quarter to 31 december 2016 at a glance lcp investment ... · in-depth lcp investment update here...
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Global growth prospects rise; bond prices fall; yields rise; Trump’s victory spurs on US equity markets; UK property and commodity prices recover In a break with recent tradition, the OECD’s November 2016 projections
for global economic growth were revised upwards. While better for the
world as a whole, the figures paint a somewhat gloomy picture for the
UK with growth expected to drop to 1.2% in 2017 and 1.0% in 2018.
Other forecasters’ more recent UK predictions reveal a slightly brighter
outlook (see chart) – but the downward trend is clear.
Theresa May’s Lancaster House speech has brought a degree of clarity
to the UK’s Brexit negotiating stance. It’s ambitious – tariff-free trade
with Europe and control over immigration, all within a two-year time
frame. And if Europe doesn’t agree, then Britain may become a lightly
taxed, lightly regulated “Singapore-on-the-Thames”.
Pollsters got it right in Italy
Pollsters bucked their own trend by correctly predicting that the
Italian electorate would vote “No” in the 4 December referendum on
constitutional reform – yet another victory for the “anti-establishment”.
While three of the Eurozone’s four major engines – France, Germany
and Spain – are, if not purring then at least ticking over, Italy is
struggling to get into first gear. Some might argue it’s in reverse, with
the country not having grown over the last 16 years. Bigger political
tests lie ahead for investors, with elections looming in the Netherlands
(March 2017), France (May 2017) and Germany (August-October 2017).
The Trump effect
Five months earlier, investors had been shocked by the UK’s EU
referendum result. By comparison, Donald Trump’s November US
presidential victory proved positively stunning.
The late New York Governor Mario Cuomo once said of politicians:
“You campaign in poetry. You govern in prose.” As with so many things
political, Trump is doing it differently. He campaigned on Twitter
and it looks like he may govern the same way. Over the course of his
campaign, Trump managed to steer clear of much by way of specific
policy plans (after all, you can’t squeeze too much detail into 140
characters). But, tax cuts, infrastructure, immigration, deregulation and
protectionism were constant themes.
After an initial wobble lasting all of a few hours, investors seemed to
decide that Trump, initially at least, was good for the US, presaging
continued labour market strength, higher economic growth, higher
inflation, and further Dollar strength...read more
LCP investment snapshotA summary of our in-depth quarterly investment update on markets, macroeconomic outlook, topical investment issues and environmental, social and governance issues.
QUARTER TO 31 DECEMBER 2016 AT A GLANCE
Campaign in poetry, govern in prose, or, maybe just Tweet instead
Continue reading... request a copy of the in-depth LCP investment update here
Consumers have performed heroics in driving the economy forward. However, their resources and confidence are becoming stretched as Brexit-induced inflation picks up, eroding real income growth.
Consensus GDP growth forecasts
Source: Consensus Economics
0.0%0.5%1.0%1.5%2.0%2.5%3.0%
UK Eurozone US Japan
2016 2017 2018
Source: Consensus Economics
Consensus GDP growth forecasts
LCP Quarterly Investment Snapshot - Quarter to 31 December 2016 2
At a glance
Market commentary
BOND PERFORMANCE � Bond prices fell over the quarter
� The Federal Open Market Committee rose rates by 0.25% to 0.75% on continued US strength of the US economy and labour market; three more rate hikes are expected this year
� Mark Carney has “looked through” what is seen as a short term rise in inflation (fingers crossed), keeping rates on hold to provide the UK economy the support it needs
Many had thought (or perhaps hoped) that Trump’s electioneering
threats / promises were mere rhetoric. His first few days in office
suggest he intends to deliver on them.
Confrontation with China is emerging on a number of fronts – trade,
with tariffs threatened; political, with the US’ “one China” policy being
questioned; and military, with an arm wrestle over control in the South
China Sea in the offing. Elsewhere, American participation in the Trans-
Pacific Partnership deal is now dead while “very major” border taxes are
to be imposed on companies that move production overseas and then
import goods back to the US.
Short term, markets have moved higher in response to the “sugar rush”
of the new administration’s pro-growth policies. Longer term, some
elements of this mix might leave investors feeling rather sickly...read
more
EQUITY PERFORMANCE � Mr Trump’s victory and promises of tax cuts, infrastructure spending and looser regulation spurred a rally in US stocks. Other markets followed their lead
� Short term, Trump has been good for the markets. Longer term, possibly not
� We continue to recommend strategies not wholly reliant on “the market”
ALTERNATIVE ASSET PERFORMANCE � UK property transactions have recovered more quickly than expected
� Long-term, UK property remains well supported – a prospective yield in excess of gilts, often inflation-linked, is attractive. Brexit will continue to weigh on the asset class, for now
� Commodities recovered following an agreement to cut oil production – the first agreed cut since 2008. But will it stick?
The US Consumer Confidence Index surged in November and December (by enough to prompt a proud ‘tweet’ from Trump)
Q4 lowest returns (GBP)
-6.0% Fixed gilts >15 years
GBP corporates >15 years-5.3%
Worst performers
Q4 highest returns (GBP)
9.0% US
Overseas (ex UK)6.8%
Q4 highest returns (GBP)
5.8% Commodities (USD)
Property2.6%Best
performersBest
performers
Data source: Bloomberg, IPD, FTSE, Macquarie, Thomson Reuters Datastream
Mar
ket
com
men
tary
Consumer confidenceEquity market reaction to Donald Trump’s election
Source: Thomson Reuters Datastream
Consumer confidence
Q1 Q2 Q3 Q42016
90
95
100
105
110
115
USSource: Thomson Reuters Datastream
Source: Thomson Reuters Datastream
LCP Quarterly Investment Snapshot - Quarter to 31 December 2016 3
At a glance
Macroeconomic outlookGROWTH ASSET VIEWS
DOWNSIDE 25-35%
Crises, political risks and economic stagnation
UPSIDE 10-15%
Acceleration of global growth as consumer and business confidence returns
CENTRAL50-60%
The global economy continues on a path of sluggish growth
++ Emerging markets - multi-asset
Long-lease property
Private credit
+ Absolute return bonds
Alternative risk-premia
Commodities (active)
Diversified growth funds
Emerging market bonds
Equities – emerging
markets
Equities – global
developed markets
Equities – global small cap
Equities – UK
Listed infrastructure
Multi-asset credit
Opportunistic credit
Protection strategies
Secured loans
Timberland
Unlisted infrastructure
- Corporate bonds
High yield debt
Insurance-linked securities
Property – European
Property – UK commercial
Property – UK residential
-- Fund of hedge funds Private equity
Government bond yields
� UK and US yields have ticked up since September 2016
� German and Japanese yields have also risen from their lowest historic levels
� German and Japanese 10 year government bond yields have moved back into positive territory
Interest rate expectations
� Expectations of UK base rates for the next 1-5 years have risen since September 2016, but fallen since December 2015
� UK base rates were cut in August 2016, but markets are not currently expecting further cuts in 2017
Comparing swap and gilt yields
� As yields on both swaps and gilts have begun to rise from record lows over recent months, clients should consider carefully the timing of hedging implementation
� Where appropriate, we recommend that clients consider an LDI approach that can dynamically switch from one hedging asset to another, selecting from a range of different hedging instruments including swaps and gilts
� Despite the recent volatility, we believe that clients should add hedging to move towards their long-term strategic hedging targets
HEDGING ASSET VIEWS
It is important to note that some of the above asset classes represent a broad range of approaches. Please contact your investment consultant to discuss the most appropriate approach for your Scheme. All non-Sterling denominated assets are assessed on an unhedged currency basis.Rankings of asset classes represent LCP’s views of their attractiveness over a medium-term timeframe (2 to 3 years) informed by our central case economic scenario for the next 12-18 months. They do not take account of scheme-specific circumstances. The order within each group is alphabetical.
Mac
roec
onom
ic o
utlo
ok
ECONOMIC SCENARIOS
DOWNSIDE Scenario 3
UK downturn led by Sterling crisis
UPSIDE Scenario 1
Negotiations calm markets
CENTRAL Scenario 2
Uncertainty in Europe, UK and Eurozone growth falls
ECONOMIC SCENARIOS(BREXIT)
DOWNSIDE Scenario 4
Wider European downturn
10 year government bond yields (%)
Market expectations for UK interest rates
CreditEquitie
s
Real A
ssets Abs
olut
e R
etu
rn
Opportunistic
Liability matching strategies
Liability m
atching strategies Liabilit
y mat
chin
g st
rate
gie
s
We recommend that investors consider using the full toolkit to enhance returns while managing risk.
STRATEGIC ASSET ALLOCATION
New asset class:Opportunistic absolute return
Source: Thomson Reuters Datastream
Source: Bank of England
Opportunistic absolute return: unconstrained, high-conviction absolute return funds that seek to exploit market inefficiencies and structural change.
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
2016 2021 2026 2031
Market expectations for UK interest rates
Dec-15
Dec-16
Source: Bank of England
LCP Quarterly Investment Snapshot - Quarter to 31 December 2016 4
GILT YIELDS AND LDI FUNDS – PREPARING FOR CASH CALLS
In our previous issue, we commented on the continued rise in UK DB pension schemes deficits due to the seemingly relentless fall in bond yields. No more. Last quarter saw a significant reversal in the trend. While overall this represents much-needed good news, it also presents a governance
challenge – you may need cash, and fast.
� Over quarter 4 2016, the seemingly relentless fall in bond yields reversed
� If the trend continues, scheme trustees may need to pay money into their LDI funds, and quickly
� To do that, trustees need to be clear about how they will source the required funds
� For most trustees, this is one of the few occasions when having to
shell out cash should be seen as good news...read more
THE FCA’S ASSET MANAGEMENT MARKET STUDY – FEES HIGH, TRANSPARENCY LOW
In November 2015, the FCA set out the scope of its market study of the asset management industry, focusing on whether institutional and retail investors are getting value for money. The interim findings published in November 2016 indicated there is room for major improvement.
� The FCA has found weak price competition and high levels of profits in the asset management industry. It calls for greater transparency to improve matters
� Within the institutional investment advice market place, competition
is also seen to be weak...read more
The FCA’s full report is expected to be released in the second quarter of this year. Responses on this interim report are being accepted until 20 February.
BUILDING IN INFLATION PROTECTION – HOW ABOUT A BIT OF INFRASTRUCTURE?
December’s CPI figure was up to 1.6%, the highest since July 2014. Longer-term inflation expectations are also at a two-year high – currently expected to hit 3% in the next 5-10 years. What can pension scheme trustees do?
� For those who need inflation-linked cashflow matching assets and not too concerned about mark to market matching, infrastructure is worth considering
� While government can sometimes act as a hindrance, the re-emergence of fiscal policy as a means to stimulate economic growth provides a supportive backdrop
� Asset managers are responding to both the investment opportunity and to pension schemes’ need for long-term inflation-linked
cashflows...read more
OUR ANNUAL DE-RISKING REPORT
Looking back at 2016, volatile markets and uncertain economic conditions, fuelled by the world’s changing political situation, generated challenges for pension schemes looking to de-risk, but also opportunities.
� The market accelerated in the second half of 2016, following the bedding down of Solvency II, with over £17bn of insurer capacity being deployed.
� Pensioner buy-in pricing is currently at its most favourable level since 2011. Non-pensioner pricing has improved over the year.
� There are currently seven insurers in the market positioned to write business competitively under Solvency II, compared with nine at the end of 2015.
� In 2016 short-lived opportunities for particularly favourable buy-in pricing were driven by the Brexit vote and market volatility.
� We predict that buy-in and buy-out volumes will set a new record in 2017 of over £15bn, exceeding the £13.2bn of buy-ins and buy-outs in 2014.
Read the full report here
LCP VISTA: A PERSPECTIVE ON TODAY’S INVESTMENT IDEAS
LCP Vista aims to offer you access to our latest investment thinking, enabling trustees and employers to make good decisions about managing risk and making sure schemes can pay members’ promised benefits.
� Macro-economic outlook - Democracy posing some challenges?
� Can real estate solve a real problem?
� Getting your scheme through its mid-life crisis
� Buy-ins: making volatility work for you
� DB investment platforms: keeping trustees in the driving seat
� Governance: enhancing your decision making
Read the latest LCP Vista here
WHAT’S ON THE HORIZON FOR DC?
2016 was extremely busy, with a new DC Code of Practice, further reductions to pension taxation limits and the cessation in April of member-borne commission payments / active member discounts.
� Money purchase annual allowance could reduce
� Pension scams – ‘enough is enough’
� TPAS launches online pension scam guidance tool
� Royal Assent received for the Lifetime ISA (LISA)
� Financial Conduct Authority (FCA) proposes enhanced ISA approach to regulating LISAs
� Pension providers making good progress on reducing fees and charges
� Financial Reporting Council tweaks SMPI assumption
Read the latest DC Update here
At a glance
Topical investment issues
10 years on… and one million pensions in the UK have now been insured through buy-ins and buy-outs.
LCP PENSIONS DE-RISKING 2016
BUY-INS, BUY-OUTS AND LONGEVITY SWAPS
DECEMBER 2016
Top
ical
inve
stm
ent
issu
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Reserve your seat for LCP DC Conference Wednesday 22 March 2017
#LCPVista
IDE
AS
AN
D V
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S
IDE
AS
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1 LCP Vista Investment
VISTAMAGAZINEOUR INVESTMENT VIEWISSUE 5 NOVEMBER 2016
MACROECONOMIC OUTLOOKDemocracy posing some challenges?
LONG-LEASE REAL ESTATECan it help you solve a real problem?
BUY-INSMaking volatility work for you
What else is inside? � Getting your scheme through its
mid-life crisis � DB investment platforms: keeping
trustees in the driving seat � Governance: enhancing your
decision making
LCP Quarterly Investment Snapshot - Quarter to 31 December 2016 5
“A CODE WITH TEETH” – THE TRIPLE-TIERED UK STEWARDSHIP CODE
At a glance
Environmental, social and governance issues
ASOS, in October, became the latest company to come under fire for poor distribution centre working practices. Its Barnsley warehouse, described as “Victorian” by the GMB Union, joins Sports Direct’s Shirebrook hub in the workplace doghouse. While life expectancy continues to improve, it seems unlikely that many of the firm’s warehouse operatives will be able to put in the 214 year shift necessary to match CEO Nick Beighton’s 12 month package.
Commonwealth Bank of Australia (CBA) rubbed shareholders up the wrong way. After a series of company scandals, CBA’s bright idea was to reward senior management with a “culture bonus” for putting things right. You really couldn’t make it up, although CBA’s executives gave it a good go.
Sky at its AGM in October, embarrassingly, more than 50% of Sky’s independent shareholders voted against James Murdoch’s election as Sky chairman. Many shareholder advisory firms encouraged investors to vote against, arguing that, self-evidently, Murdoch was not independent. Royal London Asset Management, owner of 0.3% of Sky, said the resolution was not in the interests of the firm’s minority shareholders
Well Fargo’s “employee sales goal programme” – “eight is great” has rather backfired. Following evidence of malpractice in its implementation, the company’s share price fell; shareholders are now suing the company, while fines have hit $185m and public trust has
collapsed. Not so great....read more
CORPORATE ENGAGEMENT – FOURTH QUARTER 2016
� The Financial Reporting Council has introduced a strict categorisation system for those asset managers who are signatories of the UK Stewardship Code
� Appearing in the third and lowest tier implies lack of effective adherence to the principles of the Code
� Those ranked in Tier 3 have six months to improve to Tier 2; failure to do so will result in a removal from the list of signatories
� Managers on the naughty step have to decide whether to up their game or slouch off sulking. The latter is potentially dangerous, at least if new institutional business wins figure in those managers’
long-term growth plans...read more
ESG
issu
es
QUESTIONS TO CONSIDER
� We recommend clients make themselves aware of how their investment managers are ranked, and consider this as part of any decision making. You can check the classification here for managers. You can also see how service providers and asset owners rank.
� It is also possible to become a signatory of the UK Stewardship Code as an asset owner. Why not consider it as part of an increased effort to encourage higher corporate governance standards?
GREEN PAPER ON CORPORATE GOVERNANCE REFORM
� In November, the Government published a Green Paper setting out plans for corporate governance reforms in the UK, and inviting comment from business, investors and the public on how best to achieve them
� The Green Paper followed a number of bold statements from Theresa May, outlining a series of wide-ranging proposals aimed at tackling corporate excess, employee board representation, and tighter controls on executive pay
� Following criticism from big business, the plans set out in the Green
Paper fell short of expectations...read more
THERESA MAY’S LATEST PROPOSALS TO REFORM CORPORATE GOVERNANCE
� Shareholders may be granted more power over executive pay
� Companies may be forced to reveal pay ratios between chief executives and average workers
� Employee representation should be improved, but there will not be mandatory board seats for employees
� Existing governance rules could be applied to large privately-held companies
All rights to this document are reserved to Lane Clark & Peacock LLP (“LCP”). This document may be reproduced in whole or in part, provided prominent acknowledgement of the source is given. We accept no liability to anyone to whom this
document has been provided (with or without our consent). Lane Clark & Peacock LLP is a limited liability partnership registered in England and Wales with registered number OC301436. LCP is a registered trademark in the UK (Regd. TM No
2315442) and in the EU (Regd. TM No 002935583). All partners are members of Lane Clark & Peacock LLP. A list of members’ names is available for inspection at 95 Wigmore Street, London W1U 1DQ, the firm’s principal place of business and
registered office. The firm is regulated by the Institute and Faculty of Actuaries in respect of a range of investment business activities. The firm is not authorised under the Financial Services and Markets Act 2000 but we are able in certain
circumstances to offer a limited range of investment services to clients because we are licensed by the Institute and Faculty of Actuaries. We can provide these investment services if they are an incidental part of the professional services we
have been engaged to provide. © Lane Clark & Peacock LLP 2017.
Lane Clark & Peacock LLP London, UK Tel: +44 (0)20 7439 2266 enquiries@lcp.uk.com
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LCP is a firm of financial, actuarial and business consultants, specialising in the areas of pensions, investment, insurance and business analytics.
Ken WillisPartner ken.willis@lcp.uk.com
Natalie BrainAssociate Investment Consultantnatalie.brain@lcp.uk.com
Contact us to discuss the work we have been doing and how we can help you identify opportunities for your pension scheme.
+44 (0)20 7439 2266
Paul GibneyPartner paul.gibney@lcp.uk.com
@LCP_Actuaries
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3 February 2017
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