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Alan Brown is an outspoken and insightful commentator on markets and fund management. As chief investment officer at Schroders, he oversees a fund management operation managing some £123bn of assets for clients. He has been working in markets since 1974 when he joined Morgan Grenfell as an equity analyst.
After working for several fund management firms, he joined State Street Global Advisors in 1995 and later became chief investment officer and vice-chairman, playing a pivotal role in building up the profile of firm and shaping its investment culture. Mr Brown answers your questions below.
Globally we see a property boom, and this has also rippled down to the developing economies. Do you feel that global hedge funds will be looking at a global real-estate fund to gather capital gains from property prices?
Sahan J, Sri Lanka
Alan Brown: We have indeed seen a global property boom that has spread to many parts of the world. Looking at your question, I am not sure that I necessarily see hedge funds capitalising on rising property prices. However, we do believe that the property market is ripe for a more global investment approach. Historically, the majority of property investment has been carried out on a local basis. Increasingly, we now see investors interested in more geographically diversified strategies thereby seeking to avoid potential local hot spots. Another catalyst has been the growing number of REIT type structures available around the world.
Quite clearly developing economies should be a part of this. Emerging market investment started with equities, moved on to bonds and we see no reason why it should not embrace property as well. One caveat though, this expansion into developing countries is likely to occur one country at a time. There are minimum standards of law of property and transparency that will be necessary to attract foreign investors. Some countries are already clearly there, others have a way to go.
Where are global markets heading in the next couple of years in your view?
Su Hoi, Tokyo, Japan
Alan Brown: When thinking about the global equity markets today, I am reminded of the old Hong Kong airport. A final approach to the runway with a sharp right hand bend taking one apparently perilously close to apartment blocks on either side!
The runway today represents a soft landing view of the world’s economy where the US slows down to 2 to 2 1/2 per cent growth, Japan and Europe put up reasonably solid numbers and China continues on track with continued high single digit growth. Against that backdrop, with equity markets quite reasonably priced by historical standards, markets could quite likely have a reasonable year in 2007 even in the face of slower earnings growth. This is a benign scenario with a better balance to world growth than we have seen in years.
The apartment blocks to the left represent the possibility that the consumer reaction to the housing downturn could be much more severe than currently expected. The theory here is that individuals save with a monetary goal in mind. To the extent that stock markets and housing realise those goals without the need to actually save, then individuals can spend, and indeed can dis-save through taking out equity from their houses. Hence the negative savings rate in the States.
When house prices actually decline (and we are in uncharted waters here) then first it becomes much more difficult to extract equity from your house to support current spending and second, there is the possibility of an abrupt rise in the savings rate driving the economy into recession. If this were to happen it is likely that the rest of the world would follow too. The one bright spot here is that the Fed’s gun is “reloaded” now and there would be plenty of room for cutting rates aggressively to re-ignite growth.
The apartment blocks on the other side represent the possibility that the American consumer is more resilient than we expect and the economy doesn’t slow down. In which case all bets are off as to where interest rates would peak as we would expect the Fed to continue to tighten quite aggressively.
Today, we look set fair to make it to the runway. I reckon we have missed the apartment blocks on the right, but we are still keeping an eye on those on the left.
Certain investors such as Warren Buffett and Peter Lynch have publicly claimed that they do not pay much attention to the state of the economy, the general direction of the equity market (in the short-term at least) as well as other macro-economic indicators. How important is these information to your operation and how do you filter out the noise from what really matters?
SK Tan, Hong Kong
Alan Brown: We believe that there is more than one way to “skin a cat”. Warren Buffet espouses a particularly long-term strategy and so for him, worrying about the short-term outlook for the economy is not going to add much. What is most important is that whatever philosophy one espouses (growth or value manager for example), one should not get blown off course because of short-term set backs.
Having the conviction to follow a particular approach is likely to be rewarded in the medium term. We do pay attention to economic indicators, but to filter out the noise, we do so against a cyclical perspective of the economy where we are interested in developments over years not months.
One other thing, not everything is as quite as it appears in investing. For example, one often hears the view that high levels of turnover on stock markets mean that we are all becoming speculators, rather than investors. But consider this: If you think back to the days of the “nifty fifty” when one was supposed to be able to buy IBM, Kodak and Xerox and hold them forever, which was the most speculative act?
Was it the investor who had the hubris to think that he knew anything about the world thirty years on, or was it the investor who recognised that he couldn’t see beyond the next couple of years or so, and so invested with a much shorter-term horizon?
Today’s product and management life cycles in the face of rapidly changing technology do not allow us the luxury of buying and holding forever.
If you want to have an average return of 12 per cent per annum, how would you allocate your investment portfolio? What would be your weighting on emerging market such as eastern Europe and Latin America? How risky do you think for entering India now?
Kaili Jen, Taiwan
Alan Brown: This is an interesting question. It is very important to make sure that ones investment aspirations are consistent with market opportunities or risk premia.
Given the headline return numbers we see so often from individual countries or stocks, it is tempting to assume that it should be relatively easy to earn 1 per cent a month. Part of the problem here is the difference between ex-ante and ex-poste. After the event it is always easy to find stocks or markets that have delivered 12 per cent and indeed very much more. The difficulty is in identifying them in advance!
It always helps when thinking about returns to go back to some basic theory. And when thinking about equity markets I often find a Gordon model being a good place to start. The Gordon model simply stated says that in the long run the return from equities is equal to the dividend yield plus the growth in the yield.
Growth in dividends in the very long-term has to keep pace with growth in the economy and inflation. So, if you have a market with a dividend yield of 2 per cent, inflation of 2.5 per cent and trend growth of 3 per cent, a first cut at the long-run return of the market would be 7.5 per cent per annum. Many markets in the developed world would today be fall into the range of offering returns of between 7 and 8 per cent, and remember that is before fees and expenses of investing.
So, to earn a return of 12 per cent is either going to require a very high degree of added value from active management, or investment in riskier markets (emerging markets would be good candidates) or the use of leverage. Or some combination of all three.
How should I allocate investments during a downturn in the markets, especially if I need this money during retirement?
John Koh, Chicago, US
Alan Brown: Managing investments where one is dependant upon them for current income presents some quite different challenges to managing investments during the accumulation phase of saving. As far as is possible, it is highly desirable if you can structure your investments in a manner which will not lead you to be a forced seller during market downturns when asset prices are depressed.
So, for example, if you are in the fortunate position of being able to set up a portfolio which can meet your income needs through dividend income, bond interest and other forms of income (rental, for example), then you will be able to ride out market downturns quite easily.
To the extent that that is not possible, it makes sense to consider building in some natural liquidity into your portfolio through having bonds with staggered maturity dates providing additional funds through return of capital. Other strategies which can help could include capital protected investments.
Some people think that active fund management is an expensive waste of time. What would you say about this and what is the role of active management in the average investor’s profile?
Tunde, London, UK
Alan Brown: The Capital Asset Pricing Model (CAPM) which underlies much of the thinking behind passive management strategies has stood the test of time pretty well. However, few today believe that markets are perfectly efficient and most recognise that CAPM is at the end of the day a partial equilibrium model. As such it is an abstraction of reality. At times the active/passive debate, which invokes so much passion amongst practitioners, must leave our clients feeling somewhat bemused.
I think the answer to your question can be found in taking a look at what the world’s most sophisticated investors are doing. Sophisticated institutional investors routinely use both active and passive strategies. Our clients recognise that they are natural bedfellows and not oil and water! It makes sense to employ active strategies where they are most likely to be rewarded, in more inefficient markets. Where markets are very efficient, it makes more sense to go passive.
Active management also comes in many guises. Being too benchmarked focused can also cause real difficulties during bear markets such as we experienced during 2000 to 2002. Increasingly we see investors interested in managing towards real world outcomes, for example earning inflation plus returns, protecting surpluses. All of these require active management.
What do you think is the best way to invest in Chinese companies and capitalise on the China growth story?
Robert Gollings, Russia
Alan Brown: China clearly represents a tremendous opportunity for investors. However, it is not without its own special risks. So far, the rewards of high levels of economic growth have flowed very unevenly to shareholders, and standards of corporate governance and the law of property are well below western norms.
One of the lower risks ways to benefit from China’s growth is to invest in developed country companies who will benefit as suppliers to China, or as trading partners. Resource stocks in the Asian region, for example, are likely to be prime beneficiaries from China’s rising need for raw materials.
Investing directly in China requires a great deal of expertise and local knowledge. It is an area where investors are most likely to require professional help from firms with a wide experience of the country and region.
What is your opinion on BRICs as an investment? Should a short term investor get involved or is the investment strategy more long term?
David Labrie, Rhode Island
Alan Brown: Investing in emerging markets in general is likely to be towards the more risky end of most investors portfolios. As such, it makes sense to take a long-term view of the asset class, recognising that markets can be volatile in the short-term. The case for emerging markets is a strong one. These are some of the most vibrant areas of the world economy, experiencing well above average economic growth rates.
Stock markets are small in relation to GDP compared to the developed word and valuation levels are generally cheaper. Since the Asian crisis in the late 90s, national accounts have been brought well under control and indeed Asian central banks have acquired very substantial Dollar reserves. These economies are not therefore as vulnerable to economic shocks as they were in the past and, at the same time, standards of corporate governance have been gradually improving.
The BRIC story obviously focuses on a sub-set of emerging markets concentrating on the big four. Generally, for a core emerging market strategy, we would recommend a broader, all inclusive approach. There is little advantage to be gained by unnecessarily reducing the investment opportunity set. However, once an investor has an established core investment in emerging markets, a focused strategy alongside the core can have its place. Certainly, beyond the economic dimension, the big four by virtue of their very size are likely to be particularly important political and economic partners to the West.
Where is the best bet for low risk capital gains, disregarding any requirement for dividends or any other income stream?
Michael Beaman, London, UK?
Alan Brown: Of the main asset classes, public equities look better value than most. Although equity markets have enjoyed good returns over the last few years this has been fully supported by increases in earnings. As a result, Price Earnings multiples appear quite reasonable. Of course there are always risks, and one to focus on right now is the extent of the US consumer reaction to the housing downturn. For the moment, a soft landing for the US economy seems most likely, but this is an area to watch. Any abrupt increase in savings could tip the US and then the rest of the world towards recession. We see no sign of this at the moment but we are keeping a careful eye out.
If low risk is paramount, then you could consider capital protected strategies which will ensure that you at least get your money back. However, there is a price to pay for protection. Otherwise, a broadly diversified, global equity strategy would be a good place to look. While you may have no requirement for income, do bear in mind that high yielding stocks can have defensive characteristics in the event of a market downturn.
I’m setting up a venture capital house focusing mainly on emerging markets (commodities and natural resources) and long term wise I plan to establish a CSR Investment Fund for Africa. Can you advise me what is the best way to learn and master the art of fund management and investment in natural resources?
Tony Malalane, Mozambique
Whenever I am asked about learning about investments, I always refer people to a book by Peter Bernstein called Capital Ideas, the Improbable Origins of Modern Wall Street. While this will not particularly help you with the specialist skills necessary to manage natural resources in emerging markets, it will give you a very solid foundation in the workings of capital markets in general.
In doing so, it will make sense of many of the apparent contradictions in the investing world and should help keep you out of trouble! It is also, in my view, a cracking read!