WWW.KL-COMMUNICATIONS.COM MAR 17

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Yellen's pitch perfect rate hike

P3ARTICLE 50:

WHAT NOW?

P4POPULIST DEFEAT

IN DUTCH VOTE

P6MID-CAP PREMIUM

SET TO RETURN

Neuberger Berman's Brad Tank believes conditions are ideal for the Federal Reserve to begin the process of rate normalisation (page 2)

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Brad TankNeuberger Berman

know nothing of Federal Reserve Chair Janet Yellen’s abilities as a singer, but she

was pitch perfect at her press conference this month, as evidenced by the constructive reaction from both the bond and equity markets to the rate hike.

The Fed has the perfect set of circumstances over the next few quarters to move to a normalisation of policy: improving economic growth, rising equity markets, growing consumer confidence and moderate inflation.

It is vital to get normalisation started now in order to avoid having to backload rate increases later in the cycle.

Over the last 70 years, the central bank has not had a great track record when it comes to forecasting recessions. At times, it almost seems as if it has been complicit in helping to foster them. This ‘complicity’ came from a late policy response to curtail accelerating inflation when an earlier, more pre-emptive approach might have been more appropriate.

More recently, in each of the last three recessions going back to 1990, it could be argued

the central bank was chasing inflation, aggressively moving to higher rates, which ultimately produced an inverted yield curve. The majority of recessions going back to World War II have been preceded by an inverted yield curve. Traditionally, it is been seen as a good indicator of a recession.

By focusing on normalisation, the Fed has an opportunity to be more pre-emptive and avoid chasing inflation later in the cycle. The key element evidenced in Yellen’s actions this month was the more aggressive path to higher rates, together with the assertion her forecast had not really changed.

The Fed is now acting confidently, clearly and decisively as it moves to more normal conditions. Unconventional monetary policy is something most market participants have concluded is no longer necessary. In short, a return to normal is good for markets.

Janet Yellen’s performance this month was the best combination of action, policy statement and press conference I have ever seen her display. She really hit a high note.

Yellen's pitch perfect rate hike

ordea Asset Management, the leading

investment manager in the Nordics, has rocketed up 14 places into the top ten of asset management brands in Europe.

Only the top three brands retained top ten positions from last year, research from Fund Buyer Focus revealed.

"In a challenging year for the industry, Europe’s professional fund buyers provided asset managers with some clear signals on the types of companies and brands they want to engage with in the future," says Diana Mackay, joint-CEO of MackayWilliams, the publisher of the study. "More than ever before, asset managers need to establish enduring differentiation through the emotional appeal of brands. Delivery of product at the right price is no longer enough."

Thomas Nehring, the head of institutional and wholesale distribution for UK and US at Nordea, says the group has built up solid momentum over a number of years.

"The solutions managed by Nordea's internal Multi Assets boutique, which forms a core part of our proposition, have played a major part of our recent success," he says. "The strong track record of our Multi Assets team over the past decade has been built on controlling risk in uncertain environments – such as the one faced by investors today."

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Nordea among top ten manager brands in Europe

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"Over the last 70 years, the central bank has not had a great track record in forecasting recessions"

Hartwig KosSYZ

Jon JonssonNeuberger Berman

Saker NusseibehHermes

arkets are grappling with the great dichotomy of

Trump’s ambitious promises and the harsh reality of his ability to deliver, given the Obamacare defeat. Besides that, investors continue to be complacent about French politics.

There is very little room left for investors to worry about Brexit.

One could see some sterling volatility, which may well be skewed to a stronger pound given

ne of the main flaws of this entire process, indulged

in by both sides, is to talk as if the effects of Brexit would be instantaneous or clear-cut once it is triggered.

To restate the obvious, Brexit is a long, complicated and arduous set of negotiations, of which the commercial outcomes and long-term effects on the economy are unlikely to be clear for many years to come.

riggering Article 50 marks the start of a two-year process

that will have many twists. We are currently allocating a

minimal portion of risk to the UK, as our conviction levels remain low. We prefer other European countries, where we see more attractive opportunities.

In terms of currency, our long-term view is that sterling is undervalued. The pound tumbled on the Brexit vote and has since

inflationary pressures in the UK and increasing questions on the BoE’s ultra-loose stance.

Having said this, given the broader context of markets right now, Theresa May’s letter could well be the spark that lights the fire in markets. Either way, the bulk of ‘Brexit pain’ will only be seen in a few months, when May’s cabinet finally realises the negotiations are going to be much harder than anticipated.

The most immediate effect – the 20% devaluation – was not about the outcome of Brexit per se, but a logical hike in the risk premium while we wait to see whether the effects are good or bad over the long term.

Triggering Article 50 can therefore be likened to embarking in a raft down windy and dangerous rapids. All we know at present is the journey is long and will take unusual twists and turns.

traded about 15% lower against the dollar. How it performs over the next few months depends on the tone and content of the negotiations that lie ahead.

Europe continues to recover, although it is highly sensitive to shocks. While mindful of the ongoing negotiations, investors will be more concerned about the outcome of the first round of the French elections next month, hoping it will be relatively benign.

"Theresa May’s letter could well be the spark that lights the fire in markets"

"Triggering Article 50 can be likened to embarking in a raft down windy and dangerous rapids"

"How sterling performs over the next few months depends on the tone and content of the negotiations"

Article 50 triggered - what happens now?

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Ken OrchardT. Rowe Price

he centre-right People’s Party for Freedom and Democracy (VVD), led

by current Prime Minister Mark Rutte, earlier this month won the largest share of seats in the Dutch general election, easing some of the political uncertainty that is hanging over Europe during a year of crucial elections.

A resumption of the status quo in the Netherlands may take the wind out of the sails of the populist movement sweeping through Europe and make voters in France's imminent presidential election less likely to back Marine Le Pen, the far-right leader of the Front National, which wants to exit the European Union.

The VVD is now placed to form a new ruling coalition that excludes Geert Wilders’ far-right, anti-immigration Party for Freedom (PVV), the next-largest party.

The election result means there will be a protracted period of political uncertainty in the

Netherlands as the numerous parties seek to fashion a government.

Bond markets had not priced in the Dutch elections as a major risk event. The main channel through which the result could have impacted bond markets was the potential boost in popularity that Wilders’ relatively strong showing could have given other populist parties in Europe, notably the Front National.

We have held a slight underweight position in Dutch government bonds for some time, which was unrelated to our conviction on the outcome of the election. However, we are moderately underweight French debt ahead of the French presidential election.

From a fixed income perspective, France is the focus. While the probability of a Le Pen victory remains slim, it is a major risk that the markets are wary of and would deal a serious blow to the future of the eurozone.

Populism thwarted in Dutch poll

s pressure continues to mount on asset

managers, the raft of consolidation recently witnessed in the sector is unlikely to end any time soon.

This is the view of Mike Clements, the head of European equities at SYZ Asset Management.

Hot on the heels of the Janus/Henderson and Amundi/Pioneer deals, Scottish giants Standard Life and Aberdeen agreed a tie-up earlier this month.

Clements says the collective headwinds for the sector are proving too much for many standalone asset managers.

"The rise of ETFs, persistent fee pressure, struggling fund performance, rising regulatory and compliance costs and higher capital requirements are making life tough for standalone and sub-scale asset managers," he says.

"The need for scale has never been more apparent in a sector which is dominated by a few global giants, but has an incredibly long tail of smaller players. Finding the right partner and coupling up seems to be the strategy pursued by many management teams.

"After presumably having scoured the market for US-centric opportunities, Aberdeen has found what looks to be a great deal on its own doorstep. The cost synergies are clear given the operational and geographic overlaps."

Asset manager consolidation set to continue

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"From a fixed income perspective, France is the focus"

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Hugh YarrowEvenlode

Esmé van HerwijnenEdenTree

esults season for the consumer branded goods sector was eclipsed to

a large extent by Kraft Heinz’s takeover attempt of Unilever.

This brief flirtation by Kraft Heinz offered us a thought experiment in what the UK stock market would lose if Unilever ceased to be a listed company.

Unilever offers a fairly unique combination of characteristics to UK investors. It is the global number two player in homecare, the number three player in beauty and personal care and the number six player in food. It is also a highly diversified business both by category and geography.

Unilever has a low-ticket, repeat purchase business model, with economic resilience and pricing power. It also generates

mproving board diversity has become an important consideration for investors. Female director numbers

have increased significantly over the last few years, but it has taken concerted effort. In 2011, women made up just 12.5% of FTSE 100 boards. The Davies Review encouraged 25% female representation on boards by 2015 and the Hampton-Alexander Review raised the bar to 33% by 2020. At the end of 2016, 27% of FTSE 100 directors were female.

The voluntary approach has been effective in the UK, while other countries have adopted a regulatory or quota-based approach. Norway set a mandatory 40% quota in 2003, while last year Germany set a quota of 30%.

high, compounding returns on invested capital and consistently converts earnings to cash. This is supported by a strong balance sheet. It also has an unrivalled and impossible to replicate footprint in emerging markets.

Unilever has delivered for income investors. Dividend growth has averaged more than 10% over the last 50 years. Despite the current low inflation environment, it continues to grow its dividend at +6% p.a. and has a starting dividend yield of >3%.

As such, we greeted the news that talks had been terminated with no disappointment. It would be a great shame to permanently lose such a high-quality dividend stream from both the UK market and Evenlode’s investable stock universe.

While progress has been made, there is still further to go. In the UK, women still represent less than 10% of executive positions. Why is this important? We think companies encouraging and empowering diversity will be better long-term performers. Academic evidence suggests boards make better decisions with a variety of voices.

We have integrated board diversity into our UK corporate governance policy, and look to vote against nomination committee directors where companies have made little progress since 2010 to improve board diversity. Working with the 30% Club, of which we are members, we also aim to encourage further progress in medium and smaller companies.

Relief over 'Kraftilever'

Gender diversity boost

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Lending void increasingly filled by asset managers

"Divi growth has averaged >10% over the last 50 years"

"Boards make better decisions with a variety of voices"

s tougher regulations on capital requirements

force banks to scale back on corporate lending, asset managers – such as Hermes Investment Management – are stepping forward to capture the strong and stable yields this market offers.

Prior to 2008, banks provided more than 80% of larger corporate loans in Europe, but this volume has fallen substantially. Since 2012, European direct-lending loan volumes have surged 120% year-on-year, with an estimated 86 funds raising more than £50bn.

The UK is the largest direct lending market, offering a consistent pipeline of deals, strong investor protections and political support for the growth of the SME sector.

"Offering strong and resilient returns in a low-yield environment, combined with security owing to the loans' seniority in borrowers' capital structures, direct-lending can serve a range of purposes for investors with long time horizons," Hermes says.

"The corporate leveraged-lending market has benefited from asset managers. Not only are borrowers able to diversify sources of long-term funding, institutional investors can capture the attractive yields on offer by working with fund managers who have expertise in the origination, structuring and monitoring, restructuring and workout of loans."

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Phil HarrisEdenTree

he effect of the sharp fall in sterling post the referendum had some

initially predictable effects on the UK equity market.

Large cap stocks, with on average 70% of earnings derived from overseas, were mechanically re-rated to take account of 'cheaper' valuations. For the first year since the financial crisis, mid-caps saw significant underperformance, a direct correlation of the lower overseas earnings and reduced commodity exposure. The post-crisis premium to large caps disappeared.

However, it is important to note, earnings growth forecasts for this year and next – which show continuing strong growth for mega caps – are almost wholly dependent on continued weak levels of sterling. For stocks such as Unilever or Diageo, underlying organic growth rates of 2%-3% can just as easily be wiped out by even a modest rally in sterling.

In contrast, mid-cap earnings are based much more on secular growth trends. We expect mid-caps to re-establish the premium as sterling stabilises or rallies.

As initial corporate hedging strategies, especially in retailers, wears off, inflation will have significant implications for a number of stocks and sectors. Headlines suggest many suppliers and retailers are looking to pass through price increases – just look at Marmite-gate between Unilever and Tesco – to

consumers, but the history of significant devaluations suggests a more nuanced response. It is more likely there will be a pain sharing between suppliers, retailers and the end consumers.

The mix will be critical for corporate profitability and consumer spending, the key driver for the economy. Sectors at risk include domestic retailers and legacy restaurant and pub groups, as cost inflation will be joined by Living Wage and business rate increases. This is a potentially lethal cocktail for profitability. For the average restaurant or pub group, like-for-like sales growth of at least 3% will be necessary to merely maintain profits, levels few companies have reached or sustained in recent years.

However, growth stocks should largely avoid these issues, as greater buying power should allow supplier renegotiations.

Mid-cap premium set to return

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Hotel Chocolat, for example, expects to hold prices as it reinvests considerable synergies from factory automation. Patisserie Valerie also believes cost inflation will be manageable as it expands rapidly. The clear message is to buy growth and avoid ‘legacy’ assets.

Weak sterling will make the UK a particularly attractive destination for M&A, as overseas bidders seek cheap assets. We recently saw several approaches for formerly unloved industrials and support services companies, such as Lavendon and Brammer. We expect much broader M&A activity in mid and small cap stocks this year.

Now the initial devaluation re-rating of mega caps has been priced in, investors are witnessing an interesting and more complex menu of asset and sector allocation opportunities.

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"Earnings growth for mega caps are almost wholly dependent on continued weak levels of sterling"