaard, Evert Waterlander, Charlotte Wilberts

Collaborators PHOTOGRAPHY Johannes Abeling, Henrike Beukema, Getty, Mario Hooglander, Philip Jenster, Henk Veenstra, Laurence Winram TEXT Jos Leijen, Daniëlle Levendig, Bas Kooman, Stephanie Lewis, Lesa Sawahata

Kempen Capital Management is included in the register of the Netherlands Authority for the Financial Markets (Autoriteit Financiële Markten) as manager of investment funds and as asset manager. This information may not be construed as an offer and provides insufficient basis for an investment decision.

Art direction/design Henrike Beukema

remain alert to the short term and set our sights on the long term. I look forward to hearing your comments and suggestions on reading this Insight.

Lars Dijkstra Chief Investment Officer lars.dijkstra@kempen.nl

Kempen Insight, July 2016

/// by Lesa Sawahata Lphoto johannes abeling

‘We ne growing s As co-author of the seminal article ‘Focusing Capital on the Long Term’ (with Mark Wiseman), Dominic Barton of McKinsey & Company triggered the long-term investing discussion that is (slowly) gaining traction in global finance. In this Q & A interview, conducted with the editors of Kempen Insight, Dominic answers key questions regarding why – and how – the shift to longterm should be implemented, and how The Netherlands is already wellplaced to drive the FCLT agenda.

In your opinion, what changes must be made in asset management in the near future?

Interview Dominic Barton, Global Managing Director McKinsey & Company 4

Kempen Insight, July 2016

‘Asset management has a critical role to play in reorienting the investment value chain toward long-term value creation. First, asset owners and managers must reorient their portfolios toward longer-term performance, looking to asset classes and investments, like infrastructure, that provide long-term value, but may take longer to see returns.

eed to combat the short-term mindset’ To support these changes, asset managers

saw the growing costs of short-termism.

should align compensation and perfor-

I had spent over a decade living and

mance measurement with these longer

working in East Asia, where corporate and

time horizons – such as GIC’s (investment

investor timelines are far longer, and when I

corporation of the Government of

returned to living in London, I was

Singapore) policy to evaluate manager

surprised by how much pressure CEOs felt

bonuses on 5- and 10-year performance.

to demonstrate results in a matter of quar-

Furthermore, new benchmarks have a role

ters. We saw that this was destroying

to play in encouraging asset managers to

economic value, diminishing shared pros-

take a longer view and encourage compa-

perity among a broader set of stakeholders,

nies to adopt and showcase sustained value

and undermining trust in capitalism in the

creation plans. For example, the recent

wake of the financial crisis.

creation of the S&P Long Term Value Creation Index –and the strong interest in using

The initiative was launched – along with

the new benchmark – is a great step

Mark Wiseman from the Canadian Pension

forward.

Plan Investment Board, Larry Fink from BlackRock, Cyrus Mistry from Tata and

Finally, asset managers must devote more

Andrew Liveris from Dow – because we

time and resources to engagement with

believed that the issue needed more public

management teams and boards. There is

attention, more rigorous analysis, and

no substitute for active investors who

concrete action plans to help investors,

develop a deep understanding of busi-

executives, and boards combat the

nesses and promise support for long-term

growing short-term mindset.’

value creation. 64% of asset managers say their engagement with boards is increasing

What is the role of Dutch institutional

– and this is an encouraging sign.’

investors (pension funds) in the longterm debate?

The newsroom www.shiftto.org

What has been your motivation in

‘The Netherlands has a proud tradition of

facilitates the debate on long-term

launching the Focusing Capital on the

leadership on long-term investing and

investing. Here you can find

Long Term (FCLT) initiative?

incorporation of environmental, social and

articles, columns and research from

‘Along with our partners, McKinsey helped

governance factors, and it is a hub of

thought leaders from varied

to launch the FCLT initiative because we

leading pension players. For example, ABP

background and ages.

Kempen Insight, July 2016

/// tekst Xxxxx XXXXX foto xxx XXXXXXXXXXX

About Dominic Barton Dominic Barton is the Global Managing Director of McKinsey & Company. In his 27 years with the firm, Barton has advised clients in banking, consumer goods, high tech and industrial. Dominic leads McKinsey’s work on the future of capitalism, long-term value-creation and the role of business leadership in society, and is the author of more than 80 articles on related topics. This includes the article ‘Focusing Capital on the Long Term’ (co-authored with Mark Wiseman) and which sparked the ongoing FCLT discussion. Amongst his many board and advisory positions, Dominic is a member of the Canadian Prime Minister’s Advisory Committee on the Public Service, a Trustee of the Brookings Institution and a member of the Editorial Board of SHIFT TO, Long term investing.

Dominic Barton and Paul Gerla, CEO of Kempen Capital Management. KCM recently became a partner of the FCLT-initiative that was founded in 2013 by McKinsey & Company en the CCPIB (Canadian Pension Plan Investment Board).

was recently ranked by the Asset Owner

on these topics?) and the tenor of corpora-

results, and what value sacrifices they are

Disclosure Project as the 4th best instituti-

te-investor dialogue (e.g. are analyst calls

willing to make to meet short-term targets.’

onal investor in the world at managing

focused on minutiae over the next quarter

climate risk (and was by far the largest in

or truly strategic issues?). Long-term health

What do you find particularly important

terms of assets among the Top 10). Another

measures such as quality of talent pipeline,

and significant in such initiatives as FCLT

good example is PGGM’s active engage-

innovation rate, trust levels with key stake-

and www.shiftto.org ?

ment with the companies in its small-cap

holders, and resilience also need to be iden-

‘I am impressed by the breadth of interest

equities portfolio on long-term strategic

tified for each company.

in these initiatives. Despite the geographic

topics. Institutional investors elsewhere in the world need to consider the relevance of these approaches to their own strategies.’ How – and with what measurements – can you determine when long-term investing is a success? ‘Long-term investing is a notoriously difficult outcome to measure. However, there are several areas that are key indicators.

differences in business culture or regulation,

‘Despite the geographic differences in business culture or regulation, we find that shorttermism is of concern around the world’

First, and foremost, we can look to invest-

we find that short-termism is of concern around the world. Unlike many business associations, these efforts have attracted an incredibly diverse set of stakeholders across geographies and industries– from mining to consumer products and from hedge funds to government officials. In addition, I believe the practical orientation of these efforts is unique. While we are

ment returns for managers over horizons

At a systemic level, we can measure long-

interested in studying and diagnosing the

and whether asset owners are meeting their

term investing by the proportion of cash

issue, we have also worked collaboratively

most fundamental long-term objectives

flow and profits going back to investment

with members to create concrete action

(e.g. can pension funds meet obligations

(either in capital expenditure or R & D),

plans to pilot new approaches within

without taking undue risk?). Similarly, we

and unfortunately these numbers seem to

investment funds, boards, and manage-

can look at corporations and boards’ dedi-

be falling. Finally, we continue to conduct

ment teams. We hope that FCLT will

cation of time and resources to long-term

qualitative surveys of how much pressure

continue to take this action-oriented

strategy (e.g. how long are they spending

managers feel to demonstrate short-term

approach as we grow!’ 

Kempen Insight, July 2016

Edinburgh Castle

to castle rock Visiting the European small-cap team in Edinburgh

Karen McGrath, Vivienne Taylor, Erika White, Mike Gray, Tommy Bryson, Martin Stockner, Kathleen Dewandeleer. Mark McCullough (in-absentia).

SOLID FOUNDATIONS, BRIGHT FUTURE High conviction. Quality companies. ESG engagement. Kempen has been generating alpha in European small-caps from Edinburgh since 1997. Kempen Insight, July 2016

/// by jos leijen visual getty

Interest rate risk partially explains outperformance by low volatility equities

The role of interest rate Low volatility equities yield a higher return than might be expected based on their level of risk. Analysts call this the low volatility anomaly. Until recently, the explanation for this discrepancy was chiefly sought in investor and analyst behaviour. Yet interest rate risk also plays a significant role, according to investment strategist Ivo Kuiper at Kempen Capital Management.

Low volatility equities are equities that are

Investors seek higher returns and conse-

subject to relatively minor price fluctua-

quently tend to ignore low volatility equi-

In addition to his job as an

tions, without excessive outliers. They

ties. They prefer to gamble on earning a

investment strategist at

belong to low–risk sectors, such as utilities

high return and accept the risk that the

Kempen Capital Management,

and consumer staples. These companies

return may turn out lower. Another expla-

Kuiper is a part-time researcher

enjoy stable incomes and predictable earn-

nation is that analysts are over-optimistic

at Tilburg University. Kempen

ings. Dutch examples include Unilever and

about high volatility equities.

Capital Management and the

Ahold, or further afield Nestlé and brewer

These mechanisms probably do play a part,

university have worked together

Anheuser-Busch Inbev. Solid companies.

but according to Ivo Kuiper this is smaller

since 2011. Its Master’s

than has been assumed in the past.

students can complete their

Gamble

degrees at Kempen Capital

As long ago as last century researchers

Sensitive to interest rates

Management. Among other

discovered that low volatility equities display

As cashflows and earnings for low volatility

things, Kuiper is conducting

a better return than they ought to given the

equities are easy to predict, interest rates

research into the relationship

relatively low risk involved. The reason for

are important to determining the cash

between low volatility equity

this inexplicable outperformance was chiefly

value, Kuiper explains. If interest rates fall,

prices and interest rate trends.

sought in analyst and investor behaviour.

the future earnings are worth more.

Kempen Insight, July 2016

If interest rates rise, these equities become

play a role, but a smaller one than has

What is more important is that investors

less interesting. This effect can be

previously been assumed. We also see that

take the interest rate effects on low volati-

compared to the value growth of bonds.

the reward for interest rate risk is relatively

lity equities into account in their investment

“The more easily earnings can be

high. Further research should reveal the

strategies, Kuiper says. “Say that your

predicted, the more sensitive the equities

reason for this. We do not yet understand

strategy involves your portfolio containing

are to interest rate trends. Yet if this is the

everything.”

one third equities, one third bonds and one

case, you should also expect to receive a

third other securities. In this case, you need

reward for the interest rate risk. After all, if

Caution

interest rates rise, the future earnings and

Over the past few years, low volatility

move more in line with bonds than other

due dividends will be worth less in relative

equities have profited more from the

equities do. You therefore hold a higher

terms. The research I have conducted

declining interest rates than other equities.

interest rate risk in your portfolio.”’ 

together with Master’s student Robbert

Kuiper predicts that low volatility equities

Beilo demonstrates that this effect does

will underperform when interest rates rise.

exist.”

As Kempen Capital Management expects

The interest rate effect explains part of the

interest rates to rise in the long term, we

low volatility anomaly, but not all of it.

are cautious about recommending this

Investment Strategist

“The behaviour factors undoubtedly also

strategy at the moment.

ivo.kuiper@kempen.nl

to be aware that low volatility equities

Ivo Kuiper

Kempen Insight, July 2016

/// by Roelof salomonsâ&#x20AC;&#x192; photo henk veenstra

Predicting

On investment theory and asset management Noise in the data, the latest crazes.... In the short term, investment is speculation. In the long term, however, predictability can work in your favour, Roelof Salomons argues in his inaugural speech as Professor of Investment Theory and Asset Management at the University of Groningen. 10 Kempen Insight, July 2016

returns Rector Magnificus, esteemed guests, Each year, I play a variant of the beauty contest as described in such lively terms by John Maynard Keynes (1936) with my students. The idea is to get everyone in the lecture theatre to write down a number between 0 and 100, whereby the winner is the player with the number closest to 2/3 of the average. As all the players possess all the information and are completely rational, there is only one ‘correct’ number: 0. Unfortunately, it doesn’t work like that. Most players start by randomly choosing a number from the set (50) and then think one step ahead (33). Step 2 thinkers end up at 22, while those who think one step further name the number 15. And each year I have a few students (mostly those with quantitative backgrounds) who then go through all the steps and come up with 0. The game shows all too clearly that it’s not about who is ‘pretty’ but about the expectation of what the consensus considers to be ‘pretty’. The same goes for modern investment practice. It is not so much about the predictability of earnings, growth and discount rates, but rather about ‘predicting’ what others expect of them: it’s all about ‘predicting’ market psychology. In this case investment becomes speculation, and the short term cannot be predicted.

Noise dominates the short term The latter becomes clear if we analyse time series of financial assets over different horizons. Smith (1924) and Siegel (1998) demonstrated many years ago that investors require a great deal of patience. In the long term, equities outperform bonds and there is a lower risk of a negative return. You can depict this graphically using moving average yields as shown in figure 1.Yet there is more. The longer the investment horizon, the more ‘normal’ the distribution of the returns. In the short term, noise has the upper hand and predictions are difficult. The opposite applies to the long term.

* This article is a highly-abridged version of ‘Beyond the noise – on investment theory, towards long-term asset management’, the inaugural speech given by Roelof Salomons on 14 June 2016 on acceptance of the Professorship of Investment Theory and Asset Management. Read the unabridged inaugural lecture on www.kempen.nl

Kempen Insight, July 2016

Figure 1 Moving average yields

% 100

% 20 15

50 10 5

0 -50 -5 -100

1872

1892

1912

1932

1952

1972

1992

Sources: Shiller and Standard & Poor’s

12 Kempen Insight, July 2016

2012

-10

1881

1901

1621

1941

1961

1981

2001

2011

The top graphs show the real total returns (adjusted for inflation and including dividends) on equities over 1-year and 10-year periods. The data period is 1871 – 2015. The monthly data for the S&P500 index, a market capitalisation equity index, come from Shiller and Standard & Poor’s. The bond market data are from Global Financial Data and Bloomberg.

Figure 2 Price/earnings (P/E) ratio

50 40 30 20

The graph depicts the CAPE (cyclically-adjusted price earnings) for the S&P500. Here, prices are divided by the reported earnings over the past ten years, filtering out the effect of the economic cycle on the valuations. The data period is 1881 – 2015. The monthly data for the S&P500 index, a market capitalisation equity index.

10 0

1872

1892

1912

1932

1952

1972

1992

2012

Source: Shiller

Predicting returns Over the last two decades it has become clear that returns can be predicted to a certain extent based on valuation criteria. Campbell and Nobel Prize winner Shiller (1998, 2001) were the first to demonstrate this. In my own doctoral thesis (Salomons, 2005 - Ed.), I show that the value - ranking prices based on underlying fundamental indicators such as earnings (Figure 2) - at the time of purchase is a sound indicator of future returns. The predictability derives from the ‘reversion to trend’ in the valuation variables. If P/E ratios revert to trend, this may be due to changes to the price, the earnings or a combination of the two. This is worth remembering. As a lecturer this is when I say to my students: “I would make a note of this.” High valuations go hand-in-hand with low expected returns and vice versa. There is predictive value in the long term. There is no relationship in the short term between current valuations and future earnings or future returns. In the short term there is noise. Yet this relationship does exist in the long term, but only for future returns. Valuations tell us nothing about future earnings. P/E ratios revert to trend, but it is the prices that prompt that reversion to trend. So if as an investor you cherish the hope that although current valuations are on the high side this means that earnings will grow more quickly in future, I’m afraid you are hoping in vain. Figure 3 demonstrates this.

Improved investment within markets A long-term investment horizon therefore helps us to predict the returns on a market index. It is also beneficial to seeking returns within asset classes, in the cross-section. I will quickly lead you through the literature on the subject. The Capital Asset Pricing Model (CAPM) was created in the 1960s. In it a single factor, the beta of the equity, or the correlation between the equity and the general equity index, determines the risk and expected return. By the time I graduated in the late 1990s, two additional factors were generally accepted. Nobel Prize winner Fama and French (1993) described how small companies (size, measured by market capitalisation, small minus big or SMB) and cheap companies (value, measured as book-to-market value, high minus low or HML) also explain the cross-section of returns. The momentum (momentum, measured as the difference between returns over the past year, winners minus losers or WML) effect of Jegadeesh and Titman (1993) and Carhart (1997) was added later.

Kempen Insight, July 2016

Figure 3 Relationship between current valuations and future returns

% 100

% 20

-50

-10

-100

-20

% 100

% 20

-50

-10

-100

-20

The top graphs show the relationship between the CAPE (cyclically-adjusted price earnings) on the x-axis and the corresponding 1-year and 10-year real total return (adjusted for inflation and including dividends) on the y-axis. The bottom graphs depict the relationship between the CAPE and the corresponding 1-year and 10-year earnings growth.

The data period is 1881 â&#x20AC;&#x201C; 2015.

Sources: Shiller and Standard & Poorâ&#x20AC;&#x2122;s

These are the factors about which there is a general consensus. The academic and financial worlds have not stood still since then. In a recent article, Harvey, Liu and Zhu (2015) discuss the more than 300 different factors that have since been tested and are supposed to lead to improved investment results. Yet the statistical relevance of a positive result needs to be viewed with some scepticism, especially if several strategies are tested simultaneously. In Figure 1 you saw that investors in equities need a great deal of patience. The same applies to the underlying factors in the equity market. There are long periods in which factors do not work. Time is a restrictive factor.

Predictable additional returns By introducing the correct long-term exposure within their portfolios, investors can therefore earn a higher than average return. Yet, as is the case with equity risk premiums, these premiums are not stable. This immediately begs the question of whether it is possible to predict these premiums. In my humble opinion, the answer is: yes, although research into this is still in its infancy.

14 Kempen Insight, July 2016

Roelof Salomons, prior to this inaugural lecture, in the senate chamber at the University of Groningen.

Allow me to conduct a thought experiment. If the P/E ratio of the equity index is a sound predictor of the future return on that index, is the relative P/E ratio of a factor a sound predictor of the future return on that factor? If cheap/value equities are valued as extremely cheap versus expensive/growth equities, is there then a greater chance of value performing better in future? And can small caps become so expensive that the size factor yields less than the historical average? I think so.

Key question in the short term As we know from the theory that returns at market level and within markets are predictable in the long term and we know that the liabilities of institutional investors are of a long-term nature, why is there then so much emphasis on the short term? Or to go back to Keynesâ&#x20AC;&#x2122; beauty contest: why is there such a focus on the latest psychological craze? I want to make the case for reverting to investment based on fundamental analysis and placing less emphasis on indices. A case for the long term and for investors in their role as providers of capital. There is also the aspect of social relevance here. Traditional portfolio theory has brought us many wonderful things. Yet if you want to exaggerate you could say that when major institutional investors allow themselves to be guided completely by the index they then surpass their role as providers of capital. Investment is more than just numbers in a spreadsheet.

I have said. Kempen Insight, July 2016

Johan Cras on cost transparency

If the price is right Johan Cras is ideally placed to discuss the strengths of the UK and Dutch ‘cultures’ in his position as Managing Director of Kempen’s London based business given his experience working in both financial markets. In this Q&A, he offers his perspectives on why cost transparency – an important and specific focus of Dutch funds – should matter to the UK.

16 Kempen Insight, July 2016

/// by lesa sawahata photo pmi/tv

Johan Cras stresses the importance of cost transparency during an interview with PMI-tv.

What in your opinion are the big differences

So why is cost transparency relevant?

between UK and Dutch pension funds?

‘Ultimately it’s about good value for money. Are we paying a

‘What I like about working in the UK pension market is this

‘fair’ amount of money given the return ambitions that we have

notion that people invest with ambition. It’s the ambition to

as a scheme?

effectively give a pension to members which is geared towards

So the first element is to understand whether what you’re

a real income rather than a nominal income - and the diffe-

paying is a fair price. This is not a game about ‘the good, the

rence between the two is the inflation rate. And although infla-

bad and the ugly’ – this is about whether you’re paying the

tion is very low at the moment, we do believe that in the longer

right price, given your investment ambitions.

term it has an enormous impact on what people can actually

The second element is that every pensioner pays premiums for

spend their pension on. The longer term focus on investments

his pension, and I think there’s a fiduciary duty - not only for

provides greater opportunities to realise a

the providers but also for the trustees - to

pension with real value. UK pension

understand what specific amount of money,

schemes are much more focused on providing that real income than Dutch pension schemes. So that would be a plus for the UK.’

And in the Netherlands?

‘We feel very strongly about transparency’

given those premiums, is paid to the different providers. Once you understand what’s being provided you can also start to judge whether what you’re paying is the right price for the service provided and potentially make some adjustments there. It seems prudent that the

‘In the Netherlands, people are more

ultimate owners of the assets - the members,

geared towards answering the question

and the trustees on their behalf - know who,

‘how’- how we do things rather than a single sided focus on

how and where money being is made from these assets. This is

what the outcome is. Investment is a profession which is pretty

one of the few industries where customers are not allowed to

difficult in terms of garanteeing outcomes, and so in the

know what the price of their services is.’

Netherlands we’ve gotten used to defining prudency as process rather than just outcome. From my point of view we would

What should the UK be doing to start organising

encourage UK schemes to spend a bit more time on finding out

itself for greater cost transparency?

how things are being done rather than just focusing on the

‘First start with raising the question; make sure that every time

outcome.

you meet with the provider you raise the question about fees. And then the second stage is to ensure that you understand

Another thing where I think Dutch funds have really progressed

what you hear back - and if you don’t, raise the next question.

is this cost transparency issue. A lot of effort is being made by

The final question should be ‘Can you confirm that there are no

the industry to make sure that people understand what costs

other costs involved? That there are no costs or fees being

are being paid to whom, and with what ambition in mind.’

charged against these assets?

Kempen Insight, July 2016

In raising questions you make it clear to the provider that this is an issue which is important and on your agenda; that you truly want to understand what’s happening, who’s earning what for what purpose and what the benefit might be. As mentioned earlier it’s not about the good, the bad or the ugly, it’s understanding whether given your investment ambitions, you pay the right price for the services you’re getting.’

Is there practical guidance you provide to pension schemes to address this challenge? ‘At Kempen we have developed a document that we refer to as a ‘Heath Check’, a document that trustees find very useful. The objectives of the ‘Health Check’ is to draw out key points of

pensions management institute

note – looking at all services provided and both the implicit and

The Pensions Management

explicit costs/charges, then to present what these findings mean

Institute (PMI) is the UK’s largest

for the pension scheme and suggest areas for improvement.

and most recognisable professional

The benefits of this approach is that the scheme, in a timely

body for employee benefit and

way, gains insight in their current approach to investments, it

retirement savings professionals,

enhances their understanding of what’s being paid for thus

supporting over 6,500 members.

improving transparency, they will see their costs being

PMI have partnered with firms in

compared to the existing investment strategy and compared to

sectors relevant for the industry to

alternatives, putting them in a better position to evaluate and in

provide knowledge and thought

some cases rethink their strategy or the fees paid.’

leadership in their respective areas. Kempen is the PMI Expert Partner

Any further advice about how to get beyond the

in the area of Fiduciary Manage-

current challenges around cost transparency?

ment. PMI recently interviewed

‘There’s relatively little availability of cost transparency informa-

Johan Cras, Managing Director at

tion at the moment, and we would urge everybody – together

Kempen, to discuss the main chal-

- to raise questions around that.

lenges for UK pension schemes,

One of the things we would encourage UK plans to do is to take

preparing the UK for cost transpar-

this on in collaboration with each other; form a group of people

ency and the future of fiduciary

who together will start raising those questions as an industry,

management.

rather than as an individual scheme. We would certainly support an initiative from UK schemes to collaborate on cost transparency. We feel very strongly about transparency.’ 

18 Kempen Insight, July 2016

www.pensions-pmi.org.uk

A behind-the-scenes look at pensions

Banks as the Achilles heel of the economy

This is the fourth book by Canadian pension guru Keith Ambachtsheer in

A former governor of the Bank of

barely twenty years. This time he

England who chooses the title ‘The end

reviews trends in the pension sector in

of Alchemy’ for his book on money, the

different countries since 2008. The

role of the banking system and how

book provides evidence of the high

our economic future depends on these

dynamics in this sector and of the tough challenge of maintai-

is guaranteed to capture our attention. Don’t expect any

ning an affordable and reliable pension system. For pension

memoirs: this is an experienced expert’s reflections on the

industry leaders, the trick is to apply an integrated strategy to

financial system. On the basis of long-term economic trends,

the pension system, the governance model and their invest-

King concludes that banks are not fulfilling their role of drivers

ment convictions. Ambachtsheer discusses several aspects of

of economic growth. Banks earn money by creating money

each of these areas. Sometimes using academic research, some-

through the confidence placed in them: alchemy. Yet this acti-

times by taking a look behind the scenes at a prestigious

vity makes banks the Achilles heel of our economy at times of

pension fund. Each chapter closes with practical and feasible

crisis. As a result, capitalism experiences frequent and long

policy options which often merit classification as best practices.

periods of economic stagnation. Central banks can steer the

Title: The Future of Pension Management Author: Keith P Ambachtsheer Publisher: Wiley ISBN: 978-1-119-19103-2

economy less well than they think at such times. Just look at the persisting moderate economic growth since 2008, in spite of large-scale, global quantitative easing. We need a new vision for the role of banks. Like other policymakers, King also points to measures that allot a central role to maintaining confidence in

The excessive power of shortterm investors

the banking system. For commercial banks, that may well be more important than being an alchemist.

How is it possible that a deliberate stra-

Title: The end of Alchemy Author: Mervyn King Publisher: W.W. Norton & Company

tegy to increase shareholder value over

ISBN: 978-0-393-24702-2

the past few decades has gone hand-inhand with lower economic growth rates in the Western world? Masouros demonstrates that changes to corporate law aimed at encouraging the free movement of capital have simultaneously – and partly unintentionally – increased the power base of investors with a short-term focus. This book posits a post-Key-

BOOKS TO INSPIRE

nesian theory: these investors are ensuring that these companies have less capital available for investment, which is in turn affecting future growth. Masouros illustrates his theory using several case studies and international comparisons. Amendments to corporate law that give greater weight to longterm interests could play a role in achieving economic growth. Take situations involving weighing up stakeholders interests to the disadvantage of shareholders, or moving away from the principle of equality between shareholders. After all, the interests of shortterm investors differ from those of loyal long-term investors. Title: Corporate law and economic stagnation Author: Pavlos E, Masouros Publisher: Eleven International Publishing ISBN: 978 – 94-90947-8

Evert Waterlander is Director Client Solutions at Kempen Capital Management. He selects for Kempen Insight books on investing. evert.waterlander@kempen.nl Kempen Insight, July 2016

/// by jos leijen visual henrike beukema

See through real estate Kempen Capital Management has a unique system for determining the value and quality of property companies. This enables the Real Estate team to take well-founded investment decisions. Clients consequently obtain greater insight into their investments.

‘There are several different methods for

it is properly programmed. With the help of

This is how we decide whether or not to

deciding which property funds to invest in,’

the team we worked out different scenarios

select a property investment fund.’

Head of Real Estate Matthijs Storm explains.

and inputted these into the platform. This is

This strategy yields benefits for Kempen & Co

‘You can allow yourself to be guided by

how we achieve data-based property invest-

clients. To start with, there is the sound return

macro market data, or you can examine the

ment, as rationally as possible.’

(January 2012 – April 2016, compared to the

underlying information on the property

Apart from the platform itself, the information

FTSE EPRA NAREIT DEVELOPED EUROPE

investment funds and their properties. We

it contains also needs to be reliable. ‘We have

INDEX). ‘We have applied our strategy for

apply the latter method, bottom-up.’

selected our sources with great care. From

four and a half years now, the past eighteen

Kempen Capital Management Real Estate has

time to time we test their reliability, for instance

months as a global strategy,’ Storm continues.

developed a digital platform containing

by personally visiting a shopping centre that

‘Each year we have succeeded in earning an

information on about 300 listed property

our source tells us has high-quality tenants.

above-average return. On average, the return

investment funds in which it can potentially

This allows us to obtain an accurate picture.’

is 200 basis points higher than the bench-

invest. The data are derived from various

mark.’ (The value of your investment may

companies themselves, Kempens own

Identifying undervalued funds

research and information purchased from

The bottom-up strategy applied by Storm

specialist providers.

and his team also enables them to identify

Transparency

undervalued investment funds. ‘There are

Another benefit is that Kempen & Co can

sources, such as information provided by the

Chess computer

fluctuate. Past performance provides no guarantee for the future.)

different types of investors in the real estate

very easily explain the reasons behind invest-

Our proprietary data infrastructure processes

market, which results in inefficiencies. We

ment decisions. ‘The real estate market is by

the information and supports the deci-

assess the ratio with respect to the price and

its very nature highly opaque. We provide

sion-making. ‘You can compare it to a chess

quality of the real estate. For example, we

complete transparency about what we do

computer,’ Storm says. ‘It is important that

examine the debt position and rental income.

and why we do it. We can show clients the

20 Kempen Insight, July 2016

GOV

ERN ///A tekst Xxxxx XXXXX foto xxx NGXXXXXXXXXXX NCE EILI C M MU AXI M CO2 CO MM UT IN G DIS TA NC E

KEMPEN EUROPEAN PROPERTY STRATEGY TRACK RECORD*

2012

2013

2014

2015

2016

4,5yr

* Source: KCM June 2016 The digital platform contains information on about 300 listed property investment funds.

underlying data and explain how we reached our decision.’ Client can also stipulate specifications for their investments. ‘For instance, pension funds want to know the CO2 emissions for their portfolio. We hold all the data relating to buildings and property companies and their CO2 footprint. We can provide all kind of detailed information on the sustainability of the investments.’

Accountability

‘We can provide all kind of detailed information on the sustainability of the investments’

come down to the best-possible combination of objective information and instinct. I think we are very good at that. We believe the strongest combination is the chess computer and human input.’ 

days, you arrange your holiday yourself on booking.com and other websites. We offer

Another issue is that pension funds have to

our clients the same level of transparency. We

answer to their regulatory authorities in rela-

arrange everything for them, but they have

tion to various aspects of their investments,

precise insight into what we do.’

such as exposure to debt. ‘Real estate invest-

centres? Ultimately, structured decisions

ment funds finance part of their assets with

Best-possible combination

debt capital. We know the financial leverage

Does this mean there is no longer any room

of each fund in which we invest.

for instinct and experience in investment? ‘Of

‘It’s just like when you used to go to a travel

course there is,’ Storm insists. ‘We cannot put

agent and you sat staring at the rear of the

everything in terms of data. What does the

Matthijs Storm

computer screen waiting to be told how

shopping centre of the future look like? And

Head of Real Estate

much your holiday was going to cost. Nowa-

what does this mean for today’s shopping

matthijs.storm@kempen.nl

Kempen Insight, July 2016

Volatility on the horizon

Valuations form the basis for investment decisions taken by investors with a longterm outlook. With valuations aboveaverage levels for several years now, investment strategist Marius Bakker argues in favour of selective risk-taking. 22 Kempen Insight, July 2016

For some time now, financial market valua-

Emerging markets

tions have been significantly higher than

We see selective opportunities for the

the long-term (10 years or more) average

equity markets, chiefly at regional level.

across virtually the whole investment spec-

After a volatile first quarter, the stock-

trum. We do not view this as a stable situa-

market has calmed down again some-

tion in the long term and anticipate that

what. While sentiment was recovering,

valuations will be lower. During this period,

however, prices once again started to rise.

we are being cautious about taking risk and

Although valuations became slightly more

believe capital retention to be at least as

attractive during the turbulent start to the

important as the return on capital.

year, we are seeing them increase again

Yields are at historically low levels thanks to

now that the market is calming down

the repeated intervention of central banks.

again.

An increasingly large portion of the

For some time now, we have been selective

outstanding sovereign debt offers no yield

about risk-taking in those markets in which

at all, and sometimes even a negative one.

the reward for this is marginal. Moreover,

This has driven investors towards riskier

our fundamentals that form the basis for

investment classes, such as equities and

our expected returns deteriorated in the

credits, blowing valuations up even further.

first quarter of 2016. Corporate results and

Credit spreads are the most obvious

margins are being squeezed in all the major

example from the past few months. The

economies. On the other hand, we have

ECBâ&#x20AC;&#x2122;s latest package of stimulatory meas-

seen yields fall further, especially in the

ures â&#x20AC;&#x201C; they are now also buying corporate

Eurozone. We believe that premiums on

bonds - has placed further pressure on

European equities still offer sufficient

credit spreads in the European market.

compensation for the higher risk compared

Hence lending to large corporations is not

to government bonds. Emerging market

rewarded in terms of risk. In our opinion,

equities are the most attractive option in

investors are no longer sufficiently compen-

the equity universe with respect to valua-

sated for the higher credit risk compared to

tion, but at the same time they are the risk-

government bonds.

iest. In spite of this, in the wake of years of

Expected vs required return

Expected return

EM EQUITY

8 6

EU EQUITY HIGH YIELD

US EQUITY 2

US GOVERNMENT BONDS EUR CREDITS EMU BOND

0 1

5 6 7 Required return

The solid line shows where the required return is equal to the expected return. The dotted line shows that the slope of the line connecting expected equity and bondreturns (the risk premium) is still the same, but that expected returns are lower.

Source: Kempen Capital Management - 31 May 2016

economic headwinds, we currently see

Political unrest

folioâ&#x20AC;&#x2122;s total risk without significantly redu-

the greatest opportunities for growth in

The shrinking pool of attractive options

cing the total expected return. At current,

emerging markets. Yet the course of the

within the usual investment universe makes

historically-low yields, the opportunity

recovery depends on the growth of the

it interesting to look at alternatives. One

costs (what is the value/what are the costs

Chinese economy and the upturn in

important aspect in relation to alternatives

of the best non-selected alternative) for

commodity prices: two themes about

is their low correlation to other positions.

diversification are also lower. We only need

which we are not particularly positive.

The diversification effects can cut the port-

to relinquish a marginal return if we include alternatives in the portfolio. The market is highly likely to become more volatile in the second half of this year.

Why valuations matter

Political trends in both Europe and the US are dominating the markets. At the same time, economic growth in the developed

The framework we use at Kempen Capital Management for valuing individual asset

world is displaying the first signs of fatigue,

classes is based on the most important assessment we make as an asset manager: the

which raises doubts as to the interest rate

trade-off between risk and return. The return on an investment needs to provide

path to be pursued by central banks. As

sufficient compensation for the relevant risks we run. We expect the market to price

each of these factors has the potential to

investments correctly in the long term and therefore offer a realistic reward for risk.

shake up the markets considerably, our risk

If the expected return on an investment is too low in relation to the probability of the

attitude remains neutral for the time

invested capital not growing or even incurring a partial loss, we view that investment

being. ď Ž

as unattractive. In our opinion, an investment class is valued neutrally when the expected return is equal to the return we require. Fluctuations in economic trends or market sentiment can cause markets to deviate for short or longer periods from what we view as a neutral valuation. Yet when the investment horizon is long enough, we expect the valuation of an investment to revert to the neutral zone. Although these fluctuations may be the main drivers for return in the case of a shorter investment horizon, valuations are the dominant factor when we examine the long term.

Marius Bakker Investment Strategist marius.bakker@kempen.nl

Kempen Insight, July 2016

24 Kempen Insight, July 2016

/// visual PHILIP JENSTER

US spectacle with repercussions Summer is usually the silly season for

stay as it is has deeper economic

news. Yet this summer proves to be

causes. Over the past decade, income

anything but dull. We have the US

inequality in the US has increased

political spectacle to entertain us.

further. The average household

Donald Trump and Hillary Clinton are

income has fallen, partly due to job

expected to battle it out for the key to

losses in industry. These job losses can

the White House on 8 November.

in turn partly be attributed to US

Trump is like a bull in a china shop. He

trade policy, for example with China.

couldnâ&#x20AC;&#x2122;t care less about the unwritten

It is no coincidence that Trump

rules of conducting a campaign,

strongly opposes free trade agree-

adopts politically incorrect stances

ments. The changing political climate

and is not afraid to pick a fight with

has also prompted Clinton to reverse

everything and everyone. In doing so,

her support for the Trans-Pacific Part-

against the expectations of the elite,

nership. Greater protectionism, which

he knows that he appeals to a section

cannot be ruled out under either

of US society. He is harnessing the

Trump or Clinton, is bad news for

anger and frustration felt by part of

multinationals that rely on internati-

the population and convincing them

onal trade.

that someone is finally listening to

Yet the US presidential elections not

them, whereas they often feel the

only have a high entertainment factor,

ruling elite fails to take them seriously.

they are also important from an invest-

This is an issue that has long been a

ment perspective. What will the political

problem in Europe.

manifestos look like? This, and therefore

This is an indication that the populism

the impact on individual asset classes,

in the US will not simply go away.

should become clear over the coming

Even if Trump fails to win the US presi-

months. One thing is certain: it will be a

Ruth van de Belt

dential elections (as we currently

politically hot summer on the other side

Investment Strategist

assume), the phenomenon is here to

of the Atlantic. ď Ž

ruth.vandebelt@kempen.nl

Kempen Insight, July 2016

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