2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
2012 2013 2014 2016 20172014 2014 (final) 2015 2015 (final) 2016 2017
Global growth estimates fall; political risks mount; yields remain ever so low; equity markets shrugged off their post Brexit blues; UK property recovers some of its composure Both the IMF and OECD revised down their global growth forecasts
for 2016 and 2017, to 2.9% and 3.2% respectively, part of an on-going
trend. For example, in mid 2012, the 2014 growth rate was forecast to
be over 4%, but was only 3.4% by the time we got there (see chart).
While the OECD’s 2016 post-Brexit UK forecast rose from 1.7% to 1.8%
in 2016, 2017’s fell sharply, from 2% to 1%. Theresa May believes, rather
enigmatically, that “Brexit means Brexit”. The OECD clearly believes it
means something rather nasty, economically speaking.
Following Theresa May’s speech at the Conservative Party conference,
the consensus is coalescing currently around ‘Hard Brexit’ (strict
immigration controls, with the UK / EU trading relationship governed by
WTO rules) rather than ‘Soft Brexit’ (flexible immigration controls with
some form of membership of the EU single market).
Wrong call, according to the currency markets – which have been
dubbed by some wags as HM’s official opposition in the absence of
Labour party visibility on the issue.
Sterling has been pushed down against the Dollar to levels not seen for
over 30 years, while the BoE recently suggested the effective exchange
rate was at a 168 year low.
Following the Referendum result the BoE, as expected, quickly injected
fresh stimulus into the system. It was not the only monetary authority to
do so.
In the absence of more radical monetary measures (anyone for time-
limited spending vouchers?), monetary policy in some regimes seems
to be running out of road. How long can the ECB effectively continue
its bond buying policy given the mismatch between Eurozone debt
issuance and its purchases of those securities.
Attention does at last seem to be shifting towards fiscal and structural
measures. Canada, Japan and the US have raised spending on
investment while here in the UK, Chancellor Philip Hammond’s has
confirmed an easing in the country’s strict budgetary stance. The
OECD has urged others to do more, most notably the Eurozone, where
the rules governing the region’s Stability and Growth Pact stymie the
introduction of a more supportive fiscal stance.
In the absence of such measures, the OECD fears the world is set to
remain in a low growth trap, with poor growth expectations depressing
trade, investment, productivity and wages ...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 30 SEPTEMBER 2016 AT A GLANCE
Global growth estimates continue their downward trajectory
Continue reading... request a copy of the in-depth LCP investment update here
As the prospects for ‘Hard Brexit’ rise, so the prospects for the UK economy fall – if we believe the currency markets, where Sterling is at 30 year lows versus the Dollar.
IMF global growth projections over time
Source: IMF World Economic Outlook
LCP Quarterly Investment Snapshot - 30 September 2016 2
At a glance
Market commentary
BOND PERFORMANCE � Bond yields remain at historically low levels – cheaper at one point than in ancient Sumer in 3000 BC, apparently
� The BoE’s ‘four-point plan’ of monetary policy measures helped soothe investor nerves
� Some might question the design of the corporate bond buying part of the policy – do Apple and McDonalds need the BoE to support their financing?
When once asked what he found most difficult about his job, the then
UK prime minister Harold McMillan famously replied “events, dear boy,
events”. He might therefore have had sympathy with today’s politicians
(and investors) who face a range of bear traps, pitfalls and hazards
as electorates go to the polls. The political obstacle course over the
coming year is varied - US elections and Brexit to name just two.
US data has been fairly mixed, but the economy is still the most sure
footed of all the major developed economies. September jobs growth
was below expectations, but steady. Meanwhile, the Fed is laying the
groundwork for an end of year rate rise.
Brexit’s impact on the real UK economy thus far has been fairly limited.
Although business confidence has taken a hit and multinationals
are expected to pause investment decisions until negotiations are
progressed, consumer confidence has remained steady. The test may
come as prices spike in response to imported inflation.
The Eurozone remains weak, growing by a meagre 0.3% over the year
to June 2016. As well as looming Dutch, German, French and Italian
electoral challenges, the region’s banking fragility has raised its head
once more. Italian and Portuguese banks have now been joined on the
naughty step by Germany’s Deutsche Bank, described by the IMF as
‘the world’s most dangerous bank’ ...read more
EQUITY PERFORMANCE � Equity markets shrugged off their post Brexit blues remarkably quickly, apparently – UK and US indices reached records highs over the quarter
� Easy money continues to act as the market’s life support amidst a troubled backdrop, but seems to be approaching its limits
� We continue to recommend strategies not wholly reliant on “the market”
ALTERNATIVE ASSET PERFORMANCE � UK property fell sharply on Brexit, but has since recovered some of its composure
� UK property is supported by easy money and has several features that are attractive to the long-term, income oriented, investor
� Diversified growth funds could hardly fail to rise in a quarter where almost all asset were up sharply
Investment grade credit spreads contracted over the quarter. UK spreads fell sharply following the BoE’s announcement of its corporate bond buying programme.
Q3 highest returns (GBP)
12.9% Index linked gilts > 15 years
GBP corporates – all stocks10.1%Best
Performers
Q3 highest returns (GBP)
12.3% Asia Pacific ex Japan
Japan12.1%
Q3 highest returns (GBP)
4.1% Diversified growth
Infrastructure3.4%Best Performers
Best Performers
Data source: Bloomberg, IPD, FTSE, Macquarie, Thomson Reuters Datastream
Mar
ket
com
men
tary
Investment grade credit spreads
Source: Thomson Reuters Datastream
LCP Quarterly Investment Snapshot - 30 September 2016 3
0.0%
1.0%
2.0%
3.0%
4.0%
Sep 2016 Sep 2021 Sep 2026 Sep 2031
Market expectations for UK interest rates
Sep-15Sep-16
Source: Bank of England
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 market 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
High yield debt + to -
Government bond yields
� German and Japanese yields have reached their lowest historic levels
� UK yields are historically low but could still fall further towards German and Japanese levels
� Japanese and German 10 year government bond yields remain in negative territory
Interest rate expectations
� Expectations of UK base rates for the next 1-5 years have fallen further
� UK base rate rises have been increasingly pushed back
� UK base rates were cut in August 2016, and could be cut further in 2016 / 2017
Comparing swap and gilt yields
� At record low yields on both swaps and gilts, clients should consider carefully the timing of hedging implementation programmes
� 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
*New asset class added Q3 2016It 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 amedium-term timeframe (2 to 3 years) informed by our economic scenarios 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
Protection strategies - to +
Multi-asset credit ++ to +
Long-lease property and Private credit + to ++
Source: Thomson Reuters Datastream
Source: Bank of England
LCP Quarterly Investment Snapshot - 30 September 2016 4
DIVIDENDS AND DEFICITS
Recent figures from the PPF highlight the worsening financial health of UK DB pension schemes, with aggregate deficits reaching record highs.
The prime driver of the deterioration has been the sharp rise in liabilities, caused by the seemingly
relentless fall (rise) in bond yields (prices), a trend most recently exacerbated by the Bank of England’s decision on 4 August 2016 to cut interest rates from 0.5% to 0.25% and to restart its bond purchasing programme. While asset values also rose, buoyed by cheaper Sterling, the effect was modest by comparison.
� According to recent data released by the PPF, DB schemes’ aggregate funding deficits are at record highs
� In many cases, the cash is there to (at least partially) fix the problem. Not so much ‘can’t pay, won’t pay’, more ‘can pay but would prefer not to pay, too much, right now’
� With the size of some firms’ DB scheme deficits causing investor jitters, it may simply be enlightened self-interest for management to rethink cash priorities (ie a bit more for the scheme)...read more
EMERGING MARKETS – ON THE UP. CAN THE GOOD TIMES LAST?
Emerging markets have tried investors’ patience sorely in recent years. Now that patience is at last being rewarded.
Over the three years to 30 September 2015, both emerging market equities and emerging market bonds lagged badly relative to developed markets.
� There are a number of reasons to invest, or to stay invested, some good, some not so good (but not necessarily bad)
� Emerging markets presently hold an almost irresistible allure for yield-starved investors...read more
On balance, for emerging markets, it’s better to be in than out, given both the near-term outlook and the prospects for long-term growth.
QUANTITATIVE EASING – LAST ORDERS PLEASE?
These days, anyone with even a passing knowledge of financial matters will probably be able to have a good stab at explaining quantitative easing (QE).
It is though a relatively new phenomenon. It first appeared in the East (although some argue that the US Fed engaged in a form of QE to combat the Depression).
� Quantitative easing (QE) has been front and centre of central banks’ successful attempts to avert economic heart failure following the financial crisis
� But, its effectiveness appears to be waning, with the economic patient still looking rather peaky
� Some are calling for more radical medicine. No, that low rhythmic whooshing sound you hear overhead is not the air ambulance, but the sound of helicopter money
� By stimulating demand in the short term, helicopter money can generate a self-sustaining economic recovery. Perhaps...read more
IORP II AND ESG – WAKE UP AND SMELL THE COFFEE
On 30 June the final draft of the long-awaited new European Pension Directive (IORP II) was agreed. Given the likely timeframe for Brexit, it is expected that this will be implemented in full in UK law. The new Directive includes far-reaching provisions relating to environmental, social and
governance factors (ESG).
� The IORP II Directive is on its way to a pension scheme near you, almost certainly
� The Directive has major implications for ESG-related issues
� The Pensions Regulator is ‘on message’ as far as ESG is concerned, stating that “I would urge any trustee or asset manager out there who still thinks these [ESG] things don’t matter to wake up and smell the coffee”
� Double espressos all round ...read more
THE ASSET CLASS THAT NEVER QUITE WAS
The government’s decision to kill off the secondary annuity market caught everyone by surprise. Many will be disappointed at the news, including many of the pensioners who were forced to buy an annuity before April 2015. Still, there must be some sympathy for the new government’s
position and ultimate decision, given the potential risks to the elderly and the vulnerable.
� An inability to balance a vibrant market with sufficient consumer protections was the reasons for the move
� From a pension scheme perspective though, it would have been interesting to have seen this market develop and grow, given the prospects for constructing diversified portfolios with income characteristics similar to bonds but with general longevity protection...read more
At a glance
Topical investment issues
Top
ical
inve
stm
ent
issu
es
GET LCP VISTA ISSUE 4 HERE
LCP Quarterly Investment Snapshot - 30 September 2016 5
ASSET MANAGERS IGNORE RESPONSIBLE INVESTMENT COMMITMENTS
At a glance
Environmental, social and governance issues
Starbucks’ decision to allow proxy access mirrors that of several other US companies including Apple and Microsoft. The debate over proxy access has gained momentum over recent years, with pension funds putting forward more than 100 proxy access resolutions on US companies during 2015.
Ryanair investors remain dissatisfied with executive pay. Rather sniffily, a spokesman noted that “Mr O’Leary thinks he’s seriously underpaid…” Roger and out. Rather bizarrely, non-executives are allowed to participate on the company’s share option scheme. Best practice is for a fixed fee.
Sports Direct featured for the fourth time. Previously, it was to report investor outrage at the riches directors wanted to lavish on themselves. This time, it’s about the company’s shoddy treatment of its workers.
Goldman Sachs’ investors were unhappy with CEO Lloyd Blankfein’s $22.6m pay deal. The episode is a reminder of the “heads I win, tails you lose” mind-set that once characterised the investor / banker relationship and, in some cases, still does.
CORPORATE ENGAGEMENT – THIRD QUARTER 2016
A recent study carried out by the Asset Owners Disclosure Project
(AODP) has revealed that several investment managers who are
signatories of the UN-backed Principles of Responsible Investment
(PRI) are not acting in accordance with the commitments made when
signing up to the PRI.
� By rejecting a resolution at ExxonMobil’s AGM (covering disclosure of financial risks associated with climate change), asset managers seemingly failed to abide by their UN PRI commitments
� BlackRock was accused of “disturbing hypocrisy”, voting against climate change resolutions on the same day it released a report on responsible investment...read more
ESG
issu
es
We believe that an economically efficient, sustainable global financial system is a necessity for long-term value creation. Such a system will reward long-term, responsible investment and benefit the environment and society as a whole.
QUESTIONS TO CONSIDER
� Are you addressing members’ interests and responding to their concerns in relation to voting activity?
� Why not ask your investment managers about their views and how they voted on the climate-related issues? Should those that voted against and are signatories of the PRI be challenged on their contradictory actions?
THE LIVING WAGE
� In contrast to the statutory ‘national minimum wage’, the Living Wage is voluntary and is deemed to be the wage necessary to address the basic cost of living for individuals and their family
� The Living Wage Foundation supports employers in applying the Living Wage and provides formal accreditation of those that do
� Are your investment managers part of the Investor Collaborative for the Living Wage? If not, how do they engage directly with investee companies on staff pay?...read more
PRI mission
INVESTOR COLLABORATIVE FOR THE LIVING WAGE
� This is a group of institutional investors encouraging FTSE100 companies to adopt the Living Wage
� Significant progress has been made since the Colloborative’s launch in 2011, with the number of accredited FTSE100 employers increasing from two to thirty
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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
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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 [email protected]
Natalie BrainAssociate Investment [email protected]
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
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@LCP_Actuaries
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8 November 2016