Avant Garde Wealth Mgmt - Quarterly letter - 1406 - Appendix

Avant Garde Wealth Management Pvt. Ltd.

Note: “Portfolio” refers to the weighted average of all client portfolios managed by us over the relevant time period. Any metrics such asreturns or portfolio weighting similarly refer to the weighted average of all portfolios. Individual clients portfolios may defer materiallyfrom the blended “Portfolio” and clients should refer to their portfolio statements for details on their portfolios

APPENDIX

Context from the June 2014 investor letter:

"The BIS (Bank of International Settlements), which is the central bank to central banks, caused aflutter with the commentary in its recent annual report (published on 29 June 2014). Theyessentially warn that central bank policies of easy money have increased the risk of a financial crisis,and suggest that central banks should pre-emptively tighten policy to moderate this risk. At theirfirst public appearances after the report was published, both Janet Yellen (US Fed Chairman) andMario Draghi (ECB Chairman) took the opportunity to assuage investors that they were not inclinedto heed the advice. To avoid making this letter too lengthy we have included the highlights from theBIS annual report as an appendix in a separate document for those of you who are interested."

Note that the following is NOT a summary of the contents of the BIS Annual Report. We haveselectively highlighted content that pertains to weak economic fundamentals, easy monetary policyof central banks, high valuations of risk assets, and high level of complacency among investors.



"Through its impact on risk-taking behaviour, monetary accommodation had an impact on assetprices and quantities that went beyond its effects on major sovereign bond markets. Credit spreadstightened even in economies mired in recession and for borrowers with non-negligible default risk.Global investors absorbed exceptionally large volumes of newly issued corporate debt, especiallythat of lower-rated borrowers. And, as the search for yield expanded to equity markets, the linkbetween fundamentals and prices weakened amid historically subdued volatility and low riskpremia."

"Term and risk premia can only be compressed up to a point, and in recent years they have alreadyreached or approached historical lows. The risk is that, over time, monetary policy loses tractionwhile its side effects proliferate. These side effects are well known (see previous Annual Reports).Policy may help postpone balance sheet adjustments, by encouraging the evergreening of bad debts,for instance. It may actually damage the profitability and financial strength of institutions, bycompressing interest margins. It may favour the wrong forms of risk-taking. And it can generateunwelcome spillovers to other economies, particularly when financial cycles are out of synch.Tellingly, growth has disappointed even as financial markets have roared: the transmission chainseems to be badly impaired. The failure to boost investment despite extremely accommodativefinancial conditions is a case in point."

"In contrast to what is often argued, central banks need to pay special attention to the risks ofexiting too late and too gradually. This reflects the economic considerations just outlined: thebalance of benefits and costs deteriorates as exceptionally accommodative conditions stay in place.And political economy concerns also play a key role. As past experience indicates, huge financial andpolitical economy pressures will be pushing to delay and stretch out the exit."



“The current weakness of aggregate demand may suggest the need for further monetary stimulus orfor easing the pace of fiscal consolidation. However, these policies are likely to be either ineffectivein current circumstances or unsustainable: taking a long-term perspective, they may simply succeedin bringing forward spending from the future rather than increasing its overall amount over the longrun, while leading to a further rise in public and private debt. Instead, the only way to boost demandin a sustainable manner is to raise the production capacity of the economy by removing barriers toproductive investment and the reallocation of resources. This is even more important in the face ofdeclining productivity growth."

"Unless productivity growth picks up, the prospects for output growth are dim. In particular,population ageing in many advanced economies, and not only there, will act as a drag on growth.The share of the working-age population has been falling in the euro area and, even more rapidly, inJapan. In the United States and the United Kingdom, it peaked just before the beginning of thefinancial crisis... These considerations suggest that sustainable long-term growth requires structuralmeasures that directly tackle the sources of low productivity rather than policies aimed atstimulating aggregate demand...By contrast, debt-financed stimulus may be less effective thanhoped and raise long-term sustainability issues."



"It would be too easy to dismiss these indicator readings as inappropriate because “this time isdifferent”. True, no early warning indicator is fully reliable. The financial system evolvescontinuously, and the nature of risks shifts over time. But credit gaps and debt service ratios haveproved to be relatively robust."



"The impact of US monetary policy is found to be statistically significant for 16 of 20 EMEs. Since2012, easier US monetary policy has been associated with an average reduction of 150 basis pointsin EME policy rates (Graph V.C, left-hand panel), although the impact has varied substantially acrosseconomies and time. The response of EME policy rates to inflation was often weaker than theprescription of the conventional Taylor rule. These results are consistent with the finding that EMEpolicy rates have, over the past decade, run below the level suggested by domestic macroeconomicconditions as captured in standard Taylor rules (Graph V.C, right-hand panel)."



"The benefits of unusually easy monetary policies may appear quite tangible, especially if judged bythe response of financial markets; the costs, unfortunately, will become apparent only over time andwith hindsight. This has happened often enough in the past. And regardless of central banks’communication efforts, the exit is unlikely to be smooth. Seeking to prepare markets by being clearabout intentions may inadvertently result in participants taking more assurance than the centralbank wishes to convey. This can encourage further risk-taking, sowing the seeds of an even sharperreaction. Moreover, even if the central bank becomes aware of the forces at work, it may be boxedin, for fear of precipitating exactly the sharp adjustment it is seeking to avoid. A vicious circle candevelop. In the end, it may be markets that react first, if participants start to see central banks asbeing behind the curve. This, too, suggests that special attention needs to be paid to the risks ofdelaying the exit. Market jitters should be no reason to slow down the process."

"The temptation to postpone adjustment can prove irresistible, especially when times are good andfinancial booms sprinkle the fairy dust of illusory riches. The consequence is a growth model thatrelies too much on debt, both private and public, and which over time sows the seeds of its owndemise. More generally, asymmetrical policies over successive business and financial cycles canimpart a serious bias over time and run the risk of entrenching instability in the economy. Policydoes not lean against the booms but eases aggressively and persistently during busts. This induces adownward bias in interest rates and an upward bias in debt levels, which in turn makes it hard toraise rates without damaging the economy – a debt trap. Systemic financial crises do not becomeless frequent or intense, private and public debts continue to grow, the economy fails to climb ontoa stronger sustainable path, and monetary and fiscal policies run out of ammunition. Over time,policies lose their effectiveness and may end up fostering the very conditions they seek to prevent.In this context, economists speak of ‘time inconsistency’: taken in isolation, policy steps may lookcompelling but, as a sequence, they lead policymakers astray."

"The risks of failing to act should not be underestimated."

Avant Garde Wealth Mgmt - Quarterly letter - 1406 - Appendix

Economy & Finance

Transcript of Avant Garde Wealth Mgmt - Quarterly letter - 1406 - Appendix