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Episode 82: Peter Smith & Sunil Krishnan
2021 has certainly kept us on our toes, so we thought this week we would do the same to Sunil. Watch as we put him under pressure to tackle 20 quick fire questions from Peter. Join the discussion #AskTheFundManager
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When it comes to ESG, we demand a lot of the companies we invest in. But to have credibility with clients, we need to hold ourselves to even higher standards.
It's hard to say exactly what "The Metaverse" is exactly. However, broadly speaking it's a virtual world where we can socialise and work together. Join the discussion #AskTheFundManager
Episode 81: Thomas Stokes & Guillaume Paillat
As we hit December and with the emergence of the new Omicron variant, memories of tier 4 and a seasonal lockdown will be at the forefront of many people's minds. Join the discussion #AskTheFundManager
Episode 80: Peter Smith & Baylee Wakefield
There is no one-size-fits-all approach to ESG investing. We discuss the different approaches currently being used in the market.
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Module 4: The many faces of ESG in asset management
We discuss some practical ideas, with industry experts, to help you integrate ESG into your financial planning business.
Module 5: ESG’s place in financial planning
The diversification benefits of multi-asset funds have made them a firm favourite of advisers and their clients over the last decade or so and exclusive research from Money Marketing reveals adviser attitudes towards the selection of multi-asset funds
With Aviva Investors Multi-asset Funds, you get:
There’s a transformation happening in financial markets and people’s mindsets, as we transition away from fossil fuels in favour of clean renewable energy sources, writes Thomas Stokes.
Being on the right side of change: Renewable energy
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Short weekly interviews with the fund manager team explaining the impact of global issues.
Practical support and guidance about ESG for advisers. This CPD programme is designed to help advisers navigate the changing ESG landscape.
Multi-asset ESG stories
How ESG considerations are integrated into our multi-asset investment process.
Multi-asset views
Highlighting the latest asset allocation considerations shaping our multi-asset portfolios.
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Demonstrating value for money can be a challenge. That’s why we’ve added a generous helping of everything your clients may want from their investment fund. With Aviva Investors Multi-asset Funds, you get:
Aviva Investors also has a range of support materials available designed to enhance your client conversations, from weekly market updates, ESG education and asset allocation views.
Risk-targeted ranges with clear performance objectives Active and low cost passive options
Our experts provide a simple guide to climate change that should equip you for net zero conversations with your clients.
Module 6: We need to talk about net zero
A closer look at what Aviva Investors is doing to help tackle climate change.
Turning climate change talk into action
A strong economic recovery and continued reflationary bias from the Federal Reserve could push long-dated yields higher on US Treasuries
Moving short on duration
Although economic growth, operating leverage and valuations support equities, it is too early to tell whether value stocks are finally set to make a comeback.
Equities on a style merry-go-round
While inflation is expected to rise after last year’s lows, it will likely be transitory. Sunil Krishnan explores what this means for the economy, yield curves and equity markets.
Loose policy doesn’t rule out a steeper curve
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ESG Story: What have banks got to do with climate change?
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Multi-asset allocation views: Room to grow
ESG Story: Being on the right side of change: Renewable energy
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Episode 43: Thomas Stokes & Guillaume Paillat
Investment Director, Thomas Stokes and Fund Manager, Guillaume Paillat discuss President Bolsonaro and the political tensions driving Brazil’s equity market performance
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Episode 46: Thomas Stokes & Paul Parascandalo
In this latest episode Thomas Stokes and Paul Parascandalo discuss how the Suez Canal shipping incident highlights the fragility of the global supply chain, serving as a reminder to companies about the importance of resilience.
The driving forces behind the ESG revolution. Where did it all start, what is it, and what’s the current state of play?
Module 1: The evolution of the ESG revolution
The early part of a year gives investors an opportunity to take stock. Sunil Krishnan reflects on how the current environment is shaping our views for multi-asset portfolios.
Russia plans on using a giant forest twice the size of India to tackle climate change. A great news story or a massive green washing exercise? Find out in our latest Ask The Fund Manager with Thomas Stokes and Baylee Wakefield.
Episode 45: Baylee Wakefield & Thomas Stokes
Tech company Stripe has been valued at $95 billion. But this is really a tale of two young brothers and their journey from a remote area in Ireland to Silicone Valley. Watch this week's #AFTM with Thomas Stokes and Baylee Wakefield to find out more.
Episode 44: Baylee Wakefield & Thomas Stokes
Current and future regulations will have a dramatic impact on not only your firm but also the industry as a whole.
Module 2: The regulation which is transforming the finance industry
ESG issues, such as climate change, inequality and biodiversity, will have a profound impact on our lives and those of future generations.
Module 3: The key sustainable threats that we face today
In the first of a new series on how ESG considerations are integrated into our multi-asset investment process, Shane O’Brien explains how consistent engagement with a well-known UK financial institution led to a positive commitment on climate change.
Multi-asset ESG update: What have banks got to do with climate change?
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A closer look at what Aviva Investors is doing to help tackle climate change
Although economic growth, operating leverage and valuations support equities, it is too early to tell whether value stocks are finally set to make a comeback
Environmental, social and governance (ESG) is one of the hottest topics in our industry. So, it probably won’t come as a massive surprise that investors are asking us more and more questions about our approach to integrating ESG issues into our investment solutions. Sometimes, however, we’re also asked about how we stack up against our own ESG criteria. The good news is that Aviva stacks up very well. Based on our proprietary ESG “Elements” score Aviva scores 8.6 out of 10 versus the sector average of five. With that in mind, here’re some of our “ESG” highlights you and your clients may find interesting. Environmental • In 2006, we were the first global insurer to become ‘carbon neutral’. • Aviva worked with the Scottish Government to launch one of the UK’s largest combined solar carports and energy storage facilities at our Perth office. • We have replaced all standard lighting with efficient LED alternatives in all our UK offices. • Aviva UK became single-use plastic free in 2019, saving seven million cups per year and over 50 tonnes in waste. Social • We have a strategic partnership with the British Red Cross. Since the outbreak of COVID-19, we have committed an extra £10 million in response to the pandemic, one of the biggest single corporate donations ever received by the British Red Cross. • The Aviva Community Fund has helped over 9,800 projects since 2015, with our people volunteering over 256,000 hours of their time. • We encourage a diverse and inclusive workforce. Out of 31,200 employees, 52 per cent are female, as well as 38 per cent of the Aviva Group Executive Committee. Governance • We have a malpractice helpline, ‘Speak Up’, to provide employees with a confidential way of reporting any concerns to an independent investigation team, with a zero-tolerance policy for any acts of bribery or corruption. • We work hard to ensure our supply chain is responsible and sustainable and ask our suppliers to sign our Supplier Code of Behaviour before working with them, as well as including a Living Wage clause in all appropriate contracts. • We have a specific committee that oversees our responsible and sustainable business strategy and the policies that underpin it. We do not invest directly into Aviva, given that it’s our parent company. However, if you’re interested in ESG then you should be reassured that Aviva has been actively thinking about its impact to environment, social and governance issues for decades. More importantly, as we move into a new decade, we remain committed to running a responsible business in the future.
By Thomas Stokes, Investment Director, Multi-assets
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In the first of a new regular series on how ESG considerations are integrated into our multi-asset investment process, Shane O’Brien explains how consistent engagement with a well-known UK financial institution led to a positive commitment on climate change.
Integrating environmental, social and governance (ESG) considerations is a core part of the investment process for our multi-asset portfolios. In the first of what will be regular updates on how we’re doing this, we focus on our efforts to tackle the biggest, long-term threat facing the planet, economies and financial markets: climate change. We have talked in the past about work we have done with companies like BP to press them to transition their business away from fossil fuels. This month, we look at perhaps a less obvious example of our engagement efforts to tackle this issue, with a look at the banking sector and our recent work with Barclays. The issue • Barclays began 2020 as one of the worst-performing European banks on climate change with no clear plan in place on how it can help address this issue. • What does a bank like Barclays have to do with climate change? Quite a lot actually; it is one of the top lenders to huge fossil-fuel projects. The action • We initiated an intense period of engagement on the issue, including meeting the chairman on four separate occasions in 2020. • We encouraged the bank to view this as an opportunity to establish a market-leading climate strategy for the sector and shared our perspective on this would look like.
By Shane O'Brien, Senior Investment Director
Engaging with companies to improve their ESG practices can have far more impact than simple exclusion
The outcome • Barclays took on board our suggestions and brought a new climate plan to its Annual General Meeting in May, which received 99 per cent shareholder support. • Barclays has now committed to becoming the first major bank targeting net-zero emissions across its entire financing activities, notably moving beyond the requirements of the original shareholder resolution. In the process, it has essentially gone from a climate change laggard to a leader. • We continue to work closely with the bank as it develops a detailed climate framework and roadmap to achieve its ambitious objectives. We hold Barclays within our MAF range. This is another example of why engaging with companies to improve their ESG practices can have far more impact than simple exclusion. We believe this is the right thing to do as it can really help drive significant change and lead to better outcomes for investors over the longer term.
Let me give you two options. The first is ExxonMobil, a well-known oil major, with roots that can be traced back to John D. Rockefeller’s Standard Oil. Its operations span every continent except Antarctica. The other is a lesser known company called NextEra, which you may or may not have heard of. They began building a renewable energy business back in the 1990s and have since become the largest producer of wind and solar energy in the US. Now, out of these two companies, which do you think now has the highest stock market value? If you went for NextEra, you would be correct. This year, for the first time, NextEra’s stock market value exceeded ExxonMobil.[1] Yet, this isn’t just a story of two companies but symptomatic of a much larger, global trend in which interest in renewable energies has skyrocketed. In the green bond market alone, there was an estimated $143 billion raised in 2019 for alternative energy investments, up from $30.3 billion in 2015.[2] The forces behind the trend are not only fascinating to observe but also have massive long-term implications for all investors. This time really is different It all starts with a recognition that if human-driven climate change remains unchecked it poses an existential threat to our way of life. A world ravaged by dying oceans, wildfires, infectious diseases and unbreathable air will have profound consequences for governments, companies and, of course, each and every individual. Even the ones reading this article. Yes you.
A world ravaged by climate change isn’t a place anyone would want to retire into or leave for the next generation. We need to change how we produce energy by swapping dirty fossil fuels in favour of clean renewables energies. The good news is that action is already happening and accelerating fast. Most governments, for instance, accept more aggressive policy action is needed. In fact, the UK in 2019 became the first major economy to pass legislation targeting net-zero carbon emissions by 2050.[3] To achieve this ambitious goal, the Committee on Climate Change has stated that energy from low-carbon sources, such as wind and solar power, must quadruple by 2050. This will mean a lot of investment capital being directed into assets that are involved in renewable energy. This change isn’t just limited to the UK. Even China, the world’s biggest coal producer, made a pledge this year to achieve net zero carbon emissions by 2060.[4] Nor is it just governments. Companies are also changing their business activities to reflect climate change; in no small part due to pressure from their investors such as ourselves. In February, BP, a large emitter of greenhouse gases, pledged to be net carbon-zero company by 2050, which will require it to increase its focus on renewable energy. And it’s not just energy companies that are taking on the challenge. Another example is Microsoft. It has gone one step further by aiming to be carbon negative by 2030, which means having the net effect of removing carbon dioxide from the atmosphere. Microsoft’s data centres, which require huge amounts of electricity, are now primarily powered by renewable energy. Every investor penny counts Finally, individuals have a big part to play in shaping the future through what they decide to do with their pensions and investments. There are promising signs that an increasing amount of people are taking a more active interest in where their money is being invested. For example, a recent Aviva survey showed 92 per cent of advisers believe environmental, social and governance factors will make up a larger proportion of their business in the next couple of years, primarily due to increased demand from their clients. What we can glean from this is that people care about being good citizens and looking after the environment: increasing our reliance on renewable energy sources is a key part of that.
Renewable energy[5] made up almost half of Britain’s electricity generation in the first half of the year.[6] This is unquestionably positive news, but it still means a large proportion of the remainder (37.4 per cent) is still sourced from fossil fuels that are damaging the planet. Nevertheless, we believe that over the next few years growth in renewable energy, both in the UK and globally, will grow exponentially; indeed, our survival as a species counts on it. This monumental change will be driven by governments, companies and individuals all around the world. We want to encourage and help our clients be on the right side of this change. We can do this by using our influence as a large asset manager to push companies to align their businesses to a lower carbon world, while also investing into exciting pioneering companies that are providing solutions to our renewable energy needs. References 1. Gregory Meyer, ‘Clean energy group NextEra surpasses ExxonMobil in market cap’, October 2, 2020 2. Dorothy Neufeld, ‘New Waves: The ESG Megatrend Meets Green Bonds’, Visual Capitalist, August 11, 2020 3. ‘CCC welcomes Government re-commitment to onshore wind and solar’, Committee on Climate Change, March 3, 2020 4. Dennis Normile, ‘Can China, the world’s biggest coal consumer, become carbon neutral by 2060?’, September 29, 2020 5. 'Renewable energy', The Guardian, 2020 6. Vanessa Martin and George Creasey, ‘UK electricity generation, trade and consumption, April to June 2020’, Department for Business, Energy & Industrial Strategy, September 24, 2020
We need to swap dirty fossil fuels in favour of clean renewables energies
We believe that over the next few years renewable energy will grow exponentially
Despite some clear economic challenges, we are constructive on the outlook for the economy and risk assets. Strict lockdowns have been imposed in Europe once again, and at least parts of the US have followed suit. However, the distribution of vaccines to bring the global pandemic under control should have a positive impact on economic activity in the medium term. Two other themes inform our current views. The first is that there are signs of froth in equity markets, particularly in US small caps and some tech companies. Retail investor participation, especially from US households, is high in these names and there is evidence of speculation in short-dated options, again likely from retail investors. Signs of excess bullish sentiment are increasing across a range of markets.
By Sunil Krishnan, Head of Multi-asset Funds
Although we do not yet see them as being material enough to pose a systemic risk to the global equity market, we are watching closely for indications of contamination. Following Tesla’s entry into the S&P 500, it would be a concern if gains in a single stock became a major force in the overall index performance. Similarly, if GameStop-style speculative behaviour began to emerge further afield, in European or Asian markets for instance, we would see it as a further warning sign. The second theme informing our views is the change of administration in the US. Following the Democrat Senate wins in Georgia, investors have been debating whether the prospect of greater stimulus would be balanced out by more investor-unfriendly measures like tax rises or tightening of regulation.[1]
Stimulus and regulation On balance, we see the election result as constructive. While there may be appetite to consider changes in the tax regime, it is unlikely to be high on the US administration’s priority list in the middle of a pandemic, whereas President Biden has already put forward a $1.9 trillion rescue plan and is talking of an ambitious recovery plan to follow.[2] This proposal may be watered down in the legislative process, but even a programme of half the size would have been unthinkable before the Georgia Senate election results given the recent passage of a smaller programme. We expect to see increases in near-term fiscal stimulus.
Signs of excess bullish sentiment are increasing across a range of markets
The environment is a stated priority for the new administration
With regards to regulation, the environment is a stated priority for the new administration. President Trump passed a raft of executive orders to roll back environmental regulation over the last four years, and the Biden administration has already begun to restore some of it.[3] However, this is a return of the inevitable rather than a major surprise, especially in light of the global trend towards decarbonisation. The second area of debate concerns the tech sector and whether regulation there could pose an existential threat to the largest companies. There is growing interest in trust-busting measures in China, Europe and the US, but without international coordination regulators will struggle to force major changes in tech companies’ business models.[4,5,6] For example, large US tech firms may be tempted to address European Union rules by simply creating a standalone European entity. Regulators are also looking at whether companies’ past acquisitions were made for anti-competitive purposes. It would be difficult to unwind those decisions, but it signals greater scrutiny of such deals in future. The real question is to understand which companies’ business models are most dependent on being able to acquire assets defensively and which benefit from organic growth and innovation. We may see more differentiation between the two in the medium term. But we do not see the current regulatory pressure as a major challenge for tech earnings as a whole in 2021.[7] The final element of pressure on tech relates to content moderation due to public and political criticism over the seeming inability of platforms to address hate content. Regulators aim to put social media platforms in the position of content editors. It is to some extent inevitable, and we expect the distinction between platforms and content publishers to diminish over time, but this is more likely to require platforms to refine rather than upend their business models. They may need to invest in moderation or editorship, but it is not quite the same as having to shut down large parts of their business.[8]
Threats to big tech do not look quite so severe but could still be a headwind for those companies
If the threats to big tech were more existential, they would lead us to challenge the US market as an investment. At the moment, they do not look quite so severe but could still be a headwind for those companies. That is one of the reasons we prefer to remain diversified in terms of geographies, despite the relative US outperformance over the last year and decade. Diversified exposure in equities We otherwise remain constructive on equities, particularly since investor expectations do not yet fully reflect the positive medium-term impact of vaccine rollouts in some sectors (despite signs of froth elsewhere). For instance, in industries suffering most from the pandemic, such as airlines, or areas that are highly dependent on global economic demand like energy, prices remain well below pre-pandemic levels.
Figure 1: Airline and energy stock prices, 2019-2021 (US$)
Source: Bloomberg, Aviva Investors, as of February 5, 2021
Despite the uneven price recovery between sectors, we prefer to keep our equity positions broad-based across developed and emerging markets. This is partly because of the potential regulatory headwinds for US tech stocks and general signs of froth, and partly because focusing solely on sectors where stock prices are lagging can become bound up in style and factor risks. The exception we make is in European oil and gas, as a cyclical play which has not recovered very strongly. Even allocations to energy can be influenced by environmental, social and governance (ESG) considerations. Our ESG team’s analysis shows European firms are much more advanced than their US counterparts in responding to engagement and adapting their business models to a net-zero future.[9] In terms of valuations, one of the key drivers for energy companies is oil prices. The pandemic continues to limit the potential for increases for now, but the medium-term outlook for demand is more positive in light of vaccine rollouts. In addition, at a meeting in early January 2021, OPEC surprised the market by deciding against a widely expected rise in production levels, to which Saudi Arabia added a unilaterally expressed willingness to take on more of the burden in terms of output reduction to protect prices.[10] Suppressed production and a more favourable demand outlook in the medium term could combine to support oil prices. Credit is more sensitive to US Treasuries Credit has been a preferred allocation for us over recent quarters as the economy recovered and central banks pledged support, helping underpin corporate bond markets. However, alongside high yield and hard-currency emerging-market debt, investment-grade credit has seen significant spread compression since the wide levels reached in March 2020 when the pandemic first hit. As spreads have tightened and total yields converge on equivalent government bonds, these markets have become more sensitive to interest rate moves and the US Treasury market. In this regard, they have become less compelling.
European firms are much more advanced in adapting their business models to a net-zero future
Figure 2: HY, IG and EMD option-adjusted spreads, 2020 (basis points)
In contrast, local-currency emerging-market debt is not as sensitive to US Treasuries and could benefit if emerging-market currencies rally against the US dollar. This did not happen strongly in 2020 despite dollar weakness versus developed peers; perhaps reflecting investor caution towards emerging economies given the progress of the pandemic. However, that could change in 2021 if economic activity rebounded in emerging markets at the same time as in the US – especially as a more dovish Federal Reserve will not tighten policy in a hurry, creating less supportive conditions for a strong dollar.[11]
Figure 3: JP Morgan Emerging Currency Index (US$)
Source: Bloomberg, JP Morgan, as of February 5, 2021
‘Risk-neutral’ Japanese yen In terms of currencies, we continue to like being long Japanese yen versus the US dollar, although it may be less of a risk-reducer than it once was. Indeed, as more investors short the US dollar, the currency’s correlation with risky assets could become more negative. In other words, episodes of weakness in risky assets could see the dollar rally as investors unwind their levered positions.
Japanese yen could be somewhat sheltered from risk-on/ risk-off movements
In the current context, being long Japanese yen and short US dollars is not a risk-off position but, with the Japanese yen being a traditional safe-haven currency, it could be somewhat sheltered from risk-on/ risk-off movements. The currency is also supported by domestic investors bringing more investments back into Japan. There is some evidence reshoring began towards the end of last year, especially in equities, and we expect it to gather pace in 2021.
Figure 4: Net purchases of foreign equities by Japanese investors (negative net = repatriation)
References 1. Taylor Tepper, ‘Markets like democratic victories in Georgia—here’s why you should remain cautious’, Forbes Advisor, January 7, 2021 2. Tami Luhby, Katie Lobosco, ‘Here's what's in Biden's $1.9 trillion economic rescue package’, CNN, January 15, 2021 3. Juliet Eilperin, Brady Dennis, John Muyskens, ‘Tracking Biden’s environmental actions’, The Washington Post, January 22, 2021 4. Javier Espinoza, ‘Big Tech told work with EU or face patchwork of national laws’, Financial Times, January 20, 2021 5. Kiran Stacey, Hannah Murphy, ‘Now Republicans and Democrats alike want to rein in Big Tech’, Financial Times, January 12, 2021 6. Ryan McMorrow, Tom Mitchell, ‘Beijing launches antitrust investigation into Alibaba’, Financial Times, December 24, 2020 7. Press release, ‘FTC to examine past acquisitions by large technology companies’, Federal Trade Commission, February 11, 2020 8. Kiran Stacey, Hannah Murphy, ‘Now Republicans and Democrats alike want to rein in Big Tech’, Financial Times, January 12, 2021 9. ‘Crude awakening: The path for oil and gas after COVID-19’, Aviva Investors, January 20, 2021 10. Julianne Geiger, ‘OPEC+ meeting ends with major surprise cut from Saudi Arabia’, Oilprice.com, January 5, 2021 11. Sunil Krishnan, ‘Vaccine hope, Biden and central bank policy: The outlook for multi-asset in 2021’, Aviva Investors, December 17, 2020
Exclusive research reveals adviser attitudes towards multi-asset funds
Performance, transparency and asset allocation lead the most important factors in selection, while advisers say much more can be done when it comes to ESG
The diversification benefits of multi-asset funds have made them a firm favourite of advisers and their clients over the last decade or so. A rise in popularity has led plenty of new strategies to emerge in the years since they first launched, including more exposure to alternative assets to counterbalance less favourable returns from bonds, as well as more recently putting a greater focus on environmental, social and governance (ESG) factors. But what do advisers make of the current landscape? Money Marketing recently surveyed 103 to find out. Interestingly, it was found more could be done when it comes to ESG. When asked how respondents would score their multi-asset providers on their ESG credentials, the average came in at just six out of 10. When asked what would most improve the multi-asset solutions currently in the market, ESG was a major talking point. One respondent asked for “more ESG funds from main fund managers,” while another wanted “easily comparable ESG ratings”. Another called for more defined mandates for ESG funds: “Most are vague, only defining positive or negative in selection,” they said. Elsewhere, a request for “more good value ESG funds” tied in with another hot topic for advisers: cost. Indeed, cost came up again and again as a key factor to improve the current multi-asset landscape, with a whopping third of all suggestions based around lowering fees and charges. Most important elements That said, our survey found cost only comes fourth in the top five most important elements when it comes to choosing a multi-asset fund. First on that list is performance, followed by transparency at number two and asset allocation at number three, then track record/length of experience comes in at number five. When asked specifically how important global diversification is when selecting a multi-asset fund, advisers scored it highly at eight out of 10. “There needs to be better investor education around the fact diversification of asset class and geographic location drive a successful long-term investment,” said one respondent. Surprisingly, advisers were slightly less passionate about some of the other buzzwords in multi-asset investing at the moment. For example, when asked how important having exposure to alternative assets is in a multi-asset fund, the average score came in at six out of 10 (with 10 as highest importance). Respondents were subsequently asked whether such exposure should increase in the medium term, to which just 40% said yes, 22% said no and 38% said they did not know. When asked how important a contrarian approach is in a multi-asset manager, respondents scored the attribute just five out of 10. One respondent pointed out, “Most managers are trying to be too contrarian. As Occam’s Razor suggests, the simplest solution is usually the right one.” Meanwhile, 63% of respondents said they preferred a mixed-asset benchmark over a risk-targeted solution, which garnered 37% of votes. On the future of the multi-asset landscape, 70% of respondents said they expected the use of multi-asset funds to increase in the medium term. With more specific reference to their role in retirement planning, 71% said they expect the use of multi-asset funds to increase in the medium term for the accumulation phase, but this figure went down to 62% when it came to in the decumulation phase.
“Right now we are facing a man‐made disaster of global scale, our greatest threat in thousands of years: climate change.” David Attenborough More people than ever are realising how serious climate change is, as well as understanding the role we all play in finding solutions. It is no surprise then that investors are asking how asset managers are addressing the issue; both as a company and in terms of the assets that they manage. With that in mind, here are a few highlights to show you how we’re turning talk into action. So what are we, Aviva Investors, doing to address this issue? • Through active engagement, we are encouraging more and more businesses to reduce their carbon footprint. But it’s vital that we practice what we preach. To this end, 15 years ago, our parent company, Aviva, were the first global insurer to become ‘carbon neutral’ and recently announced the most ambitious net‐zero target by any UK insurer – 2030. • We have also helped make over 1.2 million people’s lives better since 2012 through our carbon offsetting projects. This includes provision of household water filters in Laos and Cambodia. What are we doing on your behalf to help tackle climate change? “The climate crisis is the single largest risk facing our society and economy, but it also represents a great opportunity,” – Mark Versey CEO, Aviva Investors • We plan to invest over £5 billion into low carbon equities and climate transition strategies over the next 18 months and will look to increase the level of investment after that. • We have divested Aviva’s own assets from 52 thermal coal mining and power generation companies, where we concluded they’re not making sufficient progress towards the engagement goals we set them. • We have invested £6bn in green assets since 2015 and we are a member of the UN Net Zero Asset Owner Alliance. The ambition of the alliance is for all investments to have net‐zero greenhouse gas emissions by 2050. How can we change the industry? We are a part of the Task Force on Climate-related Financial Disclosures. This is a high-profile group, including individuals like Mark Carney and Michael Bloomberg. The aim has been to improve and increase reporting of climate‐related financial information for all companies around the world. We hope you have found this useful and given you confidence that we’re doing our part to tackle climate change.
Multi-asset allocation views: Loose policy doesn’t rule out a steeper curve
Although there have been some difficulties in Europe, our view that vaccine rollouts will enable most developed economies to reopen in the medium term hasn’t changed. As a result, we expect to see higher US inflation in the near term due to base effects when comparing with 2020. Looking at year-on-year inflation, we will shortly be comparing current inflation to the low point in 2020 when the world economy was experiencing a deep recession. That will automatically make year-on-year inflation look high, not just for headline measures that include energy prices, but also for core measures.
For instance, in the United States, the Federal Reserve (Fed) has a long-term two per cent target for the core Personal Consumption Expenditures index (core PCE), one of its preferred measures of inflation. Core PCE will likely run well ahead of its target for at least a month or two. However, we don’t expect inflation measures to continue coming in at those levels in the second half of 2021, and that by itself should dissipate some of the recent market concerns about a significant spike in inflation. One indicator that could point to inflation becoming more entrenched is the housing market, as it has an important weight in US inflation measures, which try to capture home-ownership costs. We watch this closely, but resilience in the US housing market has not led to a meaningful rise in inflation so far.
"We expect to see higher US inflation in the near term due to base effects when comparing with 2020"
Figure 1: Inflation could receive a short-term boost (per cent)
Source: Bloomberg, Aviva Investors, as of April 8, 2021
From time to time, investors will continue to doubt the Fed’s commitment to keep policy, easy even as the economy seems on a solid footing. However, the Fed is clearly communicating its intention to keep rates low for a long time yet. Ultimately, that will provide support for the Treasury market, as well as for the real economy by keeping financing conditions loose, which will benefit listed companies. Steepening curve However, it doesn’t rule out the possibility of a continued rise in longer-dated US Treasury yields. The immediate reaction to the March Federal Open Market Committee (FOMC) statement was a significant steepening of the US Treasury curve; while yields up to five years barely rose, there were much bigger rises at ten and 30 years.
"From time to time, investors will doubt the Fed’s commitment to keep policy easy"
Figure 2: The US Treasury curve has steepened
This is consistent with the Fed’s plan, which considers an upward-sloping yield curve a sign of more normal risk appetite and financing conditions as it (in theory) reflects an improving economy. A continued rise in yields in long-dated Treasuries therefore cannot be ruled out. Five-year yields could even rise if the economy recovers enough for doubts to re-emerge on the Fed’s commitment to keep interest rates down. Treasuries may benefit, but limited upside in credit While this possibility poses some near-term risks to Treasuries, it isn’t indicative of a breakdown in the bond market. The Treasury market is also becoming more attractive to non-US investors from a carry perspective compared to their home markets, which should limit downside risks.
Figure 3: Credit spreads are historically tight
"While Treasuries should gradually regain some attractiveness, we remain neutral on government bonds"
As a result, while Treasuries should gradually regain some attractiveness and reach a point where they will offer both value and diversification potential for our portfolios, until then we remain neutral on government bonds. In contrast, increased volatility in interest-rate duration makes the risk-reward less attractive for credit, particularly given credit spreads remain near to historically tight levels. As well as there being a risk of widening credit spreads if economic activity disappoints, higher volatility reflects the risk of a continued sell-off in duration. Therefore, having relied on credit significantly through the summer and second half of 2020, we are now slightly underweight, as the potential upside looks limited.
Figure 4: Bond declines have been a headwind for Emerging markets
References 1. ‘Chair Powell’s press conference’, Federal Reserve, March 17, 2021: “With regard to interest rates, we continue to expect it will be appropriate to maintain the current 0 to ¼ percent target range for the federal funds rate until labour market conditions have reached levels consistent with the Committee’s assessment of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. I would note that a transitory rise in inflation above 2 percent, as seems likely to occur this year, would not meet this standard.” 2. ‘March 17, 2021: FOMC projections materials’, Federal Reserve, March 17, 2021 3. Jim Tankersley, ‘Biden details $2 trillion plan to rebuild infrastructure and reshape the economy’, The New York Times, April 7, 2021 4. Source: IBES estimates of 12-month forward EPS growth, as of April 8, 2021
Any spike is therefore likely to be temporary; something the Fed supported in its most recent statement when it said it would not consider transitory inflation pressures sufficient reason to raise interest rates, particularly as the central bank aims to achieve inflation moderately in excess of two per cent for some time.[1] Given this significant change in the Fed’s policy, which followed its framework review in 2020, it is trying to offer clarity that it will not move quickly to a tightening cycle. For instance, the dots showing various members of the Fed’s opinion about when they think interest rates will next rise indicated only a small minority expect rates to rise in 2022, and slightly more in 2023.[2]
Volatility is also affecting the attractiveness of local-currency emerging-market debt (EMD) on two fronts. Firstly, it has meant that duration has played an unusually large part in driving total returns in the asset class in the year to date. As local-currency EMD is relatively short duration – generally four or five years – movements in local currencies tend to be the biggest driver of total returns. But given how volatile duration has been, it has become the bigger driver. This is not an attractive property for the asset class, and although a rate-hiking cycle has begun in some emerging markets like Brazil, Turkey and Russia, it has some way to run before the carry picture becomes compelling.
Secondly, the rise in longer-dated interest rates in the Treasury market is marginally supportive of the US dollar. This also makes it less attractive to take significant risk exposure on emerging-market currencies, whose performance is often negatively correlated to the US dollar. Strong spending and easy money favour equities In equities, this possibility of rising yields may threaten some high-valuation pockets, but we don’t expect it to impact the broader global market and retain our medium-term overweight. In contrast to the years following the global financial crisis, policy is being run very differently, with more fiscal support. This puts equities in a more privileged position, both generally and for specific sectors.
For example, the industrial sector typically benefits most from a combination of strong private-sector demand (supported by low interest rates) and fiscal demand, which is possible in 2021 and 2022. Although infrastructure spending was not included in the Biden Administration’s first round of stimulus, it has been the focal point of the latest package.[3] There have also been moderate improvements in companies’ capex intentions, and the potential for growth is not yet reflected in valuations.
Figure 5: US regional Fed capital spending surveys
Source: Philadelphia, New York and Kansas City Federal Reserves, Bloomberg, Aviva Investors, as of April 8, 2021
In terms of equity regions, we maintain our preference for the US and UK and are concerned about the outlook for emerging markets. While emerging markets led in terms of earnings momentum in the second half of 2020, they are now back in the pack.[4] This could reflect the fact China – and the economies that depend on it – began to recover from the pandemic fastest, a recovery which may now be plateauing, while other economies like the US and the UK are catching up.
"Infrastructure has been the focal point of the latest stimulus package"
"Some large Chinese companies are caught in the political crossfire between Xi Jinping and Joe Biden"
Some large Chinese companies are also caught in the political crossfire between Xi Jinping and Joe Biden. Minority shareholders are likely to be low on the priority list as these companies navigate the challenges, which reinforces our preference for a small underweight position in emerging market equities. Current conditions offer more visibility in the equity market than in rates or credit. As a result, a significant amount of our portfolio risk is now in equities, both in our absolute and relative views. This is a significant change compared to 2020.
Multi-asset allocation views: Equities on a style merry-go-round
Although economic growth, operating leverage and valuations support equities, it is too early to tell whether value stocks are finally set to make a comeback, says Sunil Krishnan.
In November 2020, as positive news was breaking on vaccine efficacy, equity markets were slow to grasp the significant prospect of reopening economies. They have since caught up, but continue to underestimate the global economic growth potential for 2021 and 2022. [1] For example, the US Federal Reserve (Fed) raised its US growth forecast for 2021 from 4.2 per cent in December – when our estimates were already above six per cent – to 6.5 per cent in March. This is a significant change for a central bank. [2] Published sell-side consensus has risen accordingly, yet risks remain tilted to the upside.
"Investors appeared to bank the strong fundamental performance"
Figure 1: Bloomberg economist consensus for 2021 US real GDP growth (year-on-year, per cent)
Source: Bloomberg, as of April 9, 2021
Markets remain too pessimistic on growth Two key areas might drive upside risks, in the US and China respectively. First, while the size of US fiscal stimulus is broadly understood and discounted, it is more difficult to assess the willingness to spend of individuals and companies. The private sector has built up large savings over the past year and could release a meaningful amount as the US economy reopens. Market forecasts do not yet fully account for this, most assessments conservatively discounting pre-pandemic levels of spending and not much more. [3] Added to this is an idea we have discussed previously, which is the Fed’s willingness to allow the economy to run hot for longer. Instead of acting after one or two months of above-target inflation, it could be several quarters or maybe a year before the Fed considers tightening policy. This is something investors have still not entirely embraced, which adds to the upside risk. [4] The second area is that, at the start of 2021, the Chinese authorities spoke publicly about a possible targeted reduction of stimulus in frothy areas, such as the property market.5 However, the appetite for weakening growth in China is questionable, and the authorities have extended support rather than reining it in. That is a positive surprise. Investors generally expected China to face a more material slowdown by now as stimulus wound down, but that does not seem to be the case. [6]
"Sales growth was 10.9 per cent while earnings growth was 48.6 per cent"
Valuations are not yet extreme Although broad equity valuations and investor sentiment are high, based on the measures we consider, they are not yet in extreme territory. For instance, market volatility has declined, but not to a point which would suggest widespread complacency. As of May 5, 2021, the VIX index of implied volatility stood at 18.7; this is much lower than January, when it peaked at 37 as markets corrected, but is not particularly aggressive by historical levels. By comparison, before markets became more volatile in 2018, the VIX hovered around ten for most of 2017.
Figure 2: VIX index, 2017 – 2021
"Headline inflation numbers are going to rise in the next few months"
Stronger economic growth than expected, alongside operating leverage, is translating into healthy company earnings and being rewarded by investors.
References 1. ‘House View Q2 2021’, Aviva Investors, April 8, 2021 2. ‘US economy to grow faster than forecast, says Federal Reserve’, BBC News, March 17, 2021 3.‘The world’s consumers are sitting on piles of cash. Will they spend it?’, The Economist, March 13, 2021 4. Sunil Krishnan, ‘Multi-asset allocation views: Loose policy doesn’t rule out a steeper curve’, Aviva Investors, April 15, 2021 5. Dorcas Wong, ‘China’s 2021 policy priorities: Achieving continuous, stable, and sustainable growth’, China Briefing, January 19, 2021 6. ‘Chinese economy continues its pandemic bounce back’, BBC News, March 15, 2021 7. Source: Bloomberg, as of May 12, 2021 8. The source for all sales, earnings, analyst consensus and stock price movements is Bloomberg, as of May 5, 2021 9. Sunil Krishnan, ‘Multi-asset allocation views: Room to grow’, Aviva Investors, February 16, 2021 10. Source: Bloomberg 11. Ron Bousso, Shadia Nasralla, ‘Shell raises its dividend as profits surge’, Reuters, April 29, 2021 12. Edward Thicknesse, ‘BP to kick off share buyback plans as profit climbs on rising oil prices’, City A.M., April 27, 2021 13. Source: Bloomberg, as of May 5, 2021
Small changes have a big impact The most important factor in translating changes in revenue to changes in profit is operating leverage. While some companies have warned markets of rising input costs, this is confined to those using a lot of raw materials, such as consumer staples. Overall, this is a small headwind, easily outweighed by the large pool of unused capacity that will allow businesses to increase output quickly without significant additional cost. Small changes in revenue can therefore lead to big changes in profits.
Dramatic style rotations It has been a dramatic year so far for style rotation. We have at times seen strong performance from some value companies, including some of the biggest losers from the early period of the pandemic that have started to recover at the expense of growth stocks. This has spurred a widespread debate on whether the rotation from growth to value is a long-term trend. It is still too early to tell; for value to really gain traction, we need to enter a period of more meaningful reflation.
European energy In terms of sectors, as mentioned we are positive on US industrials and European energy. For the latter, earnings reports have underlined additional points to consider. [9] European energy companies are relatively diversified with substantial refining, chemicals and, increasingly, renewable energy businesses. However, their traditional extraction and warehousing activities mean that rising oil prices should still have a positive earnings impact. Oil enjoyed a strong 2020, but after a quiet period in early 2021, it has again started to recover, reaching $69.70 a barrel as of May 5. [10] We previously noted the oil price was lagging the general economic recovery, and there would be upside for energy companies when it caught up. However, these companies face other challenges, particularly in terms of decarbonisation. A key question for investors in European energy companies – which are more committed to decarbonisation than their US counterparts – remains whether they can both deliver credible long-term net-zero emissions plans and increase distributions to shareholders. While they cut dividends aggressively going into the pandemic, they have now resumed distributions to shareholders. Shell has increased its dividend while BP has announced a new buyback programme; this suggests the companies believe they can deliver on net zero and increase distributions – which is positive for the sector overall. [11,12]
"The UK equity market has enough value representation to perform well in the current environment"
"European energy stocks rose by 2.3 per cent on average in the five days following earnings reports"
The impact of operating leverage has come through in companies’ most recent earnings reports. As of May 5, 2021, 375 companies in the S&P 500 have reported. On average, sales growth was 10.9 per cent while earnings growth was 48.6 per cent. These figures were a positive surprise when set against analysts’ consensus. The sales growth numbers were 3.7 per cent ahead of consensus, while earnings were 23.4 per cent higher. Operating leverage is not just working to deliver growth, it is also delivering outperformance against expectations. Against this backdrop, US equities earned solid returns, with the S&P 500 rising over five per cent in April. [7] Looking at a couple of sectors, the earnings surprise in industrials was roughly in line with the S&P 500 average, with a positive price performance of 2.4 per cent in the five days following announcements. The consensus for industrials had been much more negative than for the overall index, which supported the larger price movement.
In contrast, although earnings were 18.9 per cent ahead of consensus for information technology companies, share prices went down by 2.5 per cent in the five days following their earnings reports. Investors appeared to bank the strong fundamental performance, perhaps reflecting high expectations and background concerns about how reflation may challenge high valuations in technology. [8]
Headline inflation numbers are going to rise in the next few months, but it is not clear whether it can be sustained in a way that will restore pricing power to value sectors, such as certain commodities or heavy industry and manufacturing. Financials are another important value category, but it remains to be seen whether reflation will translate into even higher rates and a steeper yield curve that would further restore banks’ profitability. We are still agnostic on the outcome; our base case is that inflation is likely to moderate after the initial rebound, hovering closer to central bank targets or just above them; this may not be quite enough to continue the pace of gains we have seen in value stocks so far in 2021. It is worth recalling how consistent the performance of growth stocks has been over the last 15 years. However, things could prove different this time. The combination of accommodative monetary policy and generous fiscal policies could see reflation get traction, harming high valuation growth companies and supporting economically sensitive value names. Given the current uncertainty, sector positions with a value tilt, such as European energy or US industrials, as well as UK equities, can balance out exposures with a growth tilt, such as US equities.
After underperforming in 2020 and over longer term, the UK equity market has enough value representation to perform well in the current environment. On the growth side, we expect US equities to continue to grow earnings and generate cashflow. A lot of the promised fiscal spending is intended to stay at home, benefiting US households and firms, and even large-cap US companies have a large tilt towards domestic revenues. For that reason, the US still represents a legitimate source of exposure to the reflation theme and is a good way to maintain a balanced position in the growth versus value conundrum.
In addition, although the sector’s average revenues were slightly behind expectations, the earnings surprise was 39.3 per cent above consensus. Coupled with good news for shareholders in terms of cash distributions, this led to European energy stocks rising by 2.3 per cent on average in the five days following earnings reports. [13] Investors are starting to see what they hoped they would, not just in terms of earnings versus expectations, but also in terms of European energy companies’ future plans.
Multi-asset allocation views: Moving short on duration
A strong economic recovery and continued reflationary bias from the Federal Reserve could push long-dated yields higher on US Treasuries, says Sunil Krishnan.
Our thinking on equities remains broadly unchanged. Since March 2021, investor consensus has broadly caught up with our positive view on the economic forecasts for the US and Asia. However, we remain more optimistic than most market participants on other regions, such as Europe. We also continue to see more upside risk potential than the consensus. While investors no longer seem to be underestimating the central case for US growth, they may still be misjudging how strong this could be. Households and firms have built up large savings and may be willing to increase spending on items like holidays and restaurants as the economy reopens, without necessarily foregoing the things they were spending on during lockdowns. [1] To put this into context, investors have started debating the question of peak growth – the time when the economy continues growing but growth stops accelerating. It can trigger some volatility in the markets and lead investors to be more cautious. But the current consensus estimates GDP growth in the US to slow down from roughly nine per cent in the second quarter to seven per cent in the third and five in the fourth. [2] By any historical standards, this is not what we would expect peak growth to look like. In the past, it would have typically slowed from around three per cent to one per cent; so this time is different, and investors may not be fully appreciating it. That is one reason we continue to favour risk assets and have not changed our positioning.
"The reflationary bias gives a positive skew to the potential outcomes for rates in the Treasury curve"
Going short on duration Where we have revised our thinking is on government bond duration. Until recently, we were neutral, as reflationary forces and loose fiscal policy cancelled out the attractiveness of diversification and bonds’ carry profile. Even though we held a strong reflationary view from an economic perspective, the investment case was not compelling. [3] However, the period since March has seen a material rally in government bond markets, with 30-year US Treasury yields having peaked on March 18 at almost 2.45 per cent, falling to just over 2.04 per cent on July 2 – a 40 basis-point rally. [4] This removes some of the concerns we held earlier, such as the carry from an excessively steep curve at the long end of the market. Similarly, some of our indicators earlier in the year suggested short positioning was quite extreme, but the substantial rally is likely to have forced a number of investors out of their short positions. The positioning is no longer as crowded as it was in March.
"Many industries have been disrupted, as have certain geographic areas"
Short-term tremors For those reasons, we have taken a short duration position in our portfolios through 30-year US Treasuries. Shorter-term moves will probably remain quite dependent on the next Federal Reserve speech or FOMC minutes but, in the longer term, the US economy will continue to recover, the central bank will not be quick to step on the brakes, and private and public sector spending will bring continued support. On the public sector side, for example, the news remains broadly in line with expectations. The Biden administration may not manage to pass a bipartisan infrastructure spending bill, but it is not ‘bipartisan or nothing’. If it must, the administration will proceed with only the Democrat votes, and we are still looking at a substantial expansion in public spending at a time when private spending is likely to recover as well.
Meanwhile, our view on credit is unchanged, which is that spreads do not currently offer an attractive risk-reward balance. While the asset class will likely perform well in our central macroeconomic scenario, being underweight can prove a useful hedge if things go wrong, as spreads could then widen significantly. However, if US monetary policy stays relatively easy, pushing up longer-dated rates, that could coincide with a rising equity market and strong corporate profitability. It is therefore important to size positions appropriately and avoid taking too much risk in any single area.
References 1. Sunil Krishnan, ‘Multi-asset allocation views: Equities on a style merry-go-round’, Aviva Investors, May 18, 2021 2. Source: Bloomberg, as of July 9, 2021 3. Sunil Krishnan, ‘Multi-asset allocation views: Loose policy doesn’t rule out a steeper curve’, Aviva Investors, April 15, 2021 4. Source: Bloomberg, as of July 2, 2021 5. ‘FOMC projections materials, accessible version’, Federal Open Market Committee, March 17, 2021 6. ‘FOMC projections materials, accessible version’, Federal Open Market Committee, June 16, 2021 7. Jeff Cox, ‘Fed’s Jim Bullard sees first interest rate hike coming as soon as 2022’, CNBC, June 18, 2021 8. Steve Matthews and Craig Torres, ‘Fed’s Rosengren says 2022 rate hike in play as job market heals’, Bloomberg, June 27, 2021
Payroll numbers are misleading The idea economies may not be as strong as they look has been one challenge to the investment case for being short on duration. It could be argued labour market outcomes in the US, for example in terms of payroll figures, have not been as strong as they were at the highest point of the recovery.
Portfolio construction From a portfolio construction perspective, it is important to think about the interaction between the government bond market and our equity and credit positions. Taking the long view, we believe the Federal Reserve will remain supportive of the economic recovery, despite all the recent market debate, which remains positive for equities.
However, this does not seem particularly indicative of a drop in demand from companies for workers, but rather suggests some mismatches in terms of skills and geographies. Many industries have been disrupted, as have certain geographic areas with, for example, fewer hospitality jobs or retail jobs in city centres. Though it will take time for the labour market to adjust, companies are still looking to hire. Unemployment benefits also remain supportive. Some Federal Reserve commentators have begun talking about the expiry of some of those enhanced provisions, and when schools go back in September, people may revisit their willingness to work. Therefore, while the hiring figures haven't always met expectations over the last couple of months, there may be some artificial – and temporary – reasons behind them.
In addition, the more the Federal Reserve is seen to err on the side of caution and let the economy run hotter, the more the sense of it being behind the curve will appear at the long end of the Treasury market. Long-dated, 20 to 30-year yields could well be pushed higher because, ultimately, they are not driven as much by where rates are today as by what investors think must happen. There is a reasonable case that the longer the Federal Reserve waits to raise rates, the more it will eventually need to do so.
Moving dots The other potential challenge to the investment thesis was the change in the dots – the voting members’ projections about where they think the funds rate could go – announced at the last Federal Open Market Committee (FOMC) meeting. These went from no rate hikes expected in 2023, as of the March 2021 FOMC meeting, to two rate hikes in 2023, as of June.5,6 Markets were implying a gentle move in this direction, but with possibly one hike rather than two. Since then, a couple of Federal Reserve speakers have also said the conditions for raising interest rates could emerge in 2022.7,8 That has led investors to think the central bank may move quicker than previously thought to stamp down on inflation if it emerges, which could justify a reluctance to hold short positions on duration. Again, an important element of context is that, if it followed historical norms in reacting to the current growth and inflation numbers, the Federal Reserve would be tightening rates now rather than potentially in 18 months’ time. That is a crucial change that investors may be missing and reflects a reflationary bias. Added to our view growth could be stronger than markets seem to expect, it gives a positive skew to the potential outcomes for rates in the Treasury curve.
"We are still looking at a substantial expansion in public spending"
"It is important to avoid taking too much risk in any single area"
