LA FORUM Adaptations to public sector pension scheme asset allocation
Investment Choices
Market Overview
The case for Alternative Investments
Hot Property The growing appetite for infrastructure debt among pension funds
UK Residential Sector Investors vote for PRS
Tranquil Waters A global economy with reasonable real growth and low inflation.
Issue Q2 2017
The Knowledge Framework
For professional investors only
Residential Land Partnership In association with Palmer Capital Unique opportunity to promote land for residential development Simple but compelling investment strategy Ȃ There is strong demand but a fundamental undersupply of housing across the UK. There is a favourable planning environment for housing development. Ȃ Sites are acquired, repositioned for residential development and then sold to house builders. Ȃ Returns will be driven by the change in respective land values. Targeting outperformance via stock selection, value creation and well timed disposals
Contact Information Fund Manager Graeme Rutter Tel: +44 (0) 20 7658 6768 Email: graeme.rutter@schroders.com
Ȃ Target ungeared IRR of 12-15%1 over a five year life.
Institutional Client Relations
Ȃ Palmer Capital’s network of seven regional partners gives local knowledge and expertise when securing planning and relevant statutory consents.
Claire Glennon
Unique real estate fund offering diversification Ȃ Residential Land Partnership provides investors with exposure to an asset class which is distinct from commercial real estate, and offers further diversification from traditional asset classes. Strong management and deal sourcing coupled with team alignment Ȃ Strong partnership between Schroders’ fund management expertise and the specialist investment experience of Palmer Capital and their operating partners. Ȃ The two partners have worked together since 2005 and Palmer Capital has an intial £50 million deal pipeline.
Tel: +44 (0) 20 7658 4366 Email: claire.glennon@schroders.com Real Estate Client Relations Olivia Pember Tel: +44 (0) 20 7658 3552 Email: olivia.pember@schroders.com
Focus on Environmental, Social and Governance factors Ȃ Schroders has established Environmental Social Governance (ESG) policies and practices. Schroders is a signatory to United Nations-supported Principles for Responsible Investment (UNPRI). Ȃ Helping to deliver thousands of new homes in the UK.
Target only and not guaranteed
1
Important information: For professional investors or advisers only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. Schroders has expressed its own views and opinions in this document and these may change. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. The Fund is a collective investment scheme within the meaning of Section 235 of the Financial Services and Markets Act 2000 (“FSMA”). The Fund is not an authorised unit trust scheme, OEIC or recognised scheme within the meaning of the FSMA and therefore constitutes an unregulated collective investment scheme. As an unregulated collective investment scheme, the distribution and promotion of units are restricted, for the purposes of Sections 21 and 238 of the FSMA, to persons who are themselves authorised under the FSMA or who otherwise fall within the categories or exceptions made under Sections 21 and 238. Accordingly, this material is directed at market counterparties and authorised persons; intermediate customers; existing investors in a substantially similar real estate fund; and clients and newly accepted clients of the
Schroder Group where reasonable steps have been taken to ensure that investment in the Trust is suitable. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Real estatebased pooled vehicles, such as the Fund, invest in real property, the value of which is generally a matter of a valuer’s opinion. It may be difficult to deal in the units of the Fund or to sell them at a reasonable price because the underlying property may not be readily saleable, thus creating liquidity risk. There is no recognised market for units in the Fund and, as a result, reliable information about the value of units in the Fund or the extent of the risks to which they are exposed may not be readily available. Funds that focus on specific sectors can carry more risk than funds spread across a number of different industry sectors. Issued by Schroder Real Estate Investment Management Limited, 31 Gresham Street, London EC2V 7QA. Registered No: 1188240 England. Authorised and regulated by the Financial Conduct Authority. For your security, communications may be recorded or monitored.RC61951
Contents Page Page 3
Foreword : The case for Alternative Investments
Page 4
LendInvest & Merseyside Pension Fund partner on £12,000,000 property loan syndication
Page 5
Local Pensions Partnership celebrates first birthday by launching its new Private Equity structure
Page 6
LaSalle - Investing in the UK’s Private Rented Sector
Page 11
New Capital - The Case for Emerging Markets
Page 21
Heitman - Debt Today
Page 25
Legg Mason - World Class Investment Capabilities
Page 29
Schroders - Mind the gap: how will the LGPS manage the real estate transition?
Page 31
Palmer Capital - UK Real Estate 2017
LA FORUM 2 Statham Court Statham Street Macclesfield Cheshire SK11 6XN Telephone 01260 226 610 Mobile 07429 652 970 Email enquiries@laforum.co.uk © Copyright 2017 LA Forum. All rights reserved. LA Forum is a division of Edupension Ltd Company Number: 8974277
The case for Alternative Investments FOREWORD LA Forums latest publication will outline the biggest change to the world economy in the last decade. It has taken some time, but now the scene has been set for the next ten years of investing. Alternative assets are more popular than ever, with growth of £231bn during 2016 and more than £6tn in hedge fund and private capital assets managed globally*. Participation in multiple alternative asset classes is now the norm for the majority of Local Government Pension Schemes, with alternatives portfolios becoming more and more diverse. As a result and in response to a rapidly changing economic environment, the administering authority’s ability to fully disclose their investment decisions is more important than ever. Preparing their Investment Strategy Statement in addition to sound governance is the foundation for meeting investment aims in a supportable manner. However, the majority of public sector investors remain below their long-term target allocation to alternatives. With almost 18,000 alternatives funds open for investment*, LGPS officers are finding it harder to discover attractive opportunities across alternative asset classes without specific training. Finding the true outperformers is a difficult prospect, particularly when the majority feel that the marketing documents they receive are not meeting their needs. This is a missed opportunity for alternative fund managers as the capital is there for investment. For fund managers, standing out amid the unprecedented level of competition is a challenging prospect, and it is more important than ever to understand the changing requirements of the UK Local Government Pension Schemes community. LA Forum provide LGPS fund officers, board members and trustees bespoke educational publications and seminars. As the duties and responsibilities placed upon public sector officers become more diverse, our strategy is to continue working closely with the LGPS officers to meet their particular training requirements. Depending on the feedback from our publications a more bespoke training agenda can be arranged for interested parties. LA Forum will deliver a tailored service for both attendees and presenters. Venues, catering and accommodation will support this end to end service. * Preqin Investor Outlook: Alternative Assets H1 2016
LendInvest & Merseyside Pension Fund partner on £12,000,000 property loan syndication In March 2017, LendInvest, the UK marketplace for property finance, announced a unique partnership with Merseyside Pension Fund to finance a loan secured against a development site in Canary Wharf, London. The £12 million deal was originated and underwritten by LendInvest and syndicated with Merseyside Pension Fund. Under the terms of the deal, LendInvest and Merseyside Pension Fund were equal partners with LendInvest, an FCA-regulated fund manager and short-term property lender since 2008, acting as security trustee and loan servicer. Prompting this deal, Merseyside Pension Fund had identified property debt as providing strong relative returns and had completed a number of direct property loans over the last 18 months. The loan was made to an established property development company to finance the purchase of a strategic development site in London’s Docklands. The borrower was seeking planning consent to build a 320 bedroom budget hotel and 199 residential units and a decision is expected during 2017. Rod Lockhart, Managing Director of LendInvest Capital, said: “We are delighted to work with major public sector institutions like MPF which is something that we have built LendInvest to do successfully. Returns from short-term property debt are increasingly attractive to investors in this low interest rate environment. We look forward to making co-investments with MPF and other UK pension funds as a regular component of our funding mix.” Chris Shorrock of CBRE Capital Advisors, the Strategic Advisor to MPF, added: “At the current time we believe that investing into the property debt space provides attractive relative returns compared to direct equity property investments. Having an allocation for debt funding in the property portfolio should assist us in outperforming the Fund’s IPD Benchmark. We are pleased to have undertaken our first debt syndication with LendInvest and it demonstrates that alternative lenders and institutional investors can team up to achieve attractive returns for their investors.” To find out more about partnering with LendInvest to invest in UK property loans, please contact: Rod Lockhart, rod@lendinvest.com / 0207 118 1144 About LendInvest LendInvest is the UK’s leading online property lending business. The company manages over £430 million on behalf of pension and endowment funds, private clients and family offices, deposit-taking banks, asset managers and other institutions spread broadly across Europe and Asia. All funds are invested in loans originated by LendInvest’s experienced mortgage underwriting team and secured against registered UK property. The company specialises in the supply of bridging, development and short-term buy-to-let loans for experienced property investors and developers. To date, the company has lent £1 billion to help borrowers buy, build and renovate almost 4,000 properties worth in excess of £1.8 billion. The firm employs over 110 individuals based in London, Manchester and Edinburgh. LendInvest is authorised and regulated by the Financial Conduct Authority and is the only UK online lender to have been rated twice by a regulated European credit rating agency (2015 & 2016), receiving both times the highest possible rating for the quality of its loan servicing. www.lendinvest.com
LendInvest: shaping the future of property finance
Local Pensions Partnership celebrates first birthday by launching its new Private Equity structure The Local Pensions Partnership (LPP) has successfully launched its new Private Equity (PE) structure, coinciding with LPP’s first full year of operation, having received its FCA accreditation in April 2016. The new structure brings the £1.8 billion PE assets of its two shareholder funds, the London Pensions Fund Authority and Lancashire County Pension Fund under the management of LPP Investments (LPPI), a fully-owned subsidiary of LPP. It also sets up LPPI to act as a full-fledged, FCA-authorised investment manager that can now be appointed directly by other funds to manage private equity investments. LPP’s Private Equity strategy seeks to achieve long-term investment returns by investing in companies at various stages of the growth cycle (Buyout, Growth Capital, Special Situations and Distressed). Susan Martin, LPP Chief Executive, said: “We’re delighted to have taken our next step in the pooling process, especially so quickly after launching our equity fund in November last year. “Over the next few months we will continue to launch more funds and structures with infrastructure, total return, fixed income and credit in the pipeline. As a not-for-profit pension services organisation, LPP is implementing an effective investment management structure that helps to deliver cost savings and investment benefits to our clients, their employers and scheme members.” The launch of the new Private Equity structure follows the launch of a £5 billion Global Equity Fund by LPP in November 2016, and marks the first anniversary of LPP receiving FCA accreditation. LPP’s Global Equities Fund has already delivered a significant reduction of more than £7.5 million per annum in the overall costs for the founding investors. The launch of the new Private Equity structure will enable us to continue to achieve greater cost savings and investment benefits for our pension scheme members. For More Information Please Contact: Media Relations: Andrew Fleming - MHP Communications MHP Communications Andrew.Fleming@mhpc.com +44 (0)20 3128 8523 About LPP: LPP is a not-for-profit pension services organisation. It offers a full suite of pension services – investment management, liability and risk reduction and pension administration – that help to reduce deficits, lower costs and improve the efficiency of public sector funds. By offering a whole pension service and being an active steward not just of assets, but also liabilities and risk, LPP generates significant savings and effective deficit management for public sector bodies. As at 31 March 2017, LPP looks after pension arrangements for over 500,000 members and 1,000 employers. Please note: This press release has been prepared to inform the external media of information regarding LPP Ltd and/or its subsidiary, Local Pensions Partnership Investments Ltd only. It does not provide advice on legal, taxation or investment matters and should not be relied upon for any other purpose without seeking independent advice. No investment decisions should be based upon its statements without such advice. No other parties may rely or make decisions based on the content of this press release whether they receive it with or without consent. LPP and its employees acknowledge no liability to other parties for its content and no representation or warranty is made, expressed or implied, as to the accuracy or completeness of the information provided. This press release may not necessarily contain the information that would be provided to another party whose objectives or requirements may be different. This press release may contain ‘forward-looking statements’ with respect to certain plans and current goals and expectations relating to LPP’s future financial condition, performance results, strategic initiatives and objectives. By their nature, all forwardlooking statements are inherently predictive and speculative and involve known and unknown risk and uncertainty because they relate to future events and circumstances which are beyond LPP’s control. Any projections or opinions expressed are current as of the date hereof only.
Investing in the UK Private Rented Sector
Contacts:
Andrew Stanford Head of Residential – UK +44 (0) 20 3147 1440 andrew.stanford@lasalle.com
LaSalle Research & Strategy
Investing in the UK’s Private Rented Sector The Investment Opportunity Investing in UK residential property through its Private Rented Sector (PRS) is a compelling opportunity today. The sector has a place in a balanced diversified investment portfolio, given its low historical correlation with other asset classes and the potential to deliver attractive risk-adjusted real returns. PRS is backed by strong market and demographic fundamentals, a longstanding supply and demand imbalance and, more recently, broad government support to its development as a sector for institutional investors. It is widely recognised that the UK has a long-term housing shortage, which has persisted for over 40 years. This lack of supply has caused house price growth to exceed general price inflation by 2.7% p.a. since 1970, in comparison with commercial property whose capital value has undershot inflation by 1.6% p.a. The UK is viewed by many international investors as having one of the most developed real estate markets globally. Given that the residential sector is a significant part of most developed countries’ institutional investment universe (see chart below) and given the momentum building within the UK’s PRS ‘Build to Rent’ sector, as it has become known, there is potential for UK residential investment to form an increasing proportion of institutional real estate portfolios.
Source: LaSalle MSCI/IPD
The UK PRS has grown significantly since 1997 and now comprises 20% of the housing stock (see chart below). The vast majority of this growth has come from private individuals becoming ‘Buy to Let’ landlords. Landlords that own only a single property hold 40% of the PRS stock and just 8% describe themselves as full-time landlords. Thus, the market is highly fragmented. The Government is phasing out Buy to Let mortgage tax relief for higher rate taxpayers and the Bank of England is increasing its regulation of the Buy to Let mortgage market. There is therefore potential for fewer Buy to Let landlords in the market.
Source: LaSalle/ONS
Despite the lack of institutional investment, residential property has outperformed commercial property and the other main UK asset classes (except for equities) over the long-term. These returns have been achieved with both lower volatility and low correlations versus other UK asset classes. As a result, residential can play a valuable role in a multi-asset portfolio (see table below).
*Unsmoothed, or 7.2% smoothed UK Residential Returns based on Nationwide House Price Index plus long-run income return of 3.4%pa from MSCI IPD Residential Sources: LaSalle, MSCI IPD, Thomson Reuters, Nationwide (2016)
Location and Market Dynamics In considering where best to build a PRS portfolio, the prospects for London’s economy and its PRS market are undeniable. Key indicators from independent sources support this argument. However, focusing on London alone would be to the detriment of many regional hotspots which merit equal scrutiny and reveal some attractive characteristics of their own. Furthermore, examining the ratio of house prices in London versus the UK average (see chart below) shows how the spread between the two has been steadily rising over time. More relevant than the ratio itself, however, is how far the ratio currently deviates from its long-term trend as this will likely have more influence on growth rates during the next ten years. This indicates the potential for a slowdown in London and/or a catch up in the Regions and helps to support a national PRS investment strategy.
Conclusion In a post Brexit investment environment, the macro-fundamentals supporting UK PRS investment continue and the opportunity for investing in a national strategy which includes London remains. Any liquidity concerns at this early stage of the build to rent sector’s development should be negated by its rapid growth and strong interest from institutions.
About the author Andrew Stanford is Head of UK Residential at LaSalle Investment Management responsible for developing and implementing LaSalle’s UK residential strategy, focusing initially on build to rent. Andrew has over 25 years’ UK residential investment, asset management and valuation experience. Much of this experience was gained whilst head of residential consultancy at Cluttons. Before joining LaSalle in April 2015, he headed the UK Government’s Private Rented Sector taskforce. He chairs the British Property Federation’s Build to Rent Committee and is a member of the BPF’s residential committee.
This presentation does not constitute an offer to sell, or the solicitation of an offer to buy, and is subject to correction, completion and amendment without notice. This presentation has been prepared without regard to the specific investment objectives, financial situation or particular needs of recipients. No legal or tax advice is provided. Recipients should independently evaluate specific investments. By accepting receipt of this publication, the recipient agrees not to distribute, offer or sell this publication or copies of it and agrees not to make use of the publication other than for its own general information purposes. The views expressed in this presentation represent the opinions of the persons responsible for it as at its date, and should not be construed as guarantees of performance with respect to any investment. LaSalle has taken reasonable care to ensure that the information contained in this presentation has been obtained from reliable sources but no representation or warranty, express or implied, is provided in relation to the accuracy, completeness or reliability of such information. LaSalle does not undertake and is under no obligation to update or keep current the information or content contained in this presentation for future events. LaSalle does not accept any liability in negligence or otherwise for any loss or damage suffered by any party resulting from reliance on this presentation. Copyright © LaSalle Investment Management 2017. All rights reserved. No part of this publication may be reproduced by any means, whether graphically, electronically, mechanically or otherwise howsoever, including without limitation photocopying and recording on magnetic tape, or included inany information store and/or retrieval system without prior written permission of LaSalle Investment Management. LaSalle Investment Management is authorised and regulated by the Financial Conduct Authority in the UK.
HIGHLIGHTED IN THIS PUBLICATION:
Research Note
The Case for Emerging Market Equities Daniel Murray Chief Economist
GLOBAL STRATEGIC ASSET ALLOCATION
GLOBAL SECURITY SELECTION
REGIONAL ASSET ALLOCATION
REGIONAL PORTFOLIO CONSTRUCTION
indepth The Case for Emerging Market Equities
About the author Dr Daniel Murray Daniel Murray is Chief Economist at EFG. He was previously employed as a Director of Strategy at Russell Investments, before which he worked as a portfolio manager at Merrill Lynch Investment Managers. He began his career at Smithers & Co. Ltd. He has broad investment experience, having worked as an economist, strategist, asset allocator and portfolio manager with exposure to a wide range of markets, instruments and investment styles. He has been a CFA charter holder since 2003. Daniel has a BSc Hons Degree in Economics, an MSc in Econometrics and Mathematical Economics and a PhD in Economics. In 2009 he was awarded the CFA UK Wincott Prize.
Summary • Emerging market (EM) equities have underperformed developed market equities for the past six years. With the potential for rising US rates and a stronger US dollar there is concern in some quarters that this trend will continue. • Our view is more constructive, based on a number of structural and cyclical factors we think outweigh the potential drag from dollar strength. • Not only is the US dollar starting from a position in which it is already fundamentally overvalued but the structural prospects for growth are much better in EM than in the world’s so-called advanced economies, supported by demographic profiles and productivity trends. • It is also notable that many EM economies have a much greater degree of policy flexibility in the event of a cyclical slowdown. • Private sector debt levels have been rising relative to GDP in many EM although still remain below the levels seen across the developed world.
Daniel Murray Chief Economist
• A perpetual concern for investors in EM is the exposure to political risk and relatively weak adherence to the rule of law. Whilst a gap still exists with the developed world, there has been a steady improvement in this regard in many EMs in recent years. • From an investment perspective, valuations in many EM look cheap both relative to their own history as well as relative to developed markets. In particular, the markets of Emerging Europe look cheap on a fundamental basis. • EM equity markets have tended to react positively when EM GDP growth accelerates. An expected increase in EM growth in 2017 would therefore be a positive for EM equities. • Taken as a whole the evidence suggests to us that, while a stronger US dollar may act as a short term headwind, there are many other factors that support EM equities.
indepth The Case for Emerging Market Equities
Introduction Emerging market (EM) equities have underperformed developed market equities for some time. For the six years to end 2016, the MSCI Emerging Markets equity index returned -1.1% while the MSCI World developed market index returned 72.4% (both net dividends reinvested in US dollar terms) – a difference of over 70% (Chart 1). There are concerns in some quarters that EM equity underperformance will continue in 2017 against a background of tighter US monetary policy and the potential for a stronger US dollar.
Chart 2. Performance of MSCI EM relative to MSCI World and the US dollar
Chart 1. Performance of MSCI World and MSCI EM 200
30
180
20
160 Annual % change
Index, 31 December 2010 = 100
Looking at annual performance, Chart 2 illustrates the point. It shows that in general EM equities have underperformed in years when the trade weighted US dollar2 has been strong. In 12 out of the 15 years in the sample, the performance of MSCI World relative to MSCI EM was in the same direction as the performance of the US dollar; MSCI World outperformed (underperformed) MSCI EM when the US dollar strengthened (weakened).
140 120 100 80
10 0 -10 -20
60 -30
40 20
01
02
MSCI World
03
04
05
06
07
08
09
10
11
12
13
14
15
16
17
MSCI EM
Source: Bloomberg, EFG calculations. Data as at 7 March 2017.
This note explores the prospects for EM equities in that context. The conclusion we reach is that, in spite of the more hawkish outlook for US monetary policy, there are good reasons to be optimistic about the asset class. Indeed it is notable that over recent months, EM equities have performed much better, both in absolute terms and also relative to developed markets.
US dollar correlations It is often held by financial market commentators and investors that a stronger US dollar is associated with the underperformance of EM assets. There are several theories as to why this might be the case. For example, a stronger dollar makes it more expensive for EM countries to service their dollar denominated debt. Furthermore, a stronger dollar, higher US interest rates and higher returns on US assets often go hand-in-hand, reducing the relative attractiveness of EM assets. Another potential reason is that commodity prices often decline when the US dollar strengthens and many EM economies are reliant on commodity exports as a major source of foreign income. Given expectations of higher US interest rates over the next few years, there is concern this will be accompanied by a stronger US dollar and the underperformance of EM equities. There is evidence in support of the argument that EM growth slows when the US dollar strengthens.1 There is also some empirical support for the idea that EM equities underperform when the US dollar strengthens.
-40
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Trade-weighted US dollar
Performance of MSCI World less MSCI EM
Source: Bloomberg, EFG calculations. Data as at end-December of each year shown
However, the chart also shows that the relationship has varied enormously over time. That reflects the fact that the effect of the US dollar on EM equities depends on why the dollar strengthened. Thus, in 2013 the US dollar strengthened by a negligible 0.3% whilst MSCI World outperformed MSCI EM by 28.1%. In 2014 the US dollar was up by 12.8% - the strongest year in the sample - and MSCI World outperformed MSCI EM by a much more modest 7.6%. The most notable exception was in 2005 when the US dollar rose by just under 12.8% but MSCI World underperformed MSCI EM by 16.5%.
The US dollar Given the nature of the relationship between EM equity performance and the US dollar, it is worth saying a few words on prospects for the dollar. It has risen by over 25% on a trade weighted basis over the past three years with much of that strength coming in 2014 and the pace slowing since then. For the year ahead we believe the US dollar will remain supported by robust domestic growth and a more hawkish Federal Reserve but that any gains will be modest, not least because we are starting from a position in which much is already priced in to the currency - Chart 3 overleaf shows that the US dollar is overvalued against all major currencies. This is a long way of saying we do not expect the US dollar by itself to exert much of an influence on EM equities this year.
indepth The Case for Emerging Market Equities
worth $463 billion. Yet exports to the US represent less than 5% of Chinese GDP and this ratio has been in decline in recent years. The two countries that stand out as being by far the most heavily exposed to slowing US imports are Canada and Mexico.
Chart 3. US dollar overvaluation
% Overvaluation of the US$ versus specified currency
25
20
Of course, any change in trade policy will be offset to some extent by a stronger US dollar. On balance we do not anticipate a shift in US trade policy to act as a major short term headwind to EM growth although at the margin it may act as a small drag. The exception is Mexico where the impact is expected to be much greater because of the size of the relationship.
15
10
5
0
Sterling
March 2016
Brazilian Real
Euro
Renminbi
Yen
Trend growth: demographics and productivity
March 2017
Japan has a poor demographic profile, reflected in a rapidly ageing population and a shrinking labour force. However, most other developed nations also face demographic headwinds in coming years. Such trends are gradual and hard to reverse. In contrast, many EM have relatively attractive demographic profiles.
Source: Petersen Institute for International Economics, Bloomberg, EFG calculations. Data as at 7 March 2017.
Overall we believe there is support for the theory that EM equities underperform when the US dollar strengthens but that the relationship varies over time and other factors also need to be taken into consideration. Below we comment on some of these additional factors.
Trade flows In addition to concerns about the US dollar, there is also trepidation with regard to the new US administration’s trade policy. President Trump has made it clear he wants to bring jobs back to America and a part of his strategy involves policies that will discourage global trade. Few details have yet been released although it is notable that he has put people with hawkish trade views into senior and influential positions. Countries that export a lot to the US could therefore suffer. Table 1 shows exports to the US as a percentage of that country’s GDP. China is often cited as a major exporter to the US and it is certainly a sizeable flow; in 2016 China exported goods to the US
Table 2 overleaf demonstrates one such feature of the differing demographics. It shows how the population of working age across most EM is expected to grow at a healthy pace over the next few years whilst it is stagnant at best for most of the developed world. Mexico, ASEAN and India are expected to experience particularly fast growth in their working age populations whilst Japan and the eurozone are expected to see their working age populations shrink, as are Russia and China. Growth in working age population is an important determinant of overall economic growth: the more people working, the greater is output. The other dimension is productivity, as measured by output per head. If the same number of people are working in two countries but the first country is able to produce twice as much output per head, then, trivially, aggregate output will be twice as high in the first country as the second. It is hard to find international comparisons of productivity across both developed markets and EM and even more so if one wants
Table 1. Exports to the US as % of own country GDP HK + India + Indonesia + Singapore + S. Korea + Taiwan
Japan
China
Eurozone
UK
Canada
Mexico
Brazil
31 Dec 2011
3.6
2.1
5.3
2.1
2.0
17..7
22.5
1.2
31 Dec 2012
3.6
2.4
5.0
2.3
2.1
17.8
23.4
1.3
31 Dec 2013
3.6
2.7
4.6
2.3
1.9
18.1
22.2
1.1
31 Dec 2014
3.6
2.8
4.5
2.4
1.8
19.4
22.7
1.3
31 Dec 2015
3.7
3.0
4.4
2.9
2.0
19.1
25.9
1.5
Source: Bloomberg, EFG calculations. Data as at 7 March 2017.
indepth The Case for Emerging Market Equities
Table 2. Working Age Population: 2017 – 2025 Millions of people
Population aged 15-65 2017
Annual growth rate (%)
2020
2025
2017-2020
2017-25
Russia
97.6
95.3
92.0
-0.8
-1.2
China
993.6
980.9
970.1
-0.4
-0.5
Brazil
143.8
147.5
151.5
0.9
1.0
Mexico
82.2
85.3
89.4
1.3
1.7
ASEAN
439.3
453.4
472.5
1.1
1.5
India
851.5
888.2
942.5
1.4
2.1
TOTAL
2,608.0
2,650.5
2,718.0
0.5
0.8
Japan
75.0
73.2
71.0
-0.8
-1..1
Eurozone
213.7
213.1
210.6
-0.1
-0.3
41.7
42.0
42.4
0.2
0.3
United Kingdom United States
214..4
216.5
219.0
0.3
0.4
TOTAL
544.8
544.8
543.0
0.0
-0.1
Source: US Census Bureau, EFG calculations. Data as at 7 March 2017.
to examine the trends over time. As a proxy for productivity we use GDP per capita, for which data is much more widely available. The trends are shown in Chart 4 across a range of developed and emerging economies.
The combination of expected future productivity improvements and favourable demographics should therefore continue to support robust economic growth across much of the developing world in the years ahead.
Policy flexibility
450 400 350 300
Emerging markets
250 200 150
Developed markets
100
Chart 5. Government debt and global policy rates
50 0
While it is useful to look at the prospects for trend growth, it is also important to understand what tools are available to offset any cyclical slowdown. Chart 5 is a convenient way to visualise the degree of fiscal and monetary flexibility inherent in a country. The main central bank policy rate is shown on the horizontal axis and the ratio of government debt to GDP is shown on the vertical axis.
00 01 02 03 04 05 06 07 08 09 10
Large ASEAN (2.8%) Brazil (0.6%)
China (7.8%) India (5.4%)
11
12 13 14 15
Russia (1.6%) US (1.2%)
Japan (1.1%) Euro area (1%)
Numbers in brackets represent 5-year average growth in GDP per capita to end 2016 Source: World Bank, Bloomberg, EFG calculations. Data as at 7 March 2017.
Output per head has grown by around 1% p.a. across the developed world on average over the past five years but by significantly more in most emerging economies. Brazil and Russia have been the laggards within EM, the former having suffered a prolonged period of political uncertainty from which it now seems to be escaping and economic performance of the latter being closely tied to the oil price. It is natural to expect growth in GDP per capita to slow as these economies mature but the recent pace of expansion has been so rapid that, except for Brazil and Russia, it allows for a significant slowdown before growth approaches the rates experienced in the developed world.
Government debt-to-GDP ratio (%)
GDP per capita in constant 2005 US dollars December 199 = 100
Chart 4. Global productivity trends
Canada
100 90
Eurozone
80
UK Brazil
US
70 60 Malaysia Thailand Australia South Korea Poland Sweden Taiwan Switzerland
50 40 30 20
-2
0
2
4
India Mexico South Africa Indonesia 6
8
Main central bank policy rate (%) Source: Bloomberg, EFG calculations. Data as at 7 March 2017.
10
12
14
indepth The Case for Emerging Market Equities
A country that has a higher central bank policy rate - further to the right on the horizontal axis - has more flexibility to cut rates in the event of a cyclical downturn. Similarly, a country that has a lower ratio of government debt to GDP - closer to 0% on the vertical axis - has more flexibility to add fiscal stimulus in the event of a cyclical downturn. So it could be argued that countries with a high policy rate and low debt to GDP ratio have the most potential policy flexibility.
sector EM debt is not excessive.3 Moreover, most of the increase in the ratio – and in the amount of debt outstanding - can be attributed to China; excluding China the increase in the EM debt ratio is much more modest. A point worth noting is that the rapid growth in the Chinese ratio over the past few years may represent a separate source of risk.
The chart area has been subjectively divided into four quadrants. Countries in the top left exhibit high debt to GDP (>60%) alongside an already low policy rate (<2%) so might be considered to have limited policy flexibility. Countries in the top right exhibit high debt to GDP (>60%) alongside a high policy rate (>2%) so might be considered to have limited fiscal policy flexibility but good monetary flexibility. Countries in the bottom left exhibit low debt to GDP (<60%) alongside a low policy rate (<2%) so might be considered to have good fiscal policy flexibility but limited monetary flexibility. Countries in the bottom right exhibit low debt to GDP (<60%) alongside a high policy rate (>2%) so might be considered to have good monetary and fiscal policy flexibility.
Corruption
It is discernible how many of the world’s developed economies sit in the top left and how many of the world’s developing economies sit in the bottom right quadrant. This is a relatively simple way of demonstrating the far greater policy flexibility inherent in many emerging market economies.
Private sector debt The discussion above demonstrates the bias within EM for lower government debt-to-GDP ratios than within the developed world. However, as was evident during the financial crisis, when economic conditions are stressed, the government often has to take onto its balance sheet a degree of private sector debt. Moreover, if private sector debt levels are high there is a risk this increases the probability of a financial crisis. Chart 6 illustrates how the ratio of non-financial private sector debt-to-GDP remains around 20 percentage points lower in EM than for the group of advanced economies, suggesting private Chart 6. Non-financial private sector debt-to-GDP 200 175
Debt-to-GDP (%)
150 125 100
A feature of EM that has historically acted as a restraint on EM equities has been the perception - often backed up by real events - that the rule of law is less robustly applied than in the developed world. This could manifest itself in numerous different ways in any particular country, which has meant that investors sometimes demand a higher risk premium for investing in EM assets. However, the varied nature of this source of risk makes it difficult to quantify. As a proxy for this risk we have found it useful to look at some of the indicators supplied by the World Economic Forum in their annual Global Competitiveness Report. One of the reported metrics is a corruption index, as shown in Table 3 – a higher number indicates less corruption. This shows how the degree of corruption in EM remains greater than for the developed world but that the gap has been narrowing over the past 20 years – in general EM have become less corrupt. A continuation of this trend would be a support for EM assets. Table 3. Corruption indices (Score out of 10, lower = more corrupt) Country/ Region
1997
2002
2007
2012
2016
Average
7.73
7.68
7.82
7.58
7.65
US
7.61
7.70
7.20
7.30
7.40
Canada
9.10
9.00
8.70
8.40
8.20
UK
8.22
8.70
8.40
7.40
8.10
France
6.66
6.30
7.30
7.10
6.90
Germany
8.23
7.30
7.80
7.90
8.10
Japan
6.57
7.10
7.50
7.40
7.20
Average
3.46
3.15
3.30
3.80
3.90
Indonesia
2.72
1.90
2.30
3.20
3.70
Thailand
3.06
3.20
3.30
3.70
3.50
Malaysia
5.01
4.90
5.10
4.90
4.90
Philppines
3.05
2.60
2.50
3.40
3.50
75
BRICs
2.87
3.23
3.20
3.85
3.73
50
Brazil
3.56
4.00
3.50
4.30
4.00
25 0
99 00 01
Emerging Markets
02 03 04 05 06 07 08 09 10 Advanced Economies
Source: BIS, EFG calculations. Data as at 7 March 2017.
11
12
13
14
15
16
Russia
2.27
2.70
2.30
3.60
2.90
India
2.75
2.70
3.50
3.60
4.00
China
2.88
3.50
3.50
3.90
4.00
EM ex China
Source: WEF. Data as at 7 March 2017.
indepth The Case for Emerging Market Equities
Valuations
Table 4. Change in growth and EM equity performance
If the macro backdrop looks good for EM – not just in isolation but also relative to advanced economies – it is reasonable to ask the question as to what extent this is already priced in to markets. Charts 7a and 7b illustrate how valuations vary across different regions but on average EM equities are attractively valued both relative to their own history and relative to developed equity markets. The most expensive region within EM is Latin America, driven by recent strong Brazilian equity market performance. Chart 7a. Price-Earnings ratios
Performance of MSCI World less MSCI EM (%)
2002
0.7
-13.2
2003
1.9
-21.3
2004
1.5
-2.3
2005
-0.7
-16.5
2006
0.9
-11.4
35
2007
0.5
-27.4
30
2008
-2.8
7.2
2009
-2.7
-34.2
2010
4.3
-1.8
2011
-1.1
8.9
2012
-1.1
1.8
10
2013
-0.2
28.1
5
2014
-0.4
7.6
2015
-0.3
10.2
2016
0.5
1.9
25 P/E ratio
Change in EM GDP growth (%)
20 15
0
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
Asia ex Japan Emerging Europe
Latin America World
Source: Thomson Reuters Datastream, EFG calculations. Data as at 7 March 2017.
Source: IMF, Bloomber, EFG calculations. Data as at 7 March 2017
Chart 7b. Price-to-Book ratios It is therefore interesting to note that expectations are for an acceleration in EM GDP growth this year. For example, in its most recent update in January to its World Economic Outlook, the IMF forecast GDP growth of 4.5% this year compared to 4.1% last year for the world’s Emerging Market and Developing Economies. By region, GDP growth is expected to pick up by 1.6%, 0.1%, 0.2% and 1.9% for the Commonwealth of Independent States, Emerging Asia, Emerging Europe, and Latin America respectively.
4.0 3.5 3.0 P/B ratio
2.5 2.0 1.5 1.0 0.5 0.0
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
Asia ex Japan Emerging Europe
Latin America World
Source: Thomson Reuters Datastream, EFG calculations. Data as at 7 March 2017.
Short-term growth and market outlook Chart 2 showed how a stronger US dollar has historically been associated with the underperformance of EM equities. It is possible to perform a similar analysis for economic growth. Rather than the simple level of growth, we have found it instructive to examine the relationship between the change in growth and EM equity performance. This is shown in Table 4. The data show how in 12 out of the 15 years in the sample a rise (fall) in EM growth has been associated with MSCI EM outperforming (underperforming) MSCI World; when the data in the middle column is positive, the data in the right column is generally negative and vice-versa.
Conclusion There is a reasonable case to be made that EM equities underperform developed world equities during periods when the US dollar strengthens. In the current environment of a more hawkish Federal Reserve there is thus some reason for caution. However, against this we must take into consideration a number of factors, including the fact that the US dollar already looks overvalued and so the prospects for a further aggressive strengthening look limited. In addition, there are a number of other good reasons to feel upbeat about the prospects for EM equities such as: relatively fast trend growth supported by good demographics and positive productivity trends; a high degree of policy flexibility; improving legal standards; relatively low levels of private sector debt relative to GDP (particularly ex-China); attractive valuations; rising GDP growth. Our view is that these positive factors outweigh the potential drag from a marginally stronger dollar. Within EM there are
indepth The Case for Emerging Market Equities
regional differences, notably Latin American equities look relatively expensive whereas emerging European equities look decidedly cheap and have done for some time. A potential catalyst for an improvement in performance of the latter is a climate of dĂŠtente between the US and Russia in line with the preferences of the new US administration. Any firming in commodity prices, particularly oil, would also be a tailwind for emerging European equities. Sometimes markets efficiently discount the shifting newsflow in a rational way that approximately prices future macro and corporate developments into the current price. On other occasions markets jump about in less rational fashion. If we were to experience a meaningful underperformance of EM equities in a Pavlovian response to fears over a stronger US dollar, we would view that as a buying opportunity.
Endnotes 1
See, for example, http://voxeu.org/article/strength-dollar-and-emerging-markets-growth
2
As measured by the USDX index, Bloomberg ticker DXY.
3
There may be structural reasons for this such as less well developed banking and credit channels.
ŠEFGAM 2017
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Legg Mason Martin Currie Diversified Income
Inception date
Mind the gap: how will the LGPS manage the real estate transition? The LGPS has a combined total of £15 billion invested in real estate, we estimate that around £5 billion of that is allocated to diversified, open-ended UK real estate funds. A further £2-3 billion is held in more specialist funds, while the remaining £7- £8 billion is invested directly into UK real estate and indirectly in non-UK funds. There is a popular opinion that once the LGPS pools are up and running, they will sell down their UK funds and reinvest directly in real estate. But how will this happen? And how will that transition be managed? Many LGPS funds are in fact underweight to real estate, so in most cases it would appear to make little sense to be in a hurry to sell property funds. Instead, a starting point for individual schemes, as they transition to larger consolidated pools, may be to allocate new money to separate account mandates. New allocations could be used to increase direct UK investments, or gain international exposure through tax-efficient REITs or other indirect unlisted strategies. LGPS funds and their real estate advisers should then consider the diversification, strategic positioning and performance outlook of existing holdings. Diversified funds with the best prospective returns or the greatest alignment with investment strategy should probably be held for longer. LGPS funds may decide simply to retain specialist property funds since they often provide exposure to properties not easily accessed, even within large direct portfolios, such as large central London offices. Specialist funds also require expert knowledge and capability which generalist direct managers are unlikely to have. So how could the LGPS manage a transition? Given the scale of their investments, the relationship between the scheme and their real estate manager is best viewed as a partnership, the benefits of which are twofold. Firstly, given prior knowledge, managers are often able to match sellers with buyers via the secondary market which may result in better exit pricing for the vendor. The seller can often achieve a better price and better liquidity than when properties are sold to meet redemptions. Secondly, where the manager needs to sell a property to fulfill redemptions, an early notification puts the manager in a better position to achieve the best selling price. Given the expected volume of transactions, an orderly disposal programme should result in higher prices and is likely to mitigate the potential of a fire sale of assets. This benefits all investors. As a real estate manager with long-standing relationships with LGPS funds, we are cognisant of the significant changes on the horizon as LGPS pooling becomes reality. We believe that with careful planning, and time, the transition of real estate investments can be managed efficiently and cost effectively. Schroder Real Estate has considerable experience in portfolio and transition management; in all we manage 13 separate accounts for LGPS and have relationships dating back over 20 years. In addition, our domestic and global investment capabilities mean that Schroders continues to offer integrated direct and indirect real estate solutions through both separate account and pooled funds.
Schroder Real Estate Schroders has managed real estate funds since 1971 and currently has £12.2 billion (EUR 14.2 billion/ $15.2 billion*) of gross real estate assets under management as at 31 March 2017. Most of the real estate funds referred to are unauthorised collective investment schemes as defined in the Financial Services and Markets Act 2000. Promotion of these funds is restricted and access to full information about these funds is only available to those exempt from the restriction. For further information about Schroders’ real estate business visit www.schroders.com/realestate *Real Estate AUM includes holdings of Schroder Real Estate Capital Partners and Schroders Multi-asset Funds.
Schroders plc As a global investment manager, we help institutions, intermediaries and individuals across the planet meet their goals, fulfil their ambitions, and prepare for the future. But as the world changes, so do our clients’ needs. That’s why we have a long history of adapting to suit the times and keeping our focus on what matters most to our clients. Doing this takes experience and expertise. We bring together people and data to spot the trends that will shape the future. This provides a unique perspective which allows us to always invest with conviction. We are responsible for £416.3 billion (€486.7 billion/$520.6 billion)* of assets for our clients who trust us to deliver sustainable returns. We remain determined to build future prosperity for them, and for all of society. Today, we have 4,100 people across six continents who focus on doing just this. We are a global business that’s managed locally. This allows us to always keep our clients’ needs at the heart of everything we do. For over two centuries and more than seven generations we’ve grown and developed our expertise in tandem with our clients’ needs and interests. Further information about Schroders can be found at www.schroders.com. Issued by Schroder Investment Management Ltd., which is authorised and regulated by the Financial Conduct Authority. For regular updates by e-mail please register online at www.schroders.com for our alerting service. *as at 31 March 2017
UK Real Estate 2017 By Alex Price, CEO Palmer Capital 10th May 2017 If history provides us with a guide to the future, then we canâ&#x20AC;&#x2122;t be far from the peak of the current UK Real Estate cycle. Whilst quantitative easing and low interest rates have extended the cycle, from a historic perspective almost all asset types look expensive. With technological change and political uncertainty likely to dominate the next decade, investors need to be careful in selecting ways of accessing returns to meet their ongoing liabilities. Letâ&#x20AC;&#x2122;s start with the Palmer Capital core beliefs. Firstly, population growth in the UK is set to continue whether we are an EU member or not, with 3m extra people forecast over the next 25 years from increased birth rate, and 3m growth due from non-EU migration (source: ONS). At the same time the UK housing stock is consistently growing below the required level to meet demand, in 2015/16 <200,000 units against the requirement of >300,000 (source: DCLG, Savills). Secondly, we think that government indebtedness and deficit will continue to dominate economic policy, with the UK likely to have low interest rates for a long time to come. Finally, we think a rapid evolution in technology such as Artificial Intelligence, on-line connectivity and robotics will dramatically reduce the employment market, weaken consumer demand and reduce the quantum and utilisation of most types of commercial real estate. So how do we use these themes to invest wisely? Firstly, invest on underlying demographics to deliver a better risk adjusted return. The simple laws of supply and demand means that in overall terms residential values will continue to rise, whether to buy or rent. Increasingly, secondary commercial property and land will become redundant, and assets located in well-connected urban areas will need to be redeveloped into more valuable residential accommodation. Secondly, acquire income producing core assets let to high quality tenants on longer term leases â&#x20AC;&#x201C; something that the adoption of IFRS 16 will make scarcer. With average property yield about 400 bps over the cost of 10 year UK government bonds, in an uncertain world, assets with income and strong residual site value for alternative uses will prosper. Finally, the technological changes will lead to demand for more flexible (and probably less) offices space and less retailing space, but more logistics and mixed use environments. Investors must become, or work with, entrepreneurial customer focused operators, proactively creating assets and delivering a high quality service to more discerning corporate and residential service focused customers. Any investment strategy requires flexibility but as a business with a twenty five year track record, Palmer Capital believes in the need to plan and invest for the long term.
UK Real Estate Investment Management Palmer Capital is a privately owned UK focused Real Estate Investment Manager. The company has a 25 year record in Real Estate and is recognised as being a leading creator and manager of assets via its ownership stakes in 7 property companies located across the UK.
KEY CONTACTS For more information, please contact Alex or Andrew: Alex Price, Chief Executive E: alex.price@palmercapital.co.uk T: 0207 409 5500 Andrew Robinson, Head of Capital Raising E: andrew.robinson@palmercapital.co.uk T: 0207 409 5500
INVESTING IN PEOPLE. INVESTING IN PROPERTY.
INFRASTRUCTURE DEBT SPECIALISTS Westbourne Capital is a specialist investment manager solely focused on investing in infrastructure debt globally on behalf of institutional clients. Our executives have been pioneers of the infrastructure debt asset class investing on behalf of institutional clients since 1999 across the full range of debt products including senior and subordinated financing. We offer clients bespoke investment structures designed to meet specific objectives and pride ourselves on our strong alignment and track record of delivering attractive outcomes for our partners.
Contact details For more information, please contact Tim Floyd or Li-Yu Loh. Tim Floyd Investment Director T: +44 203 713 7420 E: tim.floyd@westbournecapital.com.au
Li-Yu Loh Head of Client Relationships T: +61 3 9660 6900 E: li-yu.loh@westbournecapital.com.au
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