Currencies

Renminbi strengthens further despite gains by dollar

The renminbi on track for a fourth day of firming against the dollar on Wednesday after China’s central bank once again pushed the currency’s trading band (marginally) stronger. The onshore exchange rate (CNY) for the reniminbi was 0.28 per cent stronger at Rmb6.8855 in afternoon trade, bringing it 0.53 per cent firmer since it last […]

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Currencies

Nomura rounds up markets’ biggest misses in 2016

Forecasting markets a year in advance is never easy, but with “year-ahead investment themes” season well underway, Nomura has provided a handy reminder of quite how difficult it is, with an overview of markets’ biggest hits and misses (OK, mostly misses) from the start of 2016. The biggest miss among analysts, according to Nomura’s Sam […]

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Property

Spanish construction rebuilds after market collapse

Property developer Olivier Crambade founded Therus Invest in Madrid in 2004 to build offices and retail space. For five years business went quite well, and Therus developed and sold more than €300m of properties. Then Spain’s economy imploded, taking property with it, and Mr Crambade spent six years tending to Dhamma Energy, a solar energy […]

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Currencies

Euro suffers worst month against the pound since financial crisis

Political risks are still all the rage in the currency markets. The euro has suffered its worst slump against the pound since 2009 in November, as investors hone in on a series of looming battles between eurosceptic populists and establishment parties at the ballot box. The single currency has shed 4.5 per cent against sterling […]

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Banks

RBS falls 2% after failing BoE stress test

Royal Bank of Scotland shares have slipped 2 per cent in early trading this morning, after the state-controlled lender emerged as the biggest loser in the Bank of England’s latest round of annual stress tests. The lender has now given regulators a plan to bulk up its capital levels by cutting costs and selling assets, […]

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Archive | Capital Markets

Mnuchin expected to be Trump’s Treasury secretary

Posted on 30 November 2016 by

Donald Trump has chosen Steven Mnuchin as his Treasury secretary, US media outlets reported on Tuesday, positioning the former Goldman Sachs banker to be the latest Wall Street veteran to receive a top administration post.

Mr Mnuchin chairs both Dune Capital Management and Dune Entertainment Partners and has been a longtime business associate of Mr Trump. He publicly supported Mr Trump during the Republican primary and was appointed as his campaign’s national finance director in April.

Contacted by the Financial Times on Tuesday, Mr Mnuchin declined to comment.

Mr Mnuchin is expected to be announced as Mr Trump’s pick within hours, while Wilbur Ross, a billionaire investor known by Wall Street, as the “king of bankruptcy” is expected to be confirmed as Mr Trump’s choice for commerce secretary — an appointment that was expected since late last week.

The twin appointments suggest that the president-elect is filling his cabinet with loyalists who stood by him for the majority of his general election campaign — a rarity in Republican establishment circles.

Mr Ross, like Mr Mnuchin, was a vocal supporter of Mr Trump throughout the general election, and took an official role on Mr Trump’s campaign as one of its senior advisers.

Steve Bannon, Reince Priebus and Michael Flynn, who respectively have been named Mr Trump’s chief strategist, chief of staff and national security adviser, also publicly stood by Mr Trump during the ups and downs of his controversial campaign.

The president-elect’s willingness to entertain appointments from Wall Street was also in evidence as he summoned Gary Cohn, Goldman’s president and chief operating officer, for a 4pm meeting at Trump Tower on Tuesday afternoon, according to a person familiar with Mr Cohn’s movements.

Mr Cohn, who has been seen as the heir apparent to Lloyd Blankfein, the bank’s chairman and chief executive, was not offered any specific role, during a meeting that lasted for an hour and a half. Mr Cohn has been a prolific political donor. Most of his giving in recent years has been to the Republicans, according to opensecrets.org, including contributions to Marco Rubio, one of Mr Trump’s rivals for the party’s nomination for president.

However, Mr Trump has also met with Mitt Romney, the 2012 Republican presidential nominee and one of his most vocal critics during the campaign, over a potential secretary of state appointment. On Tuesday evening, Mr Trump and Mr Romney were dining in midtown Manhattan, with their wives, to discuss for a second time Mr Romney’s possible appointment.

On Wall Street Mr Mnuchin has a much lower profile than the previous two Treasury Secretaries drawn from Goldman Sachs: Robert Rubin and Hank Paulson. Mr Rubin, who served under Bill Clinton from 1995 to 1999, was a former co-chairman of the bank. Mr Paulson was chief executive of Goldman between 1998 and 2006 before a three-year stint in government, which spanned the depths of the financial crisis.

Mr Mnuchin became a Goldman partner but left in 2002, having risen to the top of the pile in trading government bonds and mortgage bonds, and in recent years has focused on west coast business opportunities, particularly in Hollywood, where he in credited as an executive producer on big budget films such as Batman v Superman: Dawn of Justice, Mad Max: Fury Road, and American Sniper.

On Wall Street, Mr Mnuchin was best known for snapping up IndyMac, the collapsed mortgage lender, in 2009. He brought in equity investors such as John Paulson, Chris Flowers, George Soros and Michael Dell, arranged the financing through Merrill Lynch, and took the chief executive role himself. The bank — renamed OneWest — was sold to CIT Group for $3.4bn last year.

“He did a tremendous job of orchestrating the job from beginning to end,” said Thomas Vartanian, a partner at Dechert in Washington who advised on the IndyMac deal. “He was just unflappable.”

Mr Mnuchin and Mr Ross will need to be confirmed by the US Senate, where some members have already warned Mr Trump against drawing too heavily from the ranks of a finance industry he promised to crack down on once in office.

“So much for draining the swamp,” said Adam Hodge, the Democratic National Committee’s communications director on Tuesday. “Nominating Steve Mnuchin to be Treasury Secretary — a billionaire hedge fund manager and Goldman Sachs alumnus who preyed on homeowners struggling during the recession — is a slap in the face to voters who hoped he would shake up Washington.”

In an open letter sent to Mr Trump last week, Sen Tammy Baldwin, a Democrat from Wisconsin, warned the president-elect not to fill his administration with Wall Street bankers, a move she said was akin to appointing “foxes to guard the hen house”.

Mr Mnuchin’s support for Mr Trump’s infrastructure plans could mean a boost to the Government’s already sizeable outstanding debt. That in turn could see the introduction of longer-bond maturities to the $13.8tn market, which currently only issues up to 30 years, making it an outlier among global government bond markets.

Fears of increased debt issuance reviving the battle over the debt ceiling have become less pronounced, however, thanks to Republican dominance of both houses of Congress, which the election that should make it easier to get any new deal through.

Mr Mnuchin has donated to both Republicans and Democrats, including Hillary Clinton, according to Federal Election Commission records​.

BGC Partners eyes new platform to trade US Treasuries

Posted on 30 November 2016 by

BGC Partners plans to launch a new platform to trade US Treasuries early next year, in a bid to return to a market in the middle of evolution, according to people familiar with the plans. 

The company, spun out of Howard Lutnick’s Cantor Fitzgerald in 2004, sold eSpeed, the second-largest interdealer platform for trading Treasuries, to Nasdaq in April 2013. The deal prohibited BGC from competing in the space for three years. With the non-compete period over, people familiar with the venture say the company is planning to launch a platform in the first quarter of 2017. BGC declined to comment. 

It comes at a time when both start-ups and established venues are seeking to position themselves for the future structure of the Treasury market. A flood of offerings have come to market seeking to shake up the traditional divide between banks trading with each other and banks trading with their clients. But so far the platforms have only made minor inroads.

The flurry of activity has been spurred in part by a rise in prominence of high frequency, principal trading firms that have muscled their way on to interbank trading venues as some established dealers have pulled back. 

Some of the new solutions, including BGC’s offering, will seek to create a market which mixes up the trading activity of PTFs, banks and buyside firms such as asset managers and hedge funds. Mr Lutnick’s new venue is likely to also have anonymous trading and lean on the settlement capabilities of Cantor Fitzgerald — settlement has been a stumbling block for smaller start-up venues.

“Why would he want to get back in to a business he has already got out of?” asked Kevin McPartland, head of market structure at Greenwich Associates. “The players, the position in the economic cycle and what is coming out of Washington suggests maybe things have changed.”

When Mr Lutnick, the entrepreneurial head of both BGC and Cantor Fitzgerald, sold eSpeed it accounted for close to 36 per cent of interdealer Treasury trading, according to Nasdaq, but that market share has dwindled to about 23 per cent, the firm added.

Nasdaq recently hired John Shay from the high-frequency trading shop Virtu to head up fixed income and commodities as part of a renewed effort to reinvigorate the platform. Shortly after Mr Shay’s arrival, the firm ended a joint venture for a new, separate start-up Treasury venue called CrossRate, after the partner firm failed to generate enough client interest, according to a Nasdaq spokesperson. 

“Hopefully first quarter next year we will come out with some interesting new ideas,” said Mr Shay. He added that the dominance of ICAP’s BrokerTec, which accounts for almost all of the rest of the market, is “unhealthy”. 

“It is weighted in one camp right now,” said Mr Shay. “From a pure market structure point of view it is unhealthy. It would be better to see it back closer to 50-50.” 

David Rutter, the former head of ICAP’s BrokerTec, has also returned to the market with a new venture called LiquidityEdge. Established venues BrokerTec and Tradeweb have also launched new platforms. Other start-ups include OpenDoor, focused on less liquid, older Treasury securities, and Direct Match, which having announced it was shutting down in August is said to be attempting to make a comeback, according to people familiar with the plans.

“The two folks who built the leading platforms are now both setting up new ones,” said Mr McPartland. “It suggests they see opportunity here.”

Hunt for yield pushes more investors into riskier assets

Posted on 29 November 2016 by

Pension funds and insurance companies have increasingly embraced riskier assets in their hunt for higher returns over the past five years.

Alternative assets such as property, infrastructure, private equity and hedge funds have been bought up by institutional investors in a world where yields on safer government bonds have hit rock bottom.

Total assets managed by the 100 largest alternative investment managers rose to $3.6tn this year, up 3 per cent on 2015, according to consultants Willis Tower Watson, as these assets have become more embedded in the portfolios of pension funds and insurance groups.

This switch into alternative products has prompted warnings that some of these institutional investors could be severely affected in the event of a financial shock or the seizing up of liquidity in the markets.

The OECD, the Paris-based group of mostly rich nations, warned last year that pension funds and insurance companies faced a growing threat of insolvency because of their increased allocations to riskier assets.

“The main concern is whether pension funds and life insurance companies have, or might, become involved in an excessive ‘search for yield’ in an attempt to match the level of returns promised earlier to beneficiaries or policyholders when financial markets were delivering higher returns. This might heighten insolvency risks,” the OECD said in its business and finance outlook for 2015.

So what are institutional investors doing to make sure they are not taking on too much risk?

Chris Hitchen, chief executive of the UK railway pension fund RPMI Railpen, says: “It is much harder to get returns today because yields are low. It takes decent returns as well as decent contributions to make decent pensions. This involves some risk.

“We have risk systems in place to try to ensure we do not get into a position where we are forced sellers. In the event of falling markets, we want to be in a position where we have enough liquid assets to pay our pensions and firepower to invest at lower prices.”

RPMI has investments in quoted shares, real estate, infrastructure, private equity and hedge funds, all considered riskier than government bonds, traditionally the safest assets.

The group has a system in place that monitors risk to its portfolios daily, while it employs experienced fund managers to ensure that its funds’ positions deliver the best returns with risks reduced to the lowest possible levels.

Other institutions such as Legal & General Investment Management carefully monitor systemic risk, or the perceived dangers to the markets of a breakdown in the financial system that would prevent investors from being able to sell assets or liquidate positions.

LGIM says that risks to the system are elevated because of rising worries over a hard landing in China, the threat of a break-up in the EU as the economies continue to struggle to grow, the potential fallout of Brexit and concerns over the impact of expected US interest rate moves.

John Roe, head of multi-asset funds at LGIM, says: “There are elevated risks in the system. As a fund manager or institutional investor, that means you have to be more vigilant and think more carefully about the weightings in your portfolio.”

Other fund managers say investors need to be more disciplined and flexible, seeking opportunities in areas of the market such as corporate high-yield bonds, subordinated bank debt, infrastructure and equities.

“Equities look good value and so does infrastructure. But you need a longer term horizon to invest in these type of securities,” says the investment director of a top UK fund manager.

“A pension fund that is still open to new members and is looking to hold an asset for a long time can be quite comfortable with equity volatility or the illiquidity in a market like infrastructure because they can hold these assets for years.

“Some pension funds refer to their quarter as 25 years, rather than three months. If you have that kind of long-term horizon, you can take quite a lot of risk and not face any threat in terms of insolvency.”

However, the reality is that it is much harder today to make decent returns.

“Going forward, if you want 8 per cent today in returns, you are going to struggle,” says Mitch Reznick, co-head of credit at Hermes Investment Management. “It is harder to hit those kind of returns with zero interest rates.”

He adds that the days when a pension fund or insurance company could rely on government bonds, typically considered close to risk-free, for returns, is in the past.

Unless a pension fund puts all its money in cash or treasury bills, which offer zero rates or in some cases negative yields, then there will always be a danger that the market could undermine its portfolio and cause losses.

As Jim Leaviss, head of retail fixed income at M&G Investments, says: “There is no such thing as a free yield. If you want yield, you have to take some risks.”

Italian 10-year bond yields slip below 2%

Posted on 29 November 2016 by

Italian government debt is rallying strongly today with 10-year yields falling below 2 per cent for the first time in a week, helped along by reports the European Central Bank could ramp up its purchases of the country’s bonds ahead of a crucial referendum on Sunday.

Yields on Italy’s benchmark 10-year bonds are down 0.07 percentage points (7 basis points) on Tuesday to 1.98 per cent – outperforming peers across the eurozone today (yields fall when a bond’s price rises).

Within the last hour, Reuters has reported that ECB policymakers are ready to temporarily accelerate their purchases of Italian government debt as part of its existing quantitative easing measures, in a bid to calm market nerves should a ‘No’ vote lead to heightened volatility after the referendum.

Italian yields have climbed above 2 per cent for the first time since 2015 this month as investors have sold the country’s debt on the back of rising concern over support for populist groups who are critical of Rome’s eurozone membership.

Addressing MEPs on Monday, ECB president Mario Draghi rejected any suggestions the central bank would intervene in a bailout of the country’s struggling banking system. He added, however, that the Italian economy remained “vulnerable to shocks”.

The ECB has been snapping up €80bn of government bonds a month as part of its landmark asset purchase programme, launched in March last year. The purchases are carried out by the eurozone’s national central banks and are done according to the share of GDP represented by each member state.

Policymakers have flexibility within the QE framework to quicken or slow the pace of its purchases of different government debt. In the past, it has used this flexibility to buy fewer bonds in periods during the summer, when debt markets are less active.

Last week, ECB vice president Vitor Constancio hinted policymakers would react to any adverse financial shock from the vote on constitutional reform that prime minister Matteo Renzi has staked his job on.

“It’s the sort of political uncertainty that will trigger or not an economic shock in financial markets”, said Mr Constancio.

“And depending on the degree of that shock, then we have to see if we have anything to do or not”.

An ECB spokesperson declined to comment.

UK inflation debt sale attracts robust demand

Posted on 29 November 2016 by

A sale of UK index-linked bonds attracted more than £10bn in orders on Tuesday, in a fresh sign of demand for securities that offer some protection against rising consumer prices after years of subdued inflation.

It comes as investors assess competing forces affecting the UK economy following a vote to leave the EU in June. Expectations of economic growth fading at the same time that a slumping pound pushes up import prices, is seen complicating the Bank of England’s policy options in 2017.

The Debt Management Office issued a £2.25bn 40-year bond maturing in November 2056 at a yield of minus 1.466 per cent, two basis points below the yield of an existing bond due to mature in 2058.

So-called “linker” bonds pay a coupon determined by the prevailing rate of retail price inflation in the UK. That provides investors with a form of protection against inflation which erodes the value of fixed coupons paid on standard government bonds.

John Wraith, head of UK rates strategy for UBS, said Tuesday’s sale indicated substantial investor interest in such securities. “In round numbers most people are assuming over the next six months to two years inflation will rise to 2.5 to 3 per cent then stay there for some period of time,” he said.

Market prices also highlight a challenge facing the central bank, to support the UK economy through any disruption associated with Brexit negotiations while also targeting inflation of 2 per cent. The implied rate of annual retail price inflation for five years, in five years’ time, is around 3.5 per cent: “It’s probably on the high side,” said Mr Wraith.

Demand for such linkers has recently outstripped orders for conventional debt, with a September sale of £400m of such paper maturing setting a record low yield for a 20-year index linked bond.

Tuesday’s sale came after the government last week raised forecasts for UK borrowing over the next five years. Achim Linsenmaier, head of SSA Syndicate for Deutsche Bank, said “the long end of the linker market is a good place for the UK DMO to access, a lot of demand is coming from insurance companies and pension funds which naturally need these long dated inflation linked investments”.

Bank of America, Deutsche Bank, Morgan Stanley and Scotiabank advised on the syndicated deal.

Demand for traditional bonds has also remained strong in recent months. Overseas investors snapped up more than £10bn of British government bonds last month, even as bond yields rebounded from record lows set in August. The fixed coupon on gilts means such debt falls in value as yields rise.

Gilts held by non-residents grew £10.55bn last month, softening slightly from the £13.27bn climb in September, but marking the third consecutive month of rises after a contraction in August, according to data from the Bank of England.

Foreign investors own around one quarter of the UK’s outstanding gilt market and play a crucial role in the country’s ability to fund itself at low rates.

Mario Draghi’s difficult juggling act

Posted on 29 November 2016 by

The calendar is not kind to the European Central Bank. A week on Thursday, its governing council will deliberate, just days after Italy’s vote on constitutional reform, and a week before the bank’s US counterpart holds a meeting which could move the world’s bond and currency markets.

Temporal pressure of another kind is also building, as the ECB buys €80bn of bonds each month in a programme that runs until March. Extending it could create a new problem, as there may not be enough German Bund’s available next year to keep the ECB’s spending on the eurozone member country’s debt in line with a carefully agreed formula.

So Mario Draghi, head of the bank, must somehow ensure stability following a referendum many expect the Italian government to lose, without unduly favouring that country’s sovereign bonds. He must try to keep borrowing costs suppressed across a continental economy where inflation is absent, while also keeping banks healthy and profitable so they lend to businesses and consumers.

The ECB must also stay credible to bond market investors and traders who were disappointed by the size of stimulus a year ago, while placating those within the institution who fret about the extraordinary measures it has taken already. All while anticipating any effect the Federal Reserve may have a week later.

A US interest rate rise is about as close to a sure thing as market prices get, but the message on how fast future increases will arrive, and how high they might go, could have dramatic implications. If accelerating US inflation is in focus, meaning higher bond yields lie ahead, a stronger dollar will help European exporters. Parity between the dollar and the euro might beckon. Yet if markets have got carried away with prospects for both inflation and a response from the Fed, the euro could soon reverse course.

So what can Mr Draghi do? An official forecast for headline inflation in 2019 to hit 2 per cent might help to remind investors that inflation will one day return.

Another option is to extend ECB bond purchases, but at the €60bn a month pace at which quantitative easing began. A taper presented as a tweak, it would at least buy that most precious commodity: more time.

dan.mccrum@ft.com

Time Warner hit with higher borrowing costs in bond sale

Posted on 29 November 2016 by

How quickly times change.

Six months after HBO and Warner Brothers owner Time Warner enjoyed the byproduct of the race into negative yielding debt — low borrowing costs — it is feeling the effects of the sell-off that has reverberated across fixed income markets.

The company was dealt far higher borrowing costs on Tuesday as it sold $1.5bn of debt compared to a May 2016 offering of similar notes, US capital markets correspondent Eric Platt reports.

The New York-based group sold new 10-year bonds with a yield of roughly 3.84 per cent on Tuesday, up from 3.099 per cent at a May sale.

The jump has been propelled by the sell-off in US Treasuries, which have slid after Donald Trump’s surprise US election victory. Yields on 10-year US Treasuries have climbed 54 basis points from when Time Warner last tapped bond markets in May to 2.29 per cent. Yields rise as bond prices fall.

The new bonds priced with a spread, or the difference between the bond and the benchmark 10-year Treasury, of 155 basis points. That is up from the 135 basis points Time Warner secured in May, but tighter than initial price talk on Tuesday of between 175 and 180 basis points.

One portfolio manager familiar with the deal said investor orders hit $4.5bn.

The media conglomerate earlier this year agreed to an $85bn takeover by telecommunications group AT&T and said the new debt would be used to purchase some of its outstanding bonds.

Russia’s rehabilitation trade prompts delight and scepticism

Posted on 28 November 2016 by

There is no mistaking the delight with which investors in Russia regard Donald Trump’s ascension to US presidency.

And after more than two years near the top of the list of countries to avoid, international equity and bond traders are placing bets Mr Trump’s victory will not just improve ties between the historic adversaries, but facilitate Russia’s rehabilitation on the global stage.

“We’re seeing that with the rouble holding up, more money is looking at Russia,” says David Nangle, managing director at Vostok Emerging Finance, a private equity firm with stakes in several Russian companies. “It’s clearly good for Russia Inc whether you are a quality company or a less quality company. Everyone benefits.”

Still, campaign trail praise for Vladimir Putin and calls for a better relationship with Russia are only the start of a long road to ending economic sanctions imposed by Europe and the US following the country’s intervention in Ukraine in 2014.

Some investors and bankers are also sceptical warmer relations would do more than exacerbate existing trends in a country already helped by this year’s return of capital to developing markets.

“You’d see growth in fixed-income trading, which is growing anyway because Russia has such high yields compared to other emerging markets,” says a senior Moscow investment banker. “But it wouldn’t do much to equities because the fundamentals don’t really change.”

Russia’s problems have been compounded by the fact that as sanctions bit, the price for crude oil — the country’s key export — fell from more than $100 per barrel to less than $50 as global supplies outweighed demand. As foreign investment ground to a halt, the economy sunk into the doldrums.

The sanctions affect a range of companies in different ways. State banks and energy companies are currently banned from raising debt of more than 30 days’ maturity from western markets. Other bans exist on companies in Russia’s defence sector, dealing with the annexed Crimean peninsula, importing dual-use technology, and doing business with people blacklisted for their role in the Ukrainian conflict or closeness to Mr Putin.

Their existence also adds obstacles to investing in non-sanctioned Russian companies for overseas investors. Viktor Szabo at Aberdeen Asset Management says internal compliance required that every position in Russia be confirmed as a non-sanctioned asset.

Andrei Kostin, chief executive of state-run VTB, Russia’s second-largest bank, released a statement hours after Mr Trump’s victory saying he expected “new possibilities for restoring constructive relations between Russia and the US, [and] improving the geopolitical situation in general. If that happens, then we could soon see an easing or even the repeal of US financial sanctions.”

Even before Mr Trump’s election win, Russia’s fortunes had been looking healthier. Within the country there are hopes that a stagnant financial services industry will be fired up with an influx of new investment. UBS has made buying Russian debt one of its top trades for 2017 while Moscow’s stock index trades at a record high.

Mr Nangle said Russia’s state banks and commodities companies would be obvious investment targets. But, he adds, “a lot has to go right before big global corporations have to take Russian risk again”.

The rouble’s fall had pushed production costs in Russia down, while sanctions prompted deleveraging that sent corporate debt levels to a five-year low, making investment more attractive.

While the country has not returned to regularly issuing Eurobonds, investors are far more relaxed about the risk of investing in Russian bonds. In January, the annual cost of insuring $10m of Russian debt against default was $400,000, according to Markit. Now it is $227,000.

International investors say they have space to include more Russian assets in their portfolios after the extended lack of issuance.

In the popular JPMorgan index of dollar-denominated emerging market bonds, Russia’s weighting is just 4.3 per cent — down from 5.75 per cent of the index in 2012.

However, there is a fair chance that markets may be getting ahead of themselves in expecting a radical new phase of Russia-US relations.

“Does Russia want better relations?” asks Mr Szabo. “Concrete signs of detente are hard to pin down and Vladimir Putin has used the idea of opposing the US as an enemy to shore up his popularity in the past.”

Alexander Morozov, chief financial officer of Sberbank, Russia’s largest bank, is more cautiously optimistic. “There’s a Russian joke where an optimist and a pessimist meet,” he told the FT.

“The optimist says, ‘It can’t get any worse,’ and the pessimist agrees with him: ‘It can’t get any worse!’

Saudi Arabia on the verge of $30bn capital injection

Posted on 25 November 2016 by

Saudi Arabia is hardly an emerging market success story at the moment, with a bout of austerity driven by low oil prices resulting in public sector pay cuts and a slump in non-oil growth to 0.07 per cent in the second quarter of 2016, putting the country on the brink for its first non-oil recession in 30 years.

Yet Saudi could be on the verge of attracting more than $30bn of foreign capital to its $380bn stock market, according to estimates by Bank of America Merrill Lynch.

A buying spree of this magnitude would represent a seismic shift for a widely ignored bourse that accounts for just 0.2 per cent of the holdings of the global emerging market fund sector.

“There is a level of apathy towards the market,” says Hootan Yazhari, research analyst at BofA, who estimates that foreign investors account for only 1 per cent to 1.5 per cent of Riyadh’s daily trading volumes.

The Saudi stock exchange’s problem is that the country is not in either of MSCI’s emerging or frontier markets indices, meaning it is entirely ignored by passive funds following these indices, and largely ignored by the myriad of “closet-tracking” active funds that do.

It does attract some interest from actively managed frontier market funds, many of which are perfectly happy to invest outside of their benchmark. Saudi Arabia accounts for about 4.5 per cent of the assets of frontier funds, according to EPFR, a data provider, making it the eighth largest market for these funds.

However, Riyadh would attract far larger flows if it could win access to one of the MSCI indices, ideally the EM one.

To this end, in May the Saudi Capital Markets Authority doubled the limit on the amount an individual foreign investor can hold of a stock to 10 per cent and scrapped a rule limiting foreign ownership of the overall market to 20 per cent, although it retained a 49 per cent cap on foreign ownership of an individual company. It also introduced stock lending and covered short selling, becoming the first Gulf market to do so.

Moreover, the CMA said foreign groups with as little as $1bn under management (rather than $5bn) could now enrol in its Qualified Foreign Investor programme, which is necessary to enter the market (other than by investing via swaps), and made some other technical changes to this regime.

While there are no specific requirements a country needs to meet to be deemed eligible for the MSCI EM index, Riyadh’s moves to ease the restrictions on foreign investment will certainly strengthen its case for inclusion.

As of May, some 25 overseas investors had entered the Saudi market, known as the Tadawul, but Mr Yazhari says that “in the last two or three months the number of QFIs has gone up quite sharply”.

He sees the May reforms not only as bringing Saudi “one step closer” to inclusion in the MSCI index, but also as indicating the country “is seeking an expedited path to inclusion”.

Such a move would potentially fit with Riyadh’s National Transformation Plan, an ambitious project launched in June designed to ween the country off its over-reliance on oil.

“Given the NTP is seeking heavy involvement and investment from the private sector, we believe the measures introduced by the CMA to attract direct capital inflows to the country are likely [to be] linked with the larger NTP process,” he says.

BofA’s core thesis is that Saudi Arabia is likely to be admitted to the MSCI EM index in 2019, with an announcement made in 2018. However, Mr Yazhari believes the reforms mean inclusion in 2018, with an announcement in November 2017, “is by no means out of the question”.

As things stand, Saudi Arabia’s weight in the EM index would be about 1.5 per cent. With about $740bn worth of active and passive funds tracking this index, according to EPFR, this would imply inflows of about $11bn as foreign investors get up to weight.

However, if Riyadh were to ease its restrictions on foreign ownership still further, something BofA thinks very possible, this would raise the “foreign ownership limit” factor that MSCI uses in its weighting calculations, potentially raising the Saudi weight to nearer 3 per cent and attracting $22bn of inflows.

Furthermore, inflows of this size could ensue even if the CMA does not loosen its regulations further. Under the NTP, Saudi Arabia is planning a series of privatisations over the next two years, probably led by the listing of a 5 per cent stake in Saudi Aramco, a company Riyadh is believed to value at about $2tn.

Assuming that these privatisations go ahead, BofA calculates that Saudi Arabia’s putative weighting in the MSCI index could be about 4.3 per cent, implying inflows of about $30bn.

In this scenario, Saudi would be the seventh largest country in the MSCI EM index, behind only China, South Korea, Taiwan, India, South Africa and Brazil, but ahead of Mexico, Russia and Turkey, as the first chart shows.

Moreover, if Saudi Arabia did succeed in engineering an expedited entry into the index, Mr Yazhari believes these flows would largely occur during 2017.

“What we have typically seen [in previous cases of entry into the MSCI index] is that passive and active funds that track an index will start the process of gaining exposure to the market well ahead of the event itself. The announcement of inclusion is when you really start to see the inflows,” he says.

The lessons from neighbouring Qatar and UAE, which both joined the MSCI index in May 2014, are a little unclear, however. Both countries’ accession was announced in June 2013. During the course of that calendar year the Dubai Financial Market, the largest bourse in the UAE, surged 108 per cent, while the Qatari market rose 23 per cent. Both markets also saw smaller gains in 2014 itself.

“We saw record levels of market activity and a massive pick-up in liquidity. It was a one-way trade,” says Mr Yazhari.

However, part of those gains would have been driven by high oil prices, as suggested by the fact that the Saudi market also rose 25 per cent, as the second chart shows, despite its lack of index inclusion.

Mr Yazhari remains confident that the examples of UAE and Qatar “provide a very good precedent” and that index inclusion “would have a profound effect” on the Tadawul.

However, he does caution that the impact of index inclusion on the Saudi bourse may be smaller than for its neighbours, given it is more liquid than they were before entry.

“Saudi is already a very liquid market, even without international investors, so maybe it wouldn’t have the same effect because you are not doubling or tripling liquidity overnight,” he says.

At present, 19 of the 168 stocks on Tadawul are included in MSCI’s standalone Saudi market index, suggesting that they would be likely beneficiaries if Riyadh were given the nod.

This index is dominated by state-controlled petrochemicals group Saudi Basic Industries, also known as Sabic, with a weighting of 25.6 per cent, followed by Saudi Telecom, (13 per cent) and Al Rajhi Bank (10.1 per cent).

Overall, banks account for about a third of the index, followed by petrochemicals and real estate, at 10 per cent.

More than $5.1bn flow into US stock funds

Posted on 25 November 2016 by

US stock funds continue to pull in investor’s cash after the US election, as Donald Trump’s rhetoric over renewed growth for the economy shows no sign of abating.

Just over $5.1bn flowed into US stock funds for the week ending November 23, according to data from EPFR. It was a lighter intake than the previous record-setting week, but still accentuated the rotation out of bond funds and into equity funds that has characterised investor flows since Mr Trump’s election victory on November 8.

Globally, bond funds lost $8.6bn, with $2.5 coming out of the US, as bond yields, which move inversely to price, have risen sharply since November 8. Emerging market bond and equity funds also continued to shed money, with investors pulling $2.9bn and $1.9bn from funds, respectively.

In contrast, investors have renewed vigour for US equities after the US election due to Mr Trump’s message of instigating growth through infrastructure spending and tax cuts.

This week all four major equity benchmarks hit new highs — the previous time this grand slam occurred was in 1999. The US dollar has also risen, bolstering smaller companies’ stock prices as they tend to be more domestically focused and therefore more protected from currency fluctuations.

Rising bond yields and potential trade negotiations could also present future headwinds for larger companies. “If trade and the dollar become an issue small caps are more insulated and should be able to maintain earnings,” said David Lebovitz, global market strategist at JPMorgan Asset Management.

Still, much of the rise is based on expectations ahead of the new administration taking control, and some investors are wary of the possibility that the market has shifted too far.

“What you are seeing markets price in right now, at least in equity markets, is Donald Trump goes on and bowls a 300,” said Mr Lebovitz. “I would be willing to say it probably won’t work out that well — he is not going to bowl a perfect score. There is an opportunity for some pullback or consolidation. It does feel like markets have run pretty far, pretty fast, on speculation.”

In Europe, the prospect of disruption from elections next year, notably in France and Germany, along with the upcoming Italian referendum on constitutional reform is prompting uncertainty, according to Jim Sarni, managing principal at Payden & Rygel Investment Management.

European bond funds alone saw outflows of $3.5bn, the largest since June 2015.

“It’s clear that the unexpected is happening with greater frequency!” said Mr Sarni. “The market does not like uncertainty and there’s just a bit of that in Europe right now!”

In addition, foreign investors have been attracted to US bond markets as yields have risen faster than comparable European markets. Strong demand at this week’s auction of 7-year Treasuries on Wednesday hinted at foreign demand, according to BMO analysts, after weaker 2-year and 5-year auctions on Monday and Tuesday.