Help for the people: A security guard checks the temperatures of customers arriving at a supermarket during the MCO to contain the spread of the COVID-19 coronavirus in Penang. The second stimulus package is expected to ease the pain of many businesses, especially SMEs that are fast running out of cash, and vulnerable households that have lost their incomes and now struggling to put food on the table. — AFP
Saving Malaysia’s economy
28 March 2020
An unprecedented situation requires unprecedented measures.
To combat the economic fallout from the coronavirus outbreak, Malaysia has unveiled a landmark comprehensive rescue plan worth a total of RM250bil, that’s almost one-fifth of the country’s gross domestic product (GDP).
It is the largest-ever stimulus package for the country.
It is also one of the most aggressive responses thus far by an Asian government to the pandemic, which has upended the lives of billions around the world.
The move, however, is expected to cause Malaysia’s fiscal deficit to widen to about 4.9% of GDP this year from 3.4% of GDP in 2019.
Prime Minister Tan Sri Muhyiddin Yassin, however, stressed the Government’s priority at the moment is to curb the spread of the Covid-10 outbreak.
“We are a nation at war with invisible forces. The situation we are now facing is unprecedented in history, ” he told the country in a televised address yesterday.
During the unveiling of the “People’s Economic Stimulus Package”, Muhyiddin said the RM250bil plan would be one that would benefit all in the country, particularly the small guys.
The package has earmarked almost RM128bil to protect the welfare of the people; RM100bil to support businesses, including the small and medium-sized enterprises (SMEs); and RM2bil to strengthen the country’s economy. It is inclusive of RM20bil stimulus package announced in February.
“This package will provide instant assistance instant assistance to ease the burden that all of you have to bear, ” Muhyiddin said.
“You will all enjoy the benefits of the economic stimulus package that this people care about. As I mentioned, no group will be left out. No one will be left behind, ” he added.
Among the key measures in the package are cash handouts to eligible households and affected businesses; a wage subsidy programme to help employers retain workers; and additional funds to assist SMEs.
Muhyiddin, however, noted almost all of the measures were one-off, so as not to burden the Government’s finances in the medium term.
“This step is important to ensure that the country’s fiscal and debt position is sustainable. Accordingly, the Government will need to re-implement fiscal consolidation measures in the medium term to create long-term fiscal space, ” he said.
According to economists, the RM250bil package involves only RM25bil of actual fiscal injection by the Government. The package is also made up of RM100bil loan moratorium measures by Bank Negara, RM50bil Danajamin guarantees, and RM40bil of household EPF savings.
Malaysia’s expansive measure is in step with other major economies that have been ramping up their responses in recent weeks to deal with the Covid-19 economic fallout.
Globally, central banks have been aggressively easing their policies, slashing interest rates and lowering capital requirements for banks, among other things, while governments have been pumping huge sums of money into the economies to fight Covid-19 and to provide stimuli that include more spending and tax cuts.
Singapore, for instance, has recently rolled out its second stimulus package worth S$48bil (RM143bil), while the US Senate has passed a historic US$2 trillion (RM8.5 trillion) rescue plan.
The whole idea is to resuscitate their battered economies by putting cash in the hands of the people and helping companies manage their cashflow and losses to avoid as much job loss as possible.
As it stands, the prognosis for the global economy remains grim.
According to the International Monetary Fund’s words, the outlook for global growth for 2020 is negative – a recession at least as bad as the 2008/09 global financial crisis, or worse, is in store.
It says advanced economies are generally in a better position to respond to the Covid-19 crisis, but many emerging markets and low-income countries will face significant challenges.
Economy in ICU
As in the case of other economies in the world, Malaysia has endured horrific economic repercussions of the Covid-19 outbreak.
For the most part, the damage is not due to the virus itself, but efforts to stop the invisible enemy from spreading, and claiming more lives.
With more than 2,000 confirmed Covid-19 cases, Malaysia is currently the third most infected nation in Asia-Pacific after China and South Korea. More than 250 have recovered, but to date, 26 have lost their lives.
Significant parts of Malaysia’s economy have now been put on an induced semi-comatose state since March 18 under the Movement Control Order (MCO) to contain the disease. The MCO is expected to last till April 14.
However, with almost all business activities coming to a halt, and millions of people forced to stay at home, the financial pain has been quickly piling up. People are losing their jobs and incomes, as business owners are losing their businesses. The hard-earned savings and retirement funds of many are also evaporating.
To borrow the medical term, Malaysia’s economy is already in the intensive care unit, or ICU, as in the case of many other countries, in the fight against Covid-19.
A grim estimate by the Malaysian Institute of Economic Research (MIER) is that Malaysia’s economy would shrink 2.9% this year.
The number of job losses could reach 2.4 million, of which 67% are unskilled workers, and household incomes are projected to fall by 12%, or RM95bil in absolute terms. This could lead to an 11% drop in consumer spending, says the think tank.
On a positive note, the damage can be contained. MIER says a massive stimulus package could help the nation’s economy to stage a V-shaped recovery into 2021.
Easing the pain
While the package will not entirely resolve the economic woes, it is expected to ease the pain of many businesses, especially SMEs that are fast running out of cash, and vulnerable households that have lost their incomes and now struggling to put food on the table.
Commenting on the second round of stimulus, economist Lee Heng Guie notes the package is bolder, as the Government acts decisively to provide a timely and much-needed financial assistance support to households as well as to businesses to manage cash flow challenges during these turbulent times.
“Businesses need to be back up and running, while the vulnerable groups need the most help, ” the executive director of the Socio-Economic Research Centre (SERC) says.
“There is a compelling need to deliver a strong dose of stimulus to soften the substantial economic damages caused by the Covid-19 pandemic. While the package is unlikely to avert a recession this year, it is expected to ease the magnitude of economic contraction, ” he adds.
Lee notes while the wage subsidy support to employers is a welcome relief, the scheme could be further enhanced to save jobs and keep employment as well as preserve income of employees.
It is inevitable that many profitable and financially viable businesses could temporarily face financial distress because of the economic fallout of the Covid-19 outbreak, Lee says, adding many SMEs could run out of cash within the next two to three months, and would unlikely be in financial good shape for the next six months to a year, if the crisis remains unabated.
“In this regard, it is important that the economic stimulus package through financial guarantee and other funds by Bank Negara provide financially distressed businesses a safety net to buffer them against this unprecedented demand and supply shocks so that they continue to stay viable to resume normal business operations and be ready for an upturn, ” Lee says.
Similarly, Khazanah Research Institute notes it is important that the economic stimulus package is aimed at protecting businesses and households, so that they have sufficient resources to ride out the shocks of the next few months and can restart production as soon as the Covid-19 crisis is over.
Economists say SMEs, in particular, matter because they are the lifeblood of Malaysia’s economy.
Collectively, SMEs contribute about 40% to the country’s GDP and 20% to exports annually.
According to the Statistics Department, 98.5% of business establishments in Malaysia are SMEs, and they cut across all sizes and sectors.
SMEs also hire 65% of the country’s workforce and contribute.
This implies that if SMEs, now suffering from immeasurable losses, were to go down, many would also lose their jobs.
Despite the expansive measure, SME Association of Malaysia president Datuk Michael Kang reckons it is insufficient to help companies pull through the current crisis.
Kang predicts 50% of SMEs will likely close down, and about four million people are at risk of losing their jobs.
Meanwhile, additional government spending to save the country’s economy will undoubtedly exert pressure on its budget balances.
Malaysia has consistently run a budget deficit every year since the 1997/98 Asian Financial Crisis, with the budget deficit rising to as high as 6.7% of GDP at the height of the Global Financial Crisis in 2009, before progressively narrowing to 3.4% of GDP last year.
But pressure on fiscal deficit should not be the focus in the current extraordinary circumstances; the priority should be on supporting the economy, economists say.
“Widening fiscal deficit and rising government debt could be one of many concerns, but the main priority now is to boost the private consumption, which contributes to around 60% of the total GDP, to ensure no deterioration in economic growth, ” Alliance Bank chief economist Manokaran Mottain says.
Similarly, Institute for Democracy and Economic Affairs (IDEAS) research manager Lau Zheng Zhou says if aggregate demand were not supported now, the country could see private consumption falling further, which would then create knock-on effects such as falling employment and business spending.
This would then result in tax revenue losses, and increased social assistance spending too, which would imply further pressure on the Government’s financial position.
“It is not expected of the Government to completely disregard the fiscal impact of stimulus packages, but rather to be highly targeted and measured when intervening in the economy, ” Lau says.
“If the economy slows down further without adequate fiscal intervention to support, the fiscal deficit as percentage of GDP ratio will rise disproportionately, and this will further spook investor and possibly aggravate foreign capital flight and the fall of ringgit, ” he explains.
What’s important, Lau argues, is for the Government to communicate its economic strategy for the short-to-medium term, which should entail measures to promote income and business recovery in order to demonstrate future capacity for tax revenue generation.
On the risk of a rating downgrade, SERC’s Lee says he believes global rating agencies would provide a breathing space for the Government to derail its fiscal consolidation path during this extreme time.
However, Lee points out, the Government must remain committed to reduce its deficit and contain the debt when the economy recovers.
“The Government needs to rebuild fiscal space as having fiscal space is like having money in the bank. It provides us the fiscal flexibility during the rainy day, ” he adds.
It is notable that the Budget 2020, which outlines Malaysia’s revenue for this year, is based on an estimated oil price of US$62 per barrel.
However, oil prices have since crashed, and they currently trading below US$30 per barrel.
According to Manokaran’s estimation, every US$1 per barrel decline in oil prices could result in a revenue loss of RM300mil for the Government. Overall, he says, the recent oil price plunge is estimated to cost the Government a revenue loss of RM12.6bil.
“We believe there are ways for the Government to reallocate its funds to more critical sectors, which are impacted by the pandemic and MCO. The Government’s fiscal position might not be jeopardised if the Government could recalibrate its funding wisely, ” he says.
“We believe the Government could still come up with measures to ensure the sustainability of its revenue streams, ” he notes, adding that the re-implementation of the goods and services tax (GST) and reducing less critical allocations could be viable solutions for the budget shortfall.
The stimulus packages aside, Lau of IDEAS says, Malaysia’s economic outlook remains dependent on three “E”s – epidemic, external and employment.
“It is still unclear when Covid-19 spread will peak. The longer it takes, the longer will normal economic activities be disrupted, ” he says.
He notes demand has been artificially suppressed in most countries because of lockdowns, while businesses that have been put in hibernation could face liquidity issues if the epidemic prolongs.
“Supply chain will be disrupted in the short term even after the epidemic has reached a peak because many suppliers and buyers could become non-existent by then and business sustainability will be tested, ” Lau explains.
“Malaysia, like most countries, is dependent on a healthy external environment to grow.
The previous US-China trade war has already impacted its trade and dampened investor sentiment; so, even if Malaysia managed to contain Covid-19 successfully, if the external conditions did not improve, it would be hard for the country to have full economic recovery, ” he adds.
Lau points out that the longer the epidemic and external challenges persist, the risk will be even greater in terms of losses in employment. This will weigh on private consumption growth and creates a vicious cycle of falling demand and businesses suffering from losses.
No one knows how long the war against Covid-19 is going to last, but this crisis will eventually pass.
As the Italian Embassy to Greece says, the common enemy we are facing may be invisible. But it is not unbeatable.
IMF says world in recession, countries must ‘go big’ on spending
28 March 2020
The coronavirus has already driven the global economy into recession and countries must respond with “very massive” spending to avoid a cascade of bankruptcies and emerging market debt defaults, the head of the International Monetary Fund warned on Friday.
IMF Managing Director Kristalina Georgieva said emerging market countries will need at least $2.5 trillion in financial resources to get through the crisis, and their own internal reserves and market borrowing capacity will fall short of meeting this need.
“It is now clear that we have entered a recession as bad or worse than in 2009,” Georgieva told a news conference, adding later that it will be “quite deep.”
But unlike the slow recovery from the 2008-2009 global financial crisis, she said there be may be a “sizeable rebound” in 2021,”but only if we succeed with containing the virus everywhere and prevent liquidity problems from becoming a solvency issue.”
The worst is yet to come for many emerging market countries, which she said have not yet been hit hard directly by the virus, but are suffering from capital outflows, reduced demand for their exports and a steep drop in commodity prices.
So far, 81 countries have requested or inquired about emergency financing from the IMF, including 50 low-income countries and 31 middle-income countries, including Pakistan, Ghana, Iran and Kyrgyzstan, which was granted the first aid under the program late on Thursday.
Heavily-indebted Lebanon expressed interest in such financing, but has not made a formal request for funds, IMF officials said on Friday.
Georgieva told Reuters in an interview that IMF member countries had encouraged the Fund to focus its efforts on steps that could be done quickly, including a doubling of emergency financing to $100 billion and creation of a new short-term liquidity facility.
Asked whether the global economy needs more than the $5 trillion in new rescue spending pledged by G20 countries on Thursday, Georgieva said: “Our advice is go big.”
“This is a very big crisis and it’s not going to be sorted out without a very massive deployment of resources,” she said, noting that low interest rates made it easier for countries to provide significant fiscal support.
The G20’s $5 trillion pledge is equal to what was spent in 2009 during the global financial crisis, although economists say this crisis could be far worse because it involves essentially large portions of the global economy.
CRISIS FUND CONTRIBUTION
Georgieva welcomed a $2.2 trillion aid package signed into law by President Donald Trump on Friday to cushion the blow to consumers and businesses — nearly triple the $831 billion the United States spent on stimulus in 2009.
The bill includes a $38.5 billion contribution to a doubling of the IMF’s crisis lending fund to $500 billion. The expansion of the New Arrangements to Borrow was agreed by member countries last year.
Speaking on CNBC, Georgieva cautioned against premature moves to reopen the U.S. economy. “There is no way to come to a strong recovery without strong containment,” she said.
Also on Friday, the IMF’s executive board approved changes that will allow it to provide up to two year’s of debt service relief to its poorest and most vulnerable members as they respond to the coronavirus outbreak.
The World Bank approved similar changes to allow debt relief to all member countries and said that the board was now considering coronavirus healthcare financing projects for 25 countries totaling nearly $2 billion. The development lender has made $14 billion available for immediate coronavirus health care needs.
China poised for V-shaped
26 March 2020
IN the thick of the Covid-19 pandemic and global markets that are breaking down, Hong Kong-based Value Partners Group co-chairman and co-chief investment officer Datuk Seri Cheah Cheng Hye, also known as the Warren Buffett of Asia, says investors have to be both aggressive and defensive to profit and thrive.
In a nutshell, Cheah is bullish on China, where it is positioned for a “V-shaped” recovery.
He, however, feels it is too early to buy US stocks, with US and European stocks likely to deliver a “U-shaped” sort of recovery.
Back in his homeland of Malaysia, unfortunately Cheah remains cautious, and not surprisingly, the political scenario remains one of the key reasons.
Value Partners is one Asia’s most established asset managers with assets under management of US$15bil.
For its year ended Dec 31,2019, the fund recorded a 123.7% jump in its profit attributable to owners of the company to HK513.4mil from HK$229.5mil.
Revenue dropped slightly by 2.3% to HK$1.6bil. Its profit figures would imply impressive net margins of 32% for 2019.
“I remain cautious about the Malaysian stock market, even though the price-earnings ratio has dropped to around 13 times. Apart from the disruption caused by Covid-19, Malaysia is a victim of the plunge in oil prices and the downturn in global trade. As an export-driven, medium-sized country, Malaysia faces a very challenging environment, ” said Cheah.
He added that the renewed political uncertainty has hurt the country’s image.
In the midst of Covid-19 back in February, Malaysia saw the change of administration in the federal government with Perikatan Nasional replacing Pakatan Harapan.
“Malaysia’s politicians couldn’t have picked a worse time to engage in a power struggle. Certainly, the country cannot count on foreign investors to put money into Malaysian stocks and other assets, and the persistently weak ringgit has scared off many people, ” said Cheah.
He expresses concern that Malaysian stocks will be off the radar of international investors for years to come.
There are no shortcuts or magic pills. The solution for Malaysia’s problems will still have to be found domestically, from sound politics, reforms and good economic management.
“The country does have some advantages, including strong infrastructure, and a core group of very competent and highly-educated people in both the public and private sectors. These people should be given a full opportunity to put their abilities to work for the country, ” said Cheah.
China, cash and gold
With regard to the overall investment outlook, Cheah said the best outcome would be if a vaccine or treatment for Covid-19 could be found as soon as possible.
“I am hoping a breakthrough can be achieved this year. So the recommended investment strategy has to be both aggressive and defensive, ” said Cheah.
He explains that an aggressive investing strategy would be beneficial if a treatment can be found, or if efforts by governments around the world to stimulate their economies are successful.
However, in case the outcome remains negative, gold and cash would provide a safety net.
“So it makes sense for an investor to attack and defend at the same time, ” said Cheah.
For the aggressive part of the portfolio, Cheah likes China-related stocks and bonds.
For defence, he likes gold and cash. Furthermore, due to massive money printing, gold has strong potential.
On Monday, the US central bank launched an unlimited money-printing programme.
On Wednesday, the senate voted unanimously to approve a massive US$2 trillion fiscal stimulus package to shore up the US economy. This is the largest fiscal stimulus package in modern American history.
Despite that, Cheah feels it is too early to buy US stocks.
“China is the first major economy to emerge from Covid-19 outbreak, and it is positioned for a V-shaped recovery. Chinese stocks and bonds currently look attractive. For the United States and Europe, the situation may get a lot worse, and the recovery when it looks likely to be more of a ‘U’ than a ‘V’ shape, ” said Cheah.
Meanwhile, in Value Partner’s 2019 annual report that was released last month, Cheah, in his chairman statement, said the world face a spread of Covid-19, which has triggered a panic reaction that in some ways is worse than the disease itself.
“Because the US stockmarket, the world’s largest, had reached an extreme valuation, it was particularly vulnerable to bad news, and it plunged, adding a financial shock to the supply and the demand shock that had emerged already, ” he said.
At its peak back in January, the Dow Jones touched its high of 29,568.57 points, while it fell to its low of 18,213.65 on March 23.
As of Thursday, the Dow closed at the 22,552 level.
Cheah said like all such shocks, the impact of Covid-19 would subside, and governments and central banks are also committed to using powerful monetary and fiscal tools to fight back.
“China, currently a core focus for us, may come out of this crisis looking better than was expected. Although the damage inflicted on the economy is painful, with 2020 growth projected to drop to 5% or less after last year’s 6.1%, the country remains among the world’s fastest developing, with a massive domestic-consumer market of its own providing a solid foundation. “Robust measures taken by the Chinese authorities in early 2020 to contain Covid-19 tells the story of a China that can stay on top of crises, while avoiding the breakdown in social stability that troubles so many parts of the world today, ” said Cheah.
Currently China’s domestic “A” share market, with more than 3,800 companies listed in Shanghai and Shenzhen, is the world’s second largest stock market after the United States.
“Foreign ownership of ‘A’ shares, at less than 4%, remains low but as entry barriers ease, we anticipate major foreign inflows. China-related stocks, currently trading at around 10 to 12 times earnings, are cheap compared with the US multiple of 17 and the global average of 15, ” said Cheah.
For Value Partners, China is a core focus not only because it is a source of attractive investments but also because it is the area where its business is expanding fastest.
Value Partners has been in China for 10 years, where funds raised directly from mainland clients account for 11% of the group’s funds under management, and they are rising quickly.
Performance-wise, taking its flagship Value Partners Classic Fund as an example (fund size: US$1.2bil), the fund climbed by 32.4% net in 2019 compared with the Hang Seng Index’s 13.6% increase.
Since its launch in 1993, this fund has recorded a profit in 19 years and a loss in eight years, out of its 27 years in existence.
Coronavirus stimulus just pushed Fed’s balance sheet past $5 trillion for the first time ever
25 March 2020
Though the Federal Reserve’s efforts to keep markets running and boost the economy are just getting into gear, its asset portfolio has reached levels never seen before.
The central bank’s balance sheet, which consists largely of bonds and other assets it has purchased over the years, ballooned to $5.3 trillion for the week ending Wednesday. That’s well above the $4.52 trillion peak it hit in mid-May 2016, before the Fed started rolling off the bonds it had acquired during and after the Great Recession.
This latest peak has occurred in rapid fashion, the result of expansion begun in small steps earlier this year and then accelerated with the growth of the coronavirus crisis.
Just over the past week, the increase was 12.4%, partly a function of the Fed adding $255 billion in Treasury securities plus $19 billion in mortgage-backed securities as the Fed has entered into another round of quantitative easing. The biggest growth area proportionately, though, was in central bank currency swaps, which rose from just $25.2 billion a week ago to $206.1 billion in the latest reporting.
The Fed has greatly expanded its currency swaps with other central banks to include not only its traditional partners but also a slew of others around the world amid a huge demand for dollar-denominated assets.
On the way to $10 trillion
If things proceed as forecast, the Fed is just getting started.
“Unlimited QE & emergency liquidity programs should see the Fed balance sheet double in size over 2020,” Mark Cabana, rates strategist at Bank of America Global Research, said in a note.
The Fed had originally indicated it was going to add $700 billion to its bond portfolio — $500 billion in Treasurys and $200 billion in mortgage-backed securities. However, it switched earlier this week to an open-ended program in response to tumult in financial markets.
Wall Street now anticipates the balance sheet could hit $10 trillion this year as the Fed affirms its whatever–it-takes commitment to softening the coronavirus blow. Fed Chairman Jerome Powell told NBC’s “TODAY” show Thursday that the central bank will “aggressively and forthrightly” continue its efforts and will not “run out of ammunition.”
That means the balance sheet likely will hit $7 trillion by June, or about a $2.5 trillion gain from its previous peak, according to Citigroup. Ultimately, Wall Street forecasts are increasingly looking for a $10 trillion balance sheet that would signal a $4.5 trillion expansion, greater than the $3.7 trillion growth during and after the financial crisis.
Critics have worried about the possibility of inflation resulting from all that extra cash in the system, though it hasn’t been a problem since the asset purchases started in late 2008.
“Markets will have learned well from the 2008 experience that this increase in balance sheet size is not inflationary in any near-term sense,” Citigroup economist Andrew Hollenhorst said in a note. “In fact, the sharp drop in demand and prices for certain services and energy implies a significantly lower trajectory for both core and headline inflation.”
The balance sheet expansion creates bank reserves that the Fed credits institutions in exchange for the securities it buys. The current level of reserves at the Fed is just over $2 trillion, well above the $1.5 trillion the Fed says it was targeting as a healthy level to meet current demand.
Do fundamental managers really struggle to match that breadth?
Even the most seasoned fundamental equity analyst can only cover 30 or 40 stocks. If you do the math, if you have to cover 6,000 emerging markets stocks regularly, and let’s say that 40 stocks are the most one analyst can cover, you need 150 fundamental analysts to cover that many stocks. Does any firm have that many fundamental analysts covering emerging markets?
Is risk management part of that EMs sweet spot for quants, too?
Everyone knows that emerging markets are more volatile stocks than, say, U.S. large cap. Risk models are relevant everywhere, but become even more relevant in an area like EMs where the stocks you trade move around more than in other areas. A good quant manager builds its own proprietary risk model – we don’t just rely on standard providers. We build our own risk model that is attuned to our process and can better determine the risk in our portfolios. It’s much more finely honed in terms of how we position size a name. Once we like a name, we use our algorithm to determine how much we can buy of that name.
For example, we have simple rules such as if you’re a biotech name, we target half the weight of any single name as elsewhere because biotechs are much more volatile, and it’s an all-or-nothing story when it comes to trial phases. So, in an area like that we diversify our bets by buying more names.
Similarly, on riskier names – typically small cap names – and high beta or more volatile names, we take smaller positions than we do on Alibaba or Tencent, for example, because for various reasons there’s less liquidity in those names. So, the focus in our risk model is essentially that for every name our position-sizing algorithm determines how much we should buy. That’s critical in emerging markets, where names are riskier than in developed markets.
You don’t meet with company management as part of your strategy. Is that a strength compared to a fundamental manager?
It’s just a different approach and philosophy. Quants are disciplined, and we try to quantify everything. To us, you can tell the quality of management story by looking at financial statements – is return on equity improving? Is return on invested capital improving? We’re not interested in a judgmental, subjective lens.
The quantitative process is about ranking everything from highest to lowest in every sector, and then trying to buy the highest names and sell names that are going down in our rankings. It’s a very disciplined process that we do every day. Fundamental analysts can sometimes struggle with when to sell, because they don’t have a disciplined number telling them when to sell. Now, selling a winner is often easier – they’ve made the money, they sell it. But fundamental analysts and portfolio managers can struggle on when to sell losers – and sometimes that is because they are biased toward management. In that sense, not meeting management can make you more objective in your decision-making.
In many ways it sounds as if your strategy is optimized to seize the moment when it presents itself.
That goes back to breadth and speed. We can cover the whole globe on a daily basis, and because we look at 10 to 20 criteria per stock, such as how are you ranked on price to cash flow versus your peers, for example, we can act and trade on a daily basis. Not many active managers do that – either fundamental or quant. Our strategies are capacity constrained – we don’t want to be too greedy about assets under management – so that we are able to get in and out of names faster than other managers, and our robust infrastructure enables us to do that. That’s an advantage for us, especially in liquidity challenged areas with high transaction costs. If you can get into a name early on the upside, you can ride it up more compared to a manager getting in on a weekly rebalancing cycle or a monthly rebalancing cycle. That’s the advantage of speed we gain from daily analysis and trading.
Learn more about quantitative equity strategies focused on emerging markets and international offerings, and that use a core style of investing which employs fundamental ideas in a disciplined, risk-aware manner while seeking to generate alpha.
- 2. The Small Cap Opportunity in EM
Most investors agree that there is more inefficiency in small caps – no matter where in the world you find them – and thus more potential for alpha. In EMs, however, where small caps may be especially inefficient, there’s an opportunity that is often overlooked, and not typically part of an allocation plan by any but the largest funds.
A fairly common asset allocation plan for a U.S.-based fund would incorporate a U.S. allocation, an international allocation, and an emerging markets allocation. Historically, a reach for increased alpha in U.S. or international small caps has been more difficult because they don’t move hand-in-hand together with their large cap brethren. In both U.S. and international equities, large and small caps tend to have more independent and less correlated performance relative to large and small caps in EMs. In other words, when large caps are on an extended roll as they have been for many years now, the small caps aren’t necessarily along for the ride. In emerging markets, large caps and small caps have moved much more closely together. Further, the annualized volatility of EM large and small caps has been more similar relative to large and small caps in both U.S. and global equities.
So why does this matter? If allocations to large caps are all about beta, and allocations to small caps are about alpha, then in EMs we believe you have a better chance of getting both at the same time, rather than one or the other.
Human intelligence overlay
The emerging markets investment capacity at Mackenzie is, at a high level, constrained, so that the team can be in and out of stock ahead of managers encumbered by much larger AUM. Leveraging its computing power, the team is as nimble as they come, ranking and trading stocks daily, tapping into highly ranked names it doesn’t currently own and getting out of names that have fallen down the ranking.
Daily trading and daily rebalancing require a strong infrastructure, especially with a 24/6 clock (Middle East markets are open on Sunday). Mackenzie’s EM team spends a lot of time making sure that its models can run several times over the course of a day – as Asia opens and closes, then Europe, and finally the U.S.
“The world never stops for anyone in terms of the rebalancing cycle, so when other managers say they rebalance monthly or weekly, that’s a lot of missed opportunity, and it’s why we scrape data daily and rank stocks daily. There is always new information out there, and a name might still look cheap in a week or two, but I’d rather buy today than five days later when the stock has run up a lot already,” says Datta.
A common knock against quant strategies is that they are “black box,” meaning they lack transparency and turn over all decisions to computers. Embedded in the process at Mackenzie Investments, however, is a feature that not many other quantitative shops offer – serious and detailed human review. If there is one thing Datta makes clear he abhors it’s the “garbage in, garbage out” results of unchecked data dumping.
“It’s even more an issue in emerging markets because the data is dirtier there,” says Datta. “Most quants claim they do some statistical checks, but every trade we do is vetted or checked by either myself or my colleagues in the portfolio management and research teams at Mackenzie. And we do find names that we pull on an almost daily basis. We don’t trade them because we found that some variable the model was looking at was not correct, or that various data sources didn’t agree. Why are we selling a name? Why did we buy this for the first time? We dig deeper. If the data is bad you’re making a wrong investment decision, so we do spend time making sure the data is clean on a name-by-name basis in our buys and sells. Pulling trades is something we do almost every day, and certainly more prevalent in our emerging markets strategies than it is in our developed market strategies.”
All of this requires top-level talent, and Datta builds his team based on their programming excellence, and with an eye consistently on the future. “One trait of our quant business is that we mix the experienced people like me with the tech-savvy youth, not all of whom need to be PhDs. There are plenty of smart people with undergrad and masters’ degrees out there. The importance of mixing experience and bright, new thinking is that technology changes at a very fast pace, and it will change even faster going forward. Today, everyone uses [the programming language] Python. That was not the case five years ago, and I don’t know what the new Python will be five years from now, but I can tell you it won’t be Python. It will be something else.”
The human factor extends to EM trade execution as well, where varied exchanges, trade settlement processes, and so forth come into play.
“We have as much sophistication and discipline in our execution as we do in our stock picking and risk management – it’s all integrated into a single process,” says Datta.
The firm has proprietary market impact/trade cost models for every trade, with key drivers such as the level of liquidity demanded and stock volatility. According to Datta, its actual EM transaction costs have always come in slightly below what has been anticipated – a clear sign that trade execution is solid. “We deal with many brokers, and we are upfront in telling them that we trade a lot of names every day and we try to get the lowest commission possible because of the volume business we do,” says Datta. “And we let them know they’ll be measured versus yesterday’s closing price and VWAP [volume-weighted average price]. We monitor them closely, and if a broker is not doing well, we cut them off or lower the trading with them. It’s a very efficient process.”
Strong execution is particularly relevant when shorting an emerging markets’ stock, which is something that sophisticated investors sometimes avoid. It can be done through swaps, but execution is crucial when shorting in different regions of the world. “For example, there are plenty of hedge funds out there that appear to be shorting in Asia and China, but if you dig deep most of them have a long bias and all they’re shorting is the benchmark,” says Datta. “With the market-neutral type product such as we have in emerging markets, we actually short single stocks in almost all emerging markets.”
Wary Private Equity With $2 Trillion War Chest Sits Out Carnage
26 March 2020
U.S. private equity firms hold about $2 trillion in cash, a useful position amid the current market carnage. But, for now, very few are putting that money to work.
Deal activity has ground to a halt and discussions with businesses hit by the panic around the coronavirus pandemic are evaporating, according to people with knowledge of the matter. Recently, an arm of Brookfield Property Partners LP pulled out of financing Mirae Asset Global Investments Co.’s acquisition of a $5.8 billion U.S. luxury hotel portfolio.
While a few firms are buying some debt amid a panicked sell-off, the lack of private equity dealmaking shows how the virus’s spread has upended the economic outlook and made even the richest and most sophisticated investors wary. Economists are predicting an historic slump in U.S. GDP and some have suggested the nation’s unemployment rate could hit 30%.
Alternative-asset managers have already asked companies they own to draw down credit lines to stave off liquidity issues, and firms currently fundraising are trying to speed things up so they don’t have to ask investors for money at a time of uncertainty, the people said.
As U.S. states and municipalities expand lockdowns and infection rates rise, many executives expect the government to step in with bailouts.
Despite the wariness, some debt shops are starting to buy senior secured loans and second liens from banks, according to the people.
Distressed-debt stalwarts including Apollo Global Management Inc. are jumping in with loans to battered companies, but others say they’re still evaluating the situation.
“It is too early to have a full understanding of the economic impact of this crisis,” said Dwight Scott, global head of GSO Capital, Blackstone Group Inc.’s credit arm. “We are working to understand the economic impact on different sectors and companies, identifying companies that we believe will ultimately recover.”
For now, the largest alternative-asset managers are trying to use their network of companies to minimize damage and help share resources.
Apollo connected Chuck E. Cheese executives with its grocery store chains Fresh Market Inc. and Smart & Final Stores Inc., and later sent furloughed Chuck E. Cheese employees to work at the supermarkets and distribution centers that were facing increased demand.
Carlyle Group Inc.’s technology team has been working with its companies to enable staff to work remotely. Blackstone has been connecting firms looking for deep-cleaning services with its ServPro business, while procurement teams have been helping its portfolios companies source masks, safety glasses and other personal protective equipment.
Private equity firms are also trying to calm skittish investors.
Pension funds, endowments and family offices that have money in consumer businesses such as restaurant chains, fitness centers or travel and leisure should expect to feel some pain, said Michael Rosen, chief investment officer of Angeles Investment Advisors.
One firm in northern California told Rosen last week that revenue at some of its portfolio companies had already dropped 80% to 100%. “It’s not apocalyptic, but it’s getting close,” he said.
Big institutional investors are less nervous and are using the uncertainty to push for better terms, such as lower fees after the commitment period, according to people with knowledge of the matter. They’re getting regular phone calls and updates from the largest managers, who are adjusting to doing business via Zoom video and dealing with a world where most of the workforce is at home.
Carlyle is “patiently and thoughtfully assessing opportunities,” co-Chief Executive Officers Kewsong Lee and Glenn Youngkin said last week on a global conference call for its limited partners.
“We as a firm are extremely fortunate for the tremendous amount of dry powder that all of you have committed to us,” Lee said on the call, referring to their unspent cash piles. “But it’s very early days still and we understand from experience the benefit of patience.”
Gulf Sovereign Funds Seen Shedding $300 Billion in Market Mayhem
25 March 2020
The Gulf region’s rainy day funds are bracing for the deluge.
On top of the collapse of oil prices and meltdown in global markets, Gulf sovereign wealth funds are channeling some of their billions back to counter the recession triggered by the coronavirus pandemic. The decline in assets could exceed $300 billion this year, according to the Institute of International Finance, the industry’s global association.
The impact will echo all the way to Wall Street, where asset managers count on capital from the funds sponsored by Abu Dhabi, Kuwait, Qatar and Saudi Arabia. Now that these countries need the cash back home, hedge funds and private-equity firms risk losing a substantial piece of business.
“These interlinked shocks – an oil supply shock and covid19 demand shock – are weakening oil revenues, a source of new capital for sovereign funds, and significantly increasing spending needs,” said Rachel Ziemba, founder of advisory firm Ziemba Insights. “These funds were already barely receiving new capital in the last few years, now there will likely be drawdowns.”
$2 Trillion Assets
Middle East wealth funds built up assets in excess of $2 trillion during the past few decades, building a cushion for when oil runs out or revenues drop. They have stakes in Uber Technologies Inc., Barclays Plc, and swathes of European and U.S. property.
Saudi Arabia’s Public Investment Fund has also committed giant sums to a Blackstone Group Inc.’s U.S. infrastructure fund and Softbank Group Corp.’s $100 billion Vision Fund. Other funds in the region also have significant placements with Carlyle Group Inc., BlackRock Inc. and KKR & Co. Inc.
Exactly how much the funds have placed and with whom remain undisclosed. Most don’t even report the value of assets they manage. Abu Dhabi Investment Authority is one of the few that publishes an annual report, and that only includes broad guidance on strategy and performance.
It’s not just the wealth funds in the Middle East that are suffering. Norway looks set to withdraw a record $13 billion from its giant sovereign wealth fund to help pay for stimulus measures. Russia is also likely to draw down on its reserves as it wages an oil price war with Saudi Arabia.
Still, some analysts say fears of a large withdrawal of cash from markets are overblown, and dealing with crises like this is what sovereign funds were established for.
“It is important to remember that most sovereign wealth funds are designed to act as buffers against budget deficits, and withdrawals do happen often even if they do not make the headlines,” said Diego Lopez, managing director of Global SWF, an advisory boutique specialized in Sovereign Wealth Funds and Institutional Investors. Most funds won’t make immediate changes to how they invest, Lopez said, but “investment activity may slow down in some of the asset classes and may increase in others.”
The decline in asset values of the Gulf funds is set to be deeper than the drop in 2015, the last time crude prices collapsed, according to IIF estimates. Back then, it was just an oil price shock. This time the funds face a combination of a slump in the value of their investments, coupled with a need to spend cash at home now.
Sovereign funds in Abu Dhabi, Kuwait and Qatar will account for the bulk of the declines this year, with the assets of each set to drop by around $100 billion, according to the IIF.
In contrast to 2015, Saudi Arabia will likely focus on borrowing rather than drawing down PIF reserves, according to Garbis Iradian, chief economist for the Middle East and North Africa at IIF. Five years ago, the Saudi Arabian Monetary Authority pulled as much as $70 billion from global asset managers to help plug the kingdom’s deficit that year.
Last week, Finance Minister Mohammed Al Jadaan said Saudi Arabia would fund an expected larger deficit through borrowing more rather than drawing down reserves.
The last time oil prices sank global sovereign fund and central bank assets were expected to shrink by about $1.2 trillion in 2015, according to estimates at the time by UBS Group AG. How much ends up being withdrawn this time will depend on how deep the economic slowdown created by coronavirus and the oil slump turns out to be. That will not become clear for several more months.
Either way, asset managers may not be able to rely on large allocations of Gulf petrodollars much longer. That $2 trillion of savings could be gone in 15 years if governments in the region don’t diversify their economies and trim wasteful spending, the International Monetary Fund warned in February, before the latest oil price slump.