Inflation

Inflation

Sustainable Equity Strategies for a Global Recovery

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Image iStock/Franklin Templeton

By Mel Bucher, Co-Head of Global Distribution, Martin Currie, Edinburgh, UK

(Sponsor Content)

The investment choices we make can have a profound effect on the world around us. Investing according to sustainable principles allows investors to align their environmental, social and governance (ESG) goals with their investing choices.

Also, we believe sustainability can be a driver of long-term portfolio performance. As global equity markets recover from the COVID-19 pandemic, more Canadians want to invest in opportunities available within a wider sustainable context.

One new option is the sustainability investment expertise that Martin Currie brings to Canada.

Martin Currie may be a new name for many Canadian retail investors. Our firm is a Specialty Investment Manager of Franklin Templeton, based in Edinburgh, UK, and we focus on actively managing portfolios of the listed public equities of companies that generate long-term value from sustainable ESG polices. Our ESG framework helps to identify any material ESG issues related to a company’s cash flow, balance sheet and profit/loss account over time and whether these ESG issues could affect value creation. Having ESG analysis fully embedded in the research process enables our investment teams to uncover material issues.

Martin Currie’s leadership in ESG was recognized with the UN’s Principles for Responsible Investment A+ rating for 2017, 2018, 2019 and 2020.

This article considers our sustainable investing strategies in global equities and emerging markets equities, both of which are now available to Canadians.

A global equity strategy in a global recovery

We expect the strong comeback of the global equity market to be sustained under fairly benign inflation conditions and with asset prices supported by monetary policy. Our global equity strategy is well positioned in this environment.

The Franklin Martin Currie Global Equity strategy invests in companies with exposure to three established growth megatrends:

1.      Demographic change (e.g., aging population, urbanization, healthcare)

2.      Resource scarcity (e.g., electric vehicles, alternative energy, infrastructure)

3.      The future of technology (e.g., outsourcing, cloud computing, security).

We believe these themes will drive long-term structural growth in the global economy. The portfolio seeks diversified holdings with exposures to the megatrends to capture growth.

Global equities for growth, at the right price

The portfolio holds 20-40 stocks of sustainable, well-managed growth companies that dominate their respective industries and have high barriers to entry. They hold pricing power and face a low risk of disruption. These firms have potential for long-term structural growth and value creation. Companies undergo a systematic assessment of their industry, company, portfolio and governance/sustainability risks.

These equities may not be cheap, so the portfolio managers are highly selective about acquiring companies at the right valuations. The goal is to find equities that combine strong industry, financial and governance attributes at the right price.

This global equity strategy is now available to Canadians through the Franklin Martin Currie Global Equity Fund and Franklin Martin Currie Sustainable Global Equity Active ETF (FGSG). The mutual fund’s U.S. equivalent is a 4-star Morningstar-rated fund* in the International Unconstrained Equity category.  

Unique Approach to Portfolio Analysis and Construction

Martin Currie’s sustainable emerging markets strategy Continue Reading…

How (In)credible is the Transitory Inflation argument?

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By John De Goey, CFP, CIM

Special to the Financial Independence Hub

If there’s one thing we’ve all learned in the past two years, it is that central bankers mean business: both literally and figuratively.  In other words, when central bankers say they ‘have our backs’ in both extending the business cycle by promoting fuller employment and doing so without causing meaningful inflation, we should take them at their word.

As such, central bankers “mean business” literally (meaning they will promote business interests) and figuratively (meaning they are serious, determined and dedicated to their mission).  Then again, for the past two years, those two objectives have been mostly aligned.  What if new circumstances were to make them mutually exclusive?

Looking south of the border, we had a modest yield curve inversion in the spring of 2019 and within a few weeks, then President Trump applied some considerable political pressure (something arms-length central bankers are supposed to be immune to) in order to get the federal reserve to cut rates, which they did in three successive meetings that autumn.

At the time, inflation was benign and tellingly, unemployment was at its lowest level in a generation.  In other words, by any reasonable standard, the fed had done a superb job to that point and no interventions or adjustments seemed necessary.  Despite this, there were changes and a purportedly imminent recession was averted.  Or not. After all, there’s no reliable way of knowing what might have happened had rates not been lowered that autumn.

These days, the narrative coming from central banks is that the recent spate of above-average inflation is ‘transitory,’ meaning it will likely normalize around more traditional levels once the artificially low data of the post COVID year (basically Q2 and Q3 of 2020) falls out of the data set.

Skeptical of the Central Bank line on inflation

Of course, no one knows for sure if the inflation we’re seeing now is genuinely transitory or the harbinger of a more prolonged period of elevated prices. There’s a Chinese proverb that states, “to be uncertain is to be uncomfortable, but to be certain is ridiculous.”  I’m not for a moment suggesting that inflation is or is not transitory. Rather, I am respectfully skeptical of the central bank line.

It may indeed be true that the inflation fear will dissipate into nothingness before the end of the year. Then again, Deputy Prime Minister and Minister of Finance Chrystia Freeland has boasted that the fiscal support offered to Canadians over the past 15 months can act as a sort of ‘pre-loaded stimulus’ that will keep the economy humming long after the government cheques stop coming.  What if Freeland is understating the impact?

Specifically, what if Canadians are so euphoric about the economy re-opening that they start buying things and experiences like never before?  Wouldn’t that kind of spike in purchasing activity risk a spike (or at least prolongation) in inflation?

Higher for Longer

There are some who think central banks are managing expectations about inflation being higher for longer to buy time and provide cover for an anticipated period of deliberate bank inactivity.  In essence, what if central banks don’t act to control high and prolonged inflation because doing so (i.e., raising rates significantly and sooner than expected) would destroy both the economic recovery and the bull markets so many are currently enjoying? Continue Reading…

Equal Weight Indexing during Economic Recovery

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By Hussein Rashid, Invesco Canada

Special to the Financial Independence Hub

2020 was a year for the history books: especially from a finance perspective. With COVID-19 ripping throughout the globe, we saw equity markets decline rapidly as several countries closed their borders.

At the same time, however, we saw some companies flourish as people spent more time at home. Companies like Apple, Microsoft, and Google1 shined brightly and became larger than ever before. Central banks globally introduced measures that aided this appreciation by reducing rates to record lows, fueling most growth-oriented stocks upward at a rapid pace.

However, over three months into 2021, we are now seeing signs of recovery towards normalcy, with continued supportive measures by many central banks and governments, along with a growing number of people being vaccinated.

So, what does that look like from a market leadership perspective? As the recovery unfolds and economic activity accelerates, we would expect market leadership to align with that of the left column of the chart above.

We have already seen a steepening yield curve with longer-dated bond rates rising:  this could temper the strong run up in growth-oriented stocks. Near the end of last year, the move from growth stocks to more value-oriented cyclical stocks, and the move from large-cap stocks to small/mid-cap stocks started to occur. Many of these stocks, especially names in the S&P 500®, will tend to benefit more from the economy and society reopening. Continue Reading…

Projected Inflation and investment returns

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FP Canada issues guidelines every year to help financial planners make long-term financial projections for their clients that are objective and unbiased. The guidelines include assumptions to use for projected inflation and investment returns, wage growth, and borrowing rates. It also includes “probability of survival” tables that show the life expectancy at various ages.

The 2021 Projection Assumption Guidelines were of particular interest because, well, a lot has happened since the 2020 guidelines were published last spring. How should we project inflation and investment returns as we get to the other side of the pandemic and economies start opening up again?

Will we see sustained higher inflation? Should we expect any returns at all from bonds or cash? Should we lower our expectations for future stock market returns?

Remember, these are long-term projections (10+ years). That’s very different than guessing the direction of the stock market for 2021, or predicting whether we’ll see a short burst of inflation in late 2021, early 2022.

The inflation assumption of 2.0% was made by combining the assumptions from the following sources (each weighted at 25%):

  • the average of the inflation assumptions for 30 years (2019 to 2048) used in the most recent QPP actuarial report
  • the average of the inflation assumptions for 30 years (2019 to 2048) used in the most recent CPP actuarial report
  • results of the 2020 FP Canada/IQPF survey. The reduced average was used where the highest and lowest value were removed
  • current Bank of Canada target inflation rate

The result of this calculation is rounded to the nearest 0.10%

Projections for equity returns were set by combining assumptions from the following sources:

  • the average of the assumptions for 30 years (2019 to 2048) used in the most recent QPP actuarial report
  • the average of the assumptions for 30 years (2019 to 2048) used in the most recent CPP actuarial report
  • results of the 2020 FP Canada/IQPF survey. The reduced average was used where the highest and lowest value were removed
  • historic returns over the 50 years ending the previous December 31st (adjusted for inflation).

Equity return assumptions do not include fees.

Unlikely that bonds can replicate their projections of last 50 years

Projections for short-term investments and Canadian fixed-income returns included the assumptions from QPP and CPP, the results of the 2020 FP Canada/IQPF survey, but the 50-year historical average rate was removed in 2020 as a data source. This makes sense given that interest rates were significantly higher than they are now and so it would be impossible for bonds to replicate the performance of the last 50 years. Continue Reading…

The case for caution with cryptocurrencies

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Vanguard Group

Special to the Financial Independence Hub

Republished with permission of Vanguard Canada

The tremendous surge in the price of cryptocurrencies has attracted the attention of many investors, who may be considering the digital currency as a potential substitute for traditional asset classes in diversified portfolios. But Roger Aliaga-Díaz, chief economist for the Americas and head of portfolio construction at Vanguard, cautioned against speculating in cryptocurrencies, which are largely unregulated and accompanied by considerable risks.

“Cryptocurrency prices depend mostly on speculation about their adoption and use,” Mr. Aliaga-Díaz said. “And that speculation creates volatility that, ironically, undermines their potential use as either a currency or asset class in an investment strategy.”

What is a cryptocurrency?

A cryptocurrency is a digital or virtual means of exchange. There are more than 6,700 cryptocurrencies today; among the better known are Bitcoin, Dogecoin, Ethereum, XRP, Tether, and Litecoin.

Unlike traditional currencies, virtual currencies currently operate without central authorities or banks, and they are not backed by any government. Cryptocurrencies are stored in “digital wallets” on a holder’s computer or phone, or in the cloud. The wallet serves as a virtual bank account that enables holders to pay for goods and services or simply store the currency in hopes of an increase in value.

Cryptocurrencies defy neat categorization. They are not a traditional currency, commodity, or asset class, though they share characteristics of each.

There are several reasons why cryptocurrencies are not a traditional currency. Although some merchants have begun to allow cryptocurrency payments, they are generally not accepted as a medium of payment. Cryptocurrencies also are not used as a unit of account because prices, trade invoicing, and contracts are not quoted in digital currency units. Finally, cryptocurrencies’ ability to serve as a store of value—a safe instrument to preserve the value of people’s financial wealth—is severely limited by their notorious volatility.

“The fact that cryptocurrencies are not issued by a central bank is actually the very reason why they can’t achieve the quality of other well-accepted currencies,” Mr. Aliaga-Díaz explained. “The role of a central bank is precisely to preserve the value of the currency by keeping inflation under control. That’s why prices are more predictable under Federal Reserve management of the U.S. dollar money supply.”

Cryptocurrencies share some characteristics of commodities. For example, they can be bought and sold in cash markets or via derivatives. But Mr. Aliaga-Díaz said they are not commodities because they are not physical raw materials.

No substitute for stock and bonds

Some wonder whether cryptocurrencies can be used in strategic portfolios as substitutes for stocks and bonds. “But unlike traditional asset classes, cryptocurrencies lack intrinsic economic value and generate no cash flows, such as interest payments or dividends, which can explain their prices,” Mr. Aliaga-Díaz said.

Mr. Aliaga-Díaz pointed out that as with currencies and spot commodities, such as gold, there is no risk premium expected with cryptocurrencies as compensation for bearing the risk of their price movements. “Because cryptos represent uncompensated risk to the portfolio, they are not a good substitute for stocks and bonds in a long-term portfolio,” he said.

Some investors may be willing to bet on sustained crypto price increases based on the belief that crypto demand will always outpace its supply. And though there might be some valid reasons around projected demand and usage to make a compelling case for a persistent supply shortage that can sustain increasing prices, Mr. Aliaga-Díaz noted, the supply of cryptos has exploded over time, and there is no reason to believe that supply can’t keep up with demand.

“The biggest risk for all investors would be to assume that demand growth will continue just because their prices have recently gone up,” he said. “That’s speculation, not investment.”

Other risks to keep in mind

Despite all the recent attention devoted to cryptocurrencies, Mr. Aliaga-Diaz cautioned that there are a number of additional risks associated with digital currencies, including: Continue Reading…