We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global...
Transcript of We at Aberdeen believe that the high yield market at …...Source: BofA Merrill Lynch Global...
In the United States, Aberdeen Asset Management (AAM) is the marketing name for the following affiliated, registered investment advisers: Aberdeen Asset Management Inc., Aberdeen Asset Managers Ltd, Aberdeen Asset Management Ltd and Aberdeen Asset Management Asia Ltd, each of which is wholly owned by Aberdeen Asset Management PLC. "Aberdeen" is a U.S. registered service mark of Aberdeen Asset Management PLC.
For professional use only – Not for Public distribution
The “Third” Asset Class High Yield: An asset class with both bond and equity-like characteristics
September 2015
Patrick Maldari, CFA, Senior Fixed Income Investment Specialist Aberdeen Asset Management
1
What is the “third” asset class?
We at Aberdeen believe that the high yield market at times will exhibit the characteristics of both equities
and high grade bonds. In our opinion, this creates an opportunity for investors to capture the majority of the
upside while also protecting the downside.
2
Talks like a bond, acts like an equity U.S. high yield bonds showed higher correlation* to equities than 5-year U.S. Treasuries
Sources: BofA Merrill Lynch, Barclays, 31 Aug 15 * Rolling 3-year correlations For illustrative purposes only
-0.60
-0.40
-0.20
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Cor
rela
tion
with
clo
sest
US
Tre
asur
y by
dur
atio
n
US HY Bonds to 5-year Treasuries US HY Bonds to EquitiesIndex level
3
Attractive diversification dynamics Correlation of global high yield versus other asset classes 12/31/2002 – 8/31/2015
Global High Yield
US Equities US Investment Grade International Equities
Global High Yield 1.00 0.70 0.24 0.76
US Equities 0.70 1.00 0.01 0.87
US Investment Grade 0.24 0.01 1.00 0.10
International Equities 0.76 0.87 0.10 1.00
Source: BofA Merrill Lynch Global Research, USD, Hedged, 31 Aug 15 Correlation Matrix 12/31/2002 - 8/31/2015 Attribute=Total Return Percentage, gross of fees, Frequency=Monthly Global HY: The BofA Merrill Lynch Global High Yield Constrained Index US Equities: S&P 500 Index US Investment Grade: The BofA Merrill Lynch US Corporate Index International Equities: MSCI AC World ex US Index Hypothetical positions are used here and actual markets conditions may have a different impact on the portfolio Diversification does not ensure a profit or protect against a loss in a declining market. For illustrative purposes only
4
-40
-20
0
20
40
60
80
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015YTD
Total Return Income Return Price Return
Income matters Global high yield has been providing positive income-driven returns over the years
Source: Source: BofA Merrill Lynch Global Research, 31 Aug 15. Past performance is not an indication of future results The above data represents: (HW0C) BofA Merrill Lynch Global High Yield Constrained Index For illustrative purposes only
%
5
What makes global high yield attractive?
Source: Bloomberg, BofA Merrill Lynch Global Research, 31 Aug 15. Past performance is not an indication of future results Cumulative Performance of Monthly Index Returns hedged to USD For illustrative purposes only
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
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02
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15
Gro
wth
of $
10,0
00
MSCI All Country ex US S&P 500 Barclays US Aggregate BofA Merill Lynch Global High Yield
6
This says it all…
Source: Jantoo
7
Lower treasury yields typically offset by higher spreads
From To 10Y Treasury Yield High-Yield Spread SPX Price
Oct ’87 Mar ’88 -1.44% – -16.8%
Mar ’89 Aug ’89 -1.49% +138 bp +19.8%
May ’90 Feb ’91 -1.02% +358 bp +4.0%
Jul ’91 Jan ’92 1.53% +3 bp +12.4%
May ’92 Oct ’92 -1.23% +45 bp +0.7%
Dec ’92 Oct ’93 -1.56% -48 bp +6.4%
Dec ’94 Jan ’96 -2.33% +64 bp +35.8%
Apr ’97 Oct ’98 -2.48% +335 bp +34.3%
Feb ’00 Mar ’01 -1.77% +240 bp -11.1%
Jul ’01 Nov ’01 -1.18% +142 bp -13.4%
Apr ’02 Oct ’02 -1.80% +379 bp -28.9%
Jul ’07 Apr ’08 -1.62% +507 bp -12.0%
Nov ’08 Jan ’09 -1.74% +122 bp -6.8%
Apr ’10 Sep ’10 -1.36% +106 bp -10.3%
Apr ’11 Oct ’11 -1.56% +309 bp -14.7%
Median -1.56% +140 bp -6.8%
Source: Citi Research, Bloomberg, 31 Mar 15 Note: All periods are month beginnings For illustrative purposes only
8
Higher treasury yields typically offset by narrower spreads
From To 10Y Treasury Yield High-Yield Spread SPX Price
Mar ’88 Mar ’89 +1.15% – +7.9%
Aug ’89 May ’90 +1.22% +1.32 bp -4.4%
Oct ’93 Dec ’94 +2.52% -66 bp -1.1%
Feb ’96 Sep ’96 +1.36% -94 bp +2.5%
Oct ’98 Feb ’00 +2.25% -122 bp +37.1%
Nov ’01 Apr ’02 +1.16% -227 bp +8.3%
Jun ’03 Jun ’04 +1.28% -228 bp +16.3%
Jul ’05 Jul ’06 +1.22% -43 bp +6.6%
Jan ’09 Jan ’10 +1.63% -962 bp +23.5%
Sep ’10 Apr ’11 +1.00% -207 bp +26.4%
May ’13 Sep ’13 +1.11% +41 bp +2.2%
Median +1.22% -108 bp +7.9%
Source: Citi Research, Bloomberg, 31 Mar 15 Note: All periods are month beginnings For illustrative purposes only
9
Lower ouch factor Global high yield typically less sensitive to interest rate movements than other fixed income sectors
Source: Source: Morningstar, 30 Jun 15 Citi Treasury Benchmark 10 Yr USD Barclays US Agg Bond TR USD BofAML US Corps 1-3 Yr TR USD BofAML US HY Master II TR USD Credit Suisse Leveraged Loan USD BofAML All Convertible All Qualities S&P 500 TR USD For illustrative purposes only
Period 10-Year Treasury
Barclays Aggregate
Short-Term Corporates
High-Yield Bonds
Floating-Rate Loans
Convertible Bonds S&P 500
9/30/1993 - 11/30/1994 -9.5 -3.8 1.8 1.4 13.4 -2.6 1.9
1/31/1996 - 8/31/1996 -5.4 -1.6 1.8 3.2 5.4 9.1 4.9
9/30/1998 - 1/31/2000 -5.6 -0.3 5.2 5.1 6.1 58.1 35.2
6/30/2005 - 6/30/2006 -5.0 -0.6 2.2 4.9 7.4 9.0 7.9
12/31/2008 - 12/31/2009 -4.2 5.6 14.8 58.9 39.4 50.7 28.3
8/31/2010 -3/31/2011 -2.3 -0.6 1.6 10.2 7.8 19.2 27.8
7/31/2012 - 12/31/2013 -7.2 -1.5 3.3 14.0 11.1 33.7 37.7
Color gradations range from worst performing (red) to best performing (green)
10
High yield can protect from rising rates
Source: Bloomberg, Jul 14 Past performance is not an indication of future results The above data represents the BofA Merrill Lynch Current five year Index (US 5yr Gov’t), BofA Merrill Lynch US Corporate Index (US IG) and CS Leveraged Loan Index (US HY) For illustrative purposes only
Total return (periods of five year treasury rates up by > 100bps)
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-4
0
4
8
12
US 5yr Government US IG US HY
Sep 93 to Nov 94 Dec 95 to Aug 96 Oct 98 to Feb 00 Sep 01 to Mar 02 May 03 to Jun 06 Aug 12 to Jul 14Return (%)
… Less sensitive to rates due to higher coupon and risk premium and low
duration
11
Top performing asset classes Global high yield returns are compelling relatively to other asset classes
15 year period to 31 Aug 15
Source: Bloomberg, 31 Aug 15. Past performance is not an indication of future results Global HY: The BofA Merrill Lynch Global High Yield Constrained Index, Investment Grade: The BofA Merrill Lynch US Corporate Index, Gold: Generic 100 oz. Gold Futures Contract (ticker is GC1) Indexes are unmanaged and have been provided for comparison purposes only. No fees or expenses are reflected Individuals cannot invest directly in an index.. For illustrative purposes only US treasuries are backed by the full faith and credit of the US government
Historically higher returns with lower risk compared to equities
5yr Treasury 10yr Treasury US Aggregate
Global HY
S&P 500
Wilshire 5000
Russell 2000
FTSE 2000
CAC 40
DAX
Gold
US Inflation
0%
2%
4%
6%
8%
10%
12%
0% 5% 10% 15% 20% 25% 30%
Ann
ualiz
ed R
etur
n
Annualized Volatility
12
Why global high yield?
13
Exponential growth in global high yield over past 17 years Non-U.S. high yield is 48% of global markets and growing.
Source: Source: BofA Merrill Lynch Global Research, 31 Aug 15. Past performance is not an indication of future results For illustrative purposes only
0
500
1,000
1,500
2,000
2,500
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Face
Val
ue, U
S $
bn
US High Yield Constrained Index High Yield US Emerging Markets Corporate Plus Global High Yield European Issuers Constrained Index Canada High Yield
14
Bank of America Merrill Lynch Global High Yield Constrained Index
Source: BofA Merrill Lynch, 31 Aug 15 Standard & Poor’s credit ratings are expressed as letter grades that range from “AAA” to “D” to communicate the agency’s opinion of relative level of credit risk. Ratings from ‘AA’ to ‘CCC’ may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories. The investment grade category is a rating from AAA to BBB- Diversification does not ensure a profit or protect against a loss in a declining market. Figures may appear not to add due to rounding. For illustrative purposes only
Country breakdown Credit rating breakdown Currency breakdown
• 80 countries, 1736 issuers, 3688 issues
• Market cap: US $2,102 bn, modified duration: 3.95 yrs, YTW: 7.14%
CAD 0.4%
EUR 17.5%
GBP 3.8%
USD 78.3%
Industry breakdown
Africa 0.7%
Asia 5.1% Cash
0.4% Eastern Europe 4.9%
Europe 26.7%
Latin America
7.4% Middle East 0.4%
US/ Canada 54.5%
BB 54.2%
B 33.9%
CCC & Below 11.5%
Cash 0.4%
Basic Industry, 12.3%
Capital Goods, 5.0%
Consumer Goods, 3.2%
Energy, 13.7% Financial
Services, 3.1%
Healthcare, 6.7%
Leisure, 3.3%
Media, 7.8%
Real Estate, 2.5%
Retail, 4.6%
Services, 4.0%
Technology & Electronics,
3.4%
Telecommunications, 9.3%
Transportation, 1.7% Utility,
3.6% Automotive,
3.2% Banking, 10.7%
Insurance, 1.3%
Cash 0.4%
15
Why own the “third” asset class now?
16
Negative articles continue to dominate headlines
Carl Icahn’s Warning About the High Yield Market Bubble Market Realist, May 15, 2015
Wall Street Sees Junk Bond Collapse, Prepares to Profit from it Zero Hedge, Aug 13, 2015
Junk Bond Market: Danger ahead Market Watch, Sept 8, 2015
Yet another measure of risk in junk-bond market flashing red Market Watch, Sept 8, 2015
17
“Research has shown that over the long term, going back at least to the 1960s, high-yield bonds in general have tended to produce annualized returns of about 4% a year above inflation”. Today investors are receiving a 50% premium above that long term average.
Source: Aberdeen Asset Management; Brett Arends, “Junk bond market: Danger ahead, “Market Watch”, 8 Sep 15
Real return opportunity in high yield market
18
1990*: -4.34 1994*: -1.17%
2002*: -1.14% 2000*: -3.79%
2008*: -26.21%
* Positive returns for 25/29 years
0
500
1,000
1,500
2,000
0%
4%
8%
12%
16%
1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
bps High-yield default rate (LHS) High-yield spreads (Domestic) (RHS)
-10%
-5%
0%
5%
10%
1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
GDP % GDP QoQ
Economic growth is the foundation for improving or deteriorating credit fundamentals Roadmap for high yield Investing
Source: Aberdeen Asset Management Inc., Bloomberg, JP Morgan, 30 Jun 15 * BofA Merrill Lynch US Cash Pay High Yield Index For illustrative purposes only
19
Coverage ratio
Aggregate credit quality – Still supportive of the high yield sector Interest coverage, maturity profile & leverage all point to low default expectations
Source: BofA Merrill Lynch Global Research, 31 Aug 15 Forecasts are offered as opinion and are not reflective of potential performance, are not guaranteed and actual events or results may differ materially. For illustrative purposes only
HY and leveraged loan maturity
Leverage by Sector
Bond and loan default rates
Source: BofA Merrill Lynch Global Research, 30 Jun 15. For illustrative purposes only
Source: JPMorgan, 31 Aug 15 Note: 2014 default rates exclude TXU’s $36.1bn default. For illustrative purposes only
Source: BofA Merrill Lynch Global Research, 30 Jun 15. For illustrative purposes only
0
50,000
100,000
150,000
200,000
250,000
2015
2016
2017
2018
2019
2020
2021
2022
2023
Mat
uriti
es ($
mm
)
Bonds Loans
1.8
2.3
2.8
3.3
3.8
4.3
1998 2000 2002 2004 2006 2008 2010 2012 2014
Cov
erag
e (L
TM
EB
ITD
A/N
et L
TM In
tere
st
Exp
ense
), x
Excluding TXU,CCU,CZR and FDC HY Coverage Ratio1.
71%
4.10
%
5.00
% 9.
10%
8.00
%
3.30
%
1.10
%
2.80
%
0.90
%
0.40
%
2.30
%
10.3
0%
0.80
%
1.70
%
1.30
%
0.70
%
1.63
%
2.26
%
1.50
%
4.20
%
6.60
%
6.30
%
6.00
%
2.30
%
1.00
%
3.00
%
0.50
%
0.20
% 3.90
%
12.8
0%
1.80
%
0.40
%
1.40
%
1.70
%
1.70
%
1.51
%
0.0%
3.0%
6.0%
9.0%
12.0%
15.0%
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
High-yield bond default rate Loan default rate
Par-weighted default rates
0 5 10 15 20 25 30
EnergyGaming
MaterialsTelecommunications
UtilitiesMedia
TechnologyHealth CareReal Estate
Consumer ProductsCommercial Services
Hotels & LeisureRetailFood
Capital GoodsTransportation
Automotive
Leverage (Net Debt/LTM EBITDA), x
Q2 '14 Q2 '15
Average Leverage ex-Energy Q2 '14: 5.0x Q2 '15: 4.0x
20
Option adjusted spreads – At the upper end of our valuation range High yield at current valuations is at almost 2x historical averages
BofA Merrill Lynch Global High Yield Constrained Index (Option adjusted spreads – 2/01/10 to 8/31/15)
Sources: Bloomberg, 31 Aug 15 For illustrative purposes only
Shaded region represents Aberdeen’s fair valuation range
0
100
200
300
400
500
600
700
800
900
1000
2010 2011 2012 2013 2014 2015
Global HY OAS(bps)
Slowdown, Sovereign Debt, & Fiscal Mess
European Concerns
Tapering Talk Oil Decline / Global Growth Concerns
China, Fed Concerns, Emerging Markets
21
What is priced into the high yield market Ex-energy expected default rate is expected to be 1.5%, well below what’s priced in
Global High Yield OAS 588bp
Less Premium For Liquidity 100bp
Implied Default Risk Premium 488bp
Expected Default Rate 4.88/(1- 0.40) = 8.13%
Global High Yield OAS-Ex Energy 519bp
Less Premium For Liquidity 100bp
Implied Default Risk Premium 419bp
Expected Default Rate 4.19/(1- 0.40) = 6.98%
Source: JPMorgan, Bloomberg, Aberdeen Asset Management, 3 Sep 15
22
New thoughts on liquidity and lower recovery rates
Source: JPMorgan, Bloomberg, Aberdeen Asset Management, 3 Sep 15
Global High Yield OAS 588bp
Less Premium For Liquidity 200bp
Implied Default Risk Premium 388bp
Expected Default Rate 3.88/(1- 0.38) = 6.25%
Global High Yield OAS-Ex Energy 519bp
Less Premium For Liquidity 200bp
Implied Default Risk Premium 319bp
Expected Default Rate 3.19/(1- 0.40) = 5.31%
23
High yield energy sector default rate sensitivity analysis Current valuations are consistent with lower for longer oil prices
Annual Default Rate
Case Scenario 2015 2016 2017 Average Cumulative
Modest Recovery $55 oil, $2.75 gas 4.6% 3.8% 11.6% 6.7% 20.0%
% Services 24.3% 70.3% 53.7%
% E&P 75.7% 29.7% 46.3%
Spot Market $45 oil, $2.75 gas 4.6% 6.4% 18.6% 9.9% 29.6%
% Services 24.3% 66.3% 25.0%
% E&P 75.7% 33.7% 75.0%
Unsustainably Low $35 oil, $2.75 gas 4.6% 20.0% 10.7% 11.8% 35.3%
% Services 24.3% 44.3% 11.2%
% E&P 75.7% 55.7% 88.8%
Source: J.P. Morgan, Aberdeen Asset Management, Bloomberg, 31 Aug 15 Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially
Energy OAS 1026bp
Less Premium For Liquidity 400bp
Implied Default Risk Premium 626bp
Expected Default Rate 6.26/(1 - 0.20) = 7.82%
24
9% of Global high yield index trading at distressed levels
Percentage of global high yield Index trading at an option adjusted spread of above 1000
Source: BofA Merrill Lynch, 31 Aug 15 For illustrative purposes only
0
5
10
15
20
25
Dec
09
Feb
10
Apr 1
0
Jun
10
Aug
10
Oct
10
Dec
10
Feb
11
Apr 1
1
Jun
11
Aug
11
Oct
11
Dec
11
Feb
12
Apr 1
2
Jun
12
Aug
12
Oct
12
Dec
12
Feb
13
Apr 1
3
Jun
13
Aug
13
Oct
13
Dec
13
Feb
14
Apr 1
4
Jun
14
Aug
14
Oct
14
Dec
14
Feb
15
Apr 1
5
Jun
15
Aug
15
% o
f Ind
ex
Broad-based concerns
about global economic
recession
48% of recent surge is
driven by Energy and
Metals & Mining
25
High yield energy sector Proceed with caution in the E&P sector
• Midstream 5% to 8% YTW
• Services 8% to 42% YTW
– Offshore
– Onshore
• Refining 3% to 8% YTW
• Exploration & Production 5% to 78% YTW
Source: BofA Merrill Lynch, Aberdeen Asset Management 31 Aug 15 For illustrative purposes only
Ranges of Yield to Worst by Tier
Tier 1 30% of E & P 5% - 8%
Tier 2 28% of E & P 8% - 11%
Tier 3 17% of E & P 11% - 15%
Tier 4 10% of E & P 15% - 20%
Tier 5 15% of E & P > 20%
26
Not all is bad in global high yield
Source: BofA Merrill Lynch, 31 Aug 15 The above data represents the BofA Merrill Lynch Global High Yield Constrained Index For illustrative purposes only
Trailing 3-months
Trailing 12-months
Energy Basic Industry
Services Utility
Technology & Electronics Banking
Consumer Goods Leisure
Real Estate Healthcare
-12 -10 -8 -6 -4 -2 0 2Total Return (%) Hedged to USD
Energy Basic Industry
Services Utility
Technology & Electronics Banking Consumer Goods
Leisure Real Estate
Healthcare
-20 -15 -10 -5 0 5 10Total Return (%) Hedged to USD
27
Liquidity
28
High yield mutual fund ownership over time Mutual fund ownership not that significant in historical context
Source: Morningstar, BofA Merrill Lynch Global Research, 31 Jul 15. Past performance is not indicative of future results The above data represents BofA Merrill Lynch US HY Cash Pay Index & Morningstar US Open-end High Yield Category and excludes ETFs, Money Market Funds, and Fund of Funds For illustrative purposes only
-
200
400
600
800
1,000
1,200
1,400
1,600
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Feb
93Au
g 93
Feb
94Au
g 94
Feb
95Au
g 95
Feb
96Au
g 96
Feb
97Au
g 97
Feb
98Au
g 98
Feb
99Au
g 99
Feb
00Au
g 00
Feb
01Au
g 01
Feb
02Au
g 02
Feb
03Au
g 03
Feb
04Au
g 04
Feb
05Au
g 05
Feb
06Au
g 06
Feb
07Au
g 07
Feb
08Au
g 08
Feb
09Au
g 09
Feb
10Au
g 10
Feb
11Au
g 11
Feb
12Au
g 12
Feb
13Au
g 13
Feb
14Au
g 14
Feb
15
US
Hig
h Y
ield
Mar
ket V
alue
(in
billio
ns)
Mut
ual F
und
Ow
ners
hip
as %
of I
ndex
Mutual Fund Ownership as % of Index (LHS) US High Yield Market Value (in billions) (RHS)
29
Liquidity risk exaggerated? We think so… Markets historically not very liquid in global high yield
Past performance is not indicative of future results The above data represents FINRA – BLP Active High Yield US Corporate Bond Index and the BofA Merrill Lynch US High Yield Constrained Index. For illustrative purposes only
Primary Dealer Positions in Corporate Securities (old)
Source: Federal Reserve Bank of New York, 7 May 14
High Yield US Corporate Bond Trading Volume as Percent of Index
Source: BofA Merrill Lynch Global Research, FINRA TRACE, 31 Aug 15
Primary Dealer Positions in Corporate Securities (new)
Source: Federal Reserve Bank of New York, 19 Aug 15
MarketAxess High Yield Bid-Ask Spread
Source: MarketAxess, 31 Aug 15
0
50
100
150
200
250
Jul 0
1
Feb
02
Sep
02
Apr 0
3
Nov
03
Jun
04
Jan
05
Aug
05
Mar
06
Oct
06
May
07
Dec
07
Jul 0
8
Feb
09
Sep
09
Apr 1
0
Nov
10
Jun
11
Jan
12
Aug
12
Mar
13
Dea
ler I
nven
torie
s, U
S$b
n Old Series (includes CDO)
0
5
10
15
20
25
30
Apr 1
3M
ay 1
3Ju
n 13
Jul 1
3Au
g 13
Sep
13O
ct 1
3N
ov 1
3D
ec 1
3Ja
n 14
Feb
14M
ar 1
4Ap
r 14
May
14
Jun
14Ju
l 14
Aug
14Se
p 14
Oct
14
Nov
14
Dec
14
Jan
15Fe
b 15
Mar
15
Apr 1
5M
ay 1
5Ju
n 15
Jul 1
5Au
g 15
Dea
ler I
nven
torie
s, U
S$b
n New Series (IG & HY Corporates Only) High Yield Only
0%
2%
4%
6%
8%
10%
Aug
05
Apr 0
6
Dec
06
Aug
07
Apr 0
8
Dec
08
Aug
09
Apr 1
0
Dec
10
Aug
11
Apr 1
2
Dec
12
Aug
13
Apr 1
4
Dec
14
Aug
15
Mon
thly
trad
ing
volu
me
as
perc
ent o
f US
Hig
h Y
ield
In
dex
00.5
11.5
22.5
33.5
4
Jan
07
Jan
08
Jan
09
Jan
10
Jan
11
Jan
12
Jan
13
Jan
14
Jan
15
Bid
-Ask
Spr
ead
30
What are we focusing on today?
• Where are rates headed?
• China. Will the China slowdown drag the rest of the world with it?
• Commodities and TIPS. What is the market telling us?
31
Where are rates headed?
32
Lower interest rates for longer than you might think
We at Aberdeen believe that there is a compelling case to be made that interest rates might be sticking around at historically low levels longer than most believe possible. The foundation for that view can be seen in some of the structural changes to the economy as well as some underlying trends that are not so obvious.
33
There are two schools of thought
Normal cyclical recovery • Real GDP at or above long-term trend growth
• As unemployment rates move lower, wages will increase
• Inflation will accelerate
• The transmission mechanism of velocity of money, wealth creation, and animal spirits will lift us to a new glide path for growth
Lower for longer • Deteriorating demographic trends worldwide
• World inundated with debt
• More deleveraging
• Lower productivity growth
• Regulatory environment creating headwinds
34
The more obvious
• Still too much debt
• Demographics
• Declining productivity
• Regulatory overhang still creating head winds
• Potential Real GDP expected to remain well below trend
35
What happened to deleveraging?
Source: McKinsey Global Institute analysis
36
Aging US population
Percentage of population younger than 15 vs. 65 and older in the U.S.
Source: United Nations, Department of Economic and Social Affairs, World Population Prospects: 2012 Revision, Jun 13 http://esa.un.org/unpd/wpp/index.htm, PEW Research Center. For illustrative purposes only Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially
37
Increasing dependency across much of the world
Number of dependents (younger than 15 and 65 and older) for every 100 people of working age (15-64)
Source: United Nations, Department of Economic and Social Affairs, World Population Prospects: 2012 Revision, Jun 13 http://esa.un.org/unpd/wpp/index.htm, PEW Research Center. For illustrative purposes only . Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially
88
82
54 54
36
49 52 52
38
47
57
69
60
48 47
63 66
83 88 88
94 96
0
20
40
60
80
100
Nigeria Kenya India South Africa China U.S. Germany Italy South Korea Spain Japan
2010 2050
Fewer Dependents More Dependents
38
Source: McKinsey Global Institute analysis Forecasts are offered as opinion and are not reflective of potential performance, are not guaranteed and actual events or results may differ materially. For illustrative purposes only
Productivity growth and labor force growth suggest sub-par growth ahead
39
Productivity slump plaguing the US economy
US productivity growth
Source: The Economist Intelligence Unit, 14 Aug 15. For illustrative purposes only
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
(% change, year on year, five-year rolling average
40
Federal Regulations….a massive headwind
• Federal regulation and intervention cost American consumers and businesses an estimated $1.88 trillion in 2014 in lost economic productivity and higher prices.
• If U.S. federal regulation was a country, it would be the world’s 10th largest economy, ranking behind Russia and ahead of India.
• Economy-wide regulatory costs amount to an average of $14,976 per household – around 29 percent of an average family budget of $51,100. Although not paid directly by individuals, this “cost” of regulation exceeds the amount an average family spends on health care, food and transportation
Source: “Ten Thousand Commandments 2015”, The American Enterprise Institute, 8 May 15
41
Output gap: Real GDP compared with potential GDP Is this what a normal recovery looks like?
Output gap: Real GDP compared with potential GDP, 2000Q1–2014Q4
Source: Bureau of Economic Analysis’ National Income and Product Accounts Tables and U.S. Congressional Budget Office, 13 Apr 15 Old Potential GDP was based on data gathered in Q2 2014. The third and fourth quarters of 2014 were estimated based on this data and calculated using the slope of potential GDP since Q1 2000. New Potential GDP is based on U.S. Congressional Budget office data as of 13 Apr 15. For illustrative purposes only
Real GDP
Potential GDP (Old vs. New)
$11,500
$12,500
$13,500
$14,500
$15,500
$16,500
$17,500
2000
Q1
2001
Q1
2002
Q1
2003
Q1
2004
Q1
2005
Q1
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
2012
Q1
2013
Q1
2014
Q1
Bill
ions
of c
hain
ed 2
009
dolla
rs
Real GDP New Potential GDP Old Potential
$326.3 billion below new potential
$608.2 billion
42
The not so obvious
• Corporate Pension Funds and Insurance Portfolios Love Higher Rates!
• Retiring Baby Boomers
• The Global Savings Glut
• Global Government Yield Curves
43
US Corporate DB plans are desperately trying to avoid the pains of 2008 when their funding ratio dropped precipitously
Source: UBS Global Asset Management, Barclays, Markit, Mar 15. For illustrative purposes only
Fund
ing
Rat
io
Funding Ratio R
eturn
Funding Ratio Return
Funding Ratio
• Corporate America is increasingly turning to Liability-Driven-Investing (LDI) to de-risk their DB pension
portfolios and immunize their pension liabilities
• As their funding status improves, more assets will be shifted towards long-duration fixed income
44
Retiring baby boomers need more fixed income
Source: S&P Capital IQ Financial Communications, 2013. For illustrative purposes only
25-year-old 45-year-old 65-year-old
85%
10%
5%
Stocks Bonds Cash
70%
20%
10%
Stocks Bonds Cash
50% 40%
10%
Stocks Bonds Cash
45
Combined retirement market over $24 trillion
U.S. Total Retirement Market
Source: Investment Company Institute, Federal Reserve Board, National Association of Government Defined Contribution Administrators, American Council of Life Insurers, Internal Revenue Service Statistics of Income Division, and Government Accountability Office, 24 Jun 15 * Data are estimated For illustrative purposes only
2.6 4.7 3.7 5.9 7.0 7.1 7.3 7.3 7.4 7.6
3.0
4.6 3.6
5.3 6.2 6.3 6.5 6.5 6.7 6.8
2.0
2.6
2.0
2.7
3.1 3.1 3.2 3.2 3.2 3.2
3.0
4.4
3.6
4.4
5.0 5.0 5.1 5.1 5.1 5.1
1.0
1.7
1.4
1.8
2.0 2.0 2.1 2.0 2.1 2.1
11.6
18.0
14.2
20.1
23.3 23.5 24.2 24.2 24.6 24.9
2000 2007 2008 2012 2013 Q1 14 Q2 14 Q3 14 Q4 14 Q1 15
IRAs DC plans Private-sector DB plans Government DB plans Annuity reserves
* * * * * * *
Trillions of dollars, end-of-period, selected periods
46
The trend to immunize continues
Asset allocation – equities Asset allocation – fixed income
Source: Milliman-Corporate Pension Funding Study, Dec 14 For illustrative purposes only
47
Global household wealth totaled $263 trillion in 2014. This global aggregate has more than doubled since 2000 creating a global savings glut that continues to look for a safe place to park money.
Total global wealth 2000 – 2014, by region
Source: James Davies, Rodrigo Lluberas and Anthony Shorrocks, Credit Suisse Global Wealth Databook, Oct 14 For illustrative purposes only
48
5-Year Government Yields of G10 countries 5 of the 10 at or close to zero
Source: Bloomberg, 17 Aug 15 For illustrative purposes only
-0.25
0.25
0.75
1.25
1.75
2.25
2.75
Dec
-13
Jan-
14
Feb-
14
Mar
-14
Apr-1
4
May
-14
Jun-
14
Jul-1
4
Aug-
14
Sep-
14
Oct
-14
Nov
-14
Dec
-14
Jan-
15
Feb-
15
Mar
-15
Apr-1
5
May
-15
Jun-
15
Jul-1
5
United States Belgium Canada France Germany Italy Japan Netherlands Sweden United Kingdom
49
Fed Funds Rate and 10-year US Treasury Yield during the last tightening cycle Expect a similar path for the 10-year US Treasury during this upcoming tightening cycle
Fed Funds Rate and 10-Year US Treasury Yield During the Last Tightening Cycle
Source: US Federal Reserve, Bloomberg, 31 Aug 15 For illustrative purposes only
0
1
2
3
4
5
6
7
Dec
-99
Apr-0
0
Aug-
00
Dec
-00
Apr-0
1
Aug-
01
Dec
-01
Apr-0
2
Aug-
02
Dec
-02
Apr-0
3
Aug-
03
Dec
-03
Apr-0
4
Aug-
04
Dec
-04
Apr-0
5
Aug-
05
Dec
-05
Apr-0
6
Aug-
06
Dec
-06
Apr-0
7
Aug-
07
Dec
-07
Apr-0
8
Aug-
08
Dec
-08
Apr-0
9
Aug-
09
Dec
-09
Apr-1
0
Aug-
10
Dec
-10
Apr-1
1
Aug-
11
Dec
-11
Apr-1
2
Aug-
12
Dec
-12
Apr-1
3
Aug-
13
Dec
-13
Apr-1
4
Aug-
14
Dec
-14
Apr-1
5
Aug-
15
US 30 Day Fed Funds Rate US 10-year Government Bond Yield
US 10-year 4.583%
US 10-year 4.981%
50
China - Can they drag down the rest of the world?
51
The disconnect between the Chinese economy and equity markets
A-share market (index, 2001=100, 6mma)
Source: EM Advisors Group, 31 Jul 15, For illustrative purposes only
0
100
200
300
400
500
600
700
2000 2003 2006 2009 2012 2015
GDP Index
52
China - Can they win the currency war? Total return of various currencies between 8/11/15 and 9/8/15
Source: Bloomberg, 8 Sep 15, For illustrative purposes only
Malaysian Ringgit
Brazilian Real
Turkish Lira
South African Rand
Colombian Peso
Russian Ruble
Indonesian Rupiah
Australian Dollar
Indian Rupee
Mexican Peso
Polish Zloty
Swiss Franc
Hungarian Forint
Czech Koruna
Romanian Leu
Danish Krone
Euro
Swedish Krona
Iceland Krona
Japanese Yen
-10.00 -8.00 -6.00 -4.00 -2.00 0.00 2.00 4.00 6.00Currency Total Return (%)
Chinese Yuan has depreciated 2.54% vs. USD
53
Composition of China GDP Exports less than 5% of GDP
Source: Emerging Advisors Group, Sep 15, For illustrative purposes only
-5%
0%
5%
10%
15%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Consumption Investment Net exports Overall GDPContribution to GDP growth (% y/y 3qma)
54
There are some signs of a domestic recovery
Source: NBS, Bloomberg, 30 Jun 15 For illustrative purposes only
Property sales improve Loan growth picks up following easing measures
-20
-10
0
10
20
30
40
50
0
20
40
60
80
100
120
140
160
180
Jan 13 May 13 Sep 13 Jan 14 May 14 Sep 14 Jan 15 May 15
Residential Floor Space Sold sqm mnResidential Floor Space Sold % yoy (RHS)
0
500
1,000
1,500
2,000
2,500
3,000
-500
0
500
1,000
1,500
2,000
2,500
3,000
Jan 13 May 13 Sep 13 Jan 14 May 14 Sep 14 Jan 15 May 15
RMB Bank Loans Foreign Currency Bank LoansOff Balance-Sheet Lending Corporate BondsEquity Financing Total Social Financing (RHS)
Aggregate Financing (RMB bn)
Source: PBOC, 30 Jun 15 For illustrative purposes only
55
What are the markets telling us?
• Commodities
• Break Even Inflation Rates
• Forward Rates
• We can learn a lot from the last tightening cycles
56
Declining commodity prices dampen inflationary pressure
Source: Bloomberg, 20 Aug 15, For illustrative purposes only
50
100
150
200
250
300
350
400
450
500
300
400
500
600
700
800
900
1000
Dec
-09
Feb-
10
Apr-1
0
Jun-
10
Aug-
10
Oct
-10
Dec
-10
Feb-
11
Apr-1
1
Jun-
11
Aug-
11
Oct
-11
Dec
-11
Feb-
12
Apr-1
2
Jun-
12
Aug-
12
Oct
-12
Dec
-12
Feb-
13
Apr-1
3
Jun-
13
Aug-
13
Oct
-13
Dec
-13
Feb-
14
Apr-1
4
Jun-
14
Aug-
14
Oct
-14
Dec
-14
Feb-
15
Apr-1
5
Jun-
15
Commodity Research Bureau BLS/US Spot Raw Industrials Index (LHS) S&P-Goldman Sachs Commodity Index (LHS)
Bloomberg Commodity Index (RHS) Thomson Reuters/CoreCommodity CRM Commodity Index (RHS)
57
Inflation expectations back to new lows 10 yr US Treasury vs. 10 yr TIPS
Source: Bloomberg, 31 Aug 15, For illustrative purposes only
100
120
140
160
180
200
220
240
260
280
Dec
-10
Feb-
11
Apr-1
1
Jun-
11
Aug-
11
Oct
-11
Dec
-11
Feb-
12
Apr-1
2
Jun-
12
Aug-
12
Oct
-12
Dec
-12
Feb-
13
Apr-1
3
Jun-
13
Aug-
13
Oct
-13
Dec
-13
Feb-
14
Apr-1
4
Jun-
14
Aug-
14
Oct
-14
Dec
-14
Feb-
15
Apr-1
5
Jun-
15
Aug-
15
164
58
The forward yield curve is usually too pessimistic. This suggests that five year rates will be well under 3% in five years!
Source: Bloomberg, 19 Aug 15. For illustrative purposes only Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially
0.37
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
Aug-
15
Nov
-15
Feb-
16
May
-16
Aug-
16
Nov
-16
Feb-
17
May
-17
Aug-
17
Nov
-17
Feb-
18
May
-18
Aug-
18
Nov
-18
Feb-
19
May
-19
Aug-
19
Nov
-19
Feb-
20
May
-20
Aug-
20
3 Month Eurodollar Futures Curve 5 Yr Fixed-Rate Futures Swap Curve
1.60
0.37
59
High yield performance surrounding a tightening cycle
Rising Rate Period 1: February 4, 1994 - February 1, 1995 Calendar-year returns (before, during, after full period) 1993 1994 1995 1996 Ending Fed Funds Rate 3.00% 5.50% 5.63% 7.00% US High Yield 17.18% -1.17% 19.91% 11.06% Investment Grade Corporate 12.42% -3.34% 21.55% 3.39% Five Year US Treasury 9.41% -4.26% 16.93% 2.31% S&P 500 10.06% 1.31% 37.54% 22.91%
Rising Rate Period 2: June 30, 1999 - May 16, 2000 Calendar-year returns (before, during, after full period) 1998 1999 2000 2001 Ending Fed Funds Rate 5.00% 5.25% 6.25% 1.25% US High Yield 3.66% 1.57% -3.79% 6.21% Investment Grade Corporate 8.72% -1.86% 9.14% 10.73% Five Year US Treasury 9.81% -2.54% 11.88% 7.51% S&P 500 28.55% 21.03% -9.10% -10.92%
Rising Rate Period 3: June 30, 2004 - June 29, 2006 Calendar-year returns (before, during, after full period) 2003 2004 2005 2006 2007 Ending Fed Funds Rate 0.94% 2.25% 4.00% 5.38% 3.00% US High Yield 27.23% 10.76% 2.83% 11.64% 2.17% Investment Grade Corporate 8.31% 5.41% 1.97% 4.38% 4.64% Five Year US Treasury 2.51% 2.4% 0.016% 2.81% 10.42% S&P 500 28.66% 10.88% 4.91% 15.78% 6.30%
Investment Grade Corporate Index US High Yield Index Difference Annualized Return for Cumulative Period 6.39% 8.07% 1.68%
Source: Bloomberg, 2007. Past performance does not guarantee future results Investment Grade Corporate: The BofA Merrill Lynch US Corporate Index, US High Yield: The BofA Merrill Lynch US Cash Pay High Yield Index For illustrative purposes only
60
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