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January 27, 2014 at 07:00 PM
The world has changed for investors, more than most advisors might realize. Despite everything that has occurred to markets and the economy over the past 10 years, the world economy has gotten much, much bigger. The reasons for that are the “tectonic shifts,” as Doug Coté, chief market strategist at ING U.S. Investment Management, likes to call the forces that have been driving the global economy over the past few years. Those forces include the widespread penetration of technology; the rise in global manufacturing; the importance of the global consumer; and continued innovations in the energy industry.
Few observers, however, realize the extent to which these ongoing forces have impacted global economic expansion, Coté said. Nor do they realize how just a few years after the greatest economic recession in recent history, those forces have successfully pushed total global output from $37 trillion to $73 trillion.
“Everyone was focused on the depression we went through, but right underneath our noses, these changes have been going on, and the world economy is now twice the size it was a decade ago,” Coté said.
That positive momentum, Coté believes, is only going to gain steam going forward, with emerging and frontier markets benefiting the most from the inevitable and underlying global dynamics.
Last year, emerging markets debt and equity were among investors’ least favorite asset classes, but long term, investment opportunities in developing economies abound, Coté said. That’s because these countries more or less have it all: commodities and raw materials, a stronghold on manufacturing, young populations and a continued increase in consumer spending. That spending is growing to such an extent that Chinese consumers are forecasted to make up 5% of global consumption by 2020, and the African Development Bank projects consumer spending in sub-Saharan Africa will reach $2.2 trillion in 2030.
As that dynamic continues to play itself out, the increasing incomes and improved lifestyles in the emerging and frontier markets are also leading to other kinds of cultural shifts, which in turn are creating new kinds of investment opportunities.
The Good and Bad of Emerging Markets
As an example of the big cultural changes around the world, consider a recent report from U.K.-based research firm the Overseas Development Institute. It found that rising incomes in developing economies are leading to higher rates of obesity and diabetes among their populations as traditional diets are abandoned in favor of fast food and other more unhealthy options.
“This is a disturbing trend that we’re going to continue to see as first-world lifestyles catch on in these countries,” said Clem Miller, investment strategist at Wilmington Trust Investment Advisors. “Ironically, though, and sad as it may be, it makes for a great long-term investment opportunity in companies that make diabetes drugs, for example.”
On a fundamental economic basis, Miller is of the opinion that developed economies—European ones in particular—don’t stand a chance against developing economies.
The United States’ abundant supplies of affordable energy, especially natural gas, are a magnet for both foreign direct and portfolio investment, and the country is quickly moving from a net energy importer to a net exporter. Europe, however, is dogged by a host of challenges. Those include aging populations and high wages, Miller said, all of which have been compounded by the problems brought on by the sovereign debt crisis and the ensuing recession.
“I believe the only direction we’re moving in is toward an Asia-Pacific, Latin America and Africa-led world,” he said.
Nevertheless, most large companies are no longer truly European or American, even if they’re listed on a particular exchange.
“A large percentage of the U.K.’s stock market, for example, is made up of energy and raw material companies, so it’s clear that it is more correlated with raw material prices around the world than with the U.K. economy,” Miller said.
How Europe Is Changing
More importantly, though, the crisis has highlighted the need for fundamental changes in the existing European economic model. Already there has been a noticeable cultural shift in certain areas that may well inspire a more competitive model for business and create a better framework for corporate activity and investment.
According to Giorgio Caputo, portfolio manager and senior research analyst at First Eagle Investment Management, one of the more positive developments in the post-crisis period has been the gradual shift from bank-led debt markets to institutional debt markets.
Historically, banks and businesses in Europe enjoyed cozy relationships, but with problem loans still lurking on bank balance sheets and new capital requirements specified in Basel III, “we are starting to see the further development of an institutional lending market in Europe that I think is set to continue,” Caputo said.
High-yield bond issuance, for example, has roughly doubled in the last year in Europe, and this presents opportunities for global income funds like First Eagle’s. Caputo is also encouraged by the improvement in bankruptcy regulations in Europe that are helping creditors feel more comfortable in certain jurisdictions. Great progress has been made in several European countries in terms of creditors being able to enforce their rights, he said.
“In the past, regulation tended to extort value from senior secured lenders and this impacted the future of even viable businesses because the reorganization process could be so expensive and time consuming,” Caputo said. “So to have an improved, better controlled [bankruptcy] process that gives businesses a greater say, similar to the way Chapter 11 provides a means to rehabilitate business in the U.S., is a good step forward for Europe. Allowing businesses to declare bankruptcy and then restructure rather than limping along means that resources can be redirected to more productive uses.”
Innovation Among European Financials
Financial sector innovation is definitely one of the more positive consequences of Europe’s protracted crisis, agreed Bill McQuaker, deputy head of equities at Henderson Global Investors. That’s particularly seen in the extent to which the financial markets are evolving to replace bank lending as a source of capital, and the creative ways in which companies are seeking out that capital.
Over the past months, Henderson has been approached by a few companies that want to source fund capital as opposed to bank loans or high-yield bonds, and are doing so in partnership with their banks by using the banks’ credit network to source cash that would come from a third-party investment fund and not the bank’s balance sheet.
