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A Brief History of Time

EDITORIAL

 

Since the beginning of the crisis, all eyes have been riveted alternately on the ECB or the Fed. Today we are suffering from exotropia, with investors focusing simultaneously on two obsessions: will Greece plunge into chaos, will the Fed tighten? Our view is that in fact the two issues are not all that divergent. In both cases we are buying time and in both cases the good news is that in a zero interest rate world flooded with liquidity buying time costs nothing or nearly nothing.

We are in the camp of those who believe that we are a long way away from a normalisation, in all parts of the world. We remain permanently exposed to a debt crisis and leverage is still the rule of the game, at the state and/or household level. The most recent and impressive illustration of this phenomenon is probably China where on the one hand regional governments have accumulated a pile of debt comparable to that of western countries, and on the other hand private investors have been playing with leverage in order to finance their most recent speculative bets on China A shares.

At the end of the day, especially after the traumatic experience of 2008, there is definitely no one in the loop who would be inclined today to be the one to trigger a new financial crisis. This accommodative tone remains our best ally for risky assets, starting with equities, and explains why we remain constructive even if the most popular words circulating at present are “bubble” or “bankruptcy” to describe current threats.

To conclude, we are tempted to affirm that in a world of lasting zero interest rates coupled with QE policies we should be able to defy gravity for a long period of time. We may not feel richer on the moon, but we certainly feel lighter, and we are now learning to live in levitation.

Romain BOSCHER
Global Head of Equities 

 

 

 

2015-07-EQ1
2015-07-EQ2

 

 

CONVICTIONS

Risk with yield: the attraction of equity income strategies

In the fixed income world the risk-free rate is becoming a rate-free risk, leading us to think about alternative sources of revenue. In the real world Investors need revenues to match their spending. In our world of central bank activism, reluctant investors are “invited” to climb up the scale of risks to cover their liabilities because of yield extinctions in the bond markets. That means increasing or maintaining a significant equity exposure.

Does it make any sense ? Yes. The equity dividend yield is decent (2.5%), and is covered with some comfort by abundant free cash flows (coverage of x2.0).

Should investors buy high dividend yielders indiscriminately? No. Bond-like equities will carry the same risks as bond markets: insufficient capital preservation options. Preferably Investors should consider and mix growth options, conservative assessments of forward returns and risk diversification. This is at the agenda of our new Global Equity Income strategy.

Melchior Dechelette
Head of Active Smart Beta Strategies

 

The return of volatility

The recent rise in realised volatility on European and Asian markets led to a surge in short-term implicit volatility in Europe and Asia. Since end May 2015, one-year implied volatility on the Euro Stoxx 50 has risen from 19.5% to 21% and one-month volatility has increased from 21.6% to 32%. This modest rise as of now in medium-term volatility can be explained by the impact of structured products (which become sellers of volatility when markets are falling), central banks policies and the conviction that Greece is not a systemic risk.

We thus have a new confirmation of a change in the volatility regime on equity markets dating from H2 2014. Volatility peaks have become more frequent and now affect most asset classes with the fall in market liquidity. A Grexit or a meltdown of the Chinese market in the short term, uncertainty over a Fed hike in the medium term are all likely triggers for a surge in risk aversion. This has led us to increase the probability of a return to a high volatility regime, comparable to that of summer 2011.        

Eric Hermitte & Gilbert Keskin
Co-Heads of Volatility and Convertibles

 

Gold Mines: Towards a summer rally?

The gold market seems to be indifferent to the Greek drama that has been unfolding over the past few weeks. While signs of nervousness are multiplying, as exemplified by the recent surge in volatility, investors are preferring to seek refuge in Switzerland or Sweden, even though official interest rates in both these countries are negative. They are thus accepting to pay a price in order to shelter their liquidities from the euro zone! And yet gold has an attraction in this environment of low interest rates as it allows investors to considerably reduce their cost of carry.

Gold, which like most commodities is often inversely correlated with the dollar (historically at least two thirds of the time), has proved to be resilient in the face of the sharp dollar appreciation over the past year, thus playing its role of safe haven currency. This has benefited investors in the euro zone who have increased their gold holdings by 7% since the beginning of 2015 and by 9% over one year.

At the start of what promises to be an exceptionally hot summer, in all senses of the term, it is worth underlining that the summer period is very often one of the best seasons for gold and gold equities. This has been the case for the past 14 years (2001-2014), with an average rise of +14.9% in dollar terms for gold and +23.6% for gold mines (S&P/TSX Global Gold index). Only the summer of 2008 was slightly negative for gold equities (-3.4% in USD) at the time of an unprecedented credit crisis. We can note that gold equities gained 38.2% in the summer of 2013, even though 2013 was one of their worst years and they plunged 52.8% over the full year.

The gold industry today is at a particularly interesting turning point. The decline in the gold price over the last few years has led to spectacular value destruction in the sector and obliged a large number of companies to completely overhaul their strategies simply to survive. Their efforts should start bearing fruit this year with cash flows expected to return to clearly positive territory ($2.5bn expected compared to ~0.2bn in 2014). This is the key for the revaluation of the sector.

With gold equities in a bear market since April 2011, losing more than 70% over approximately 1,550 days, very few investors are now exposed to this asset class. While the valuation of the major markets may appear today to some to be particularly high, gold mines in contrast are at a historically low point, even below that of 2000 (the last trough in the gold price, at $250) and 2008 (collapse of Lehman and an unprecedented credit crisis). The valuation of gold equities, based on a P/NAV approach, presents a discount of nearly 50% to their average value over 1985-2011. Lastly, let us not overlook the fact that gold equities have the specificity of being one of the assets with the lowest correlation with other markets.

Arnaud du Plessis
Senior Portfolio Manager, Gold and Global Resources Equities

 

 

 

2015-07-EQ3

 

 

 

 

2015-07-EQ4

 

 

 

 

2015-07-EQ5

 

FOCUS
THE Revival of Socially Responsible Investment

Watch the video 

2015-07--Equity-Letter---Laurent-Trottier--EN-player

 

The range of Socially Responsible Investment solutions has grown significantly and allows investors to access usual search of performance as well as a simple hedging of specific risks or a thematic exposure.

First of all, the Best In Class approach, favored by institutional investors for a long time, has the dual advantage of providing equity exposure respecting its sectorial and geographical features while improving portfolio footprint on Environmental, Social and Governance dimensions. Hence the use of « Core SRI » terminology to name this approach. Portfolio construction is governed by simple and transparent rules (i.e. within a sector, overweight companies with the best ESG practices and on the other hand exclude/underweight companies with the least good practices). This allows to capture the performance arising from good behavior (“SRI alpha”). However, since the ESG analysis is a long-term one, complementing it with fundamental and/or quantitative analysis helps to benefit from additional sources of performance and to add robustness. Our Best In Class funds benefit from our extra-financial analysis capacities and our fundamental and quantitative research abilities, all administered by fund managers specialised in portfolio optimisation techniques, implementation and risk control. The performance realised on different geographical areas illustrate the ability of this approach to generate alpha on top of presenting a “clean investment”.

2015-07-EQ6

Despite this “SRI alpha” many investors are firstly perceiving SRI as a way to be hedged against some risks. Then they are expecting a market exposure presenting nearly the same characteristics than the original index (country, sector, size, …) while avoiding investments on specific stocks or industries. Amundi index portfolio managers are frequently asked to respect a list of restricted stocks while minimising the impact of such restrictions on  the Tracking Error. Those exclusions lists can be provided directly by the investor or can be determined by Amundi extra-financial analysts based on investor guidelines such as, for example, avoiding companies with more than 5% of their revenues coming from controversial activities (tobacco, alcohol, gaming, weapons, …)

2015-07-EQ7

Risks to be hedged are sometimes limited to very specific areas of the ESG spectrum. For example, in the context of global warming, Amundi is proposing a low carbon investment approach. We are convinced that companies with the worst carbon emission scores will see their financial results at stake, facing the accumulation of constraining regulations. We are also convinced that we will not be able to use all underground carbon reserves that are key assets of extracting companies and constituting a significant part of their valuation. This imply a risk of a potential discount on the market valuation of those companies Thus, we are proposing an investment solution that helps to significantly reduce the carbon footprint (above 50% of carbon footprint reduction) while achieving a reduced Tracking Error compared to standard indices (generally ranging between 0.6% and 0.7%).

2015-07-EQ8

Finally, other investors are focusing on precise investment themes in the SRI area such as green technologies or water treatment. Here, the portfolio manager needs to start by defining the eligible investment universe, in collaboration with extra-financial analysts. Then a specific care should be taken to the portfolio construction. Due to a frequent lack of benchmark related to the investment theme and the focus on a limited number of sectors, portfolio construction mechanisms derived from Smart Beta offer interesting solutions and added value.

Laurent TROTTIER
Global Head of Index Management & Smart Beta 

 

Past performance is not a reliable indicator of future results or a guarantee of future returns.

Romain BOSCHER, Global Head of Equities at Amundi
Melchior DECHELETTE, Head of Active Smart Beta Strategies
Eric HERMITTE, Co-Head of Volatility and Convertibles
Gilbert KESKIN, Co-Head of Volatility and Convertibles
Arnaud DU PLESSIS, Senior Portfolio Manager, Gold and Global Resources Equities
Laurent TROTTIER, CFA, Global Head of Index Management & Smart Beta

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A Brief History of Time
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