Investing in a Time of (Financial) Repression. Cyril Moullé-Berteaux, Head of Global Asset Allocation

Transcription

1 Investing in a Time of (Financial) Repression Cyril Moullé-Berteaux, Head of Global Asset Allocation

2 Overview Positioning for the long-term The growing Yield Bubble Europe outperformance may just be starting Global impact of China s growth de-rating Forecasts / estimates are subject to change and may not necessarily come to pass. 2

3 Winners of One Decade Rarely Winners of the Next 1970 s Winners: Gold and Energy Stocks 1980 s Winner: Japanese Equities ,500 3,000 2,500 2,000 1,500 1, s Winner: Technology Stocks 2000 s Winners: Commodities, Metals and Mining MSIM Global Asset Allocation Team analysis. Data as of December 31, For illustrative purposes only. Past performance is not indicative of future results. It is not possible to invest directly in an index 3 Jan-79 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-72 Jan-73 Jan-74 Jan-75 Jan-76 Jan-77 Jan-78 Jan-79 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 U.S. Energy Stocks Index Gold Japanese Equities: Topix Index 6,000 5,000 4,000 3,000 2,000 1,000 Jan-95 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 0 NASDAQ GSCI Global Metals and Mining

4 All About Fundamentals: The Price You Pay Drives Returns Subsequent 10-Year Returns Based on Starting P/E Quintiles ( ) Annualized Subsequent 10-Year Real Returns (%) We Are Here x 10x 10x 12x 12x 15x 15x 18x 18x 42x Normalized P/E Quintile The Price Paid MSIM Global Asset Allocation Team analysis. Data as of December 31, For illustrative purposes only. Past performance is not indicative of future results Note: Historical average ten-year real return: 8.5% per annum. Quintile is ten year fwd average returns to each 20% of data sorted by starting P/E. 4

5 All About Fundamentals: The (Bond) Yield at Which You Buy Drives Returns Subsequent Bond Real Returns Based on Starting Real Bond Yields ( ) Annualized Subsequent 5-Year Real Returns (%) Range We Are Here (1) to to to to to 20.2 Real Yield Quintiles The Price Paid MSIM Global Asset Allocation Team analysis. For illustrative purposes only. Past performance is not indicative of future results Note: Long-term average real return: 2.5%. Real Yield average ten year fwd returns to each 20% of data sorted by beginning real bond yield. (1) Current 10-year Real Yield: 0.14% as of December 31,

6 U.S. Equity Returns: Where Did They and Where Will They Come From? (%) (2.0) % Nominal (+6.6% Real) (4.3) +6.8% Nominal (+4.4% Real) (2.4) +3.6% Nominal (+1.9% Real) (4.0) (6.0) Past 100 Years Past 10 Years Next 5 Years (Base Case) Inflation Multiple Expansion Real Earnings Growth Dividend Yield Morgan Stanley Investment Management. Please refer to Disclosures page for Long-Term Expected Returns Methodology and Calculation. Data as of December 31, For illustrative purposes only. Past performance is not indicative of future results. Forecasts / estimates are subject to change and may not necessarily come to pass. Also define real vs. nominal returns. 6

7 Long-Term Expected Returns Five-Year Expected Nominal Returns (1) (%) (0.5) (2.0) U.S. Cash U.S. Treasuries U.S. AA Corporates U.S. High Yield Japan Equities European Equities (2) (2) Commodities Private Equity Japanese U.S. TIPS Eurozone EM Debt U.S. Equities EM Equities Real Estate (3) Hedge Funds Gov t Bonds (2) Gov t Bonds (2) Morgan Stanley Investment Management Global Asset Allocation Team analysis. Data as of December 31, Please refer to Disclosures page for Long-Term Expected Returns Methodology and Calculation. For informational purposes only. Forecasts / estimates are subject to change and may not necessarily come to pass (1) Excludes Manager Alpha. (2) Hedged back to U.S. Dollar. (3) U.S.REITs. 7

8 Stocks Below Fair Value Based on Tactical Metrics and S&P Month Forward P/E Ratio Average x (1) S&P Month Forward P/E Ratio MSIM Global Asset Allocation Team analysis, Global Insight. Data through December 31, For illustrative purposes only. Past performance is not indicative of future results (1) As of December 31,

9 Stocks Cheap Relative to Bonds: , But Stock-Bond Yield Gap Earnings Yield Less Bond Yield Yield Gap (Using Normalized Earnings Yield) Stock / Bond Return Index Level Period Average 3.6 (1) Datastream, MSIM Global Asset Allocation Team analysis. For illustrative purposes only. Past performance is not indicative of future results. Stocks = S&P Total Return Index; Bonds = U.S. 10-year Treasuries. Normalized EPS = 8-year moving average of S&P 500 EPS / nominal GDP x 3-year average nominal GDP. Yield Gap: the ratio of the dividend yield of an equity and the yield of a long-term government bond. Typically equities have a higher yield (as a percentage of the market price of the equity, thus reflecting the higher risk of holding an equity. Stock / Bond Returns = S&P 500 vs. 10-Year Treasury returns (1) Data as of January 28,

10 ...Mostly Because of Bond Overvaluation As U.S. Long-Term Bond Yield 200 Year Low 2.7% U.S. Long-Term Bond Yield Datastream, MSIM Global Asset Allocation Team analysis. Long-term bond yield = 30-year/Long Term Bond Yield. Data as of January 28, For illustrative purposes only. Past performance is not indicative of future results 10

11 Stocks Are Still Not Cheap on Absolute Basis U.S. Price to Normalized Earnings Median: x U.S. Price to Normalized Earnings Datastream, MSIM Global Asset Allocation Team analysis. Data as of January 28, For illustrative purposes only. Past performance is not indicative of future results Note: Normalized EPS based on operating EPS, normalized margins and GDP. Earning Per Share (EPS): the portion of a company s profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company s profitability. Gross Domestic Product (GDP): the monetary value of all the finished goods and services produced within a country s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory. Normalized Earnings: Earnings adjusted for cyclical ups and downs in the economy. 11

12 Why EMU Has High Expected Returns EMU Return on Equity EMU Nominal Earnings per Share +1.8% (2) Long-term Avg: % (2) Normalized Normalized EMU Normalized Price to Earnings EMU Total Return Index in Euros % (2) Fair Value (1) Datastream, MSIM Global Asset Allocation Team analysis. Data as of January 28, For illustrative purposes only. Past performance is not indicative of future results (1) Fair value estimated to be at a 17.5% discount to U.S. long-term average of 14.25x. Forecasts / estimates are subject to change and may not necessarily come to pass. (2) Forecast growth of the dashed lines. 12

13 Private Equity s Best Days Appear Behind It Private Equity Acquisition Multiples vs. S&P 500 Private Equity Vintage Year Returns ( ) EV / EBITDA Annualized Return Acquisition Multiple EV/EBITDA S&P 500 EV/EBITDA Datastream, Standard & Poor s Leveraged Commodity & Data, MSIM Global Asset Allocation Team analysis. Data as of January 28, For illustrative purposes only. Past performance is not indicative of future results EBITDA is Earnings Before Interest, Taxes, Depreciation & Amortization. EV/EBITDA: a financial ratio that measures a company's return on investment. The EV/EBITDA ratio may be preferred over other measures of return because it is normalized for differences between companies. Using EBITDA normalizes for differences in capital structure, taxation and fixed asset accounting. Meanwhile, using enterprise value also normalizes for differences in a company s capital structure. Vintage Year = The year in which the first influx of investment capital is delivered to a project or company. This marks when capital is contributed by venture capital, private equity fund or a partnership drawing down from its investors. Private Equity Acquisition Multiples = Purchase Price Multiples used to compare purchase prices in mergers and acquisitions. 13

14 Hedge Funds Losing Their Edge? Hedge Fund Returns vs. S&P 500 Total Returns Index Level Index Level HFRI Index / S&P 500 HFRI Index (11.0% CAGR, 7.0% vol) S&P 500 Total Return Index (8.9% CAGR, 12.8% vol) Datastream, MSIM Global Asset Allocation Team analysis. Data as of January 31, For illustrative purposes only. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe. Past performance is not indicative of future results Note: Hedge Fund Return Index (HFRI) excess return ( : 2.3% correlation/beta to SPX 0.44/0.24). Compound Annual Growth Rate (CAGR): the year-over-year growth rate of an investment over a specified period of time. The compound annual growth rate is calculated by taking the nth root of the total percentage growth rate, where n is the number of years in the period being considered. The HFRI Fund Weighted Composite Index is a global, equal-weighted index of over 2,000 single-manager funds that report to HFR Database. 14

15 Long-Term Real Price Appreciation of Commodities = 0%! Real Prices: Economist All-Commodity Index Trend ± 1 SD Trend Trend ± 1 SD Global Insight, The Economist, MSIM Global Asset Allocation Team analysis. Data as of January 23, The Economist All-Commodity Index tracks a basket of commodities to measure performance. For illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results 15

16 Big Shifts in Pension Funds Allocations U.S. Corporate Pension Asset Allocation (%) Equity Debt Other (1) Real Estate Pensions & Investments (P&I), Goldman Sachs, MSIM Global Asset Allocation Team analysis. Data as of December 31, For illustrative purposes only and should not be deemed a recommendation to buy or sell any security. Data shown is most recent available (1) Other includes: hedge funds, private equity, managed futures, real assets, etc. 16

17 Most Portfolios Appear to Be Below the Efficient Frontier Efficient Frontier Analysis Expected Return (%) Expected Standard Deviation (%) Efficient Frontier Typical Portfolio Bloomberg, MSIM Global Asset Allocation Team analysis. Please refer to Disclosures page for Long-Term Expected Returns Methodology and Calculation. Data as of December 31, For illustrative purposes only. Past performance is not indicative of future results Efficient Frontier a set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a given level of expected return. Portfolios that lie below the efficient frontier are sub-optimal, because they do not provide enough return for the level of risk. Portfolios that cluster to the right of the efficient frontier are also sub-optimal, because they have a higher level of risk for the defined rate of return. 17

18 Optimal Allocation Can Improve Returns But Not to Hurdle Rate Asset Class Typical Pension Plan Optimal Allocation Equities 40% 48% U.S. Large-Cap Equity 20% 10% European Union Equity 10% 25% Japan Equity 5% 2% Emerging Market Equity 5% 12% Fixed Income 38% 40% U.S. Government Bonds 20% 17% U.S. TIPS 0% 0% U.S. Corporate Bonds 11% 2% U.S. High Yield 4% 2% EMU Government Bonds 0% 10% Japan Government Bonds 0% 0% Emerging Market Debt 3% 2% Alternatives 21% 12% Commodities 2% 0% Real Estate 5% 2% Private Equity 8% 3% Hedge Funds 6% 12% Cash 1% 1% Expected Return 3.7% 5.0% Expected Standard Deviation 8.4% 9.0% Expected Information Ratio MSIM Global Asset Allocation Team analysis. Hedged for EMU/Japan, USD for others. Includes alpha. Covariance matrix based on December 1998 to 2012 correlation matrix. Please refer to Disclosures page for Long-Term Expected Returns Methodology and Calculation. Data as of December 31, For illustrative purposes only. Past performance is not indicative of future results. Note there is no guarantee that the optimal allocation will achieve the returns indicated Hurdle Rate is the minimum rate of return on a project or investment required by a manager or investor. In order to compensate for risk, the riskier the project, the higher the hurdle rate. Standard Deviation: a statistical measurement that illustrates historical volatility. For example, a volatile stock will have a high standard deviation while the deviation of a stable blue chip stock will be lower. A large dispersion tells us how much the return on the fund is deviating from the expected normal returns. Expected Return: The amount one would anticipate receiving on an investment that has various known or expected rates of return. Information Ratio IR: A ratio of portfolio returns above the returns of a benchmark (usually an index) to the volatility of those returns. The information ratio (IR) measures a portfolio manager's ability to generate excess returns relative to a benchmark, but also attempts to identify the consistency of the investor. 18

19 Key Implications for Strategic Policy Expect lower benefits to diversification (though still essential in low-return world) Expect low real returns (below long-term averages) In a world of financial repression, may need to increase exposure to riskier asset classes to attempt to generate sufficient returns: Increase Equity (EMU and EM +; U.S. and Japan ) Lower Fixed Income (EMD +; HY, U.S. and Japan government ) Lower Alternatives (HF +; P.E., R.E. and Commodities ) Consider hedging currency for allocations to non-u.s. developed market asset classes Focus active management in inefficient asset classes portable alpha Consider increasing focus on tactical asset allocation opportunities (Beware of the siren song of risk parity Risks: debt-deflation, stagflation Forecasts / estimates are subject to change and may not necessarily come to pass. The views herein are those of the investment management team as of the date of this presentation and are subject to change at any time due to changes in the market, economic, or other conditions. EMU European Monetary Union; EM = Emerging Markets; EMD Emerging Markets Debt; HY High Yield; HF = Hedge Fund; PE = Private Equity; RE = Real Estate 19

20 Deleveraging After the Debt Supercycle Just Starting Total Non-Financial U.S. Debt Outstanding (%GDP) Total ex-financial Household Business Sector Federal + S&L Gov Sector 264% 90% % 77% Datastream, MSIM Global Asset Allocation Team analysis. Data as of October 31, For illustrative purposes only 20

21 Low Growth and Excess Money Creating a Yield Bubble U.S. Bond Yield % Speculative Grade Bond Yields ( ) MSCI World High Dividend vs. Standard Index Discount (15) (20) (25) (70) (35) (40) (45) Valuation Composite (PE,PCE,PBV Avg Relative Discount) U.S. NAREIT Dividend Yield Minus MSCI USA Dividend Yield Datastream, MSIM Global Asset Allocation Team analysis. Data as of January 10, For illustrative purposes only. Past performance is not indicative of future results. U.S Bond Yield represents Long-term bond yields (maturity year). Standard Index represents S&P 500 Index. It is not possible to invest directly in an index. Price to Earnings (P/E): a valuation ratio of a company s current share price compared to its per-share earnings. Price to Book Value (P/BV): a ratio used to compare a stock s market value to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter s book value per share. Price to Cash Earnings is is a measure of financial performance that looks at the cash flow generated by a company on a per share basis. NAREITis the National Association of Real Estate Investment Trusts. Standard Index is the Valuation Composite (PE,PCE,PBV Avg. Relative Discount) Speculative Grade Bond Yields = Merrill Lynch High Yield Cash U.S. Bond Yield = Long -term Growth Bond Yield 21

22 End of China Investment Boom Will Lower GDP Growth China GDP from 1980 vs. Japan GDP from 1955 (Japan GDP Led by 37 Years, i.e., 1975=2012) China s Investment Boom Unprecedented Gross Fixed Capital Formation % of GDP 15 China 9.6% China 5.0%? 40 5 Japan : 9.3% China 3.5%? (5) Japan : 4.5% Japan : 1% China GDP Japan GDP (Led 37 years) Data as of September 30, Taiwan: % China: % Korea: % Japan: % Data as of November 26, MSIM Global Asset Allocation Team analysis. For illustrative purposes only. Past performance is not indicative of future results. Forecasts/estimates are subject to change and may not necessarily come to pass. Provided for illustrative purposes only and should not be deemed a recommendation to buy or sell any securities 22

23 EU Periphery Improving Under the Surface EU Periphery Current Account Balances Ireland Greece Spain Two-Year Peripheral Government Bonds Spain Italy EU Purchasing Manager Indices Periphery MSIM Global Asset Allocation Team analysis, MSCI. Data as of January 31, 2013 (top charts), February 19 (bottom chart) For illustrative purposes only. Periphery = Italy, Spain, Ireland, Portugal and Greece 23

24 Watch Out for the Potential Fiscal Hit Change in U.S. Structural Budget Percentage Points of Potential GDP (0.5) (1.0) (1.5) (2.0) (2.5) (3.0) (3.5) (4.0) (4.5) Fiscal Restraint (+) Fiscal Stimulus (-) Fiscal Years Congressional Budget Office (CBO) with Morgan Stanley estimates for 2012, and MSIM Global Asset Allocation Team estimates for Data as of December 12, For illustrative purposes only. Forecasts/estimates are subject to change and may not necessarily come to pass 24

25 Appendix

26 Expected Returns Including Alpha 5-Year Expected Total Return (%) Expected Standard Deviation (%) Asset Class 5-Year Expected Return (%) Alpha (%) Equities U.S. Large Cap Equity European Union Equity Japan Equity Emerging Market Equity Fixed Income U.S. Government Bonds U.S. TIPS U.S. Corporate Bonds U.S. High Yield EMU Government Bonds Japan Government Bonds Emerging Market Debt Alternatives Commodities (0.5) Real Estate Private Equity Hedge Funds Cash MSIM Global Asset Allocation Team analysis. Hedged for EMU/Japan, USD for others. Includes alpha. Please refer to Disclosures page for Long-Term Expected Returns Methodology and Calculation. Data as of December 31, For illustrative purposes only. Forecasts / estimates are subject to change and may not necessarily come to pass. Alpha: a measure of performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a mutual fund and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund's alpha. Standard Deviation: a statistical measurement that illustrates historical volatility. For example, a volatile stock will have a high standard deviation while the deviation of a stable blue chip stock will be lower. A large dispersion tells us how much the return on the fund is deviating from the expected normal returns 5-Year Expected Total Return = 5-Year Expected Return + Alpha. 26

27 A More Aggressive Allocation Could Yield 5.6% Nominal Returns Asset Class Typical Pension Plan Optimal Allocation Equities 40% 70% U.S. Large-Cap Equity 20% 31% European Union Equity 10% 25% Japan Equity 5% 2% Emerging Market Equity 5% 13% Fixed Income 38% 10% U.S. Government Bonds 20% 0% U.S. TIPS 0% 0% U.S. Corporate Bonds 11% 2% U.S. High Yield 4% 3% EMU Government Bonds 0% 0% Japan Government Bonds 0% 0% Emerging Market Debt 3% 5% Alternatives 21% 19% Commodities 2% 0% Real Estate 5% 2% Private Equity 8% 5% Hedge Funds 6% 12% Cash 1% 1% Expected Return 3.7% 5.6% Expected Standard Deviation 8.4% 12.7% Expected Information Ratio MSIM Global Asset Allocation Team analysis. Hedged for EMU/Japan, USD for others. Include alpha. Please refer to Disclosures page for Long-Term Expected Returns Methodology and Calculation. Data as of December 31, For illustrative purposes only. Past performance is not indicative of future results. Forecasts and estimates are subject to change and may not necessarily come to pass 27

28 Important Disclosures For Business and Professional Investors Only and Not To Be Used With The General Public This presentation (the Presentation ) was issued and approved in the UK by Morgan Stanley Investment Management Limited, 25 Cabot Square, Canary Wharf, London E14 4QA, authorized and regulated by the Financial Services Authority, for distribution to Professional Clients or Eligible Counterparties only and must not be relied upon or acted upon by Retail Clients (each as defined in the UK Financial Services Authority s rules). The information in this presentation is provided solely for informational and educational purposes and for the exclusive use at The Ideas Conference 26th February 2013 and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The material contained herein has not been based on a consideration of any individual client circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision. Any views expressed are those of the presenter as of the date of the presentation and are subject to change at any time due to changes in market or economic conditions. The views expressed does not reflect the opinions of all portfolio managers at MSIM or the views of the firm as a whole, and may not be reflected in the strategies and products that the Firm offers. The information in this presentation (the Presentation ) is not a product of Morgan Stanley s Research Department and should not be regarded as a research recommendation. The information contained herein has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. Information regarding expected market returns and market outlook is based on the research, analysis, and opinions of the presenter. They are based on current market conditions and subject to change. In addition, these conclusions are speculative in nature, may not come to pass, and are not intended to predict the future of any specific Morgan Stanley investment. No representation or warranty can be given with respect to the accuracy or completeness of the information. This communication is only intended for and will be only distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto. Charts and graphs provided herein are for illustrative purposes only. Forecasts/estimates are based on current market conditions subject to change, and may not necessarily come to pass. Past performance is not indicative of future results. All information contained herein is proprietary and is protected under copyright law. Risk Warnings Past performance is not a guarantee of future performance. The value of the investments and the income from them can go down as well as up and an investor may not get back the amount invested. There can be no assurance that the Fund will achieve its investment objectives. Long Term Expected Returns: MSIM investment teams have built proprietary models to construct projections of the returns on key indexes within the Equity, Fixed Income and Alternatives asset classes. The Equity and Fixed Income 5 year projections (which combine to form the basis of the 5 year Alternatives projections) are based on longer term projections for nominal GDP growth (decomposed into real potential growth and an inflation assumption). Based on those projections, the Equity returns infer earnings per share growth and a terminal valuation. The Fixed Income component infers a terminal real yield (and credit spread when appropriate). In the Alternatives asset class, Hedge Fund returns are projected from a multifactor model based on the Equity & Fixed Income projections along with the alpha generated from the hedge fund industry. The alpha projection is derived using shrinkage techniques which combine historical estimates of alpha with prior estimates. Private Equity and Private Real Estate are estimated by combining Equity returns with an illiquidity premium. The liquidity premium is generated via a risk adjusted analysis of the historical spread to liquid investments. Index returns do not include any expenses, fees or sales charges, which would lower performance. Indexes are unmanaged and should not be considered an investment. It is not possible to invest directly in an index. 28