Opportunities In The Global Investment Landscape

By M. Isi Eromosele

As the global economic recovery slowly gains increasing credibility and momentum, the investing environment continues to pose new challenges.

And while this changed landscape will require higher levels of insight and due diligence, it also offers unprecedented opportunities, some of which have not been seen in more than 50 years.

To maximize the potential of this quickly evolving market, investors will need to weigh the sweeping changes that have occurred over the past several quarters in light of their own portfolios’ objectives and constraints. This analysis should be grounded in a consideration of the characteristics, themes and possible outcomes likely to define its next stages.

One reflection of the broad array of attractive opportunities is the capital market sector, which continues to rise, indicating where to best integrate worthwhile risk into existing asset allocations.

In the near- and mid-term, attractive opportunities above the line that merit further consideration range from traditional investments, such as Emerging Market Equities and Leveraged Loans, to alternative investments, such as Hedge Funds of Funds (HFOFs) and Commodities.

A closer look at four major asset categories - Emerging Market Equities, Leveraged Loans, Hedge Funds of Funds and Commodities, offers a timely starting point for an explanation of where attractive opportunities currently exist globally.

Equities

The global economy continues to rebound, and the combination of inventory replenishment, pent-up consumer demand and the gradual boost to fiscal spending could generate a fairly strong initial growth spurt.

Starting with the near-term outlook, demand is beginning to stabilize in many parts of the world. Exports show tentative signs of life and Purchasing managers Indices (PMIs) are gradually edging back toward neutral.

Together, these factors point to a fairly strong rebound in corporate profits in the coming quarters, which should warrant higher equity prices.

Emerging Market Equities

Generally, emerging market economies continue to maintain current account surpluses as well as solid financial reserves.

In the past, when emerging market countries held fewer reserves, they were under equipped to fund imports when foreign direct investment suddenly declined. This dynamic would often impair trade and ultimately lead to significant currency devaluations.

Because of the favorable reserve positions and current account surpluses that exist in many emerging market countries, the risk of widespread currency devaluations as well as other risks associated with investing in emerging markets is less prevalent than in years past.

Future For Emerging Markets

The intermediate and long-term outlook for emerging markets remains intact. Urbanization, infrastructure development and the burgeoning middle class in many of these countries contribute to their upward trajectories and these dynamics should continue to drive economic and earnings growth that is superior to that of developed markets.

In emerging markets, commodity prices are also likely to be upwardly biased (even with lower developed market demand), as the major consumers of commodities remain EM economies. Utilizing these inputs for ongoing infrastructure development, this

phenomenon is expected to continue.

Additionally, as the dollar weakens, U.S. goods, on a price basis, become more attractive around the globe. Since several emerging market currencies remain managed to the dollar (Thailand, China and Malaysia, for example), U.S. dollar weakness also causes those countries’ goods to be more attractive, as their currencies weaken. A weak dollar is generally considered positive for commodities and, therefore, emerging markets.

Fixed Income

Much of the credit market has seen a significant rebound.

·        Yields for high yield bonds and leveraged loans remain at high levels and should more than compensate for expected default losses through the remainder of this cycle.

·        The issuers and industries that have been hardest hit by this recession are well known. This allows new investors to benefit from more transparent sector allocations and individual credit selections.

·        Underwriting standards have become more conservative, resulting in a marked improvement in new-issue pricing and credit profiles.

·        With approximately $850 billion of outstanding bonds and $567 billion of outstanding loans, both markets are large and benefit from active secondary markets. The scale and liquidity of both markets allow investors to construct portfolios quickly and efficiently.

The Leveraged Loan Opportunity

The leveraged loan and high yield bond markets often move in tandem and each still represents an interesting value proposition. However, the loan market is differentiated by certain advantages:

• Recovery rates for leveraged loans continue to be higher than those for high yield bonds. This is due to the greatest advantage of loans: their senior secured position at the top of the capital structure, with a first-priority claim on the majority, if not all of the issuer’s assets.
• Furthermore, with floating interest rates, leveraged loans provide a natural hedge against rising interest rates. The likelihood of inflation, and therefore higher interest rates, has increased with the worldwide surge in spending by both governments and Central Banks. As a result, leveraged loans are poised to benefit directly as the underlying LIBOR begins to climb from its near-historic lows.
• Because demand for leveraged loans is recovering more slowly than demand for high yield bonds, loans will experience a more extended period of positive returns. The basis for this expectation is that collateralized loan obligation (CLO) issuance, which historically was the largest source of demand for leveraged loans, is likely to remain negligible for some time to come.

The Outlook For Recoveries

Historically, defaulted bonds have recovered approximately 40 percent of par, while defaulted loans have recovered about 70 percent of par. The higher recoveries for first-lien loans stem from their first-priority interest in the majority of a company’s assets.

This factor gives loan investors better bargaining power relative to holders of subordinated classes of debt, as well as the highest level of repayment when the defaulting company reorganizes or sells its assets.

Leveraged loans remain attractive long-term investments for several key reasons:

• First, as senior secured instruments, they sit at the top of their issuers’ capital structures, and, consequently, benefit from strong recoveries in the event of bankruptcy.
• Second, financial covenants embedded in the majority of leveraged loans provide investors with opportunities to improve terms or to force early repayments in the event of unforeseen financial difficulties.
• Third, the loan market is large and secondary-market liquidity is very good, affording investors the ability to enter and exit well-diversified portfolios with relative ease.
• Fourth, although loan prices have improved substantially from levels reached at the peak of the credit crisis, they remain at historically low levels providing an attractive entry point for new investors.

Hedge Funds Of Funds

Hedge Funds of Funds (HFOFs) continue to merit investor attention based on their demonstrated ability to preserve capital. Investors with the well-diversified hedge fund exposure that funds of funds can provide have fared substantially better during difficult markets than they would have without this key component of their portfolios.

As a result of the long-term benefits, current opportunities and persistent favorable conditions that are expected to continue for some time, many investors intend to increase their allocations to hedge funds over the near to medium term.

For hedge fund investors, the flight of certain investor segments from even the best-managed hedge funds has freed capacity that was previously scarce or impossible to obtain.

Accordingly, many investors are best served by accessing this capacity through hedge funds of funds.

Many market-specific conditions are expected to provide hedge funds with ample opportunities in the near and medium term.

• Event-Driven Funds are focusing more on credit opportunities in high yield bank loans and convertibles
• Relative Value Funds have reduced leverage drastically and are setting up trades to capitalize on the dislocations
• Global Macro Funds have seen strong inflows with global uncertainty and boom/bust investor views are driving trends toward profitability
• Fixed Income/macro Hedge Funds see opportunities across asset classes as the economic cycle turns

Commodities

Commodities have an excellent record of producing healthy returns coming off recessionary bottoms. Every cycle is different and this one could be a super-cycle for commodities.

With inflation in the air, it is likely that the monetary and fiscal policies of developed economies will continue to err on the side of de-risking the environment, even at the expense of future profitability and growth.

In sharp contrast, many emerging countries appear to be regaining their stride. While the challenge of re-orienting themselves away from an over-reliance on exports is a formidable one, they nonetheless continue to benefit from low costs combined with the latest technology transfers from developed economies.

Additionally, their consumer/corporate/government balance sheets are generally in good shape and so these countries are poised to finance growth, supported by the demographic imperative to do so.

Politically, many emerging economy countries continue to remove restraints to growth and remain in the infrastructure-focused stage of their economic lifecycles, which is the most commodity-intensive period in terms of long-term development.

The “commodity intensity” of such an EM-led mix of global growth is worthy of further evaluation, especially when combined with the potential for policy-driven inflation elsewhere.

While the world has experienced highly turbulent markets and these may continue for some time, there are unparalleled investment opportunities occurring throughout the world.

With the right guidance, insights and approach to balancing risk and reward, investors can capitalize on favorable conditions and benefit from this historic confluence of events.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

Copyright Control © 2012 Oseme Group