natixis asset management workshop n°5
Will we see a zero interest rate policy in Europe in 2009? What would be the consequences for investments? What will be the magnitude of interest rate cuts? Over what timescale? What will be the consequences for money market and bond fund management? What are the potential strategies to deploy? These are just some of the issues addressed during the 5th Natixis Asset Management Workshop held on March 18 and attended by 185 clients. Natixis AM CEO Pascal Voisin introduced the event, which also saw the participation of Philippe Zaouati Head of Business Development, Philippe Waechter Chief Economist, Alain Richier Head of Money Market, Ibrahima Kobar Head of Fixed Income and CDO and Franck Nicolas Head of Global Asset Allocation & ALM.
"In an attempt to contain the crisis, some months ago the United States began to implement a zero interest rate and asset purchase strategy (quantitative easing(1)). Will the ECB follow suit and cut rates aggressively? What might be the timescale for this? The response to these questions is key when it comes to deciding where to invest and the strategies to deploy. In order to stimulate activity and restore confidence, the central banks have adopted a strategy involving both lower interest rates and liquidity injections known as “quantitative easing�. These measures are ongoing. The scale and timing of future interest rate cuts in the euro zone will clearly be critical when selecting investments and strategies in coming months. In its capacity as an asset manager and the leading money market fund manager(2), Natixis Asset Management is well aware of the concerns this may raise for its clients. This is why such issues have been the focus of our thinking for the past few months and Pascal Voisin, CEO the reason we chose this theme for our Workshop. Our range has been remodeled and rationalized as a part of this process. We have repositioned our products so as to tailor them as closely as possible to the new market environment and to the specific needs of our clients, thereby anticipating the new AMF regulations. We have extended this review to our bond funds in revising the strategies implemented and in offering new products, notably aimed at taking advantage of the opportunities in the corporate bond market. This responsiveness underpinned the strong performances recognized recently in the "Le Monde Eurofonds-Fundclass 2009" Grands Prix, which ranked us the no.1 French and European asset manager for consistent performance across our funds range over the past four years. March 18, 2009 (1) Quantitative easing: strategy aimed at increasing the monetary aggregates when interest rates are very close to 0% and can go no lower. (2) No.1 in money market fund management in France according to EuroPerformance as at 12/31/2008 and No.2 in Europe according to FeriFund Market as at 12/31/2008.
www.am.natixis.com
1
hop s k r t wo
natix
et s s a is
en m e g ana
m
The economic outlook Philippe Waechter Chief Economist "The ECB could cut its policy rate to 0.75% or even 0.50% between now and June"
Recent developments: a negative shock, with a simultaneous and profound impact on the global economy Since the fall of 2008, the activity indicators have plummeted. Industrial output and exports have gone into sudden freefall. An economic downturn is simultaneously being witnessed in all world regions. All these factors characterize the deep recession affecting the global economy. The fall acceleration was the result of the uncertainty prompted by the decision to allow the collapse of Lehman Brothers.
given the lag in labor market adjustment in Europe, this is set to continue. These trends will undermine domestic demand, limiting the ability of economies to recover.
The negative shock spread to the rest of the economy, dampening investment and employment levels. The uncertainty has led to cutbacks in investment, while lower activity levels are causing jobs to be lost. In the US, job destruction is on a scale unprecedented since the end of the Second World War. In Germany and France, the deterioration in activity indicators is already being seen in a significant rise in unemployment, and
n In China, a very significant country given its growing role in the global economy, a trend reversal could take hold, reflecting the impact of the aggressive policies aimed at supporting domestic demand.
However, the business leaders who in late 2008 only saw economic meltdown, whatever their location, now hold more differentiated views.
n In the United States, activity remains lackluster but business leaders no longer see a further deterioration. While numerous sources of uncertainty and concern persist, expectations are stabilizing at a very low level
Perception of activity by business leaders
n In Europe, on the other hand, a further downturn is seen for early 2009, particularly in France. Domestic activity continues to deteriorate, while trade with the rest of the world is declining. This is prompting drastic downgrades in growth forecasts for the current year. In keeping with this outlook, the ECB continues to adjust its forecasts and currently sees a contraction for GDP of -2.7% in 2009, followed by zero growth in 2010. It also expects a significant fall in the inflation rate to 0.4% for 2009 and 1% for 2010 - way
Sources: Datastream, Natixis Asset Management calculations
www.am.natixis.com
2
hop s k r t wo
natix
et s s a is
en m e g ana
m
below its target level (2%). To move towards this inflation target it must stimulate the economy by reducing its policy rate so that the real interest rate (the nominal interest rate minus the inflation rate) is as low as possible. With the prospect of inflation at 0.4% in 2009, we should very rapidly see rates cut towards 0.5%, probably between now and June. Such a move would also limit the acceleration in the growing disparities between European countries. The ECB is likely to launch a policy of purchasing government securities (quantitative easing) before long.
Is there a risk of the euro zone imploding? The euro zone is currently being impacted by negative asymmetric shocks to which no collective response has yet been forthcoming. These shocks vary in nature depending on the country. In Ireland and Spain, the problems are associated with real estate. Austria is encountering difficulties inherent in its links with Eastern Europe. At the same time, Germany has to contend with a sudden collapse in exports and France with falling domestic demand. The weaknesses of the bank sector are compounding the situation pretty much everywhere. To date, no consistent, coordinated and cooperative response has been advanced to deal with such challenges. This lack of intervention of a more ‘political’ nature is one of the major weaknesses of the European project. However, the risk of implosion in the euro zone is small since the collateral damage would be catastrophic and all the participants would be losers: for each member country, adjustments would likely to take place principally vis-Ă -vis its neighbors and euro zone partners.
www.am.natixis.com
3
hop s k r t wo
natix
et s s a is
en m e g ana
m
Money markets: the issues Alain Richier Head of Money Market " The high level of credit spreads will offset the fall in key interest rates." The ECB’s current cycle of interest rate cuts is compatible with the targets set for it by the Treaty instituting the European Community. Inflation should remain well below its 2% target both in 2009 and 2010. Furthermore, since market regulation in the event of major malfunction is now clearly part of its mission (as with the Fed), management of the current crisis necessarily requires very low interest rates. This will help recreate appetite for risk, the crucial condition for a return to normal credit market functioning. Currently, an overnight rate(3) of close to 0% is clearly not expected by the market (c.f. the level of one month to one year OIS(4) rates), even though investors are revising down their forecasts. Having expected, a matter of weeks ago, Eonia to bottom at 0.85% at the beginning of the third quarter, they are now seeing this figure at closer to 0.70%. Similarly, they now only forecast a return to 1% plus in 2010 as opposed to late 2009. In any event, the fall in interest rates is unlikely to be accompanied by an easing in credit spreads; these will probably remain high given that the banks are still struggling to raise liquidity (particularly over three months) and the deterioration in economic activity which will now impact corporate balance sheets. The continued high credit spreads, even for short
maturities, will be a source of value added that will partly offset the low level of market rates, without necessarily increasing risk. It is still possible for investors to acquire bonds whose issuers are identified as reliable, while still benefiting from attractive spreads. In addition, the outflow risk (witnessed, for example, in the United States during the period of low interest rates between 2003 and 2004) is limited given the persistent investor aversion to any type of risk: better a low or even very low return, than any level of loss. Within this context, we also recommend extending investment maturities, on a highly selective basis, to take advantage of the high spreads offered on ‘secondary’ bonds with maturities of six months to two years, given the illiquidity in the credit markets. Investors should therefore undertake prior in-depth analysis of their asset/liability constraints in order to identify specific investment horizons by ‘maturity tranches’. They also need to be selective in terms of issuer given the damage the uncertainties of the crisis could cause to financial positions. In addition to overnight deposits, we favor, subject to certain limits, fixed income products within the money market management strategy, in order to lock in the level of return.
(3) Overnight rate: the rate at which banks borrow from one another. (4) OIS: Overnight Indexed Swaps.
www.am.natixis.com
4
hop s k r t wo
natix
et s s a is
en m e g ana
m
Bonds: the opportunities Ibrahima Kobar Head of Fixed Income and CDO "There are investment opportunities in short-dated government bonds, but also in government-guaranteed debt, corporate bonds (excluding subordinated debt and cyclicals) and in absolute return products." We believe there is room for upside on bonds due to the fall in interest rates. Currently, the market is not fully pricing in the risk of deflation in the euro zone. It sees key interest rates at between 1% and 1.25%, whereas our expectations are lower for the end of the second quarter. Similarly, in our view the yield curve has steepened excessively, especially in the United States, given the growth outlook. We believe that the curve will flatten. The widening in inter-country spreads offers some attractive investment opportunities, as the fundamentals and public deficits do not justify such high spreads. Additionally, in terms of carry, we recommend playing the tightening at the short end of the curve Security selection: n Government bonds We prefer government bonds and government-guaranteed debt. However, there is an issue with these securities: their scarcity given that market players have become extremely keen on this type of debt since the Lehman Brothers collapse. We are, however, cautious on the EIB and CADES agency given the high level of issuance to come. Similarly, we consider it too early to switch into inflation-indexed bonds (an asset class from which we made a well-timed exit last August).
n Corporate bonds The valuations on corporate bonds look attractive since spreads more than compensate for the probability of default. The issue of systemic risk was resolved by the G20 in the wake of the Lehman affair so currently investors need to focus on avoiding ‘specific’ risk. It is thus preferable to be selective in staying away from subordinated debt (nationalization risk and risk of conversion of junior debt into equity). Caution is also the watchword when it comes to cyclicals. The high yields have prompted us to create products which are intended to he held to maturity ("Hold to Maturity" products). This is an area where Natixis Asset Management has extensive research expertise both in Paris and internationally, with a significant execution capability. Lastly, we recommend absolute return products and, specifically, arbitrage funds which delivered positive returns over the 2008-09 period.
Are we underestimating the risk on corporate bonds? The ongoing crisis may impact on corporate bonds by increasing the default rate. The risk is not negligible, hence the need to be selective in the choice of security and sector. We would currently avoid investing in cyclicals and financials and would switch out of high yield debt. However, there are companies which are doing well and we think the stimulus packages will kick start economies soon. Won’t companies reduce their issuance and be tempted to redeem bonds early given yield levels? Frank Nicolas: I don’t believe so. Companies need financing and the pick-up in activity on the credit market should encourage issuance particularly given the fact that corporate debt is not particularly high compared with the levels reached in 2002. Bonds are a good way of securing financing. In the next few months, it will be households rather than the companies that will be inclined to pay down debt.
www.am.natixis.com
5
hop s k r t wo
natix
et s s a is
en m e g ana
m
Natixis Asset Management surveyed Workshop participants on their market perception and investment plans: Assuming that ECB rates remain below 1% in the medium term, what percentage of cash are you ready to invest over a longer period (3 months to one year)?
How low can ECB rates go in 2009? 1.25 = 2.2%
More than 50% = 12.4%
0.25 = 10.8%
0 = 8.2 %
1 = 35.5% 0.75 = 25.8%
Between 25 and 50% = 25.8%
0.50 = 25.8%
In a very low interest rate environment, what investments do you favor for your treasury management? Higher risk investaments* = 10.5%
Money market mutual funds = 23.8%
Interest-paying accounts = 25.7%
Between 0 and 50% = 53.6%
Does this environment encourage you to increase your credit risk within the context of your treasury management? Don't know = 9.8% Yes = 27.7% No = 62.5%
Short dated bonds = 28.6%
Certificates of deposit = 11.4% * Bonds, dynamic money market, equities.
Natixis Asset Management in brief n n n
The European expert of the asset management division of Natixis, with around 600 employees* based in Paris A multi-specialist, with e277 billion assets under management* A company offering investment solutions for institutional and corporate clients, as well as distributors and banking networks.
*At 12/31/2008 - Source: Natixis Asset Management.
Contact us Natixis Asset Management - Direction de la Communication 21, quai d’Austerlitz - 75634 Paris cedex 13 Tel : (33) 1 78 40 81 74
Next Natixis Asset Management Workshop: June 10, 2009 www.am.natixis.com
6