PAAMCO Research

The “Internet” of Stocks and Bonds

10/04/2017

Executive Summary

Given the global backdrop of strong U.S. equity markets, increased political stability and growth in Europe, and nascent signs of growth in Japan, why isn’t the bond market softer and why haven’t we seen an increase in inflation? We think technology, in particular the Internet, has been a meaningful driver of the current dynamic between inflation and the bond market. Further, we believe that the Internet is changing the way economic health should be measured and, accordingly, the way investors should position their portfolios.

Today’s asset prices have been propped up by years of easy liquidity and most credit and equity instruments are rich by historical measures. Investors have been chasing yield and do not appear sufficiently focused on risks to current valuations. We believe that investors would be wise to consider a number of factors and ideas as central banks start to remove liquidity from the system:

• Stock-picking and credit selection are likely to outperform broad indices – a focus on investments that can withstand a period of stress is warranted
• Quantitative macro models that rely on consistency across asset classes may be challenged; so too may cross-asset class relative value strategies
• Assets with weak underlying fundamentals that have been supported by yield chasers may suffer as central banks reduce liquidity in the market
• ETFs, particularly those focused on high yield bonds and loans, may sell off significantly because of limited liquidity in corporate bonds
• The time is ripe to shift portfolios to become more “all weather”

The Backdrop

Financial markets entered 2017 with high hopes the Trump administration would provide a strong growth stimulus. Post-election bond yields rose, equities rallied (especially small caps), emerging market currencies got crushed, and inflation expectations showed some signs of life. By mid-2017, the bond market had quickly changed course: 10-year yields have fallen 20 basis points while the 2/30 curve has flattened by 50 basis points.* Many believe the bond market rally is due to a lack of success in the implementation of fiscal policy. However, the equity market rally has continued with large cap stock indexes trading at all-time highs. Even the Russell 2000, which initially gave up most of its late 2016 gains on the lack of new tax initiatives, has reversed course and delivered solid YTD performance.

It is easy to side with the bond market’s reaction to the lack of fiscal progress. So far the new administration’s key agenda items have not materialized (e.g., making the U.S. tax code more competitive, rebuilding infrastructure and repealing Obamacare). Bond market caution was further justified recently by North Korea’s multiple missile launches, and earlier in the year by the uncertainty within Europe leading up to Macron’s election victory.

Then why have stocks done so well? Initially, equities took the cue from President Trump’s victory and the idea that parts of his agenda would be quickly implemented given the Republican majority in congress. Further support came from European political stability following the French elections in May and emerging signs of steady growth on that continent for the first time in many years. Asia has also played a part as global stimulus has taken hold in Japan where the economy is finally growing, albeit at a very gradual pace. Lastly, the fears of U.S. protectionism appear to have been overhyped and emerging market equities and currencies have both appreciated materially with many showing gains over 30%+ in USD terms.*

Given the positive global backdrop why isn’t the bond market softer? Given the tightening labor market in the U.S., shouldn’t inflation be rising? Or has the Phillips curve permanently flattened? What about the bond vigilantes, have they all died off? Is it possible to continue to have steady economic growth without stoking inflation? Is there something bigger at work causing inflation to remain subdued despite a tight labor market? Our answer is that yes, something bigger is at work. We think technology, in particular the Internet, has been a meaningful driver of the current dynamic between inflation and the bond market. Further, we believe that the Internet is changing the way economic health should be measured and, accordingly, the way investors position themselves.

 

Current Monetary Policy: The Risk of FOMO

Before we address what may be causing this apparent conundrum, let’s also highlight some of the current risks associated with maintaining an accommodative monetary policy. The current abundance of liquidity continues to push up asset prices around the world. Most developed stock markets and several emerging markets are at all-time highs and traditional valuation metrics are also well above their long-term averages. Equity market corrections of even a few percent are bought heavily. Anything with a yield is in demand while markets are not keenly focused on the underlying credit risk and/or creditor protections of bond issues. This is clearly a backdrop of excessive optimism about the future without an appreciation for risk that may be on the horizon.

One of the most blatant examples of this mania is playing out in the world of crypto currencies. It is hard to ignore the potential power of Blockchain technology to eliminate the middleman in financial and real asset transactions. This technological development will likely disrupt many industries, just as the Internet did over the past two decades. However, we question the need for the existence of 800+ crypto currencies, the top 10 of which have a total valuation in excess of $100 billion. Clearly some crypto currencies will be needed to transact using the “chain” and others as an alternative for a potential store of value, á la gold, but the frenzy created by this new “innovation” further supports our view that investors are currently not sufficiently factoring in risks.

Environments that lack a sufficient appreciation for risk often lead people to disregard the underlying investment they are making for fear of missing out (FOMO). As a result, investors feel the need to jump on the band wagon of every hot stock, market, or trend. In addition, the glut of global liquidity has helped fuel the proliferation of ETF (exchange-traded funds) and index products. As downside risk hasn’t really appeared in almost a decade, the comfort investors feel in taking market beta risk to a broad benchmark may be misguided. After all, this has been an environment in which monetary policy has intentionally supported asset prices. As we are now in the early innings of that support being removed, the outlook for these products is unclear should the risk environment shift to a more cautious one, or, worse yet, one in which investors become flat-out scared.

In the past few years there have been three incidents of note that have tested the market liquidity: the taper tantrum in 2013, the flash crash in equities in May of 2015, and the flight to quality in bonds in October of 2015. These incidents are stark reminders of how quickly market liquidity can evaporate. The apparent liquidity that is present during bull markets can quickly evaporate in a bear market and prices can (and often do) gap down quickly.

Lastly, investors are reaching for yield of any sort because of the assumption that the bullish environment will continue. This is most pronounced when looking at recent sovereign debt issues in emerging markets. Recently, new issues by Iraq, Ukraine, and Tajikistan came circa 7% for 10-year debt. Would a pension fund that needs to earn a 7% return really entrust their pensioners’ future to the ability and willingness of these countries to repay? Insatiable demand for long-term bond debt exists, almost without regard for risk of repayment of principal, as long as a yield meets a certain threshold return.

 

A Connectivity Conundrum

Is this bond-equity distortion – or conundrum as Fed Chair Greenspan called it two decades ago – concerning to central bankers? After all, employment and inflation – not asset price targeting – are the focus (and mandate) of central banks. Further, I proffer that our classic monetary metrics are doing a poor job of evaluating the health of the economy, as the digital economy is very hard to measure in monetary terms. Technology, particularly the Internet, has created significant increases in utility absent any real inflationary uptick. In fact it can be argued that much of the technological development to date and even on the horizon is deflationary. This is likely to continue as the next big wave of innovation, the Blockchain, strives to eliminate middlemen in many areas of the economy. This mismatch between the metrics and what is really going on in the economy could be causing central bankers keep their foot on the gas longer than needed.

Technological innovation may cause inflation expectations to be permanently lower. Further, advancements in technology may mean that traditional measurements of economic health also need to advance and evolve, particularly monetary aggregates. Modern economic theory is based on the idea that money is the ultimate measure of economic activity. Compensation, trade, commerce and investments are all measured in monetary terms. What if one could create a store of wealth that is different than money, as is occurring with crypto currencies? Initially our economies were based on bartering, then we used tokens resembling coins, later gold and then paper currency backed by gold. Then, in 1971, we finished the process of unlinking our paper currency to gold. For decades we have accepted the value of simply paper currency. Why couldn’t data encryption also become a store of value? After all, if enough people agree that data encryption has value as a medium of exchange (not unlike paper currency) then it becomes a currency. The challenge for central bankers is that their classic economic tools are unlikely to measure this potentially momentous change until it is very far along in the process of adoption. Therefore, the current policy prescription of low interest rates may be misdirected.

It is unlikely that the central bankers of today, most of whom are classically-trained economists, will publically lead a change in thinking. But they do appear to be concerned with the asset price “bubble” and may choose to allow real interest rates to rise without seeing the classic measures of inflation rise. Comments following the September FOMC quickly reversed the markets’ expectation of a minimal chance of a move in December to one in which Fed Chair Yellen expects that, despite the low inflation readings, they are still on course for a December hike.

 

Investment Implications

There will always be value to be found in the markets but, thanks to years of easy liquidity, most credit and equity instruments are currently rich by historical measures. Investors need to be scrupulous to find opportunities that can perform well while withstanding a potential period of stress brought about by an eventual change in risk perception. Investors would be wise to consider a number of factors and ideas:

• Focused stock picking and credit selection should – over the intermediate term – do much better than the broad indexes whose performance is agnostic to fundamental valuation.
• Historical cross asset correlations may have changed and equity and bond performance so far in 2017 represents to many a conundrum. Further, the USD reflects the fact that the U.S., once the model of stability given the steadfastness of our leadership, is now a source of global instability. We should prepare for a prolonged period of USD weakness despite the actions of the Fed. If this is the case, many of the quantitative macro models that rely on consistency in cross asset class behavior could be challenged. Also relative value strategies that trade across asset classes will be more difficult to assess and focus should thus be on those within asset classes.

• We are on the doorstep of a reduction in the Fed’s balance sheet and the ECB is starting to reduce its QE activity (though any moves will likely be measured and well telegraphed). Acknowledgement by central banks that new forces in the economy are dampening inflation readings might lead to the realization that higher yields are necessary to inject a dose of reality about risk into the markets. With the end to QE unfolding, the liquidity tailwind could quickly become a headwind for asset prices, putting pressure on equity and credit prices (particularly investments to which yield chasers have flocked despite weak underlying fundamentals).

• Index strategies are concerning in that they are agnostic to valuation. The more overpriced an asset becomes, the bigger its share of the index, and the more the investment strategy which follows the index must own of the overvalued asset. Such a pattern can easily reverse itself if active investors decide to sell overvalued assets en masse. Therefore, passive index strategies may be hard to beat in good times but active management is likely to prevail when the cycle moderates or turns.

• Finally, ETFs have given apparent liquidity to a sector of the market in which the underlying assets are not that liquid. Of particular concern are credit ETFs that focus on high yield bonds and loans. Should the economy cycle downward, and investors decide to shed credit risk, the selling of these ETFs will quickly test the limited liquidity of the corporate bond market.

 

 

Conclusion

The time is ripe to shift portfolios to become more “all-weather” and to balance risk. For the months ahead, we believe that a neutral weighting (at best) is appropriate for credit strategies with a beta tilt and equity strategies with a lot of beta. We are becoming a wealthier society given our increased technological utility but one with low inflation due to the Amazon, iPad and, potentially, Blockchain effects. The transition from the classic approach to monetary policy to a more “new age” approach will clearly take time. Most of our central bankers are well versed in classic economic theory and may be resistant to changing their traditional approaches. Furthermore, the outgoing Fed governors are unlikely to make any near term changes leaving measurement of “iPad iNflation” to a new Fed leadership. Technology will continue to change the inflation and utility outlook. Monetary policy must soon adapt to this “Internet of Stocks and Bonds” or risk stoking greater asset bubbles to deal with in the future.

 

*As of mid-September. Bloomberg.

 

Basil Williams is a Managing Director and Head of Portfolio Management at PAAMCO. He is responsible for the firm’s completeAlpha approach to hedge fund investing and is the Chief Investment Officer of Horizons, the firm’s fixed-income investment solution. Basil is also a member of the firm’s Investment Oversight and Management Committees. During his career, he has built and led teams in institutional investment management including equity and fixed income trading, research, risk management, and business development. Most recently, Basil was the Co-Chief Investment Officer at Mariner Investment Group, where he managed internal trading teams, led three of Mariner’s multi-strategy mandates, spearheaded the firm’s incubation and seeding business, co-authored Mariner’s Quarterly Investment Views publication and helped set the firm’s business strategy. Prior to Mariner, he spent nineteen years with Concordia Advisors and held the role of CEO for the last six of those years. Basil started his career at Merrill Lynch in 1980 and played a key role in the development of its financial futures and options business. Basil received his MBA from New York University and his BA in Applied Math from Brown University.

 

Pacific Alternative Asset Management Company, LLC (“PAAMCO U.S.”) is the investment adviser to all client accounts and all performance of client accounts is that of PAAMCO U.S. Pacific Alternative Asset Management Company Asia Pte. Ltd. (“PAAMCO Asia”), Pacific Alternative Asset Management Company Europe LLP (“PAAMCO Europe”), PAAMCO Miren Portföy Yönetimi A.Ş. (“PAAMCO Turkey”), Pacific Alternative Asset Management Company Mexico, S.C. (“PAAMCO Mexico”), and PAAMCO Colombia S.A.S. (“PAAMCO Colombia”) are subsidiaries of PAAMCO U.S. “PAAMCO” refers to PAAMCO U.S., PAAMCO Asia, PAAMCO Europe, PAAMCO Turkey, PAAMCO Mexico, and PAAMCO Colombia, collectively.

This document contains the current, good faith opinions of the authors but not necessarily those of Pacific Alternative Asset Management Company, LLC and its subsidiaries (collectively, “PAAMCO”). The document is meant for educational purposes only and should not be considered as investment advice or a recommendation of any type. This document may contain forward-looking statements. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking statements are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially from those in the forward-looking statements. Any forward-looking statements speak only as of the date they are made and PAAMCO assumes no duty to and does not undertake to update forward-looking statements.

Pacific Alternative Asset Management Company is a registered trademark in the United States, Canada, Japan, Singapore Australia and Mexico. PAAMCO is a registered trademark in the United States, Canada, Europe, Japan, Australia and Mexico. Pacific Alternative Asset Management Company Europe and PAAMCO Europe are registered trademarks in Europe. Pacific Alternative Asset Management Company Asia and PAAMCO Asia are registered trademarks in Singapore. completeAlpha is a registered trademark in Singapore, Japan, the EU, the U.S. and Canada and it is a trademark of PAAMCO in Australia.

PAAMCO is a Core Supporter of the Standards Board for Alternative Investments.

Connecting to More Opportunities in China

08/07/2017

The recent opening of the China – Hong Kong Bond Connect went relatively unnoticed but it could have long lasting implications for global asset allocations and hedge fund opportunities. Alongside the inclusion of some onshore listed A-shares in the MSCI indices, the Bond Connect can be seen to represent a further step in the opening up of Chinese capital markets – allowing access to the second largest economy on the world, the second largest stock market and the third largest bond market. In spite of the recent focus on capital controls around the onshore currency – arguably largely taken to stabilise the onshore CNY-USD rate – increased access to onshore assets through the stock and bond connect programmes should create more opportunities going forward for both outright and hedged investors.

To recap, the Shanghai-Hong Kong Stock Connect was launched in November 2014, allowing overseas investors easier access to the onshore “A-share” markets in Shanghai as well as allowing onshore Chinese investors access to Hong Kong listed names. Since the launch, the number of eligible names has increased and other limitations, such as an aggregate quota, eliminated. Covered short selling is also allowed. In December 2016, the Shenzhen-Hong Kong Stock Connect was launched, adding the smaller but racier and tech-heavy smaller cap Shenzhen exchange to the mix. These two channels have supplemented the existing QFII (Qualified Foreign Institutional Investor) and RQFII (RMB Qualified Foreign Institutional Investor) schemes. Crucially, this permits settlement in the offshore currency (CNH) which allows investors to exchange and hedge freely, albeit with some basis risk to the onshore CNY.

The Bond Connect allows access in a similar way to nearly $10 trillion of assets in China’s fixed income markets, supplementing previous access through QFII and RQFII as well as the China Interbank Bond Market (CIBM) scheme. This includes all types of bond securities tradable on the CIBM including central and local government bonds, central bank paper, financial policy bank bonds, corporate bonds, commercial paper, asset-backed securities and so on, as well as subscriptions for new issues. The People’s Bank of China (PBOC) has said that hedging tools such as bond repos (repurchase agreements) and interest rate derivatives will be available in the future. To an investor, Bond Connect means avoiding lengthy and complicated registration procedures, fewer restrictions such as a lock up on investment principal which was part of the earlier schemes, and more clarity on repatriation of sale proceeds.

In equity markets at the moment, offshore investors have typically invested in Hong Kong listed names (“H shares”) as well as those Chinese entities listed on the US exchanges. Access to onshore markets gives an investor the ability to trade a much wider breadth of industries and over 1500 more stocks of over $6.5 trillion market capitalization[1] (some are dual listed in Hong Kong, but not fungible, leading to relative value opportunities). The offshore markets (Hong Kong has just over 1000 stocks worth just over $2.3 trillion while there are about 90 listed ADRs worth nearly $1.5 trillion[2]) are dominated by the big tech names and state owned financials. Many of the consumer and healthcare names that are potential beneficiaries of the move towards a consumer-driven economy are onshore names.

 

Figure 1

Daily Turnover – Shanghai–Hong Kong Stock Connect and Shenzhen–Hong Kong Stock Connect


Source: Bloomberg. From Nov 17 2014 to July 10 2017.

Figure 2

Correlations Between Global Market and Chinese Markets


Source: Bloomberg. From Nov 2014 to June 2017.

CSI300 is an index of 300 large stocks drawn from Shanghai and Shenzhen.

SHCOMP is an index of all stocks that are traded at the Shanghai Stock Exchange.

HSCEI is the major index that tracks the performance of China enterprises listed in Hong Kong in the form of H shares.

CHINEXT is a Nasdaq-style board dominated by smaller tech companies.

Figure 3

Performance of State and Private Companies in the Onshore Markets


Source: Bloomberg. From Nov 2014 to June 2017.

To be fair, the volumes crossing the stock connect have probably not been as robust as was hoped for at the launch, as relatively higher onshore valuations and the popularity of many of the (offshore) tech names have kept offshore investors away from onshore listed names (Figure 1).

The recent inclusion of 222 A-shares into the MSCI indices (all standard country and regional indexes, including MSCI China, MSCI AC Asia, MSCI Asia Pacific ex-Japan, MSCI EM, and MSCI All Country World), after much consultation, can be seen as a further step in the internationalisation of the Chinese domestic capital markets. Yet, so far, only 5% of the Shanghai index market capitalisation of ~$700bn is being included bringing onshore Chinese exposure to just 0.1% of the MSCI World. While the impact of this inclusion is expected to be minimal, it is likely that over time its effect will be much greater. Interestingly, with low foreign participation and high retail interest, Chinese domestic markets have historically been quite uncorrelated with global markets (Figure 2) as well as giving differing returns both intra- and inter-sector, and between private- and state-owned enterprises (Figure 3).

In fixed income, the market has been developing quickly onshore – partly as a response to the massive growth in leverage, particularly at the corporate and local government level. While issuance continues to grow, secondary trading and credit discovery are weak. At the same time as the Bond Connect launch, the PBOC announced that qualified international credit agencies will be allowed to operate in the CIBM. This should help improve pricing and align ratings with the almost $1 trillion offshore pan-Asian (including Japan) bond market – at the present time onshore paper can trade at vastly different ratings and spreads from paper issued offshore by the same company (admittedly with differing legal structures and protections). After hedging back to USD, onshore yields are at the moment not particularly attractive. Foreign participation represents just 1.2% of the overall onshore market and 4% of the China Government Bond (CGB) market – much lower than more developed peers. Assuming the global bond index providers follow MSCI’s lead, and particularly at the sovereign level, where the IMF’s Special Drawing Rights (SDR) status should lead to increased ownership, the flow of funds could be enormous. Some commentators are expecting $250-300bn in flows over the next 36 months.[3]

We are not arguing that all is rosy in China – challenges abound at both the macro and the corporate level. Government-driven intervention if problems arise is a fact of life: witness the propping up of the stock market in mid-2015 and the recent short squeezes in offshore CNH funding designed to protect the currency. A cynic might suggest with some credibility that increased access to the onshore markets helps support the fixed income markets and thus the leverage in the economy with overseas capital. Corporate governance and transparency, particularly at the local government level, can differ widely. What the increase in access does provide though, is the opportunity for investors to perhaps better understand and take advantage of the changes in the world’s second largest economy.

 

David Walter is a Director at PAAMCO and serves as Head of Research for Asia. He sits on AIMA Singapore’s executive committee.

 

 

Pacific Alternative Asset Management Company, LLC (“PAAMCO U.S.”) is the investment adviser to all client accounts and all performance of client accounts is that of PAAMCO U.S. Pacific Alternative Asset Management Company Asia Pte. Ltd. (“PAAMCO Asia”), Pacific Alternative Asset Management Company Europe LLP (“PAAMCO Europe”), PAAMCO Araştırma Hizmetleri A.Ş. (“PAAMCO Turkey”), Pacific Alternative Asset Management Company Mexico, S.C. (“PAAMCO Mexico”), and PAAMCO Colombia S.A.S. (“PAAMCO Colombia”) are subsidiaries of PAAMCO U.S. “PAAMCO” refers to PAAMCO U.S., PAAMCO Asia, PAAMCO Europe, PAAMCO Turkey, PAAMCO Mexico, and PAAMCO Colombia, collectively.

This document contains the current, good faith opinions of the authors but not necessarily those of Pacific Alternative Asset Management Company, LLC and its subsidiaries (collectively, “PAAMCO”). The document is meant for educational purposes only and should not be considered as investment advice or a recommendation of any type.  This document may contain forward-looking statements.  These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate.  Such forward-looking statements are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially from those in the forward-looking statements.  Any forward-looking statements speak only as of the date they are made and PAAMCO assumes no duty to and does not undertake to update forward-looking statements.

Pacific Alternative Asset Management Company is a registered trademark in the United States, Canada, Japan, Singapore, Australia and Mexico. PAAMCO is a registered trademark in the United States, Canada, Europe, Japan, Australia and Mexico. Pacific Alternative Asset Management Company Europe and PAAMCO Europe are registered trademarks in Europe. Pacific Alternative Asset Management Company Asia and PAAMCO Asia are registered trademarks in Singapore. completeAlpha is a registered trademark in Singapore, Japan, the EU, the U.S. and Canada and it is a trademark of PAAMCO in Australia.

[1] Source for market capitalization: Bloomberg; Source for industry and equity list: https://www.hkex.com.hk/eng/market/sec_tradinfra/chinaconnect/Eligiblestock.htm

[2] Source for ADR count and AUM: Bloomberg; Source for Hong Kong equity list and market capitalization: https://www.hkex.com.hk/eng/stat/statrpt/mkthl/mkthl201706.htm

[3] Morgan Stanley – “Implications of Mainland-Hong Kong Bond Connect” July 3, 2017

Co-investments: A Framework for Investors

02/01/2017

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Over the past several years, the use of co-investments by investors as a means to enhance returns has evolved. While once seen as a high risk/high reward, one-off venture used by aggressive investors and offered by similarly aggressive hedge funds, co-investing is now close to becoming a hedge fund strategy in its own right. However, acceptance of a strategy of seeking out single one-off opportunistic trades comes with additional risks that investors would be wise to heed. As with any market, the supply of opportunity will inevitably rise to meet the demand, meaning that if there are allocators willing to provide capital, co-investment opportunities will undoubtedly appear in an attempt to procure that capital. Managers are especially attracted to the possibility of raising capital quickly and locking it up for longer than their standard offerings. This raises the potential for a riskier overall strategy as less suitable and/or less well-thought out opportunities are marketed across the industry.

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2017 Outlook: Value in Volatility

01/01/2017

 

2016 reminded many that predicting economic and geopolitical outcomes is a difficult task. Global stock and credit markets started the year with a substantial two-month sell-off on the heels of the energy price crash. Bond yields declined and, in many markets, moved into negative territory. On the political front, a wave of populism swept the globe, starting with the Brexit vote in June and culminating with Donald J. Trump’s election in the U.S. in November.

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Hedge Fund Identity Crisis Reshapes Asset Management

01/01/2017

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Overview


A paradigm shift within the asset management industry is at hand. Disappointing performance across both traditional and alternative investment approaches has opened the door for change. The barriers between traditional asset management and alternative asset management are rapidly blurring. New products that marry the investment goals of traditional active investment mandates with the trading strategies utilized by the best alternative managers are emerging, and institutional investors are taking notice. This innovative hybrid approach seeks to solve the return conundrum created by the low return environment brought on by years of easy monetary policy globally.

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Looking Beyond Brazil: Equity Opportunities in Latin America for Active Managers

10/24/2016

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Latin American (“LatAm”) equity markets are the top performers in emerging markets this year. Brazil has been grabbing the headlines because of the ongoing political drama (i.e., the impeachment of now former President Dima Rousseff) and, of course, the Olympics. But, Brazil also carries the flag as the best performing emerging market year-to-date1 (following years of underperformance compared to broader emerging markets indices). The jury is still out on the sustainability of the rally in Brazil, however, given uncertainty around the new administration’s ability to execute promised reforms to improve the deteriorating fiscal situation. While Brazil is dominating the headlines, there are also abundant opportunities in other LatAm countries because of valuation gaps, dispersion, and fundamental drivers.

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Tailored and Transparent: The Key to Absolute Return Funds Under Solvency II

09/24/2016

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Introduction
In the search for attractive and diversified returns, European insurance companies have generally dismissed absolute return funds as potential investments due to lack of familiarity, the complexity of understanding risk and return drivers, implementation hurdles, and the potential for a skeptical regulator particularly in the context of Solvency II. According to a recent Preqin study1 of more than 5,000 global institutional investors, insurers represent just 4% of all institutions invested in absolute return funds. Moreover, those that do invest in absolute return funds allocate only a small portion of their assets into such funds, an average of 3.3%. For Europe specifically, these figures are likely to be lower.

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Distressed/Stressed Credit Investing: Small Can Be Beautiful

06/24/2016

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The opportunity set for distressed investments has morphed into the most fertile environment since 2008. The China slowdown that began in 2015 appears to have marked the beginning of a new distressed cycle, and a number of factors have contributed to today’s attractive distressed/stressed credit opportunity set. After years of record inflows into credit products, markets have started to digest the beginning of an interest rate hike cycle, resulting in significant credit outflows. In 2014 and 2015, the total net outflow from high-yield mutual funds was $24 billion and $17 billion, respectively.1 Furthermore, investor demand for yield resulted in an excess of capital chasing too few opportunities as evidenced by the growth in high-yield bond issuances. The high-yield debt market is 75% larger now than it was in 2008.2 Against this backdrop of easy credit, many companies that should have been worthy of only minimal leverage were able to raise significant amounts of debt (e.g., exploration and production and commodity sectors). The resultant losses from these “true junk” investments have added to risk aversion in all areas of the market, particularly in the first few months of 2016 when investors’ risk-off sentiment, coupled with deteriorating liquidity, exacerbated a sharp sell-off.

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Investing in India – Light Amidst the Gloom

05/01/2016

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As the fastest-growing major economy in the world with broad financial markets and an active institutional investor base, India presents both a major opportunity and a potential frustration for global investors. Blessed by favourable demographics, a vibrant democracy and a largely domestic economy, India has to some extent skipped the recent emerging markets malaise with GDP growth recently hitting 7.5% (although this official number is higher than what most of the market believes). So how should investors take advantage of these opportunities given barriers to entry and various pitfalls? READ MORE

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04/24/2016

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Asset allocation is perhaps the most important choice facing CIOs. It involves evaluating the risk/return profile of various asset classes and is usually based on a combination of forward-looking expected returns and risk measures derived from historical data. In this context, the traditional modeling of private equity is subject to significant drawbacks. Available index data for private equity is lagged, smoothed, and understated with respect to the beta, volatility, and correlation with public equities. These drawbacks can have a significant impact on portfolio allocation decisions when a large share of a portfolio is allocated to private equity. The purpose of this paper is to evaluate alternative methods to proxy private equity investments in the context of portfolio allocation. This assessment draws on PAAMCO’s experience in managing hedge fund portfolios, which may contain private equity positions.

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