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Morningstar's annual investment conference comes at a particularly exciting time this year, with the outcome of the recent UK election still inconclusive, the EU and IMF having just agreed a near-$1 trillion rescue package for Greece and other indebted European economies, and global stock markets on a daily rollercoaster, our broad range of investment luminaries will be addressing all these hot topics and more.
To keep you in the know, I'll be blogging throughout the conference here, updating you with insights into our fourth annual event, key messages and insights from all the presentations, and interesting titbits that emerge during the coffee breaks.
You will find the full agenda below, and I'll be updating you on each presentation as it happens so be sure to check back regularly.
Day 1 - Tuesday May 11
Welcome Address Geoff Balzano, CEO, Morningstar UK
Equity Cycles - Despair, Hope, Growth and Optimism - Where are we? Peter Oppenheimer, Chief European Equity Strategist and Co-Head of Economics, Commodities and Strategy Research in Europe, Goldman Sachs
One of the first presentation slides shown by Peter Oppenheimer, Chief European Equity Strategist at Goldman Sachs, illustrates the organisation’s GDP growth forecasts: 4.8% for the world as a whole in 2010 and the same in 2011, with China providing the main push—11.4% expected this year and 10.0% next. Goldman forecasts 1.4% growth in the UK this year, increasing to 3.3% next, while Europe is seen expanding at an annual rate of 1.8% and 2.5% in 2010 and 2011, respectively. All of these forecasts are higher than consensus, Peter points out. Goldman is less bullish on the US, however. While consensus is for GDP growth of 3.1% and 3.0% this year and next, Peter’s organisation is looking for expansion in the region of 2.7% and 2.5%.
Goldman’s top-down model suggests strong profit rebound in 2010 and 2011 across Europe. Sales are expected to expand with higher world GDP growth, while margins pre-exceptionals are seen reaching peak levels by year-end 2011. 2010 and 2011 EPS estimates are likely to be revised up following surprises, Peter says.
Questions from the floor: First question is regarding the growth rates in the UK versus Europe--surely one would expect US growth to be stronger than in Europe?
Peter's response: It’s important to separate the investment opportunities from the growth rate. The trend rate of growth is higher in the US, the main reason being population growth, so you would expect US growth to exceed that of Europe. But at this stage in time, Goldman is moderately cautious on the US economy as it has already experienced relatively strong economic activity due to the massive fiscal stimulus. As stimulus fades, the economy needs something else to continue to support growth so the question for the US is really: what’s the outlook for consumption? Even assuming improvements in the US weak housing market and high unemployment, Goldman only has a moderate outlook for the US economy. Europe has its own problems but northern European countries are recovering increasingly well. Peripheral and southern European countries are recovering much slower, generally because they’re dealing with such high levels of debt, as is the UK, but this isn’t the case in Germany, for example. Germany’s recovery is actually very strong, in fact it is experiencing one f the strongest rises in manufacturing output in its history, partly thanks to end demand (in emerging markets, for example) remaining quite strong. Germany and France disproportionately make up a much larger share of European growth.
Risk Management: Lessons from the Credit Crisis Ed Fishwick, Managing Director and Co-Head of Risk and Quantitative Analysis Group, BlackRock
Years ago, if a girl at a party asked you what you do, you’d say “fund management”, Ed says, but you wouldn't mention you were in risk management as that was considered very boring. Now however, you say you’re in risk management as it’s actually become very exciting!
Ed kicks off with a little story: While he was holidaying in Queensland in Australia, two guys said they were going to swim across a local estuary, where swimming was forbidden due to the presence of crocadiles. Despite the authorities being up in arms, the whole village came out to watch, so Ed and his family joined too. The two guys swam across and were fine. Ed’s young son observed: “well that wasn’t so risky after all.” A story that has haunted Ed ever since. Interesting highlight of the perception of risk.
There are six key lessons to learn from the credit crisis: 1) the paramount role of liquidity; 2) assumptions are just assumptions; 3) garbage in, garbage out?; 4) the sources of risk change quickly; 5) you can’t cram for crisis—risk management isn’t something you can quickly get into; and 6) volatility is only half the story.
1) Liquidity is the life blood of a modern economy, the ability to meet immediate obligations is critical to financial survival, many market participants assumed that liquidity was a fact of life, continuous time finance is, after all, just an abstraction, not a guarantee.
Maximising wealth, assuming efficient markets exist, permits liquidity concerns to be addressed as an afterthought—value can be extracted from portfolios through the mechanism of the market; In the absence of functioning markets, cash may not necessarily be generated from wealth…alternatively, the cost of doing so becomes exceedingly onerous; Bonds are much better than you think; Reliable cash flows should be used to meet critical future liabilities—if the portfolio contains cash or cash producing securities, liquidity can be extracted relatively efficiently. Free Riding: when market participants anticipate liquidity, investors can trade products they do not fully understand. Severe disruptions in a complex and opaque product space may hit expert investors the worst since they will tend to have concentrated exposures. Just being smart isn't enough!
2) Serious risk managers always understood the limitations of models; Model based forecasts require assumptions—mean-variance, volatility, correlation, etc; It was always understood that these could be violated in practice, but the last two years show this is at levels previously unimagined (rapidly varying volatility, diversification works until it doesn’t, persistence or trending makes the measurement of risk horizon dependant); Highlights the need for caution in the use of models, and expert judgement in their interpretation and use.
3) Investors need to be more hands-on and develop a visceral understanding of the origination processes and borrowers. Recently, the quality and performance of underlying assets were materially worse than expected—the underwriting process was much worse than ever indicated in the data, originators created loans primarily for sale and retained little, if any, interest in their ongoing performance.
Going forward, investors will need to get more deeply involved in the information cycle. Relying on ratings alone was a failed strategy, previous default and delinquency data was artificially low, even using a more rigorous analytical approach based on taking historical performance data and building and relying only on statistical models and stress test is insufficient. The bottom line is Main Street played Wall Street.
4) As more power over the financial system shifts to global political capitals, market dynamics may shift from economic fundamentals or market technical conditions to political considerations. Developed markets may become more like emerging markets. Risk management teams may rely less on economists and statisticians and more on politically-oriented analysts: quants may find themselves getting traded in for politicos. The longer term impact on productivity from an increase in political control over the economy is not known. If history is to be believed, the prognosis is not positive.
5) Effective risk management is an expensive long term investment--professional risk managers with substantive subject matter expertise are critical to have impact. Analytics and information management technology are required for a reliable “information utility”. Risk mitigation is a critical part of risk management.
6) Volatility is only half the story: price has everything to do with volatility, or volatility has everything to do with price. Volatility matters but the price at which you buy stuff and the price at which you sell stuff is really, really important.
UK Equity Income: Regaining its Former Glory George Luckraft, Portfolio Manager, AXA Framlington Group
George Luckraft looks into the UK equity income sector—a sector that’s faced headwinds as companies slashed dividends. The economic crisis and banking crisis removed the stigma of cutting dividends, George tells us. His slide of the ‘FTSE Hall of Shame’ shows a very long list of UK companies that have cut dividends—financials dominate the list, while a handful of resource stocks, real estate investment trusts and leisure stocks such as pubs operators also make appearances.
George believes we are going to return to dividend payments being back on the agenda and will likely see more positive surprises that negative surprises.
Big dividend payments weightings on the FTSE:
The current situation is one of economic improvement, balance sheet improvement, strong dividend cover and a return to dividend payments, George says.
Outlook: Going forward, George says there’s obviously a requirement for income, a recognition that dividends are a core feature for equity owners. He sees a period of muted overall return increasing percentage coming from dividend...a return to normal.
Regarding politics, if he had to make a guess, George thinks we might see a minority Conservative government and another election shortly.
Asked why investors should stay in the UK, given stronger performances elsewhere, George highlights that around 75% of the UK stock market gives you overseas exposure anyway: "the best of both worlds." Looking at data on long-term trends, the London market stands out as being cheap, George says.
Regarding BP's current situation, George suspects that plans to increase the dividend are probably off the agenda at the moment given the cost of its clean-up operation in the Gulf of Mexico. However, unless the situation gets much worse, he still thinks BP will pay a dividend and the shares will outperform, though he confesses he's slightly more nervous now han he was not long ago.
Asked to estimate the dividend growth rate of the UK's top ten dividend players, George says sterling's valuation will be the biggest driver. If sterling remains unchanged, he estimates a dividend growth forecast of 3%-4% accounting for inflation.
View on property-based companies: the BoE's QE measures were designed to help the property market, to take pressure off banks' balance sheets. Sees better value in the equity market than in the physical market, so some of the smaller property companies he owns are at 20%-30% discount to NAV, which is quite unusual. Property is about management of the property--this is a key for investors.
ETFs: More Positives Than Negatives Bradley Kay, Associate Director, European ETF Research, Morningstar Inc.
Bradley gives a comprehensive overview of the exchange-traded fund market, explaining what exactly ETFs are, as well as ETPs (exchange-traded products), ETNs (exchange-traded notes), and ETCs (exchange-traded commodities). The latter is about as close as you can get to actually buying physical gold or other precious metals and storing them in your home, but a more secure version. For more on ETFs in Europe--what they are--read this article, and for more on their future--read this article.
Among the lessons we can learn from the credit crisis: counterparty risk is real. The first iteration of ETF Securities commodity fund were backed by AIG's credit alone and led to the current, collaterised ETC structure; Lehman Brothers ETNs in the US were the only funds to completely fail from counterparty default. When talking about counterparty risk, you're talking about times of crisis, as that's the only time when a major financial institution is going to default.
Liquidity and regulatory risk are bigger than counterparty risk--very little investor money was lost due to counterparty default during the latest crisis.
More to come...
The History and Economics of Stock Market Crashes Dr. Paul Kaplan, PhD, CFA Quantitative Research Director, Morningstar Europe
The Political Landscape - Where Now For Our Industry? Simon Brazier, Co-Head of UK Equities, Threadneedle Investments Services
Day 2 - Wednesday May 12
Welcome Address Geoff Balzano, CEO, Morningstar UK
The Credit Crisis: Life Beyond? Paul Lambert, Director – Macro Strategies, Polar Capital
A Journey Through the Emerging Markets Jonathan Asante, Joint Deputy Head of Global Emerging Markets, First State Investments
Risks in Short Selling and Option Writing James Clunie, Investment Director - UK Equities, Scottish Widows Investment Partnership
A Conversation with Charles Montanaro Charles Montanaro, Chief Executive and Chief Investment Officer, Montanaro Asset Management; Jackie Beard, Director of UK Investment Trust Research, Morningstar UK
What We Know About Mutual Funds, Might Know, and Don’t Know John Rekenthaler, CFA, Vice President of Research, Morningstar Inc
Morningstar/OBSR Qualitative Research: One Year On Dan Lefkovitz, Director of Business & Operations, Pan European Research Team, Morningstar Europe; Christopher Traulsen, CFA, Director of Fund Research, Europe and Asia, Morningstar Europe; Richard Romer-Lee, Research Director, OBSR, a Morningstar company
