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Macroeconomics & emerging markets

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When considering how to "supercharge" the alternative funds industry, one region that continues to offer growth potential is Emerging Markets. There are myriad opportunities to harvest yield, but equally there are plenty of risks to navigate. As such, fund managers will need to take a measured, country-by-country, sector-by-sector approach in 2016 to realise gains. 

As Paul Schulte, Founder and Editor of Schulte Research commented on one of the panel sessions at CAIS 2016: "Alibaba in China is going to become one of the largest banks and media companies in the world. At the same time, I would suggest that the number one most toxic area of the market today is Brazil corporates."

Despite the fears over some emerging markets such as Brazil, the trends in other markets are compelling. Consider the following figures: There are approximately 835mn people in India below the age of 35. Over the next four years, 990mn people in India will be coming online with mobile phones. Asia now has 900 of the world's billionaires, with China ranked number one and India ranked number three. 

It is hard to ignore these numbers, said Asma Chandani, General Counsel and Chief Compliance Officer at Chinus Asset Management, LLC, which seeks out the best local managers in Asia to tap into the region's emerging wealth. "Growth in wealth is not yet being reflected in global equities," said Chandani.

The opportunities for alternative fund managers over the next few years are likely going to be substantial to supercharge returns. This is despite the negative press on emerging markets that continues to flow out of the West. Indeed, for some, the opposite is true. 

Charles Mautz (pictured) is CEO and Founder of Chinus Asset Management. He said that when visiting Asia, he noted a palpable difference in terms of how local people view the development of their economies, versus the perception that exists in developed market economies. Said Mautz: "China hedge fund managers are very bullish, adding more personal assets into their funds. Contrast that to what you read in the US press and China is perceived to be falling off a cliff. The West underestimates China's willingness to avoid a hard landing." 

Anne Richards, Global CIO, Aberdeen Asset Management, said that from a macroeconomic perspective, the current level of disconnect (top down versus bottom up) "is quite possibly the highest I have ever seen. Sooner or later fundamentals will return, but timing it will be difficult. There is a laziness and a convenience among politicians to blame emerging markets for everything. China, after all, is forecast to grow 6.4 per cent in 2016."

Navigating through turbulent waters

That is not to suggest, given the wild volatility seen in January, that China is a low risk strategy. Credit risk is creeping higher, with non-performing loan default rates expected to rise from 1 per cent to 1.5 per cent in 2016. Numerous Chinese corporates that are uncompetitive and have borrowed substantial amounts from banks at low rates are at risk if and when interest rates rise in China. 

Moreover, currency risk has been introduced with the recent devaluation of the RMB, prompting Mark L. Hart III, Chairman and CIO of Corriente Advisors LLC, a Texas-based hedge fund manager, to forecast that the RMB could devalue by 50 per cent when foreign investors divest their positions in China. 

Quite what impact that would have is anyone's guess but if, at the same time, the US dollar appreciates further in 2016, emerging markets could be a vortex to navigate over the near term and won't be for the fainthearted. 

Raoul Pal, Economist, CEO and Founder, The Global Macro Investor, and CEO and Co-founder, Real Vision Group, forecasted that the US dollar would continue to rise in 2016, on the back of a 7 per cent appreciation in 2014 and 10 per cent appreciation last year. "Even if the US Federal Reserve cuts rates the US dollar will still rise, as was seen in the 80's and the late 90's. I think we will see another 10 to 15 per cent increase this year," said Pal. 

Pal was speaking about global macroeconomic forecasts at CAIS 2016 on an esteemed panel that also included Nouriel Roubini, Chairman, Roubini Global Economics (also known as "Dr. Doom"), and John Mauldin, Chairman, Mauldin Economics. 

The panel was chaired by Constance Hunter, Chief Economist, KPMG. Hunter identified three themes for 2016: bifurcation, debt, and `flation'. 

"We see bifurcation everywhere as a result of divergent central bank policy. The US is raising rates, Brazil is raising rates, New Zealand is raising rates with pretty much everyone else lowering rates and going from a zero interest rate policy (ZIRP) to a negative interest rate policy (NIRP). This has huge implications. In the latest stress tests issued by the US Fed, it is asking banks to look at what the impact of NIRP would be on the US economy. But for now, we still see the Fed on a raising interest rate trajectory and the rest of the world on a declining interest rate trajectory," commented Hunter. 

Roubini pointed out that policy divergence has not been the rule historically; if anything the opposite. It was only the smaller central banks looking to do negative policy rates; the Danes, the Swedes. Now the Bank of Japan have started doing it. 

Roubini: “Rates will go negative”

"I will make the provocative suggestion that the Fed will introduce more quantitative easing and rates will go negative. I think -1 per cent will become the new zero. The amount of debt will dictate this. You have to keep on monetising it to avoid deflation," said Roubini. 

Mauldin for one does not see the debt cycle continuing. "We'll have hit the debt re-set button by 2030 and so many opportunities will arise. It's going to be cool," enthused Mauldin. 

For the time being, central banks will continue to do everything within their power to support higher asset prices and create much needed inflation by suppressing interest rates. This is Neo-Keynesian economics at work, with the objective to push consumption not production. Problem is, central banks are fast running out of room because the money being borrowed is not producing growth. The next step, as we've seen in Japan, is NIRP. 

"It's precisely the wrong policy but the central banks are going to do it anyway. We'll be lucky to do 1 per cent global GDP growth over the next 10 years. Welcome to a decade of disruption," said Mauldin. He added: "Ben Bernanke said you have to put negative interest rates on the table. I would suggest that most fund managers in this room have not stress tested their own portfolios for NIRP. They have to start war gaming."

Investment suggestions from the experts

Roubini does not think policy makers have been Keynesian enough. There is still more supply than demand in the system, and not enough consumption. Asked by Constance what his two investment suggestions would be for 2016, Roubini replied: "US bond yields will fall closer to 1 per cent rather than stay close to 2 per cent. Also, buy protection against a 20 per cent correction in the S&P and global equities. The risk of a global bear market is rising day by day." 

Pal said that he predicts US 10-year Treasuries to fall closer to 0.5 per cent in the next 12 to 18 months. He added that as a higher risk investment opportunity, "Iran is a fantastic investment market and is relatively isolated from the global markets." 

Mauldin confirmed that his biggest trade for 2016 is going short the Yen with 10-year options. Second, to hedge against negative interest rates Mauldin said he would buy option puts. 

"I would qualify that trade further and go long on European negative interest rates via put options. I would also go long Argentina," added Hunter. 

Moving back to the idea of supercharging returns in emerging markets, it is worth pointing out just how nascent China's stock market is. The vast majority of investment activity on the CSI 300 Index is still retail. As corporate governance improves, and the mainland makes it easier for global asset managers to participate in its capital markets, the level of volatility could soften. For now, however, the global economy still relies heavily on China consumption. As soon as its economy experiences a hiccup, the ripple effect is significant. As Cowell pointed out: 

"Its clear now that when China has an accident the world gets hurt."

Paul Schulte compared China's transition towards an inward consumer-focused economy to that experienced by Taiwan in 1990. For the time being, however, he warned managers to avoid the value traps of investing in China via Hong Kong H-shares. "There is a 40 per cent discount price in Hong Kong. It is drowning in money. The SEHK is a quicksand market. I wouldn't be chasing that discount right now," said Schulte. 

Macroeconomics are likely to create plenty of investment opportunities in 2016 because of bifurcation, debt and a potential move to negative interest rates in developed markets beyond Japan. And whilst this is going to create further volatility in emerging markets, asset managers who can formulate unique strategies to tap into the region's growth, especially among commodity consuming nations such as India and China, could be well placed to succeed

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