#WellSaid

The Wellington Blog — A diverse marketplace of ideas, where our investment professionals share and challenge each other’s views. They decide independently how to draw on those ideas to sharpen their investment decisions, unconstrained by any single “house view.”

As China’s role on the world stage continues to loom larger, many investors are contemplating whether to separate the country from the rest of their emerging markets (EM) equity allocation. Most arguments for such separation are based on China’s fast-growing weight in broad EM equity benchmarks, but it’s not necessarily that simple. Let’s take a closer look.

The answer? It depends

We believe the key decision point here should not be China’s dominance of the EM indices, but rather, the extent to which a stand-alone China equity allocation can be viewed as similar (or dissimilar) to an EM ex-China equity allocation. If they are, in effect, more or less the “same thing,” then the relative size of one to the other will likely make…

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Samouilhan_Nick
Nick Samouilhan
PhD, CFA, FRM
Multi-Asset Strategist
Singapore
Cara Lafond
Cara Lafond
CFA
Multi-Asset Strategist
Boston
Adam Berger
Adam Berger
CFA
Multi-Asset Strategist
Boston

Sustainable investing is no longer the exclusive domain of equity investors. Indeed, there is a growing consensus that sustainability can be just as critical to investment outcomes in fixed income markets. Although environmental, social, and governance (ESG) integration and adoption have historically been slower in fixed income as compared to equities, investor demand for “green bonds” and other sustainable fixed income solutions has risen rapidly in recent years, particularly since the onset of COVID-19. Accordingly, the pace of new product innovation and proliferation has picked up as well.

Case in point: The booming global market for green/sustainability bonds has now expanded to convertibles — hybrid bonds that can be converted from debt into equity. While European debt issuers have thus far comprised most of the volume in these green, sustainability-linked, and/or social bonds, US and Asian issuers have become increasingly active in the space. The recent uptick of issuers selling green/sustainability convertible bonds includes companies focused on…

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Raina Dunkelberger
Raina Dunkelberger
CFA
Investment Specialist
Boston
Michael Barry
Michael Barry
Fixed Income Credit Analyst
Boston

In a June 2021 white paper, A source-based approach to managing inflation risk, co-authored by our colleague Adam Berger, we laid out what we believe are the five most likely sources of higher inflation over the coming decade. One of them was climate risk or, more specifically, the potential for input price shocks caused by the ongoing trend of global climate change. Since this inflation source may not be on many investors’ radar, we’d like to revisit why we think climate change is inflationary and suggest strategies to help reduce the threat to client portfolios.

The relationship between climate change and inflation

  • Overview: A price shock to a systemically important input price will tend to spur higher inflation as businesses pass it on to consumers, leading to “cost-push” inflation. While this has historically been due to geopolitical forces driving oil prices, we believe the impact of climate change on a range of commodities will be…
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Samouilhan_Nick
Nick Samouilhan
PhD, CFA, FRM
Multi-Asset Strategist
Singapore
Joy Perry
Joy Perry
Investment Director
Boston, MA

Question: Could rising “short-termism” actually provide an alpha opportunity for longer-term-oriented equity investors? Ironically, yes in my view. Let’s look at today’s financial technology (fintech) sector as an illustrative example.

Froth in fintech IPOs

I’m concerned about growing froth in the fintech initial public offering (IPO) market because much of the recent activity there signals that investors are continuing to take on more and more risk in pursuit of hoped-for near-term rewards. Here are some behaviors that, to me, highlight the potential for…

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Matt Ross
CFA
Global Industry Analyst
Boston

With US stocks notching record highs this year, significantly outperforming their Japanese counterparts, the spread between the two equity markets’ valuations has widened meaningfully in recent months (Figure 1).

Why the performance dispersion? Japan’s relatively slower COVID vaccine rollout and the disappointing lack of economic support provided by the (previously) much-anticipated Summer Olympics have clearly weighed on market sentiment of late, but equity investors’ apathy toward Japan actually dates back several years. One might even say that it has become entrenched.

The good news? The valuation gaps between Japan equity and its global peers have arguably reached…

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Jun Oh
Equity Portfolio Manager
Hong Kong

After a lengthy absence, inflation has finally returned to the US, but for how long depends on who you ask. Many observers, including the US Federal Reserve (Fed), continue to expect today’s inflationary pressures to be more or less “transitory” in nature. Market pricing suggests that many investors share that belief.

However, here are five reasons why I believe US inflation could prove to be far more enduring than widely expected by the Fed and market participants.

  1. A still-early economic cycle: The US economic cycle is still in its very early stages, as shown by the recent high level of…
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Brij Khurana
Brij Khurana
Fixed Income Portfolio Manager
Boston

In my opinion, the answer to the question above is “less than most people expect.” I think life will return to “normal” in ways that may be hard to imagine amid worries about the Delta variant. Early in the pandemic, my colleague Eunhak Bae wrote the following about living through 9/11 in New York City: “In the immediate aftermath, it seemed like no one would ever fly on a plane again. That obviously turned out not to be true. Today, it may feel like the world has changed for good. But I believe humans are blessed with selective memories and a desire to revert to what they know, so people will once more buy things, go see things, and congregate to share experiences.” When I first read those words, I thought the reversion to normal would happen much more quickly than it did, but I still think that’s our destination, perhaps within the next six – 12 months.

Why inflation will be an exception

The big change I foresee is in inflation, which has been unusually low for an extended time (1.4% over the decade ended December 2021 and 1.6% for the trailing 15 years). We have seen in past crises that economic stimulus tends to be harder to…

In their June 2021 paper, Why fragility is the new reality for the stock market, our colleagues Brian Hughes and Gordy Lawrence conclude that: ”An imbalance has developed between the supply of and demand for liquidity, and as a result we’ve seen a significant increase in the potential for the public equity market to jump from a state of calm to one of chaos.”

Within our global trading department, we couldn’t agree more. Here are our latest thoughts from a trading perspective on ways to potentially navigate those states of “chaos” that may arise, often unexpectedly, amid market shocks or bouts of heightened…

The recently announced intended merger of two key financial technology (fintech) players will be the second-largest deal ever in the global payments sector. Here’s my latest perspective on the broader implications of this major acquisition and the related investment opportunity in the fast-growing “buy now, pay later (BNPL)” space, which I believe has now reached an inflection point in its young storyline.

A changing industry landscape

Given the size of the total addressable market (TAM) for global payments, I’d say fintech companies have been little more than a thorn in the sides of the old guard thus far, but I think that’s poised to change. Indeed, I believe the recent blockbuster transaction noted above may have…

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Matt Lipton
CFA
Portfolio Manager
Palm Beach, FL

In light of some notable events over the past several weeks — China’s domestic regulatory actions, the Biden administration’s recent six-month milestone, and the US foreign policy debacle in Afghanistan — I thought now would be an opportune time to provide my latest take on the state of US-China relations.

Putting regulation in context

As many of my colleagues have observed, the recent regulatory moves by Beijing are mainly China-focused and not driven by global geopolitics or US policy shifts. That being said, there are some key takeaways here from my broader geopolitical perspective. For example, I think policymakers in both China and the US have begun to view their domestic policy decisions through the lens of the rising “great-power” competition between…

Plagued by a combination of disappointing returns, heightened volatility, global trade wars, and (most recently) the COVID-19 crisis and regulatory uncertainty, emerging markets (EM) equities have been decidedly unpopular with many investors for years now. But during that time, the EM investment opportunity set has grown and expanded significantly, making EM equities fertile ground for investors seeking enhanced portfolio diversification and strong performance potential.

We believe differentiated actively managed investment strategies rooted in fundamental research are best positioned to access and capitalize on this attractive, but often-inefficient, asset class. In fact, we think investors who adhere to passive, benchmark-driven EM equity allocations may be missing out on full exploitation of the available opportunity set.

Here are seven reasons why, in our view, EM equity investors should favor active management, in spite of…

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Andrew Sharp-Paul
Investment Director
Singapore

The growth of portfolio trading has been a constant theme in fixed income markets throughout the volatility of the pandemic. This continues the trend of clients increasingly relying on a broader variety of liquidity sources to achieve their objectives. Trading a portfolio of multiple bonds with a range of credit qualities and durations in a single transaction allows clients to access aggregated liquidity more efficiently. It can improve timing, execution, and cost, while minimizing a client’s exposure to uncertainty and volatility.

In this short blog, we share our views on the best uses for portfolio trading and discuss the current state of the market.

ETFs and portfolio trading

Importantly, standard “voice” trades remain the core of risk transfer in credit markets. However, the persistent development of the ETF ecosystem has added a…

Our ongoing climate research shows that various global regions and asset classes will face significant and growing climate risks in the coming years. We hold the view that asset allocators seeking optimal long-term results should thoughtfully factor climate change into their structural investment planning. In fact, we believe allocators can build climate resilience into their portfolios today to pursue the potential return opportunities arising from climate change.

Mounting risks and implications of climate change

While some of the risks associated with climate change may seem too far off to matter right now, many of the environmental, social, and economic ramifications are already apparent. We believe now is the time for allocators to begin thinking about how to incorporate climate change and related considerations into their strategic asset allocation (SAA) plans.

Record-setting heat, floods, wildfires, and hurricanes have repeatedly wrought massive, costly destruction and ensuing…

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Erika Murphy
CFA, CAIA
Investment Director
Boston

The SEC’s recent approval of new Nasdaq board diversity requirements will affect not only the 3,000+ public companies currently on the exchange, but also private companies hoping to someday be listed. Members of our Private Investments team explain the new rules, why they matter to company performance, and how private companies can prepare.

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Hillary Flynn
Hillary Flynn
Director of ESG, Private Investments
Celi Khanyile-Lynch
Celi Khanyile-Lynch
Sustainability Analyst

There is a sense that the world is slowly “getting back to normal,” after more than a year of COVID-induced economic lockdowns and other restrictions. Unfortunately, many countries — and even some parts of the US — are still grappling with more contagious and virulent strains of the virus (e.g., the so-called “Delta variant”) and troublingly low COVID vaccination rates. We are not out of the woods yet. But broadly speaking, the global economy has been recovering with the aid of accommodative fiscal and monetary policy, supporting the strong performance of risk assets and the ongoing rotation from growth- to value-oriented exposures.

The threat of rising inflation is a bogeyman now. Amid supply/demand imbalances in labor and other factors, we believe inflationary pressures are likely to persist in the period ahead. Against this backdrop, our investment outlook remains largely pro-risk, but is tempered to some degree by what we see as…

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Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston
Daniel Cook headshot
Daniel Cook
CFA
Investment Strategy Analyst

I believe that regional differences in COVID vaccination rates, government policy goals, and the ensuing trade-offs have led to a global economy that can now broadly (and imperfectly) be divided into three distinct ”blocks,” each moving at very different speeds and via very different catalysts: 1) the ”boosters”; 2) the COVID “racers”; and 3) the ”reformers” (Figure 1).

In my view, investors should track the dynamics of each block separately in order to successfully navigate the current phase of the global economic recovery. All three will also affect the markets to varying degrees and with varying effects.

Figure 1

The three blocks of the global economy

Block 1: The ”boosters”

The countries in this group have made substantial progress on vaccine provision, which has increasingly allowed them to…

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Samouilhan_Nick
Nick Samouilhan
PhD, CFA, FRM
Multi-Asset Strategist
Singapore

Every quarter, the Wisdom of Wellington team surveys around 100 of our Wellington colleagues across different investment disciplines and locations to get their views on what we see as the key macro questions of the day. The results can pinpoint where the firm’s views differ from the consensus and can also reveal important shifts in our collective thinking.

Given the recent minor growth scare in July when bond yields fell, we wanted to see what our survey respondents thought about where we are in the cycle. As Figure 1 shows, the consensus forecast from our survey is that the next 12 months will be the mid-cycle phase. Interestingly, however, the second most likely phase was considered to be…

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Benjamin Cooper
Ben Cooper
CFA
Multi-Asset Strategist
London
Juhi Dhawan headshot
Juhi Dhawan
PhD
Macro Strategist
Boston

As part of our recent climate investment roundtable, Director of Climate Research Chris Goolgasian and Global Industry Analyst Alan Hsu discuss why and how the physical and transition risks of climate change are driving investment opportunities. They also share insights on why they believe solutions that help society adapt to the effects of climate change are undercapitalized and could see significant upside in coming years.

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Chris Goolgasian
Chris Goolgasian
CFA, CPA, CAIA
Director of Climate Research
Boston
Alan Hsu
Alan Hsu
Global Industry Analyst
Boston

As credit spreads have compressed to post-global financial crisis tights, and with bond yields hovering near all-time lows, I believe the total and excess return prospects for investment-grade fixed income look rather grim. Tight valuations, coupled with some looming risks on the horizon (the COVID Delta variant, inflationary pressures, fading fiscal stimulus, and China’s slowdown), may present an opportunity to “take some chips off the table,” so to speak. I recommend reducing both credit and interest-rate risk in many investor portfolios.

The technical backdrop remains strong

Investment-grade credit has been well-supported by strong demand from non-US investors and the domestic pension community. For overseas investors, US credit is still their best option on the yield “menu” (made even more attractive on a currency-hedged basis), given lower prevailing yields across most other developed markets. Many defined benefit pension plans have been…

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Connor Fitzgerald
Connor Fitzgerald
Fixed Income Portfolio Manager
Boston

On 23 July 2021, Chinese regulators announced sweeping changes to China’s after-school tutoring (AST) industry, forcing AST companies to transform into nonprofit entities, banning foreign capital flows into the industry, and barring public stock listings for these firms. Following the announcement, the market capitalizations of China’s largest AST players plummeted to around 10% of their trailing 12-month highs.

But take a step back for a moment: Government regulation of Chinese industries is not new by any means. The AST policy move is consistent with the goals of China’s past regulatory actions and had even been foreshadowed through various channels during the first half of 2021.

Here’s a distillation of our China and emerging market (EM) equity specialists’ latest views on this turn of events — including why investors shouldn’t…

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Graham Proud
Graham Proud
Investment Director

US utilities stocks have trailed the broader equity market by a wide margin so far in 2021, having just posted their poorest first-half relative performance since 1997. In fact, the underperformance has become chronic: The sector has now lagged the market by roughly 40% over the past three years – its worst multiyear stretch going back to the tech bubble of the late 1990s.

Neither I nor any other member of the utilities team here has seen anything like this during our careers. So what gives? Utilities were neither COVID “winners” nor “losers” in 2020. And then the US stock market’s persistent “seesawing” between the value and growth styles has left utilities out of this year’s market gains. Increased inflation and fears of higher interest rates have also hurt the group to some degree in recent months.

But there is a silver lining. In the wake of their underperformance, US utilities have been trading at a big discount to…

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Juanjuan Niska
Juanjuan Niska
CFA
Global Industry Analyst
Boston, MA

Figure 1 highlights the six-month trailing correlation between the S&P 500 Index and the 10-year US Treasury bond as of 20 July 2021. This stock-bond correlation has shot up over the past six months or so from near all-time lows to its highest levels since before the 2008 global financial crisis. What does it mean?

Figure 1

Six-month stock-bond correlation

First, one caveat: The equity-bond correlation can be volatile, particularly amid fears of monetary policy tightening — for instance, a sharp spike around the…

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Nick Petrucelli
Nick Petrucelli
CFA
Portfolio Manager
Boston

The Chinese government’s aggressive regulatory crackdown on the country’s private technology companies (most recently, the online education sector) has shaken investor sentiment toward a range of Chinese assets, causing China’s equity and bond markets alike to swoon in recent days. The crackdown comes as Chinese policymakers embark on the delicate balancing act of redefining the role of private enterprise in China, versus the often-competing objectives of the nation’s common prosperity and social responsibility.

Here’s a distillation of our global fixed income and emerging markets debt teams’ latest views on some of the potential investment implications.

Fixed income investment implications

China equities and sovereign bonds, along with the Chinese currency, abruptly sold off in unison following the government’s latest regulatory actions during the week of July 26. But most Chinese household wealth is still mainly invested in…

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Jitu Naidu
Investment Communications Manager

Recently, I was asked about changes and trends I’m observing in asset management, as well as those I hope will develop in three to five years. The asset management industry is client-driven, so most trends I see have their roots in the changing needs of asset owners. Here are three major ones:

Climate and ESG — Asset owners I talk to are increasingly focused on the impact their capital allocation and security-selection decisions will have on climate change and broader ESG concerns. At the same time, a growing number of portfolio managers believe they can increase their likelihood of outperforming a benchmark by incorporating these risks and opportunities into their investment decisions and, in many cases, by engaging with companies directly.

China — Most asset owners are already investing in Chinese equities as part of their overall EM allocation. But given the size of China’s economy and its role on the world stage, many are thinking about…

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Adam Berger
Adam Berger
CFA
Multi-Asset Strategist
Boston

Global ESG debt issuance is growing exponentially, now topping US$3 trillion outstanding. While it took more than a decade to reach the first US$1 trillion, it’s taken just six months to add the latest.1 This growth was accelerated by the pandemic, the race to net-zero emissions, global green fiscal stimulus plans, and record-low interest rates.

The trend continues as 2021 issuances are roughly 90% of 2020’s record already, including the rapid expansion of the loan format as well as increases in social, sustainability, and sustainability-linked bonds to complement the original green bonds. Notably, the growth of loans may be somewhat misleading as the figures are based on the size of companies’ loan programs rather than what they are actually borrowing (which is often much smaller).

In this blog, we explore the potential benefits of this growing market and highlight the importance of avoiding greenwashing…

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