The Space Between
Coverage of the 2016 Risk Management Conference
BY Caroline Cakebread | October 27, 2016
Investors tend to fall into two camps: short-term and long-term. But what about the middle ground? It’s an under-represented area in most portfolios, argued Danielle Singer, senior client portfolio manager, multi-asset team, with Invesco. She focused on the importance of a mid-term investment time horizon during her presentation.
In today’s market environment, she explained, a lot of volatility stems from a virtual tug of war between cyclical fundamentals and larger structural drivers. “Central banks flow liquidity into markets and that has helped cyclical indicators show mixed but mildly positive signs of recovery,” she noted.
In this post-crisis world, however, those positive signs have come at a cost: a re-leveraging of balance sheets and over-leveraged consumers in countries like Canada.
Investors able to understand and capture the interplay between structural and cyclical drivers can benefit from the gap between.
“You need to look at what is going on cyclically but in the context of larger trends,” she added. In doing so, investors can identify medium-term trends that are often overlooked in a market that is highly polarized by long- and short-term investors.
Take fixed income, for example, Singer explained. “In 2010, cyclical indicators pointed to economic expansion post- crisis,” she said, noting that positive signs could point to a rising rate environment in the short term. However, a big- picture view of structural issues would lead an investor to a different conclusion. “The implications of larger debt and deleveraging pointed to a slowing recovery and lower credit creation — a drag on economic expansion,” she said.
This fuller picture could have led investors to add duration in fixed income in anticipation of falling yields down the road — a middle-ground solution that benefited those who were able to see it.
Emerging markets equities are another area where a mid-term perspective could lead to better opportunities. Singer noted that, in emerging markets, cyclical factors such as an increasing relative valuation gap between emerging and developed markets could lead investors to overweight on emerging markets. However, the big-picture commodity slowdown was a game changer — a structural factor that could continue to weigh down equity returns.
Investors, she noted, could have responded by looking at a different set of emerging markets countries — Poland and Hungary, which both benefited from lower input prices with improving fundamentals and undervalued currencies.
Finally, Singer discussed currencies — another way investors can take a mid-term perspective to enhance returns. “Interest rate differentials between countries can also drive exchange rates,” she said. But currencies that typically move in lockstep can easily be thrown off course by structural issues in one country.
Take Brazil, for example. Singer noted that, typically, Brazil’s and Chile’s exchange rates were closely tied to the difference in their interest rates. However, the loss of faith in Brazil’s government and the outflow of foreign direct investment caused a dramatic divergence in 2014. Investors who could weigh the structural and cyclical drivers of those currencies might have been able to interpret this signal and benefited.