WWW.KL-COMMUNICATIONS.COM FEB 16

01

Iran: A visit to the final frontier

P3MID-CYCLE CORRECTION

OFFERS VALUE

P4OIL EXPECTATIONS: A HOUSE

OF CARDS

P5MAKING A SPLASH WITH

YOUR CASH

T. Rowe Price's Oliver Bell reflects on his visit to Iran and explores the investment potential of the country following the lifting of sanctions (page 2)

02

Oliver BellT. Rowe Price

ran’s historic nuclear deal and the lifting of sanctions should bring the country back

into the global community. For investors, it is being heralded as the return of the largest economy to the global system since the breakup of the USSR in 1991.

We recently went on a fact-finding mission to Iran prior to the lifting of sanctions. It was a real eye-opener and exposed many of our biases as wrong.

Iran appeared more like Turkey than Saudi Arabia – Tehran being a very cosmopolitan city with a much more liberal attitude than we expected, with women appearing fully integrated into society. Importantly, the country is educated, entrepreneurial and asset rich, but remains cash flow poor because of the sanctions that have been in place since 1979. With those sanctions being lifted, there is much to like as an international investor.

Iran is the second-largest economy in the MENA region after Saudi Arabia, with a GDP of $406.3bn in 2014. This is roughly the same size as Thailand. Real GDP could rise from 1.9% in 2015, to 5.8% in 2016 and 6.7% in 2017.

The Tehran Stock Exchange

has 540 listed companies on the main bourse, a $120bn market cap and $40bn turnover per day. The index trades at 6x P/E (having been as low as 4-5x) and an average dividend yield of 14%, but with negligible foreign participation.

We believe there is money to be made for first movers coming into the market. The purpose of the trip was to acquaint ourselves with Iran and its idiosyncrasies, which we have done in part, but need more time with companies and officials to become truly comfortable investing.

However, interest will only grow because of its reintegration into the global economy, its huge hydrocarbon power and positive demographics. Institutional investors, however, will probably face some challenges in areas of liquidity and corporate governance.

Ultimately, with a focus on quality, investment in Iran could prove rewarding, especially given the very low valuation starting point. In addition, with Iran being one of the last great frontier markets left, it could potentially provide one of the final pieces of the investment puzzle.

Iran: A visit to the final frontier

pecialist European equity manager S. W. Mitchell

Capital has added Hugh Grootenhuis as a special adviser.

Grootenhuis, who recently spent six years as CEO of Waverton Investment Management and predecessor JO Hambro Investment Management (JOHIM), has also become a director of S.W. Mitchell Capital plc, the Irish UCITS company.

S. W. Mitchell Capital founder Stuart Mitchell, as well as a number of colleagues at the group, previously worked alongside Grootenhuis at JOHIM. Prior to establishing S. W. Mitchell Capital in 2005, Mitchell was a principal, director and head of specialist equities at JOHIM.

S. W. Mitchell Capital celebrated its 10-year anniversary in 2015 and has more than $2bn of AUM.

Stuart Mitchell comments: “We are very pleased to have Hugh join us as a special adviser. We know Hugh well from our time together at JOHIM and his expertise and knowledge of the market will be integral as we move forward.

“We are optimistic about the opportunities for future growth. Our recent relationship with Boston-based Balter Liquid Alternatives to sub-advise a new '40 Act liquid alternatives fund for US investors is good example of this."

S

Grootenhuis joins boutique S. W. Mitchell Capital

I

WWW.KL-COMMUNICATIONS.COM FEB 16

"With a focus on quality, investment in Iran could prove rewarding, especially given the very low valuation"

Erik KnutzenNeuberger Berman

or some, recent data points to a coming global recession and the end of a

business and credit cycle that has already lasted a very long time by historical standards. We disagree.

We are reminded of a similar mid-cycle correction in 2011. During this episode, the S&P 500 dropped by 20% peak-to-trough. As a result, we are cautious in our short-term outlook.

But on a 12-month basis we maintain our modest risk-on bias – and in fact we have become even more confident in our medium-term return outlooks given the sell-offs we have seen.

This slowdown will eventually offer some attractive entry points to add risk to portfolios, particularly in parts of the credit markets. The key word, of course, is ‘eventually’. Given the recent poor data, we will certainly need to see some manifestation of the increase in credit defaults that has been forecast, and some re-ratings of BBBs to BBs, before we

feel things have bottomed out.The same applies to what is

happening with oil: We want evidence of real production cuts from a marginal non-OPEC player (or even an OPEC producer), and signs the rig-count and capex declines in the US are leading to reduced production. Once these are built into the environment – possibly by the summer – we think it will be an opportune time to consider adding risk.

Until then, we are watching carefully for any further signs of deterioration. We still worry most about China, and any significant further decline of the yuan would be the signal to revisit our thesis. A 10%-plus devaluation would suggest China may be going through a ‘hard landing’, potentially triggering currency wars and global deflation.

This is far from our base case, however. Our watchword is caution – but caution in scouting for opportunities over the coming months.

Mid-cycle correction offers value

ordea Asset Management, the

€183bn arm of Northern Europe’s largest financial services group, recorded a €12.7bn net inflow in 2015.

The strong net inflow means Nordea is the only asset manager to consistently feature for the past four consecutive years in the annual list of top ten European cross-border net flows.

About €7.2bn of net inflows, or 60%, originated from third party institutional and wholesale clients.

Interest was particularly strong for the solutions managed by Nordea’s £50bn Multi Assets team – which continued to deliver stable returns in another challenging year of exceptionally low interest rates, geopolitical tensions and market turmoil.

“These continuous high net flows are a testimony of our commitment to bring solutions helping our clients to address today’s challenges” Christophe Girondel, Nordea’s global head of institutional and wholesale distribution, says.

“Core ingredients of our investment value proposition, such as a multi-boutique approach combining both internal and external expert competences, our strong focus on risk control or the development of multi assets-based outcome solutions, position us well to deliver best-of-breed products addressing these challenges."

N

Nordea among elite as fund flow surge continues

F

WWW.KL-COMMUNICATIONS.COM FEB 16

"This slowdown will eventually offer some attractive entry points to add risk to portfolios, particularly in parts of the credit markets"

3

Greg BennettArgonaut Capital

Filippo AlloattiHermes Credit

t the start of 2015, the median oil price being used by analysts

was $80 and $85 for 2015 and 2016. Currently it is $55 and $58 – a 30% cut in the most important modelling assumption – unsurprisingly resulting in negative earnings revisions.

Notwithstanding these revisions, many oil stocks remain resilient. This is because most analysts and investors believe oil will be materially higher in the near future and are looking through current weak earnings.

However, the world has been over-producing oil every quarter from the start of 2014. Since oil was last over $100, global production is up 3.6m bbl/day. The largest contributors to supply growth has been Iraq and Saudi

taly has unveiled an initiative to minimise non-performing loans (NPLs) in the country's

banking system, which will involve securitisations supported by a government guarantee. The programme is known as GACS - Garanzia sulla Cartolarizzazione delle Sofferenze.

Despite some unrealistic expectations in the market, this initiative is not a ‘bad bank’. Each participating bank can create one or more SPVs, which will acquire NPLs and be financed through the issuance of asset-backed securities.

In contrast to the bad banks in Ireland and Spain, the Italian bad-debt problem is concentrated in loans to SMEs, not to households or construction. The high NPLs in Italy are a function of the GDP

Arabia, Russia, the Gulf of Mexico and Asia. Even if, as the IEA expects, US shale production falls by 600k bbl/day next year, the world currently over-produces oil by 1.6m bbl/day. Also, global inventories are at levels not seen for more than two decades.

The clear risk is oil continues to stay at current levels, or lower, over the near term. Producers will not cut due to economics, while Saudi Arabia is unlikely to cut until it achieves its aims.

This would mean significant downward revisions to earnings expectations and valuations for the sector. Equally, it will mean recent M&A and debt issuance, based on budgeted higher oil assumptions, may not be as economical as first thought. A veritable house of cards.

decline since the financial crisis, not a boom and bust in property.

To avoid an increase in loan losses and a consequent reduction in capital, banks will likely structure these deals with ad-hoc pools aimed at limiting additional provisions. Investors must also analyse the quality of the relevant collateral, for example residential property, that is acting as guarantee for a large chunk of the Sofferenze. This collateral is being harshly overlooked by the market currently.

The scheme is a potential positive for bondholders, and possibly shareholders, given it is voluntary in nature. While it does not solve the bad loan issue overnight, it does give banks time to chip away at the problem.

Oil: A house of cards

Boost for Italian banks

A

I

WWW.KL-COMMUNICATIONS.COM FEB 16

lken’s Nicolas Walewski has written a letter

to the board of Western Digital urging the company to abandon plans to buy SanDisk.

Walewski said he was “gravely concerned about the SanDisk acquisition”, which at $19bn was a 70% premium on SanDisk’s share price before the takeover announcement.

One of Western Digital's top ten shareholders, Alken owned of more than five million shares in the tech company as of 31 December.

Attributing the stock price underperformance to market recognition of the ‘overpriced’ acquisition, Walewski outlined six key long-term concerns of the deal. If terminated, Western Digital will owe SanDisk a $185m break-up fee – which Alken would support.

“Since the agreement was signed, because of changes in SanDisk's markets and business, as well as capital market factors, the price has proven to be simply too high,” Walewski wrote.

“We believe the capital markets agree. That is why Western Digital's stock price has declined more than 40% since the deal was announced.”

Alken intends to vote against the deal at the upcoming shareholder special meeting, scheduled for 15 March. Following the letter, Western Digital announced a reduced offer for SanDisk, valuing it at $15.8bn.

A

Alken tells Western Digital to abandon SanDisk acquisition

"Most investors believe oil will be materially higher in the near future and are looking through current weak earnings"

"While it does not solve the bad loan issue overnight, it does give banks time to chip away at the problem"

4

T: +44 (0) 203 137 7823www.kl-communications.cominfo@kl-communications.com

Mette HansenRedington

obody is excited to hold cash. Historically, pension schemes have

tended to hold only the minimum required to pay pensions and administrative costs. There has therefore been little interest in how to manage cash beyond bank accounts and liquidity funds.

However, as pension schemes mature, they need more cash for pension payments. Most corporate UK schemes are now closed to new members and many to accruals as well. Hence, they will become increasingly cash flow negative over time.

Furthermore, recent changes in regulation mean many pension schemes will likely need higher cash levels within their LDI portfolios for collateral purposes.

On balance, cash will become more important in the future as liquidity takes precedence. Cash is more complex than you might think, especially in institutional investment. It is most easily defined by its central feature: liquidity.

As the liquidity of a given cash instrument is reduced, the yield increases to compensate for this. When does cash stop being cash and become something else, you may ask? While most people can agree a 3-month money market note is a cash instrument and a 10-year corporate bond is not, there is no hard rule. There is only a sliding scale of reduced liquidity and increased return (and hence risk).

Another important point is

even within comparable cash vehicles (same liquidity/risk profile), there can be wide return dispersions. We analysed 19 comparable institutional sterling liquidity funds over a 5yr period and found the highest net return to be 0.71% p.a. and the lowest, 0.36%. In fact, £100m would have grown by £3.6m over the 5yr period in the higher-yielding fund, but only by £1.1m in the other.

Pension schemes can take advantage of the sliding liquidity/return scale by matching it with their own sliding scale of liquidity requirements. You require some immediate cash to cover ongoing expenses and potential collateral needs, some in the medium term to cover pension payments, and longer-term 'strategic cash' to cover unforeseen changes.

This sliding scale of cash requirements can be matched with a so-called 'liquidity

Making a splash with your cash

N

5

waterfall', with cash divided into tranches of assets with increasing illiquidity. At the bottom is pure cash, next is a tranche of liquid money market instruments and at the top is a tranche of more exotic short-dated instruments. As cash is taken out at the bottom, the less-liquid assets trickle down the waterfall.

The yields within such a waterfall could range from negative, up towards 3% at the top. The overall yield depends on the cash requirements of each scheme and the particular liability profile and/or LDI portfolio.

Efficient cash management requires detailed and ongoing analysis of a scheme’s liquidity requirements. Going forward, such analysis will be worthwhile for many pension schemes to enhance return on an increasingly vital part of a portfolio, while ensuring smooth operations.

WWW.KL-COMMUNICATIONS.COM FEB 16

"Cash will become more important in the future as liquidity takes precedence. Cash is more complex than you might think, especially in institutional investment"