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24 FEATURE TUESDAY 4 APRIL 2017 CITYAM.COM TRADING AND INVESTMENT WHERE NEXT FOR EMERGING MARKET DEBT? EMERGING market debt (EMD) has matured as an asset class, with a growing number of investors attracted to the increasingly positive economic fundamentals and higher yields. EMD also offers an expanding opportunity set with plenty of diversification opportunities. That said, the asset class comes with distinct risks that makes achieving relatively stable returns in the shorter term no easy task. The answer, we believe, involves a different approach to asset allocation and selection, and access to the right technology to undertake risk management in real time. MOVING BEYOND THE TRADITIONAL Traditional fundamental top-down and bottom-up active management approaches can be inadequate during regime changes or when unexpected events roil markets. It is therefore not enough to implement a static asset allocation between local, hard and corporate debt based on historical data and to then try to achieve optimum timing. To take fuller advantage of the asset class, a more forward-looking investment approach that takes into account EMD’s distinct characteristics is required, even more so now. Performance drivers have become more numerous and complex, just as the investment environment in fixed income is increasingly challenging following a 35-year bull market. Central bank support is now BlackRock’s Sergio Trigo Paz examines the opportunity presented by this maturing asset class Emerging market debt has had a strong start so far this year. Hard currency sovereign debt returned 3.38 per cent and local debt is up 4.62 per cent in US dollar terms waning and investors may be left over-exposed to monetary policy risks. This suggests that further diversification away from core developed market fixed income is set to be crucial. In this context, EMD stands out as one of the few remaining places where investors can find investmentgrade yield that offers some protection against the impact of rising interest rates. So despite perceived headwinds following Donald Trump’s victory in November 2016, EMD has had a strong start so far this year. Hard currency sovereign debt returned 3.38 per cent and local debt is up 4.62 per cent in US-dollar terms as of 24 February, according to Bloomberg data. Equally, though, this year’s buoyant performance also means that valuations are now more stretched. Therefore the ability to actively pick between the winners and losers will likely become a more important returns driver. Meanwhile, the transitions already underway could again disrupt global markets, including EMD, in 2017: an interest rate regime shift led by the Fed; a move from fiscal restraint to fiscal stimulus; or a move from globalisation to protectionism, to name a few. The implications on EMD will differ from developed market fixed income, and accommodating for these differences is an important step to optimise opportunities. First, EMD is heavily influenced by global external forces that are in constant motion, making investment cycles more uncertain. Some examples include the normalisation of monetary policy in the US, China’s pace of economic growth, the direction of oil prices and the US dollar. All of them can impact significantly the performance and risk profile of EMD assets. Second, the diversity of the asset class should mean more attendant alpha opportunities for investors, but the changing nature of the performance drivers make alpha generation less straightforward than it seems. Finally, the asset class is particularly vulnerable to short-term surprises, as evidenced last year by November’s US elections. RE-ENGINEERING THE ESSENTIAL COMPONENTS These differences can have an important impact on the three essential components of active management – asset allocation, selection and risk management – and not surprisingly, stretch many investors’ ability to extract more consistent returns from the asset class. Consider groups of countries that may share commonalities impacting bond and currency performance when market conditions change. Central banks that are hiking rates, for example, can be separated from others that are more dovish, or highly-indebted economies versus lowleveraged ones. With this simple comparison, we can gain some information on how these groups would perform differently if, for example, inflows into EMD accelerate. Obviously, the actual implementation of such a view is far more complicated because the return drivers that affect the subsets of countries tend to vary in magnitude, frequency and length of time. Identifying and understanding how potential changes in global and local drivers may impact each country or groups of countries in multiple ways has become essential. It is no longer adequate to invest in a particular debt issue based on forecasts or valuation models generated from historical data. Managers also need clarity on how certain securities may perform under multiple conditions. What happens if the Fed raises interest rates faster than expected, or if the latest polls are wrong about the French presidential election? Then perhaps even more importantly, they need to have the technology and tools to interpret, quantify and efficiently manage the risks. An investment process that is fit for purpose in today’s unpredictable environment needs to address EMD’s specific characteristics: next-generation active management if you will. In practice, it means adopting a dynamic asset allocation framework with risk parameters that can be adjusted swiftly for expected market shifts; selecting countries and securities through a forward-thinking lens and skilful use of scenario-based risk management. £ Sergio Trigo Paz is head of emerging market debt at BlackRock.
CITYAM.COM TUESDAY 4 APRIL 2017 FEATURE 25 Get ready for the new tech wave Thomas Fitzgerald looks at the firms likely to fuel the next technology revolution WE ARE now entering “Tomorrow’s World”. As visions of the future become reality, the rise of tech is touching every part of the fabric of global politics, society and the economy. It is an enabler of growth and change for every business sector. Industry 4.0, the rise of smart factories, and cyber-physical systems, for example, offer the potential for a step-change in reliability, safety and productivity. Similarly, smart-cities will see greater optimisation of physical infrastructure via predictive modelling and real-time data collection. Technological advancements in fields such as artificial intelligence and virtual reality provide new business opportunities in new markets, and they raise the competitive barriers to entry for technology companies with strong credentials in these fields. TRUMP TAX OFFERS TAILWIND FOR DEVELOPMENT The new US administration’s tax plans include provisions for low-tax rates on foreign earnings repatriated to the US in order to incentivise companies to bring their cash onshore. This could be a major acceleration of advancement and a boon for shareholders. For many of the major US technology firms holding substantial cash balances overseas, this incentive (if enacted) could lead to a significant amount of cash repatriated to the US for share buybacks, shareholder dividends, as well as US-based M&A, R&D and capital expenditure, all of which have the potential to enhance the fundamentals of the industry. This change could have a tailwind effect on the four major themes driving the new wave of tech, which are destined to revolutionise our lives while offering investors plenty of opportunity. RISE OF ARTIFICIAL INTELLIGENCE AND MACHINE LEARNING Major advancements in many of the underlying technologies such as deep learning, neural networks and natural-language processing have led to the creation of computing systems that understand, learn, predict and operate without human intervention. These developments have catalysed the rapid growth of embedded intelligence within products and services, such as voice-enabled virtual assistants, autonomous vehicles and smart homes. In the future, we expect to see further progress in the capability of these technologies and an expansion in their commercial application across a number of industries, including health care, transportation and consumer services. Key players within this area include those companies with strengths within the core buildings blocks of these technologies: £ Big data (Alphabet, Facebook and IBM) £ Semiconductor producers which enhance the processing power required to manage and interpret much vaster pools of data (Intel, AMD and NVIDIA) £ Hardware manufacturers in areas such as sensors, microphones and cameras required for data collection and interpretation (Sunny Optical, Mobileye and Infineon Technologies) £ Cloud computing services, as we believe that ultimately these functions will be offered to enterprises and endusers as a part of their overall cloud computing service (Amazon and Microsoft) VIRTUAL REALITY TO BECOME A REALITY Computer processing capability has only recently become fast enough to power comfortable and convincing virtual and augmented reality experiences. Companies such as Facebook, Google, Apple, and Sony are deploying vast amounts of capital in order to make these experiences more immersive, comfortable, and affordable. Over the next few years, we believe virtual and augmented reality capabilities will further improve and these technologies will be more widely integrated across PC, mobile and wearable devices. This will serve users in enterprise, education, and health care, as well as the more obvious applications in consumer and gaming industries. CYBER-CRIME IS ON THE RISE Cyber-crime is estimated to cost the global economy more than $400bn every year. With cyber adversaries growing increasingly competent and well-resourced, while entities and individuals continue to process and store a larger amount of their assets and information digitally, we believe that the frequency and impact of cyber-crime will continue to grow. In the past, security has primarily been the responsibility of software and network providers. However, with the mass adoption of smart home devices and increasing connectivity in life critical situations, such as automobiles and medical devices, we believe that security will become a greater focus for hardware manufacturers (NXP Semiconductors and Cisco Systems). REACHING A NEW LEVEL OF SCALE With approximately 2.5bn people using a smartphone device worldwide, technology has reached a new level of scale through a new form of computing (with cameras, sensors and sound). This, in our view will continue to provide a platform to change the lives of users and significantly alter the course of numerous industries. £ Thomas Fitzgerald is associate portfolio manager at EdenTree Investment Management. AI will push music streaming into the stratosphere THE LATE, great David Bowie got it spot on back in 2002. Telling the New York Times that music is going to become like “running water or electricity,” the Starman singer predicted the meteoric rise of the streaming subscription that last week confirmed its place in the upper echelons of the industry. The fragile US music industry saw retail revenues from recorded music grow 11.4 per cent in 2016 to $7.7bn, according to the Recording Industry Association of America (RIAA). This was thanks, in no small part, to a doubling of paid streaming music subscriptions which helped the American music business experience its biggest gain since 1998. “For the first time ever, streaming music platforms generated the CNBC COMMENT Matt Clinch majority of the US music industry’s revenues... Streaming grew from just 9 per cent of the market in 2011 to 51 per cent of total industry revenues in 2016,” the RIAA confirmed, namechecking such services as Spotify, TIDAL and Apple Music. It’s an impressive rise but the new technology has yet to truly capture any of my cash. I’ve dabbled in the “freemium” models for some services and I’ve purchased a few weeks worth of access to one particular streaming subscription. But that’s it. I’ve so far resisted, clinging on desperately to my vinyl collection and any CDs I still have from the 1990s that aren’t scratched beyond playability. That is, until now. Streaming grew from 9 per cent of the music industry in 2011 to 51 per cent of total revenues in 2016 With the upcoming launch of Google Home in the UK and the advertising onslaught that Amazon is currently undertaking for its own smart assistant Alexa, it won’t be long before there’s a talking robot nestled between the books on my dining room shelf. And there lies the major selling point for me. Call me lazy, but who wouldn’t want to shout “play Roy Orbison’s Crying” at a voicecontrolled speaker when you’re about to embark on the chopping of an onion? The British Phonographic Industry is already notably excited at the prospect, highlighting in a report that these assistants “are likely to evolve into our de facto musical concierges around the home and in the car.” And it’s the list of smart commands that’s a real deal breaker. Amazon’s official list of voice commands for Alexa include some very vague human interactions that are likely to get some very interesting results. Think of how much fun you could have after demanding it to “play the top rock songs from 1988?”. Or maybe even: “Play that song with the lyrics ‘De do do do de da da da, is all I want to say to you’.” It’ll be a party gimmick, the excitement will wear off after a few weeks – but ultimately it’s an enabler and will help me listen to even more music. Bowie would have approved. £ Matt Clinch is deputy digital news editor at CNBC.com.
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