Investment Solutions for 2018 (Part 1 )
The recovery of the global economy continues and is gradually entering a late cycle environment. Investment opportunities differ from those in the cycle’s early phases.
VIDEO TRANSCRIPT (LATE-CYCLE THEMES)
Our focus today is on the 2018 investment themes. We've categorized our themes into two areas. Firstly, late cycle themes, which reflective of the fact that we are advanced in the economic cycle, we expect moderately higher bond yields and inflation. And secondly, the megatrends that we want to buy for the long run.
So start firstly with the late-cycle themes. As a fixed-income investor a client is currently challenged with tight credit spreads and low government bond yields on how to generate safe, sustainable yield.
Hence we are looking at alternative strategies such as floating-rate bonds, also synthetic bonds linked to increasing short-term rates, and finally bond managers and strategies who are unconstrained, hence not fully focused on a benchmark.
For more risk-taking investors we're also looking at EM local currency debt, which provides attractive yields.
Furthermore we think investors should also be flexible in the solutions they look at. Do not forget about the alterative space. Strategies such as macro-strategies, which benefit from trends in interest rates and currencies, which we think are starting again; and long-short strategies, the managers that can actually hedge downside exposure for clients that are actually worried about the level of equity markets, are effective strategies in this environment.
The other challenge for investors is with rising inflation this year is a focus on tangible assets. We've liked gold as a portfolio hedge. We also like it as an inflation hedge. Furthermore, we also like tangible assets such as direct property investments.
When the rental yield is an attractive spread to the mortgage cost and rents often increase with inflation, that provides clients an inflation hedge as well as attractive income in this environment.
Now we move to the equity-focused areas within late-cycle. We believe M&A external growth share buybacks and dividends are a durable theme for 2018. Why? M&A normally peaks very late in the cycle. For example, in '99, 2000, and 2007. Last year the value of M&A was well below previous peaks.
There are four reasons why we favor external growth.
Firstly, CEO confidence is high with global synchronized recovery; their stock prices are high; financing costs are low; and US tax reform provides a catalyst for money to flow back to the US, some of which will be used for share buyback, dividends, and M&A.
Keep in mind we're well below the peak in value of previous M&A cycles. We peaked before over a trillion dollars in value. We're 50% below that in 2017.
Moving toward the last theme within our late-cycle focus are value stocks. Interestingly, value stocks have underperformed growth stocks by roughly 60% since 2007. They trade cheap relative to history, and with rising bond yields as a catalyst we expect them to outperform in 2018.