Returns to the Value factor continue to disappoint. Against Momentum it has been almost one-way traffic for the whole of 2020, whilst in the longer term, we are now approaching the low point (for Value relative to Growth) reached in 2000 as per the Russell 1000 Index. [The Russell 1000 Index represents the 1000 largest capitalisation firms in the US]. Brief spikes in Value (as seems to be happening currently) last only a few days, before the selling resumes anew.
[Note: the chart below plots Value against Momentum, not growth; but a nearly all the highest momentum scoring shares ARE growth shares, they amount to one and the same].
In case there should be any doubt, it IS a global phenomenon; only US Value has beaten the MSCI World Index, and all major Value regions have even lagged long-dated UK Government bonds, which are a risk-free asset.
Harold Macmillan, the UK Prime Minister between 1957 and 1963 was reputed to have replied “events dear boy” when asked what the most likely thing would be to knock his government off course. With the increased focus on Sustainable and Socially Responsible investing it now seems that there is significant “event risk” involved in running a company in contravention of these principles and the bigger and more high profile it is, the more dangerous things can get.
The world seems more than ever eager to take offense. What would once be dismissed as a joke or mild criticism is now portrayed as something akin to assault, regardless of the intent behind the statement. The resignation of Alastair Stewart in recent days as a result of a (somewhat concocted) row on Twitter with another user is but one in a long list of the famous who have been brought low by controversy.
EBI Portfolios adopt a buy and hold strategy, which means that one year performance is not a sound basis for decision-making with regard to asset allocation etc. However, we recognise that clients wish to know how their assets are performing and so a yearly review is undertaken to allow them to understand the sources of returns; it is not always possible to discern the rationale for why millions of investors (most of whom are much better informed than we are) do what they do, so any interpretations offered here are just that-interpretations- and may be in error. But taken as a rough guide, it may help investors to better understand how markets have performed in 2019. On the basis that any information is better than none at all, we offer the below.
EBI’s ESG-integrated portfolios are now live. To mark the launch and in the run up to 2020, it’s an opportune moment to look back at the series of ESG blogs we have run over the last few months and to summarise the key takeaways for financial advisers.
Firstly, demand for passive solutions is soaring. As previously mentioned, an ETFGI report found that global ESG ETFs/ETPs assets increased by almost 30% in 2018 ($7.6 billion in net new assets) whereas assets in equivalent non-ESG funds grew by less than 5% in the same period.
Is ESG therefore a fad, with ETF providers jumping on the bandwagon? As we’ve discovered, there are ETFs for almost every whim nowadays – including a ‘vegan’ ETF which still has a heavy proportion invested in tech stocks.
From time to time both ourselves and our clients get contacted by journalists looking for quotes and views on the debate surrounding Active and Passive Investing, which (usually) revolve around asking us what our investment approach is, or how we use the two types of investment strategies for our portfolios. So, in order to formalise our response and to give clients an idea of how to respond should they receive similar enquiries, we decided to put our views down “officially”, in the form of a Q&A.
The concept of “satellite and core” is a key discussion among financial advisers when it comes to portfolio construction. In essence, core investments make up a bigger proportion of long-term invested assets, and tend to be passive funds, while the satellite can perhaps include some riskier or more exotic active investments for the shorter term and tactical plays.
This model is designed to lower costs, be more tax efficient, minimise volatility and provide some opportunity to outperform the markets - and it can be applied across investment vehicles, strategies, and asset classes. (Although it’s not to be confused with the typical way we talk about equities versus bonds - say, 60% for the former and 40% for the latter for a typical medium-risk portfolio - because both are typically longer term.)
And this is where ESG comes in. So, do you hold ESG at the core or satellite?
More than two years ago, we discussed the rise in social unrest across the globe as nations start to split apart. This has got much worse since then and it appears to have become generalised as the cleavage between populations has now spread to families. Why now and how will it all end?
Fund providers have an almost miraculous ability to create products that follow the news cycle. Index-linked funds (due to worries around inflation), robots and automation (robots taking over our jobs) and gender diversity ETFs (tapping in to Sheryl Sandberg’s ‘Lean In’ revolution). Gender diversity, hopefully, will be a lasting focus for investors, while internet-focused funds, which launched in the 1990s and early 2000s, had a seriously rocky start.
No matter an investor’s principles and good intentions, ESG is prone to the same marketing whims and opportunism of fund providers as much as any other investment sector. And just like any other sector, ESG funds are also at risk of being overpriced, especially if a fund provider claims to launch a ‘first of its kind’ and therefore has no competition. ESG or not, a fund provider is a business, and its main aim is to profit.
A pub quiz question- what has been going on for more than 3 years, amid much frustration and bemusement to all involved, having got nowhere at all during that time and is not Brexit?
Just like the debates around active versus passive funds or the definition of smart beta, the concept of environmental, social and governance-focused ETFs is hotly debated.
ESG has come a long way. What started in the 1960s as stripping out tobacco stocks has evolved to other areas like gender equality, green bonds, social impact investing and more. ESG, to a certain extent, has also had to keep abreast of societal changes, removing increasing numbers of stocks and sectors as time goes on, from companies that derive most of their revenue from arms sales to companies that benefit from practices such as child labour.
One could argue that good ESG starts at home, and not just with a product range. As demand and awareness around environmental, social and governance factors grow, ETF providers are under increasing pressure to showcase their own good practices.
Fund houses will also have to become more transparent on ESG, whether they like it or not. By 2020, the European Commission will require investment houses to disclose how they integrate ESG opportunities and risks into their processes to stop funds being labelled as ESG when they normally wouldn’t qualify - otherwise called ‘greenwashing’.
In the context of financial markets, Repo's refer not to repossessions but repurchase agreements. This is the process whereby banks who are (temporarily) short of money can borrow from those who have excess cash so that they stay within their legally required reserve requirements. Generally, the interest rates charged are that of the prevailing Fed funds rate, which s currently in a range of 1.75-2%.
Under the ESG umbrella, there is another category that pertains more to the ‘S’ and ‘G’ letters – gender equality.
Given the rise of movements like MeToo and TimesUp, there is increased recognition and acceptance of gender equality and diversity at work. And thanks to UK government-backed initiatives like the Women in Finance charter, the Alexander Hampton review, which aims for 33% women on boards of all FTSE 350 companies by 2020, as well as mandatory gender pay gap reporting for companies with more than 250 employees, gender equality has become less an esoteric aim and more mainstream.
Equities can be seen as a "call option"on the future growth of a company; once the liabilities due to bondholders are paid, the surplus accrues to shareholders in the form of dividends/share buybacks, etc. or are re-invested to generate future growth in the firm. At least, this is what happens most of the time, but every now and then, things go awry, a company fails and the "call option" expires worthless. It is not a common occurrence, but when it does happen, the shareholders tend to lose everything.
It is usually the case that any innovation or evolution in the ETF industry benefits equities first. Equity ETFs have launched in every category, from the smallest corners of the globe in terms of geography to smart beta and beyond. Fixed income and other asset classes, on the other hand, always take longer to achieve the same level of progress.
ESG is no exception. Data from Morningstar as of July this year shows the vast bulk of assets and number of funds relating to ESG investment in Europe is in equities. In fact, there are only eight so-called sustainable bond ETFs in the region. There are currently only three providers offering these fixed income funds - db x-trackers, iShares and UBS, and their products are mostly invested in corporate bonds.
"If all you're trying to do is essentially the same thing as your rivals, then it's unlikely that you'll be very successful" - Michael Porter.
In the last fortnight, there has been something of a reversal in the market's favorite Factor trade - long Growth/Momentum and short Value. It began in the US, but as is normally the case, it soon went Global. As a result of this, months of gains in Momentum (long) and Value (short) were lost in a matter of days.
But one would not have known anything of this, looking at the Indices, with all major markets seeing gains since the start of September.
One of the most persistent myths around ETFs that are focused on environmental, social and governance (ESG) factors is that investors will have to pay a premium for green exposure.
Last time, we debunked the myth that the ‘premium’ in question would be sacrificing returns. This time, let’s look at the other more common use of the word ‘premium’ – that is annual fees.
As most investors who are interested in ETFs know, there has long been a race to the bottom on annual charges. While most actively managed funds have the audacity to hover between 0.75% and 1% per year, depending on the asset class and strategy, ETFs have been falling as if there is no gravity. Investors can pick up an entire portfolio for just a couple of basis points – and as US publication ETF.com discovers every year, the price just gets lower (it hit 0.05% in 2017).
The following blog was produced by Garrett Quigley of GSI (Global Systematic Investors LLP). GSI are the appointed sub-distributor for the Global Sustainable Value fund which EBI will be using in it's Earth portfolio suite. You may wish to view former EBI blogs on the Value premium both here and here.
• In global developed equity markets, Growth has outperformed Value for a protracted period.
• Growth is now trading at a historically high price level relative to Value.
• Much of the recent outperformance of Growth vs Value is due to the change in the valuation spread between Growth and Value.
• When Growth last traded at this valuation level, it subsequently underperformed Value for 20 years.
"If you gaze long enough into an abyss, the abyss will gaze back into you" - Friedrich Nietzsche.
Amidst the sound and fury of trade war rhetoric, there are signs of problems in the banking system in China. In the last 3 months, there has been a spate of previously unknown events there - bank defaults. This week's news of a delay in the implementation of (some of) the US tariffs on Chinese goods led to an immediate spike higher in shares (and lower in bonds) but has not changed the situation that has plagued the Chinese banks.