Investors are faced with a confusing set of macroeconomic forces, as U.S. monetary policy and relative strength send the dollar higher while the European Central Bank joins the Bank of Japan in running its printing press. Following a year when so many investors got caught flat-footed by a rally in bond markets, the timing for balancing exposures across asset classes and geographies appears equally daunting for the balance of 2015. Hayes Miller, head of Baring Asset Management’s multiasset strategies for North America and a 20-year veteran with the firm, recently sat down with Institutional Investor to discuss how he is tackling asset allocation for the $54 billion in client funds that Baring oversees.
Institutional Investor: When you first meet a prospective client, what is your elevator pitch?
Hayes Miller: To use a metaphor, we start at 30,000 feet up and then zoom in. As a firm, Barings’ approach is to have a 12-month outlook and then fit our short-term perspective within this longer-term structural view. We do sector- and geography-specific research and try to identify assets that can grow in the future, rather than pursue cheapness for cheapness’ sake.
And what is your view from above in this market environment?
Economies still aren’t working in a normal way. Normal is when there is an efficient balance between savings and borrowers that creates spending and building cycles and a private sector in which jobs are being created. We are far from that now. The velocity of money has dropped rapidly in developed markets, with both supply and demand impacted by increased capital requirements for the financial sector. Banks are less willing to take risk. Meanwhile, corporate balance sheets are still deleveraging. Combined with restricted credit, this unwillingness to spend and invest is exacerbating inequality between large and small companies that mirrors the income inequality among individuals. In other words, the developed world remains dependent on policymakers’ growth policies. As a result, the pricing of assets has become front-loaded.
As an allocator, what does that mean from a risk and positioning standpoint?
Long-term forecasting for risk assets is going to be much lower than it normally is — something on the order of low single-digit growth for the next ten years — because the starting place for valuations is very high, and the starting point for global growth assumptions is very low.
Last year was tough for many fixed-income managers. How are you handling allocations to this asset class?
In 2014 investors began the year very concerned about valuations in Treasury and corporate bond markets. I think the consensus coming into 2014 was more constructive on growth and inflation because most central bank polices were inflationary. Instead what emerged was a series of deflationary forces exacerbated now by the collapse in oil prices, following aggressive stimulus from emerging-markets economies. This general malaise and lack of investment prevented wage and spending growth that could have driven inflation expectations. That was a surprise to us and many others: bonds going up on deflationary fears, coupled with flight to safety factors. We did have bonds in our absolute-return portfolio, so we were able to participate in that rally to a degree.
As the Federal Reserve appears poised to begin tightening, what is your view of bonds now?
We have a scoring system by which we rank assets and different types of mandates. We had some emerging-markets debt exposures and some absolute-return managers, but it was all predicated on a score for U.S. government debt that was an underweight. This year, as we make our allocation decisions, we’re finding the same prevailing forces as around this time a year ago. If anything, with both inflation and the risk of normalization of policy in the developed economies falling away because of oil prices, a 2 percent yield may not look all that unattractive. Even in the U.S., where we have had good news, when you factor in participation and wages, we are still far from the structural natural rate of unemployment.
Are you currently looking at developing- and emerging-markets exposures?
Well, to start with, investors have all become quite conditioned as to what are developed markets, emerging markets and frontier markets. Basically, almost every consultant relies on the percentages and definitions built into the underlying benchmarks. It’s not reflective of reality. Take Korea. Korea meets all the definitions of a developed market, but because the stock market doesn’t clear in a certain way, it is still rated as a developing market in the MSCI index. I don’t think the way these buckets are designed makes a lot of sense; nor do the investment assumptions that they are intertwined with. Many countries that are in the emerging-markets bucket meet the criterion of a higher growth rate, yet those growth rates are slowing. A lot of them structurally require commodity prices to rise to sustain growth. We happen to like China and are underweight Russia.
What market are you most excited about right now?
Japanese hedged equities are our big overweight; it’s hard to say whether this is a consensus view. It may be consensus for a large, long-only allocator. Stocks in Japan have historically produced a return on investment of half that of the U.S. There are a lot of cultural reasons for that, but now that has started to change. Markets there have largely dealt with unwinding a lot of the cross-ownership issues prevalent in the 1990s.
Isn’t there a big risk that structural reform will not follow monetary policy in Japan?
Remember that Prime Minister Shinzo Abe was former prime minister Junichiro Koizumi’s right-hand man, and Abe learned about how to push change through the Diet from him. I think Abe did a lot of preparation to ensure the Liberal Democratic Party could secure supermajorities in the Diet so that he could push a reform agenda and propel policy at the Bank of Japan and the Ministry of Finance. In some ways he is the Ronald Reagan of Japan, with a focus on eliminating waste and reforming the corporate government code, immigration and agricultural policy.
Are there any markets that you are avoiding right now?
We are underweight in high-yield corporates. The structure of the high-yield market is such that you receive a nice premium, and as long as the expected default rate is better than the spread, it looks good on paper. The problem is so much has been purchased in recent years through commingled products like ETFs that not very many investors are actually looking at individual credits. Structurally, this is a market without a lot of price discovery, not dissimilar in some ways to collateralized debt obligations and collateralized loan obligations before the 2008–’09 crisis. We suspect that if investors attempt to sell these commingled products in size, the providers will be forced to sell liquid holdings in order to meet withdrawals and hang on to the illiquid bonds to meet withdrawals. The hiccup we saw in these markets when oil sold off may have been the proverbial canary in a coal mine. Other than that, we currently are placing a high premium on liquidity and have no commodity or alternative exposures.
