For decades, Latin America has been the world’s quarry. Here you can find a diversified supply of agricultural and mineral products, from soybeans, meat and coffee to copper, silver and oil. However, this situation has made the region very sensitive to its prices. The region’s economic and financial performance dances to the rhythm of the evolution of commodity prices, with correlations of 0.57 with next year’s GDP, 0.52 with equity and 0.53 with foreign exchange. In the last year, this strong link has made this part of the world a high-return region in the eyes of financial markets.
These high correlations are consequences of structural issues regarding certain Mercado Integrado Latinoamericano (MILA) countries – traditionally made up of Mexico, Peru, Colombia and Chile. Peru’s share of mineral exports still hover above 50 percent (similar to the state of oil in Colombia and copper in Chile), while non-traditional exports are around 30 percent (and for Colombia this is decreasing).
What makes matters worse is the fact that the share of these products on fiscal revenue for each of these countries is even higher. Therefore, an abrupt reduction in commodity prices has a real impact on economic activity and fiscal position. This means that, in the short term, equity returns for these countries are expected to be slightly lower than their neutral return, in line with such a commodity downswing.
Consumption patterns
Nevertheless, there are promising signs that the dance might slow down in the next couple of years, especially for MILA countries. These countries have increased their reliance on domestic demand, which in our metaphor is equivalent to dancing to their own beat. Between the years 2000 and 2013, domestic demand relative to GDP increased its importance by 20.2, 8.3 and 10.4 percent for Chile, Peru and Colombia respectively. These countries also have a demographic bonus that, according to the UN, will keep their dependency ratios under 60 percent for the next few decades (see Fig. 1). This change will have an enormous impact over consumption patterns, market size and even national competitiveness.
Domestic demand increase relative to GDP
20.2%
Chile
8.3%
Peru
10.4%
Colombia
Secondly, since the 1980s, these countries have implemented reforms that have reduced their vulnerability to external shocks and enhanced the competitiveness of their non-tradable sectors. While the average current account deficit in the 1980s was 4.5 percent of GDP for these countries, in the last 10 years this deficit has been just one percent of GDP. Furthermore, the average inflation for these countries in the 1980s was 200 percent, while in the last 10 years it has barely surpassed three percent. The average government net debt has reduced from 24.1 percent in 2000 to 7.6 percent in 2013 (the foreign currency denominated debt followed a similar pattern).
Better still, each of these three countries has reason to believe in a more diversified and solid growth path for the next few years. Although Colombia’s oil prices accounted for 53 percent of its exports for 2014, its bet on the 4G Road Infrastructure Programme (47 projects worth $25bn) will reduce its dependence on oil and increase the competitiveness of the rest of the economy.
In a similar way, in order to reduce its tango with metal prices, Peru has recently updated its national strategic plan based on improvements in education (increasing expenditure to six percent of GDP), a reduction of the infrastructure gap (through private public partnerships) and productive diversification through attachment to global value chains and regulatory simplification.
Finally, while Chile still relies on copper prices, its track record of sound macroeconomic policies, institutional strength and development of non-traditional exports (salmon and wine come to mind), foster opportunities for a reduced role of copper in its future growth.
A blessing in disguise
The current downswing in commodity prices may be a blessing in disguise because it has put these countries’ equity at a very attractive valuation relative to the past, with a price-earnings ratio of 13.7 compared to a five year median of 15.2. Meanwhile its peers, both in emerging Asia and EMEA, are slightly over this five-year median. However, selectivity is going to be key in order to identify the firms that will rebound faster and stronger from the current level.
This decoupling from the commodity dance has been even clearer for fixed income assets. On the one hand, funding through external debt for MILA and in general Latin American governments has been switching to local debt financing, which at the end of 2014 represented a stock of almost $2trn, only surpassed by Asia.
This change has substantial implications for the insulation of government finances from commodity shocks. A local market with better liquidity and depth has been created, since today local institutional investors (pension funds, insurance companies, mutual funds and banks) share a common platform with international investors to trade and improve the secondary market, and benchmarking to local corporate debt. In addition, governments may now match their funding in the same currency as they expend the resources and issue long-term bonds (even tenors longer than 30 years), which diminishes the currency and duration mismatch in fiscal accounts. Finally, it has created a ‘high-beta’ asset class to which international investors are increasingly adding exposure, in spite of the correlation with commodity prices.
On the corporate fixed income side, the participation of MILA and Latin American companies in global US dollars denominated REGS/144A corporate debt market has skyrocketed: over the last 10 years corporate annual issuance has increased more than 700 percent and the outstanding of corporate debt now exceeds $400bn, representing almost 35 percent of the asset class benchmark. Not so bad for a region with such correlation to commodities.
In fact, the truth is that today Latin American metals, mining and energy sectors represent less than 25 percent of the benchmark, with the remainder more fundamentally dependant on internal demand. This increasing importance of the internal demand driver is the main reason companies that achieve certain critical size and the ability to access international funding come to the primary market every year, regardless whether they have an investment grade rating or they want to issue 10 or 30-year bonds.
Equity space
As for equities, the impact of commodity prices across government debt, both external and local, and corporate debt, has brought an opportunity to gain exposure to a region where gradually, the fundamental dependence on commodities is expected to decrease with time.
In the equity space, the investment environment since the second half of 2014 has been characterised by extreme correlation, regardless of company fundamentals. For example, the main Colombian equities performed in a very narrow range, losing between 27 percent and 30 percent in US dollars, regardless of each company’s industry, as a result of the 50 percent drop in the oil price (the country’s principal export). This steep drop in value includes companies whose fundamentals are unrelated to the oil price (such as certain electric utilities), and even companies that actually benefit from the decrease in commodity prices.
A case in point is Avianca, the leading Andean regional airline, which fell 28 percent in the second half of 2014 despite facing a significant margin increase as a result of the collapse in the price of jet fuel. Avianca now trades at a 50 percent price-earnings discount compared to global airlines. This increase in correlation, and the accompanying disregard of country and company fundamentals, seems to be the result of foreign capital flows exiting the Latin American markets indiscriminately. This can be seen in the diminishing assets under management invested in regional exchange-traded funds, such as Colombia’s iColcap and Peru’s EPUs (iShares Peru).
In this environment, Credicorp has acted as the ‘liquidity provider’ in the Andean markets. Our fund managers have been buying selectively in the face of massive liquidations by foreign investors that, in our opinion, are unable to differentiate between the companies and sectors that will be affected by the commodity collapse and those that will not. We believe the current investment environment represents an opportunity for patient, long-term investors, who can weather the volatility related to market flows and wait for value to surface.
Brunei’s banking sector remains resilient, according to Standard and Poor’s. Pierre Imhof, CEO of Baiduri Bank, explains how Brunei’s government is investing in a diversified economy, and what the Brunei banking sector is doing to assist small and medium private businesses.
World Finance: Despite the recent financial crisis, and now a fall in oil prices worldwide, one banking sector that remains resilient is that of Brunei: according to the global rating firm Standard and Poor’s. Joining me now is Pierre Imhof, CEO of Baiduri Bank, one of the leading banks in the country.
Pierre: falling oil prices have slowed the Sultanate’s economy. Why has this not impacted the banking industry?
Pierre Imhof: There is definitely a sharp decline in oil and gas prices. But Brunei is a country where the economy is mainly driven by government spending.
And therefore, this year the government has decided to keep the budget – and therefore the spending – at a level very close to last year’s. For the year 2015-16 the budget will be reduced only by around four percent, so it’s very small.
Of course, the income will not be at the same level as last year, so the deficit, the budget deficit, will be covered by part of the accumulated reserves of the country.
So this budget remaining more or less at the same level will definitely help the domestic economy. And therefore, being a local bank with all our activity within the country, we expect that we will not suffer too much from the oil prices.
World Finance: So what challenges does the banking industry face, and how does Baiduri approach these?
Pierre Imhof: If the prices of oil and gas remain low for a long period, the country will probably have to adapt and adjust. The government may not be in a position to maintain such a level of its budget for too long.
The second challenge is that the oil and gas industry – and the operators in such an environment – are trying to reduce their costs. And that may affect the private sector. There might also be some delay in infrastructure developments by the government.
So all these will be challenges that the banks will have to face during this difficult time.
World Finance: Staying competitive is of course a major issue for any bank, and that often means really staying on top of the latest technological innovations. Does this relate to Baiduri? And how do you adapt to customer needs?
Pierre Imhof: Technology is definitely an important part. But our absolute priority is to give to our clients – when they deal with Baiduri Bank, whether they use one of our branches, or electronic channels – to always give them the best customer experience.
We have launched in Brunei the first Café branch. Nothing to do with banking. Our clients come to a branch, and they can relax, sit in a sofa and have a coffee while they are transacting.
We want also to give them a choice. If they want to come to a branch, we have the branch network. If they want to go through the internet, we are also able to offer them the internet.
We have been the first in Brunei in many services and many products. The latest one is the Visa payWave. So now our clients use their Visa card: just tap and pay.
The last example I would like to give is in terms of security. We pay a lot of attention, and we make a lot of investments, to make sure that our clients data are protected.
World Finance: Ninety percent of private businesses in Brunei are SMEs – how do you cater to this market, and how does this translate to the economy as a whole?
Pierre Imhof: First, our services – and especially financing – are customised for these clients.
Secondly, we are a local bank. The decision making process is in Brunei. It allows us to be more flexible, and faster, taking a decision in granting a facility, in structuring financing.
Third, SMEs need very specific financing. We have micro-finance schemes, and enterprise facilitation schemes, which we offer to SMEs in collaboration with the Ministry of Industry and Primary Resources. And these are schemes which are designed for SMEs: they are cheaper, and companies which might not be eligible to other schemes can still access financing through such schemes.
World Finance: In 2014 Brunei implemented the Local Business Development programme in the oil and gas sector. Can you elaborate a little bit on this, and how will this really impact the banking industry?
Pierre Imhof: It definitely impacts the banking industry a lot. This programme – Local Business Development – was developed by the authorities in Brunei to encourage economic players to rely more on local resources and to develop more local contacts. It has the objective to encourage local employment: 99 percent of Baiduri Bank’s employees are locals.
When its activity grows, definitely it’s an opportunity for Baiduri Bank to employ more people. So in that respect Baiduri Bank is contributing to local business development. But Baiduri Bank is also benefiting from this local business development programme. A number of companies would now under this programme be encouraged to deal with a local bank. And we have definitely in that respect benefited from it a lot.
World Finance: Finally, what trends do you foresee really impacting the banking industry in Brunei, as we move toward the second part of 2015?
Pierre Imhof: If the oil and gas prices remain at the present levels, I think that the country will not be able to rely forever on oil and gas income to maintain and develop further its economy.
The positive effect is that it may lead to accelerating the policy of diversification in the country. And the banks will have a lot to benefit from diversification: first of all it will give them opportunities in the country, but diversification will also mean, beyond the Brunei borders, Asian economic integration. Brunei and Brunei companies may have a role to play; and banks in Brunei therefore may also have a role to play.
We spoke about technology, and definitely in the future we need to continue offering our clients the latest technology.
Even though we are a small country, we cannot miss this technological challenge.
First appearing around the midpoint of last century, sovereign wealth funds (SWFs) have long occupied a significant space in financial markets. However it’s only in recent years that these rainy-day funds have come into their own.
Speaking at the 68th CFA Institute Annual Conference in May, the former CIO of the Korea Investment Corporation (South Korea’s SWF) Scott Kalb offered up some choice statistics on what he called an “active and powerful” opportunity. First was that at the end of 2014 the world’s 74 highest ranking SWFs held a colossal $7.7trn in assets, $3.3tn greater than in 2010 and significantly more than the $500bn held in 1990, according to the IMF. Next, Kalb remarked that 53 SWFs had been established since 2000, 40 since 2005, and concluded with studies to show that SWFs and sovereign pension funds averaged at over $100bn under management.
“Sovereign wealth funds represent a large and growing pool of savings. An increasing number of these funds are owned by natural resource–exporting countries and have a variety of objectives, including intergenerational equity and macroeconomic stabilisation”, according to a World Bank working paper on long-term development finance. “Traditionally, these funds have invested in external assets, especially securities traded in major markets. But the persistent infrastructure financing gap in developing countries has motivated some governments to encourage their sovereign wealth funds to invest domestically.”
The points here are proof, if ever it were needed, that SWFs have become a fixture of modern day financial markets, and on a day when asset managers are fighting for quick returns, SWFs could alter, perhaps fundamentally, the way in which institutional capital is managed.
$7.7trn
Assets held by 74 highest ranking SWFs, 2014
53
New SWFs established since 2000
Much attention has been paid recently to the rate at which assets are gaining, though the ambition for any SWF is not simply to stockpile funds, but secure a future for generations ahead, and it’s in emerging Asia, Africa and the Middle East that this focus can best be seen. Where major resource discoveries can often bring both volatility and corruption for host nations, a well-balanced SWF can keep a lid on wayward ambitions and protect wealth far into the future. Faced with a much-changed landscape from that of 10, five or even one year ago, institutional investors are evolving in what ways they can to generate meaningful returns, though often to little avail.
The intergenerational focus of SWFs, meanwhile, makes them a very different proposition to that of their privately owned counterparts, yet these government-run alternatives are more closely aligned with traditional asset managers today than they perhaps ever have been.
Studies show that SWFs are dabbling, increasingly so, in opportunistic investments, if only to keep tabs on the latest changes to capital markets, and alternative investments account for a larger share of the pie. Developing nations, particularly those rich in natural resources, are finding also that SWFs can serve as a key source of funding in low price environments and lay the foundations for sustainable development. Add to that a growing tendency to keep investments local, and “the secretive and exclusive subset of the institutional investor community”, as labelled by Preqin, has undergone a quite extraordinary transformation.
Norway out in front
“One day the oil will run out, but the return on the fund will continue to benefit the Norwegian population”, according to Norges Bank Investment Management, whose job it is to manage Norway’s Government Pension Fund Global (GPFG).
Currently the world’s largest SWF, the fund has proven itself a precious financial buffer in times of economic hardship, best seen at the beginning of the year when assets peaked and oil prices fell through the floor. At the same time, the total number of assets under management tipped the NOK5.1trn ($675.88bn) mark, equivalent to over NOK1m in local currency for every member of the population, amounting to a significant – albeit essentially meaningless – milestone for the savings pot. Fast-forward to the end of 2014, with the fund sitting at $893bn (see Fig. 1), it’s little surprise that new entrants to the subset often cite the GPFG as an example of how best to manage state-owned assets.
Another important development arrived recently when the country allowed those working at the fund to invest in real estate, rather than equities and fixed income only. Marking a paradigm shift, not just for the GPFG but the wider SWF community, over two percent of the fund’s investments fall on real estate currently, with the percentage primed to reach five in the near future.
“It’s a global trend, the shift toward real assets that provide investors with diversification, inflation hedging, asset backing and more operational effort than some bargained for”, according to PwC’s The Real Estate Equation. “Real estate attracts a significant proportion of global capital raising the challenge of bridging global demand with local supply and micro environments with macroeconomics. Sovereign wealth funds certainly face this challenge.”
In essence, what the focus on real assets brings is a far greater emphasis on local investment. SWFs, historically speaking, have invested overseas to hedge against home-grown crises, though their role in supporting domestic development means that they’ve tended recently to champion subjects closer to home. True, domestic objectives can sometimes diverge from the greater goal of capital preservation, but improvements on home soil often go some way towards mitigating long-term risks and cementing a stable base on which future generations can build.
Infrastructure investments
Closely in keeping with this focus on local investment and real assets is one on infrastructure, for which their long-term investment horizons are well suited. “Potentially competitive returns in developing economies and the sharp reductions in traditional sources of long-term financing after the financial crisis have contributed to fuel a growing interest among national authorities in permitting, and even encouraging, the national SWF to invest domestically, in particular to finance long-term infrastructure investments”, reads a World Bank report on the constraints of infrastructure financing. “Such pressure is inevitable, considering the fact that many countries with substantial savings, several of them recent resource-exporters, also have urgent needs. A number of existing SWFs now invest a portion of their portfolios domestically and more are being created to play this role.”
Preqin estimates show that 60 percent of SWFs allocated capital to infrastructure projects in 2014 (see Fig. 2), far greater than the 16 percent in 2011, as participating countries look inwards when arriving at how they might distribute capital. “Alternative assets have emerged as an increasingly important portion of the portfolios of many sovereign wealth fund investors over recent years, as these investors seek to diversify their portfolios and acquire assets that can generate yield and help them meet their long-term objectives”, according to the data and research firm.
The case in point can best be seen in resource rich nations, where fast-growing mining sectors require also that host nations improve their infrastructural competencies. In Abu Dhabi, some $30bn has been allocated to infrastructure, and both Angola and Nigeria have done much the same, albeit to a lesser degree, with $5bn and $1bn respectively. Occupied not so much with the pursuit of liquidity, long-term returns such as those on infrastructure have been made to appear all the more attractive in light of the financial crisis and recent oil price shock.
Changed reception
Any decisions made by SWFs in this instance are in keeping more so with development finance institutions than they are say hedge funds, and sustainable economic development not liquidity takes precedent in the here and now. Going back to before the financial crisis hit, SWFs were met with a note of caution. However, the part played by these government-run investment vehicles in the aftermath, both in developed and developing nations, means that these government-run investment vehicles are received more positively.
“It is difficult and unwise to generalise about the (financial) performance of SWFs and my expertise is with respect to transparency and accountability where the trend is toward improvement by many funds”, says Edwin Truman, economist and nonresident senior fellow of the Peterson Institute for International Economics.
It’s worth noting also that not all funds have been resilient recently. Truman points to Russian funds, which have been raided for political purposes, and oil-based funds, which are suffering reduced inflows. “But some funds have I think swum against the tide of general market caution”, he says.
Though blighted still by criticisms of inadequate governance and poor transparency, what’s certain is that SWFs have carved out a niche in global financial markets since the crisis. And in a period when past funding models of a more traditional sort are failing, SWFs and their long-investment horizons mean they’re well endowed to thrive in the present climate. With transparency and accountability much improved on years past, the new inward facing nature of SWFs means that they have fast become an important part of sustainable economic development.
Nestled within Central Africa, the Democratic Republic of Congo, one of the continent’s largest democracies, has enjoyed tremendous economic growth over the past three years. Under the leadership of President Joseph Kabila and Prime Minister Augustin Matata Ponyo Mapon, the once war-afflicted nation is now becoming a beacon of prosperity. Throughout the massive nation, approximately the size of Western Europe, development is evident as the middle-class continues to rise, infrastructure projects develop and investors looking for sustainable returns come by the droves in search of opportunities.
The Democratic Republic of Congo has been one of the leading economies of Sub-Saharan Africa and is showing no signs of slowing down. “I was impressed by the progress made over the last five years in bringing about economic stability and robust growth, which resulted in the DRC recording the third fastest growth rate in the world in 2014”, said David Lipton, First Deputy Managing Director of the International Monetary Fund (IMF). “I was also encouraged by the authorities’ intention to build on this record and to transform the Democratic Republic of Congo into a more inclusive economy.”
Diversifying the economy and developing human capital have both been a hallmark of
Ponyo’s campaigns
As this growth compounds, cityscapes throughout the country are beginning to take shape, while the middle class is growing at an unbelievable rate. The livelihood of Congolese citizens is improving and this change is directly translating into improved human development indicators, as well as higher rates of education and healthcare.
Known for its abundance of natural resources, estimated to be worth more than $24trn, the nation has progressed significantly as its economy has diversified to expand its vast agricultural and human capital potential.
The meteoric rise of one of Africa’s largest and most prosperous nations has been underway for years. Underpinned by strong governance, a diversified economy and an ambitious modernisation plan, the nation of 70 million is on the cusp of an unprecedented emergence as an African superpower. The rise of the Democratic Republic of Congo signals an evolution of the continent as a whole and offers a look at what Africa can come to represent.
An economic superpower
The economic state of the Democratic Republic of Congo is at one of the best points in its history. In 2013, the nation’s GDP grew by 8.5 percent according to the World Bank (see Fig. 1), while growth in 2014 was measured at 9.5 percent. Prudent monetary policies have not only encouraged this growth, but have kept inflation at one percent, the lowest inflation rate exhibited since the nation’s independence over half a century ago. “Our economic performance is the strongest since the 1960s”, said Prime Minister Ponyo. “We have an inflation rate from January to the present of just 0.3 percent.”
In addition to the impressive growth figures, other macroeconomic indicators show encouraging signs of progress. The nation’s currency, the Congolese franc, has remained stable, the national wealth has doubled due to more efficient tax collection, and, perhaps most importantly, public and private investment has increased significantly.
To promote sustainable economic growth, Ponyo and President Kabila have worked closely with members of the international community using evidence-based analysis to enact legislation and improve the country’s business climate.
These changes range from creating transparent processes, minimising bureaucracy when starting businesses and creating anti-corruption programmes. The changes, among many others that are still in progress, have been instrumental in creating an investor-friendly environment and opening up numerous sectors throughout the country to private investors.
Kabila’s latest example of creating a more favourable business climate can be seen in his efforts to tighten controls on granting mining licenses to prevent abuse and fight corruption. Improper control mechanisms have led to underdevelopment that has cost the country in tax revenue and in the livelihood of citizens throughout the mineral-rich portions of the nation.
According to Kabila, “We need to put an end to the paradox which sees huge mining potential, and ever more intense mining activity, but only modest benefits for the state.”
He later added that some of the mismanagement “had negative consequences for the improvement of the population’s living conditions”.
Congolese workers at a processing plant used to extract copper, cobalt and iron
Mining matters
In July 2014, the Democratic Republic of Congo earned full membership to the Extractive Industries Transparency Initiative (EITI), the global organisation promoting good management of oil, gas and mineral resources.
“Despite all the challenges facing the country, the Congolese people have been working together to bring transparency and accountability to the management of their natural resources”, said Clare Short, the group’s chair.
Diversifying the economy and developing human capital have both been a hallmark of Ponyo’s campaigns. “While the country is very wealthy in natural endowments regarding mineral resources, it is imperative to diversify beyond this wealth alone to propel the Democratic Republic of Congo to a state that can compete economically on a global scale”, he said.
Mining, for example, has attracted foreign investors from the US, South Africa, India and Turkey, which in turn, has fuelled growth within supporting sectors such as banking, digital commerce, and mobile services. The Democratic Republic of Congo possesses world-class quantities of copper, diamonds and coltan, a dull, black mineral used in virtually every electronic device.
“Building a strategic vision for long-term development requires sound political leadership, tireless reform efforts aimed at reinforcing the quality of the administration and vital institutions, and adhering to the rules and practices of good governance regarding our natural resources”, said Ponyo.
Already a vital industry throughout the nation, agriculture contributed 20.6 percent to the country’s GDP in 2013 (see Fig. 2), but Ponyo is seeking to boost the sector even further. His aim is to provide the Congolese ample opportunity to create an agricultural sector unrivalled in Africa.
By using the nation’s water, land and energy resources, the Democratic Republic of Congo can develop an industry of commercial farms offering fishing, livestock and vegetable production, connected to a coherent network of production and food distribution.
Strategic investments and planning can potentially propel the nation’s economy even higher by fortifying the export market, while also helping the fight against hunger and malnutrition throughout the country. These investments, both by the government and the private sector, will provide thousands of jobs bring broad education to the masses and enable a generation of Congolese to develop and become self-sufficient.
Earlier this year, the country hosted a conference in Kinshasa to address the role of agriculture to the growth of the continent as a whole. The conference – called Towards an Inclusive Growth: A New Vision for Africa’s Agricultural Transformation – brought together more than 300 people from across Africa, Europe and the US. Attendees included entrepreneurs, financiers, officials, donor funds, NGOs, foundations and farmer organisations.
To support agriculture and encourage private-sector participation, Ponyo developed and launched a nationwide programme known as the National Agricultural Investment Plan (NIPA). NIPA’s main objectives are ensuring food security and developing the agri-business sector. Its first project will be the development of 16 large agro-parks.
According to Councillor John Mususa, one of the leaders spearheading the project, “These parks will serve as an important part of the country’s rehabilitation and construction process by providing access to agricultural inputs and by combining laboratories, training facilities, storage centres and health facilities.”
“The agricultural sector is where we can have the most significant impact on the population”, said Ponyo.
Energy sector
As the Democratic Republic of Congo looks to capitalise on its economic momentum, the nation’s energy sector is attracting the attention of international investors especially as its large-scale mining and industrial sectors continue to see significant growth.
Paramount to the energy future of the Democratic Republic of Congo and the African continent is the Inga Dam Project, which is one of the largest infrastructure projects ever undertaken. The centrepiece of the project, the Grand Inga Dam, will be the world’s largest hydropower project and is an instrumental part of Africa’s future energy strategy.
The dam has the potential to generate 38,000MW of energy at a cost of $80bn. It will help power South Africa, Botswana and Angola, and will ultimately be able to export power to Europe. The first part of the project, Inga III, will top off at a nameplate capacity of 4,800MW.
In 2013 the US formally expressed interest in joining the project and is currently engaged with foreign counterparties as studies are being conducted. Rajiv Shah, the Head of the US Agency for International Development (USAID), visited the site of the future dam in 2013 with Ponyo and pledged financial aid to help develop the project.
After visiting the Inga site, Shah remarked that in addition to seeing progress in building the country, his visit was met with numerous positive signals in terms of peace and the promotion of good governance. “The reforms in the electricity sector are signals that reassured USAID and other partners to join this project”, said Shah, who welcomed the significant progress made to improve the business climate. Shah also encouraged the nation’s leadership to stay on the path of reform and substantial innovation to attract more external partners for large-scale projects.
While the amount of money to be earmarked from the US to support the Inga Dam project is still being negotiated, officials note that the task will have support from both the public and private sectors. According to Eric Mbala, Head of the Congolese National Electric Company (SNEL), the development work for the Inga III project will begin in October of 2015.
Democratic Republic of Congo’s President Joseph Kabila
Planning for sustainable growth
Kabila has vowed to continue guiding the Democratic Republic of Congo into the next phase of development by enforcing good governance and seeking to create a better environment, both for the Congolese people and foreign investors.
Seeing the need to make quick and long-reaching reforms to unite and inspire the country following national tragedy and civil strife, Kabila and his trusted advisors began to rebuild the fabric of the nation by creating a framework to help facilitate economic growth, improved welfare for the Congolese and a national identity that would help drive these changes forward.
The efforts to provide quality healthcare, education, electricity and infrastructure to meet the everyday needs of the people serve as the greatest task for Kabila and his team of leaders.
Under this framework, entitled Les Cinq Chantiers de la RDC (The Five Pillars of Congo), Kabila developed a long-term plan to improve domestic welfare through modernisation efforts, improve the country’s trade policy with foreign governments and boost domestic investments and capital flow to his country.
Improving infrastructure, education, electricity, higher employment and housing are the key components of the nation’s modernisation and long-term growth strategy.
Under the Les Cinq Chantiers framework, Kabila also vowed to improve the infrastructure of the nation. In perhaps one of the most prolific changes to turn around the failing commercial aviation industry, he encouraged the creation of new airlines to fill the quickly growing demand for cost-effective, yet safe aviation options.
From this idea, and the vision of businessman George Forrest, came Korongo Airlines. In a partnership with Brussels Airlines and its parent company, Lufthansa, this airline will help fill a gap in the Central African aviation industry and help overhaul the nation’s growing industry. Following the creation of this airline, Kabila’s work resulted in discussions with Air France to partner with local airlines to create a pan-African network based in the Democratic Republic of Congo.
Acknowledging the nation’s commitment to aviation, Ethiopian Airlines, the second-largest air carrier in Africa, opened a hub in the country’s main airport, N’Djili Airport.
“The Congo is a large country and a large market. While peace has been a problem, there seems to be a better situation developing”, said Ethiopian Airline CEO Tewolde Gebremariam. “We think it’s going to attract a lot of foreign direct investment, and it’s right in the middle of Central Africa.”
According to the IMF, in recognition of the need for better governance, many resource-rich countries in Sub-Saharan Africa such as the Democratic Republic of Congo have made a great deal of progress in the quality of their institutions over the past years. In fact, over half of the natural resource providers have improved their World Bank Worldwide Governance Indicator ratings on rule of law and corruption, and about 40 percent of these countries have improved their ratings on government effectiveness.
Perhaps one of Kabila’s greatest achievements, however, was choosing a tremendously capable prime minister in Matata Ponyo Mapon. Formerly the nation’s minister of finance, Ponyo has become a popular figure, garnering tremendous praise both within his country and the international community. As a technocrat with the ability and passion to bring change to the nation, Ponyo, a firm believer in stability and the private sector as the key to growth nations, has worked to encourage free enterprise throughout the Democratic Republic of Congo.
During his tenure within the ministry, Ponyo helped change the investment climate of the nation and began enacting newer measures to protect shareholders and boost capital flow to the country.
Aware of the magnitude of the task at hand, the government of the Democratic Republic of Congo is working on innovative mechanisms to address the challenges of development in order to propel the country towards accelerated growth. In collaboration with Harvard University, Ponyo gathered with thought leaders from around the world, ranging from professors to government leaders, to help shape policy and debate ideas for sustainable growth.
The Congolese government and private sector have worked together to launch the Kinshasa International Economic Forum, an annual event created to discuss lessons learned from successful experiences of other counties on governance and economic growth. In early January of this year, the nation hosted a team of economists and professors from the US and Europe to discuss inclusive growth needed to drive the nation forward.
Long-term vision
The prime minister understands that future of the Democratic Republic of Congo rests not only on the government, but on a public-private mandate to create opportunities and growth, which can only occur when the rule of law and governance allow for the rights of investors and citizens to be protected.
Within his first term as prime minister, Ponyo focused his attention on key initiatives that would help the nation prosper. From bolstering the legal system by implementing investor-friendly regulations, to lowering corporate taxes and decreasing the amount of bureaucracy for starting and running enterprises. The prime minister followed through on his goals to show the world the potential of the Democratic Republic of Congo under proper governance.
Taking advantage of this improved business environment, OM Group (OMG), an American cobalt refiner, became the first western investor to work within the Democratic Republic of Congo after the nation’s civil war. In addition to more than $300m in cash flow provided to the nation in taxes, raw materials and electricity, the joint venture between OMG and Gecamines, the state-owned mining enterprise, has created over 400 jobs for the local Congolese miners. The company’s executives praise Congo’s leadership as forward thinking, and advantageous to business and foreign investments.
“The business climate in the DRC has improved significantly over the past 10 years since Kabila came to office. He has done a good job, but there is still much to do”, said Steve Dunmead, Vice President and General Manager of OMG.
As the Democratic Republic of Congo continues to develop and create a wealth of opportunity for both international investors and its citizens, the development of business-friendly environments is vital in developing the country into the continent’s future superpower.
Fostering partnerships, a key aspect of the country’s growth, will be at the top of his list as he continues to work with international partners and development organisations to bring prosperity to the nation.
Through improvement of the business climate and development of the nation’s social sectors, the leadership of the Democratic Republic of Congo has proven its uncanny ability to accomplish goals necessary to bring progress.
By creating opportunities for the Congolese people and developing an environment to help businesses thrive, Ponyo is fulfilling his pledge to bring a new level of prosperity to the Democratic Republic of Congo. From subtle changes – such as decreasing the size of government – to the implementation of long-term energy frameworks, Kabila and Ponyo are leading the charge to show Africa and the world the true potential of the Democratic Republic of Congo.
Coltan from the rich deposits of Masisia territory in North Kivu, DRC
QE, so far, is said to have “boosted confidence, improved financial conditions, and contributed to a reduction in financial fragmentation.” However, it is also noted that volatility from Greece may require further action. The report notes that the situation in Greece is fluid and potentially subject to further negative developments, meaning that policymakers should be prepared to implement policies to “manage contagion risks.”
The external position of the eurozone is said to
have strengthened
“[P]olicy-makers should stand ready to deploy, and if necessary adapt, the full arsenal of available instruments,” according to the report. “[T]he ECB in particular should ensure that banks continue to have access to ample liquidity and maintain orderly conditions in sovereign debt markets. If financial conditions tighten significantly, the ECB should consider further loosening monetary policy through an expansion of its asset purchase program.”
The report notes that growth in the eurozone has picked up since mid 2014 and continued in 2015, pointing out that “private consumption remained robust, reflecting rising employment and real wages, while fixed investment has expanded,” with growth in Germany at 1.5 percent, while Spain, Italy and France have also seen activity pick up. Very low inflation is also expected to have bottomed out, hovering just above zero this year before rising to 1.1 percent in 2016. Early 2015 saw consumer and business spending pick up, stemming from the trough in oil prices.
The external position of the eurozone is said to have strengthened, with the current account having posted a surplus. The weakening of the euro in 2015 “has been beneficial given the economic cycle,” the IMF says. However, “the currency is now moderately weaker than the level consistent with medium-term fundamentals.” This can be remedied by “a broader reform agenda that strengthens growth and inflation would contribute to a gradual strengthening of the real exchange rate over the medium term,” along with appropriate monetary policy.
It is also pointed out that external imbalances within the eurozone remain, noting that although the current account positions of debtor nations has improved, owing to a lower exchange rate and labour unit costs, “rebalancing has failed to take place among creditor countries with the large current surpluses of Germany and the Netherlands continuing to grow and moving farther away from levels implied by medium-term fundamentals.” Rebalancing will require “addressing excess saving and weak investment in creditor countries, while improving further the competitiveness of debtor countries.”
A group of 13 major US companies have signed up to the government’s climate change pledge as part of the American Business Act on Climate Change, and in doing so stepped up the nation’s leadership in the lead-up to the UN’s Paris Summit this December. Supporters include Apple, Berkshire Hathaway, Goldman Sachs and Bank of America, and these names, together with nine others, have agreed to sink $140bn into low carbon investments and make efficiency gains where possible.
“We recognise that delaying action on climate change will be costly in economic and human terms, while accelerating the transition to a low-carbon economy will produce multiple benefits with regard to sustainable economic growth, public health, resilience to natural disasters, and the health of the global environment,” according to a White House statement. The statement notes also that “hundreds of private companies, local governments, and foundations have stepped up to increase energy efficiency, boost low-carbon investing, and make solar energy more accessible to low-income Americans.”
The country has committed to an emissions reduction of 26 to 28 percent before 2025, going by 2005 levels – that’s according to the country’s national climate action plan and emissions pledge, submitted to the UN earlier this year. The latest announcement underlines the private sector’s commitment to this same end and raises hopes that others might follow suit, with many more expected to join the so-called American Business Act on Climate Change this fall.
Alongside the $140bn in new low-carbon investments, the companies have agreed to install 1,600MW of additional capacity, whilst also cutting emissions as much as 50 percent, water intensity as much as 15 percent and committing to zero net deforestation in their supply chains.
Highlights:
Bank of America
Expand environmental business initiative from $50bn to $125bn by 2025
Attract a wider array of capital to clean energy investments
Berkshire Hathaway Energy
Build on more than $15bn investment in renewable energy generation through 2014 by investing another $15bn
Retire over 75 percent of coal-fuelled generating capacity in Nevada by 2019
Goldman Sachs
Achieve goal of $40bn investment in clean energy globally within the next year and establish a larger target for 2025
Aim to use 100 percent renewable power to meet global electricity needs by 2020
Google
Commitment to powering operations with 100 percent renewable energy and triple purchases of renewable energy by 2025
Targeting a 30 percent reduction in potable water use by Bay Area headquarters in 2015
Apple
Bring an estimated 280MW of clean power generation online by the end of 2016
Already succeeded in running all of its US operations on renewable energy
Finding the right stocks that offer the best return opportunities in the market is a challenging task. We believe that attractive valuations, improving profitability and balance sheet strength are clear signals of stocks with great return potential. However, achieving high information ratios for our clients’ portfolios requires not only the selection of great opportunities, but also the efficient management of risk.
Managing tracking errors and active weight is a key part of the process. At Sura Investment Management Mexico, value investing has a long-term approach that also requires the understanding of industry dynamics and an in-depth discussion of business prospects, with the help of company management to incorporate conservative and reliable assumptions in our models.
Our philosophy is focused on generating consistent superior risk adjusted performance, both against the market and our peers in medium to long-term horizons. We believe that active management generates attractive results, and in particular, in less efficient markets such as the Mexican equity market. To be able to extract consistent alphas, we have a dedicated team of portfolio managers, analysts and traders that focus on the local market, constantly in contact with companies and approaching valuations from a fundamental view.
Stock price allocation
There are plenty of opportunities in the local market, but there are also a lot of different risks. Capturing alpha requires a deep knowledge of both the companies and the market itself. Macroeconomic trends as well as individual microeconomic forces, changing regulations along with significant inflows and outflows all play their part in the setting of stock prices. Our aim is to provide our investors with the best vehicles for obtaining exposure to the Mexican markets, and our track record is a clear example of our focus.
Exchange rate behaviour is an important variable affecting business performance
Mexico has a market capitalisation of about $500bn, and remains a highly concentrated market – the 10 biggest firms represent more than 50 percent of the total market.
Our approach has been to marginally increase our performance based on valuation scrutiny and discipline, as well as to include some mid and small cap firms which offer more opportunities in mispricing as liquidity and efficiency are lower in those segments. In the last two years we have seen that the mid and small-caps index outperformed the main index. We believe this is due to the fact that the earnings growth in large caps has been low compared to the rest of the market.
In the last couple of years economic growth has gradually decreased as a consequence of lower disposable income that was affected by the fiscal reform, low productivity growth and the fact that fluctuating oil prices have also decreased the attractiveness of investments in the country (see Fig. 1). Of course, mid and small cap stocks also exposes the investor to wider risks, which is why being selective and limiting exposures is a key ingredient for being successful.
The Mexican market is quite expensive, and the IPC Index is trading at 20 times ahead of the P/E multiple based on consensus figures; which we believe have the relatively high weight of staples in the index at approximately 30 percent, and is one of the reasons for this high valuation. The implied growth of the IPC multiple based on the Gordon Growth Model stands around 8.1 percent – which is fair given that sales estimates are projected to grow at about 10 percent CAGR for the next five years.
In the last couple of years we have seen earnings revised down and the index multiple trading at the same level, the main reason bring that the performance of the IPC has been marginal. Going forward the multiple expansion seems challenging, and earnings per share (EPS) growth has not performed as expected. However, we have seen small and mid-cap companies that have over performed in the market because of multiple re-rating supported by continued fundamental improvement and better net results. Here is where the equities team at Sura strives to position its competitive advantage in the process of screening companies with high intrinsic value and sound fundamentals, always with a strong focus on risk management.
Investing in real estate
One sector that we have been looking closely at is real estate, as last year the FIBRAs (real estate investment trusts, known as REITs) index had an over performance of 16 percent against the IPC – where both local and international investors piled in this relatively new segment of the asset class and raised about $6.5bn in equity since the beginning of 2013. Currently there are nine FIBRAs in the market, and they are a growing asset class with still plenty of cash for deployment. We at Sura prefer holding FIBRAs that trade at levels near or below NAV in our estimates. Particularly, in FIBRAs we like the USD exposure given that some rents are USD denominated and the inflation protection we get as renters are mostly linked to increases in CPI. As a caution, FIBRAs have a high exposure to rising interest rates, as many investors see it as a substitute for bonds. This might become a vulnerable element for the segment going forward.
In general, our outlook for the Mexican equity market in 2015 is quite conservative, as we argue that EPS growth has been quite low in the last couple of years and although we expect a higher growth rate going forward – it will be at single-digit growth rate. Additionally, multiple re-rating seems difficult to assimilate, as no short-term catalysts are visible. In sectorial terms, we have higher conviction in firms with exposure to the US manufacturing industry (such as industrials), real estate and consumer discretionary that we expect will offer much better dynamics in EPS growth.
Weak economic growth in Mexico has also been due to lower public infrastructure spending as well as lower private construction activity, a remnant of the homebuilders collapse. Low construction activity has also impacted consumption and job loss, and despite better consumer data for food retailers with SSS increasing above inflation at the beginning of the year, we still believe valuations don’t reflect fundamentals and long- term EPS growth. So far the earnings momentum hasn’t crystallised, and the big question is how to be bullish in stocks with earnings growth at single digit rates trading above 25x forward P/Es. That’s the reason we prefer stocks with high cash generation and multiples adjusted for growth at relatively attractive levels.
One relevant issue for the equity market is the magnitude of the impact from the energy reform in potential GDP. Certainly, expectations have decreased because of the oil price collapse, but we still believe productivity gains from lower energy prices such as natural gas, gasoline and electricity will contribute in the medium-term to the improvement of gross margins of many firms. There is a lot of uncertainty in the timing of significantly higher investments in the energy sector – economists are estimating three to five years to see higher investment figures – however, we prefer to manage the expectations in a relatively moderate way.
Moving on, there are expectations of new firms coming to the market this year, with Mexican Stock Exchange officials mentioning around 10 deals between IPOs and follow-ons. New deals have been a source of alpha for Sura clients as we have found attractive opportunities in new issuances in the past. The equity that has been raised since the beginning of 2013 has amounted to nearly $22bn, which represents a significant amount of new flows given the size of the local equity market.
Exchange rate behaviour is an important variable affecting business performance. In general, companies that have a top line income in USD and COGS in MXN are always a good hedge against any sudden depreciations in the peso. Industrials, real estate and financials are generally our preferred sectors when we believe the peso will depreciate in the future, such as the current environment. On the other hand, if the peso is expected to appreciate, discretionary, staples, telecoms and materials are our favourite sectors.
Interest rates and inflation expectations also impact strongly in our investment decision process. For 2015 the 10-year inflation break-evens are at 280bps and our view is that inflation will end slightly above BANXICO’s target of 300bps, heading to 350bps. The monetary policy in Mexico will aggressively follow that of the US as the fixed income holdings from foreigners are at historical highs. This means FIBRAs could underperform if the FED liftoff takes place during 2015, which is our base case.
Even if the market looks expensive as a whole, there are still very good opportunities for extracting value in Mexican equities. Careful risk management, discipline and medium term horizon is a must, now more than ever since volatility is returning to global markets, but a focused team with a solid investment philosophy and process will make a big difference. Sura also has a presence in several markets across Latin America, reinforcing our competitive advantage in the region since we have teams of professionals based in each country. Synergies across Sura investment teams means there is a regional view that is more definite than any top-down alternative.
Brazil’s multi-layered tax system is long overdue for reform. And the country is finally trying to simplify its processes, says Leonardo Braune, Managing Director of Intercorp Group. But by bringing Brazil’s taxes in line with jurisdictions like the US and UK, the country is risking its competitive edge.
World Finance: Juggling assets and tax liability is no easy feat – but it’s something Brazilian Intercorp Group has mastered. With me to talk about navigating the Brazilian tax system is Leonardo Braune from the firm.
Well Leonardo, you deal primarily in tax; so, this is a major issue at the moment, with avoidance and loopholes dividing opinion. So how do you approach this?
Leonardo Braune: The approach is first of all to try to understand the client’s demand, and see exactly what they’re concerned about.
And then based on that, we try to match their needs with what we know in terms of the multiple jurisdictions where they may be operating from. And based on that, we try to come up with a plan that will involve sustaining efficiency, while at the same time keeping compliant. That’s the juggling that’s very difficult: how far can we stretch the efficiency side without crossing the line of the compliance?
And once we get that out of the way, then things go smoother with the client.
World Finance: How is the Brazil tax system structured, compared to other leading jurisdictions?
Leonardo Braune: Brazil has a very complex tax system – and complex I guess is a definition that applies to most tax systems! The difference in our case is that we have many taxes – over 50 different types of taxes – so the collecting system is different, the types of returns you have to file is very different.
Brazil comes from an inflationary background. And as a result of that, the need for the government to collect is actually careful, because in addition to wanting to collect taxes, they were very afraid of not being able to collect taxes in time, given the inflation. So the whole system was designed to almost calculate tax very much at the time they’re due.
So unlike the UK, for example, where the tax year ends in April, and you can file your tax return up until January; in Brazil, taxes must be paid on a monthly basis in advance. Because the tax return is really just a compilation of the process.
That makes the burden on the tax payer much higher. Because they have to file their returns, do the information, process everything on time. So this is one side of it, the compliance side is very hard.
The other side is just different issues with the taxes. Because what happens is, you have municipal taxes, state taxes, federal taxes. Sometimes you have a double layer of taxes – they don’t offset each other. So we’re trying to simplify all of that, and maybe come up with a general VAT tax system, and fewer taxes involved, and just splitting them between the different entities.
World Finance: You work for high net worth individuals; what sort of challenges do they face, and how do you assist?
Leonardo Braune: High net worth individuals are always trying to juggle between two main concerns: the income tax bracket they fall in, not getting caught up in multiple double-taxing situations, and also not getting caught by inheritance tax. Because there’s a high dispute in the US and the UK on inheritance tax issues. Brazil, just for you to compare, has a tax rate of four percent when it comes to inheritance: compared to the UK where it’s 40, the US where it’s 40.
We’re now discussing changes in that area – there may be an increase in that rate from four to 16 or 20 percent.
So the high net worth individual is always worried about keeping their high net worth as high as possible, and not being impacted by the different laws. And with cross-border changes, and the kids moving abroad, the business expanding? That becomes very complex.
That’s exactly where we come in: trying to help out, making sure that the business still stays efficiently tax-compliant.
World Finance: So how do you tailor your services to the individual?
Leonardo Braune: Basically the first thing we do is, we spend a lot of time understanding the business itself, and the individual needs, and what their approach is. We don’t simply put the rules on the table, and try to just tell them, ‘Look, this is what the tax law says’.”
Our job is to take advantage of the knowledge we have of the tax legislation, learn from the individual what his business is all about, and then try to guide them through the process.
So our approach is very unique. We spend a lot of time doing business consulting, and understanding the business. And then just simply apply what’s best from what we know. And that’s what makes us different from most of the other companies.
World Finance: And when it comes to client investments, how do you handle these?
Leonardo Braune: Well, the first thing we have to do when one talks about investments is understand, what’s the goal? And there’s a few things that are very relevant.
First of all is, how much risk is the client willing to take, versus how much risk they need to take? And also, how much risk they understand. So, it’s all about risk and goals. Some people may want to basically multiply their wealth through the investment strategy. That means they have to take higher risks – but they must be willing to lose something.
Others just want to preserve the wealth, and just basically maintain capital: that’s a whole different approach.
So again, it’s all about understanding the goals. The methods are all available, and the different approaches can be taken. But balancing objectives with the actual tools we’re going to use is what’s really key in the process.
World Finance: And finally, how are new government tax incentives impacting your clients and business?
Leonardo Braune: Well first of all, Brazil is not a country that has a lot of government incentives, unfortunately. What’s happening right now is, we’re going through a big change in terms of adjusting to the global tax systems. And as a result of that, we’re going through an increase in the tax rates, and the tax burdens in general.
So inheritance tax is probably going to grow. We’re discussing an asset tax, we’re discussing an increase in the income tax. Not much of an incentive there, but also the other way around. It has triggered a lot of ultra high net worth individuals to consider moving out of Brazil.
And actually, because, if Brazil becomes more compatible with the other jurisdictions like the UK and the US in terms of how high the taxes are, then other things play an effect on the decision of where they want to live. Security. Personal issues. The economic benefits.
So that’s a big challenge: from one end the government wants to tax more; from the other end, they can’t reach too high, because if they do people will move around and just simply look for a more beneficial relationship overall.
Tighter regulations, rising costs, and as with most industries – technological innovation – are sending ripples throughout the global car industry. As a result of economic pressures, rising commodity prices and slowing growth in some areas, the markets themselves are shifting. Traditional players, such as Europe and Japan, are showing stagnation, while others, including Russia and Brazil, are bowing to macroeconomic constraints.
Elsewhere, China – now the largest market for automobiles – continues to grow, albeit not as fervently as in recent years, while the US is showing signs of stability and optimism for the coming year ahead. Yet all markets, despite their individual nuances and various stages of maturity, face the same overriding challenges to meet evolving regulatory and user demands.
Technological drive
Consumers have come to expect the latest technology features in all aspects of life, putting electronic content and connectivity with personal devices at the forefront of current demands within the industry. This creates a huge challenge for manufacturers as production lead times can range between three to five years, whereas rapidly changing technology can become out-dated in a matter of months. “The intersection of what is really a digital world – a semi-conductor, micro-electronics world – which moves along at Moore’s Law, is very antithetical to the automobile world”, says Evan Hirsh, Vice President at Strategy& and specialist in the automotive sector.
This contrast between the two industries has led to something of a convergence, with more tech companies venturing into the field, most notably Google with its self-driving car, and far more vehicle manufacturers seeking partnerships in order to stay ahead of the game. “For the last 100 years, most automotive solutions have been developed by automotive companies – what we’re seeing increasingly over the last two to three years, is that suddenly, a lot of the solutions have become technology solutions”, says Phil Harrold, automotive expert for PwC.
This technological drive and transformation in consumer expectations does not only involve the experience within a vehicle, but extends prior to the purchase as well. As such, the assimilation of information and culture of online shopping has also infiltrated the automotive industry. Although customers still consider the test drive a deciding factor, increasingly more aspects of the purchasing process are carried out online.
Despite this change in consumer behaviour, the industry has been relatively slow to keep up in this regard, “you wouldn’t say that the automobile dealers are a leading edge in terms of retailing”, Hirsh comments. Yet, fully embracing this culture of digital interaction could also offset another road humps facing the industry – a decline in brand loyalty.
At present, consumers have become more concerned with cost savings rather than maintaining a life-long allegiance to one brand, as was the case some years ago. In order to rebuild these long-lasting relationships, manufacturers must offer more in terms of services throughout the vehicle ownership, beginning with internet platforms that can permit greater engagement.
The safety belt
Increasing austerity in terms of environmental and fuel efficiency standards, as well as safety requirements, is another growing burden for manufacturers. “These are very complex products – huge amounts of investment go into making them, so in terms of what you can and can’t do, these constraints get tighter all the time”, Hirsh explains to World Finance. Consequently, meeting European and US standards has become an onerous and costly process, which shows no signs of abating, resulting in substantial consequences to the sector and slimmer profit margins for producers.
At this juncture within the industry, there is a need for constant modernisation; by investing in R&D, firms can meet these continually changing requirements, while also taming mounting expenses: “The challenge is about innovating, keeping the product relevant [and] keeping costs down”, Harrold comments.
More rigorous competition has led firmly established brands to reassess their business models in order to stay ahead of rivals and keep up with global demand, in spite of growing overheads. Firms are unveiling more products, yet with fewer differences between them, as using the same platforms and vehicle architecture enables producers to reduce costs and share common components across different models. In addition to benefiting from economies of scale, platform modularisation also offers a wider portfolio for customers, which is vital in an increasingly competitive market.
Due to a point that is close to saturation in mature markets, such as the US and Europe, (or some would argue, one that has already been reached), growth has stagnated to around one and two percent. Although positive signs are being seen in the US and while the industry is “part of the American psyche”, as Harrold puts it, there is a limitation to the rate of growth that can be achieved in the foreseeable future. “The market has come back almost to its peak from the pre-recession levels; all of that pent-up demand has finally been satiated”, says Tim Healey, Automotive Analyst at Mintel. “It’s probably going to plateau and peter out a little bit, and that’s going to be a challenge for automakers going forward to try to maintain that momentum.”
To counter balance this slowing trend in advanced markets, Western manufacturers are entering new areas where they can experience much faster growth. “China has definitely been a boom to certain brands”, says Healey. Jaguar Land Rover, Audi and Rolls Royce recently have had huge success there for example. “That’s the luxury end of the market, so it’s typically business people and government officials”, Harrold explains. Moreover, this is just one of two prongs behind climbing sales, the other stemming from the indigenous market, with demand for smaller and more basic vehicles being met by Chinese own-brands, such as Chery and Geely.
Slow and steady growth
Despite its rapid growth, numerous challenges also exist in China, such as the sizeable import duties that foreign exporters have to contend with – leading some big players, including Audi and Jaguar Land Rover, to set up production there. As Harrold explains, “one of the peculiarities is that to enter into China, you really have to get into a joint venture agreement with local manufacturers, and so again the Western OEMs have to change their business model.” Alongside such complex market conditions, sales are also decelerating in China amid the country’s slowing GDP and an anti-corruption drive (see side bar). That being said, with a growth rate of seven percent it is still significantly higher than anywhere else in the world.
Even with new markets to revel in, the underdeveloped infrastructure of emerging economies such as India, presents a big obstacle. Furthermore, despite an expanding middle class and growing prosperity in these territories, there is a limit to a continuous upswing in demand. “I think then the big question is, what is the realistic level of market penetration or vehicles per household in many of these economies? Which don’t have the infrastructure that we have, [nor] the space that many of the early motorising countries have, and which frankly, would struggle to reach our levels of ownership”, says Peter Wells, Professor of Business and Sustainability at Cardiff University.
Even in the event of an enduring upward trend, there exist restrictions in the ability for manufacturers to keep up. Essentially, this is because rising commodity prices are a mounting burden to export-driven economies; “meaning that revenue expectations and balance of trade expectations are considerably reduced”, Wells tells World Finance. The car industry is notoriously resource heavy, requiring a huge level of investment and ongoing financing in order to keep moving. As it is seen as a key market in many economies, governments have a tendency in times of extreme pressure to prop up their respective automotive markets. “Governments have been quite sedulous in trying to support and generally encourage the industry, in terms of offering subsidies for electric vehicles, offering scrappage incentives, adjusting tax rates and so on”, Wells explains.
Such involved state support, despite growing production costs and arguably an unsustainable model, infers that maintaining this modus operandi cannot last forever – even in the most developed economies. Some experts believe that this is not the case and that such governmental policies will not continue into the future, given what technology can do for the industry. Yet, it is difficult to deny the possibility of reverberating market pressures and future recessions, as these macroeconomic phenomena are seldom unique.
The automotive industry has reached a point wherein safety and the environment have become pivotal aspects of the business that are demanded by the authorities, as well as the people – this is not a bad stage in societal development of course, but it does necessitate a re-haul in how cars are made and function. Governments still have a significant role to play in encouraging consumer acceptance of new technologies, such as electric and hydrogen fuel cell-powered vehicles, through the creation of complementary infrastructure and financial incentives. While some argue that self-driving cars can raise the bar in terms of safety and efficiency, in ways that man cannot.
Consequently, manufacturers must continue to develop safer vehicles with futuristic features that are less harmful to the environment. Meanwhile measures are also required to improve the production process, making it more cost-effective and far less resource heavy. This is particularly important for the growth models of emerging economies, which require a long-term vision with a greater internal focus that leans away from a commodity-led export market.
Only by transforming the automobile into something that meets these evolving expectations can the industry thrive. That being said, the size of each market remains finite, limited by population and wealth, and so only those players willing to adapt, evolve and perhaps even shrink, can journey through to the next exciting era of automotive history.
The “world’s largest macro hedge fund” Bridgewater Associates has expressed scepticism about the future of the Chinese economy. Talking to clients, the hedge fund’s founder Raymond Dalio said, “our views about China have changed”, reports the Wall Street Journal. “There are now no safe places to invest.”
Since June 2015, the Chinese stock market has tumbled
Dalio says that the recent stock market meltdown in China will negatively affect the country’s economic growth. Since June 2015, the Chinese stock market has tumbled. After reaching a high point in June, prices dropped off by almost a third, resulting in $3trn being wiped from the market.
The impact of this will be long lasting and widespread, says Dalio: “Even those who haven’t lost money in stocks will be affected psychologically by events, and those effects will have a depressive effect on economic activity.”
Despite the authorities stepping in and the worst of crash having passed, many foreign investors are choosing to pull out of China, as shown by “the latest ANZ/EPRF flow of funds report…for the past week to July 22,” Business Insider reports.
Further bad news for the world’s second largest economy also comes from the Caixin Flash China General Manufacturing Purchasing Managers Index. The index, an “indicator of manufacturing sector operating conditions in China,” showed that there was a larger contraction in China’s factory sector in July than there had been for the past 15 months due to a fall in orders and output. These figures cast doubt on official Chinese statistics, which put GDP growth at seven percent and have already been questioned for their accuracy.
Against the backdrop of the financial crisis, which is still causing repercussions that are felt across Europe, Liechtenstein stands out as a rare beacon for investor confidence. High-performance banking, together with an AAA rating from S&P and the absence of government debt, make the country an ideal destination for financial services.
In Liechtenstein, comprehensive fiscal support and a wide spectrum of products are on offer in a setting of assurance and protection that is unmatched in the region. World Finance had the opportunity to speak with Alex Boss, Chairman of IFOS Executive Management since 2007, a wholly owned subsidiary of VP Bank, about what makes Liechtenstein so unique as a financial centre.
What, in your view, are Liechtenstein’s advantages as a financial centre?
Liechtenstein is characterised by high-quality products and services, coupled with state-of-the-art infrastructure. The low level of red tape makes it possible to set up companies and implement products quickly, while the stable Swiss franc, free market economic policies and consolidated privacy protection, are extremely advantageous.
Moreover, the country’s track record of political continuity and social stability, combined with high creditworthiness, add to the prosperity of the financial centre.
Liechtenstein is characterised by high-quality products and services, coupled with state-of-the-art infrastructure
What characterises Liechtenstein as an investment fund centre?
The Liechtenstein investment fund centre benefits from a stable high-performance banking system and moderate taxation. The state’s investment fund laws place particular importance upon investor protection, while state supervisory authorities and audit companies are in place to monitor compliance. Then there is Liechtenstein’s EEA membership and its implementation of EU investment fund directives, such as the undertakings for collective investment in transferable securities directive (UCITSD) and alternative investment fund managers directive (AIFMD), which enable simple and discrimination-free access to the European market. Furthermore, thanks to effective cooperation between public authorities and financial institutions, internationally compliant investment structures can be launched quickly and efficiently.
How does the VP Bank Group position itself in the Liechtenstein financial centre?
The VP Bank Group is an international bank that focuses on asset management for private individuals and intermediaries. It is one of the largest banks in Liechtenstein, with client assets that totalled CHF38.6bn ($42.4bn) at the end of 2014.
The VP Bank Group, which is listed on the SIX Swiss Exchange, also has representative offices in six countries around the world: Switzerland, Luxembourg, British Virgin Islands, Singapore, Hong Kong and Russia.
What is the position of Internationale Fonds Service (IFOS) within VP Fund Solutions and what services does it offer?
The VP Bank Group offers its range of investment fund services under the VP Fund Solutions label both in Liechtenstein and Luxembourg. Clients benefit from having a central interlocutor that can draw upon the services of experienced, multilingual specialists in order to objectively assess an investment fund project. IFOS is the investment fund competence centre within VP Fund Solutions that offers comprehensive support for establishing investment funds, which includes advice during concept development, drawing up legal documents and communicating with public authorities.
IFOS offers investment fund administration and management services, including licensing for public sales abroad, realising tax transparency and publicising investment fund prices. It also collects data, which it manages along with client websites, as well as providing accountancy services.
Additionally, IFOS is responsible for handling VP Bank’s range of investment funds and the selection of third-party funds for asset management purposes of the bank and its private clients. This means that we have a team of investment professionals at our disposal that truly understand client needs and can offer unique solutions. Finally, IFOS offers risk management for UCITS and AIF investment funds through an investment committee of experts.
There is also the Pricing Committee, which assesses private equity valuations and due diligence obligations in conjunction with illiquid assets – compliance and risk reports on each net asset value round off the range of services we offer.
What are the grounds for launching a private label investment fund?
The private label fund can be individually structured and licensed to include investment policy, asset management, fee structure, marketing, sales and labelling – all in accordance with statutory provisions. The product is transparent and supervised and can be licensed for sale within the EEA and Switzerland.
How will IFOS be positioned within the private label investment fund unit in future?
IFOS currently has approximately CHF3bn ($3.3bn) assets under management in around 90 sub-funds under Liechtenstein jurisdiction; we continue to view both professionally established and managed investment funds as markets for growth. As an expert partner, IFOS serves asset managers and companies in particular who wish to realise infrastructure and real estate projects in the form of investment fund solutions.
What is your view of current regulatory developments within the context of European financial and economic policy?
The repercussions of the financial and economic crisis continue to be felt deeply in the real European economy to this day. When it broke out, the EU identified inconsistent rules, regulatory loopholes and unregulated markets as the core problem facing financial market policy. As a consequence, the EU reinforced its efforts to standardise the conditions for financial and capital markets, while at the same time created more coherent regulatory criteria for member states.
One of the first far-reaching EU measures created was the AIFMD, which was new in that it aimed to regulate the managers of alternative investments – their managed products are only regulated indirectly. This directive represented the start of further regulatory measures aimed at strengthening the single European capital market. Within the Common Monetary Union, this also saw the creation of more coherent standards, such as European venture capital funds and European social entrepreneurship funds.
What impact are these regulatory developments having on your current and future field of business?
Through ManCo, we were one of the first management companies in Liechtenstein to acquire the AIFM licence in 2013. Our aim is to extend our relevant business fields, boost professionalism and widen the spectrum of services for current and future clients.
Following implementation of the EU passport in Liechtenstein, which we are expecting this year, it is essentially the case that all directives relevant for the EEA will need to be implemented in Liechtenstein also. One of the major benefits for us is that investment funds domiciled in Liechtenstein will become market-compliant for the entire EEA.
What is your view of the current market environment for investors?
In historic terms, stock market valuations are high – at the same time, commodities and interest rates are low. Due to pricey bonds and low to negative interest rates, investors cannot expect them to be risk-free; instead, they can only expect interest-free risks. In this environment, private investors are finding it difficult to judge markets correctly and consequently, they are hesitant about making new investments. Institutional and professional investors face the problem of having to generate risk-adjusted returns because they are no longer receiving the necessary yields on bond markets, while the allocation ratios of their portfolios are already saturated with traditional investment instruments. As pension funds and insurers need to generate long-term returns, currently, traditional investment forms are relatively unsuitable. There are some movements towards short-term investments, which can be difficult to square with the ultimate purpose of capital markets: financing growth in the real economy.
What is the situation in Europe, and how is the EU responding?
The economic and financial crisis affected the ability of the financial sector to direct resources to the real economy, especially in long-term investments. A heavy dependency on intermediation among banks, in conjunction with deleveraging and lower investor confidence, led to a decline in funding for all economic sectors. Within this environment the European Commission announced that job creation and boosting competitiveness were among its main priorities, resulting in a series of initiatives, such as Europe 2020, Connecting Europe, Innovation Union and 2030 Climate and Energy Package. Other programmes launched aim at promoting R&D, SMEs, a low-carbon economy and infrastructure development.
These programmes identify the investment measures required to restore growth and competitiveness and also highlight alternative channels of finance. However, investors with a longer-term horizon, for example pension funds and insurers, did not necessarily have access to coherent pooling mechanisms within EU member states at the time. In response to this, a uniform cross-border product framework was created, called European Long Term Investment Funds, which is designed to encourage demand from both institutional and small investors.
How are you preparing for these trends?
In our view, not least on account of the pronounced political determination of the EU, there is likely to be a greater trend towards long-term investments, in particular in infrastructure, private equity and real estate. To prepare, in addition to our services in the UCITS segment, we are expanding IT systems, resources and capacities in these fields.
We are also enhancing the professionalism of our services in the fields of risk management, investment management, taxes and administration. In this conjunction, we are focusing on the client segments of initiators and investment managers, as well as family offices, portfolio managers and ultra-high-net-worth individuals (UHNWIs). In the case of UHNWIs, we are developing innovative investment funds and configurations based upon the new regulatory framework.
The 2008 financial crisis that shook the global economy still has the world on tenterhooks, while rising divergences mean monetary convergence cannot work in the EU, says economist.
Come back later for a full transcript of this video.
Peru might be a fraction of the size of Brazil, but that has not stopped this resource-rich country becoming one of South America’s most consistent engines for growth. According to data from the World Bank, Peru’s economy is set to grow by 2.9 percent this year, which compared to the 1.7 percent forecast for the Latin American region as a whole, stands as testament to the impressive strides the country has taken.
Its strong performance over the last decade has led to Lima being chosen to host the upcoming annual meetings of the boards of governors of the World Bank Group (WBG) and the International Monetary Fund (IMF) in October this year.
The 2015 WBG/IMF annual meetings will give the country the chance to showcase its economic achievements and strengthen its increasingly relevant position on the global stage. Peru’s President of the Council of Ministers, Pedro Cateriano Bellido expressed his appreciation to the WBG/IMF for recognising the country’s economic performance by bringing the event to Lima this year. “Today Peru is acknowledged worldwide as an important emerging economy, capable of hosting an event of the magnitude of the annual meetings, which will take place in Latin America after 48 years”, he said in a statement.
He went on to add that Lima is preparing itself to receive over 12,000 participants during the 2015 annual meetings and that the country is in the process of developing infrastructure that will allow the capital to become a preferred destination for other international events. “The 2015 WBG/IMF meetings in Lima will be the largest event ever to take place in the country”, said Cateriano. “It will provide local business leaders, investors, the academic community, and local social organisations with the chance to establish links with world global business and financial leaders and with civil society representatives.”
Today Peru is acknowledged worldwide
as an important
emerging economy
WBG Secretary Mohieldin has said that Peru was selected for the growing international prestige the country has won over the last two decades , due to its economic and social performance. “This designation is a clear reflection of Peru’s achievements in recent years in terms of political and institutional stability, economic soundness, investor confidence, and integration with the world economy”, he said.
Peruvian equities
One sector that has helped Peru garner the respect of the international community is its dynamic and ever-evolving financial sector. The Peruvian equities market for example, although only a small, shallow market shows great potential in supporting the country’s long-term growth aspirations.
“However, it is significantly influenced by the perception that the national economy is highly dependent on mining”, says Rafael Buckley, CEO of SURA Mutual Fund. “As a result, this market has the habit of turning volatile, along with a propensity to vagaries of the global economy, and particularly dependent on the demand for minerals.
“Given the global market situation, the Peruvian stock market is slack due to the low global growth prospects for this year and to the fact that it is a pre-election year for Peru, which could generate political unrest affecting the preferences for our stock market.”
In the last five years, there has been a significant improvement in the stock market general regulations, as well as in the Mutual Funds (SMV) specific regulations and tax system. This has resulted in a more transparent and professional market, but it has mainly promoted the creation of new funds based on new types such as international, structured, secured, flexible funds, and funds of funds.
During the first years after 2008, fund management companies focused on completing the value proposition mainly by creating defensive funds, given the risk aversion following the 2008 and 2011 crises. Then the creation of new funds increased significantly – just in the last 12 months, 21 new funds (+26 percent) have appeared – taking into account more creative initiatives involving diversification and low correlation with the local market. “Without any doubt, the government and the private sector have promoted major advances, but there is still a long way to go”, says Buckley.
“The main challenge now consists in making the funds offer available to more people by using new distribution channels and promoting long-term investment benefits.”
According to a report by BNAmericas, the investment portfolio of Peru’s mutual funds grew 13.4 percent in 2014. One reason behind the growth of mutual funds is the decreasing trend in interest rates recorded since 2008, resulting in the search for more profitable alternatives by the investors. Meanwhile the fund management companies reported consistent returns, especially in very short- and short-term funds. This is why 71 percent of all the assets under management (AUM), approximately $6.1bn, is invested in these categories.
The average Peruvian investors are generally conservative and have a poor long-term savings culture; therefore, a big percentage of their savings is earmarked for short-term deposits. Another important reason behind the increase of AUM is the significant expansion of the product range, the structured and international funds being the most popular products among investors so far this year.
“Our main objective is to generate risk-adjusted returns above the reference indexes of our funds and to make higher returns compared to the average return of our competitors’ funds”, says Buckley.
“All of this lineout with solid policies and investment and risk practices that ensure the sustainability of our business over time. Another important topic is to continue fostering in our industry the application of good social responsibility and environmental practices when evaluating investments. We do not aim to be the most profitable company every year, but we do want to consistently generate value above the funds average.”
Diverse funds
In relation to the debt market, SURA Mutual Fund manages two money market funds, two short-term debt funds, and two fixed income funds. All of these funds make investments throughout the curve of the Peruvian sovereign debt, as well as in corporate debts issued by Peruvian companies, and in short-term debt instruments (mainly in the financial sector).
It also manages one equity fund, which invests in Peruvian companies stocks, and has an investment approach focused in mining (in line with its reference index), and one equity fund which invests in companies that are part of the Pacific Alliance (Chile, Colombia, Mexico and Peru).
“Furthermore, we manage three international funds, enabling our customers to invest in North American, European and emerging markets stocks and to expose them to these markets with a tax efficient and passive management”, says Buckley. “Finally, we also manage three balanced funds that incorporate our [tactical] views.”
Investor relations
In today’s hyper-connected world there is a demand for financial organisations to take strides to improve communication with their investors. SURA aims to create spaces where it can interact with investors through Q&A sessions in different social networks, along with bi-monthly videos that allow fund managers to share information about any changes in the market and strategies used to manage their funds.
In addition, there are quarterly meetings with the media, where the company attempts to clear up any doubt about the industry in general terms (pension fund administrators – AFP, mutual funds and insurance).
“For our internal operations, we carry out programmes to bring the customers closer to our administrative staff, which raise awareness about the sales process and help them identify how to improve the service”, says Buckley. “Aside from these activities, I think the best way to keep our customers close is to advise them objectively and manage their expectations, so they can achieve their goals.
“Instead of focusing our attention into selling old returns, we are interested in dedicating a large part of the process to explain the associated risks.”
Unlike its competitors, SURA’s products can be distributed in several banks, brokerage firms, securities intermediaries, and soon in other financial institutions. Additionally, for its distribution channel it has developed unique advising processes, which are based more on managing customers’ expectations than on selling specific products.
“Without doubt, we are an innovative fund management company. The fact that we are the only big fund management company not linked to a bank makes us different. We are more focused on providing excellent results for our investors and we are creative in the design and distribution of ours products”, says Buckley.
“It is worth mentioning that for the last years we have been a benchmark for creating new products. Indeed, we have created the first funds of funds with different share packages to make the offer available to more people, as well as the first flexible funds, regional international funds, and integrated market funds.”
Overall, the Peruvian market shows great growth potential, with investors now more experienced and asking for more sophisticated products. Not only that, but the penetration of mutual funds in the market is still relatively low compared to other countries in the region regarding term deposit volume or GDP percentage. Combine this with the fact that the country as a whole is attracting increased international attention and it is likely that we will see more capital finding its way to Peruvian markets in the coming years.
The Consumer and Financial Protection Bureau is forcing Citibank North America, as well as its subsidiaries, Department Stores National Bank, and Citicorp Credit Services, to repay $700m to customers for what the US regulator describes as “unfair and deceptive practices.” According to a statement posted on the CFPB website, these practices “include unfairly billing consumers for credit card add-on products, deceptively marketing those products, and deceptive collection practices. Citibank has agreed to pay about $700m in refunds on about 8.8 million accounts.”
“Citibank has agreed to pay about $700m in refunds on about 8.8 million accounts”
Regulators found that the bank offered customers a number of debt protection add-on products that pledged to write off, balance or defer the due date of payments for customers in instances of unforeseen hardships, such as job loss, disability, hospitalisation or divorce, as well as anti-fraud card monitoring services. These products were found to be sold deceptively at the point of sale, with customers not informed of their additional costs or misled concerning a supposedly “free” 30 day trial.
The benefits of the anti-fraud monitoring services were also misrepresented. As the CFPB notes in a press release, “Citibank claimed the fraud alert service on credit card accounts would alert them of fraudulent purchases. In fact, the credit-monitoring product only provided alerts to changes in a consumer’s credit file maintained by major reporting companies, not at the transaction level.”
Further, the bank was accused of using misleading questions to obtain billing authorisations from customers to purchase add-ons, as well as using deceptive practices when collecting payment on delinquent credit card accounts, leading customers unnecessarily to pay a $14.95 fee.
Citibank must pay $479m in consumer relief to the 4.8 million customers deemed to have been affected by deceptive marketing or retention practices and $196m to roughly 2.2 million customers who enrolled in the card monitoring service, while Department Stores National Bank must provide $23.8m to the 1.8 million customers that were charged expedited payment fees on delinquent accounts. Finally, the bank must also pay a $35m fine to the CFPB’s Civil Penalty Fund.
Microsoft has turned in a record $3.2bn loss for the latest quarter, ending June 30, after having suffered a $7.5bn writedown charge recently – courtesy of Nokia’s struggling mobile business. Company sales were down also by 5.1 percent, as the impairment charge, coupled with a strengthening US dollar, dealt the world’s biggest software company its biggest quarterly loss in history.
The bad news was offset in part by growth elsewhere
The bad news was offset in part by growth elsewhere, with Surface, Xbox, Bing, Office 365, Azure and Dynamics CRM Online all racking up double-digit growth over the quarter. Chief Executive Satya Nadella went to great lengths to underline the company’s strong performance in new markets, not least in cloud computing, where results were strong but perhaps not as strong as expected. Overall, the positives were overshadowed by the company’s headline losses, and its shares took an almost four percent tumble in extended trading, despite posting an 8.6 percent gain in the quarter overall.
The chief executive stressed also that “the upcoming release of Windows 10 will create new opportunities for Microsoft and our ecosystem,” as he sought to consign Microsoft’s failings to past mistakes. The fact remains, however, that recent iterations of Windows have not been well received by critics, though the company’s decision to integrate search and gaming into the latest may yet prove a canny move.
