The World is Flat by Thomas L. Friedman, a New York Times bestselling book in 2005, praised globalization and the countries that embraced it. While many of the factors that Friedman describes in his book remain in force (in particular those related to the internet and wireless technologies), others are shifting. Ten years after the publication of The World is Flat, individual economies around the world have started to move at a different pace. As the world recovers its round shape and more traditional characteristics return, we see four opportunities worth paying attention to in 2015: Japan; liquid fixed income and currencies; distressed energy assets; and, opportunities in select emerging markets.
Looking Beyond Abenomics: Event-Driven Opportunities Resulting from Changes in Corporate Governance Rules
“Beyond Abenomics” is not about the Yen or the Nikkei; it’s about unlocking value in the vast number of listed subsidiaries in Japan. Of the 3000+ listed companies in Japan, about 20% are listed subsidiaries of larger entities. Abenomics’ “Third Arrow” revitalization program is focused on improving corporate governance. Initiatives include the creation of a new stock market index, the JPX-Nikkei 400 (i.e., the “shame” index), which is focused on companies with strong ROE and governance, and meant to “shame” companies who are not selected for inclusion. Initiatives also include the new Stewardship Code, which enhances fiduciary responsibility for asset managers vis-à-vis companies in which they invest in. Both of these initiatives are triggering buy-outs or spin-outs of subsidiaries from their parent companies, potentially unlocking substantial new value for investors.
Macro Opportunities in Liquid Fixed Income and FX Emanating from Global Central Bank Policy Divergence
This area of opportunity is triggered by the pronounced divergence in central bank policies across regions. While the Fed has effectively ended QE, Japan and Europe continue to ease, and some emerging markets have already made emergency rate hikes to defend their currencies. Decisions on interest rate policy (e.g., timing of the first hike in the US) and the likely path of future monetary policy globally are highly data dependent. Given that data is inherently volatile, we expect periodic spikes in volatility to persist, creating opportunities for nimble investors. In addition, trends in “macro” have increased in strength and relevance over the past few months (e.g., the steep decline in the Yen and Euro versus the dollar, European bond yields). We expect this to create opportunities as well.
A New Distressed Cycle Sparked by Lower Oil Prices
The startling 50% price decline in oil prices in the latter half of 2014 resulted in a tremendous downward re-pricing across the board in energy-related assets. Some of this re-pricing is reflective of the increased possibility of defaults across the high-yield energy sector, while others can be considered situations in which “the baby is being thrown out with the bathwater.” Hence we expect there to be classic distressed opportunities (where companies with too much debt will go through a bankruptcy and/or a restructuring process), as well as opportunities resulting from indiscriminate selling of energy-related securities despite strong corporate fundamentals. For example, we see opportunities in securities that are well-covered by assets even in the face of further oil price declines, have good cash flow characteristics, and have potential positive catalysts in the future (e.g., potential bond take-outs). We expect the energy theme to provide interesting opportunities across asset classes and security types.
Opportunities in Emerging Markets that Fail to Adjust
Despite a glimpse of the vulnerability of specific emerging markets during the “Taper Tantrum” of 2013, emerging markets have generally been well-supported across the board by the continued search for yield. In 2014, we saw the beginning of true divergence in emerging markets asset price performance and a renewed focus on country-specific factors. While India’s stock market has been leading global performance, Russian and Brazilian equities have sold off sharply. The reality is that various emerging markets have weak structural dynamics (e.g., current account deficits, high inflation and unemployment, and slowing growth) and challenging internal politics. Unfortunately, many emerging markets did not use the good times to restructure their economies. Although the decline in oil prices has given many structurally weak emerging markets breathing room (e.g., Turkey), others are not as fortunate. We continue to look for ways to trade differentiation across the emerging market asset classes.
After many relatively quiet years when the world seemed flat and well interconnected, we have begun to again feel it spinning, reminding us of its true shape. We have seen the beginning of increases in episodic volatility and a market more conducive to generating alpha through trading and security selection. We are deploying capital towards these “world is not completely flat” opportunities.
Special thanks to Melanie Rijkenberg for her substantial contributions to the paper.
Mayer Cherem, CFA, CQF is a Managing Director and Head of the Portfolio Solutions Group. Among other things, he chairs the firm’s Strategy Allocation Committee where he focuses on assessing the impact of asset allocation on overall portfolio risk and performance.
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