BlackRock’s global chief investment strategist, Richard Turnill, tells Danielle Myles about the new emerging market darlings, investor myths that need dispelling and the unprecedented hurdles presented by unconventional monetary policy. 

Richard Turnill

The challenges facing investors today are unlike any they have encountered before. Low returns, record low interest rates and quantitative easing (QE), combined with political uncertainty in the US and the UK, and in many markets the return of volatility, is forcing the buyside to rethink tried-and-tested strategies.   

The numbers are astounding. More than 93% of developed market government bonds yield below 2% (according to BlackRock analysis) and there is $13,000bn of negative-yielding debt globally. One of the best placed individuals to navigate such distorted financial markets is BlackRock’s Richard Turnill.

Emerging market rethink

As leader of the investment strategy function at the world’s largest asset manager (measured by assets under management), Mr Turnill’s insights are among the industry’s most valued. And his comments suggest that those who participated in recent years’ emerging market sell-off would be wise to take a second look. “There are very few alternatives now to emerging market debt and it’s one of the few areas that still offers value and yield. So we expect to see flows into the debt market persist over time, for the investors who are looking for yield,” says Mr Turnill.

Those flows actually started about six months ago, and a series of knock-on effects could spur their equities to perform strongly too. This, Mr Turnill explains, starts with the US Federal Reserve moving to a more gradualist approach to interest rates.

“That leads to a more stable dollar which leads to flows into emerging market assets drawn by higher yield. In turn, that allows interest rates in emerging markets to come down, creating more attractive liquidity conditions domestically which creates some signs of recovery and economic growth. That then attracts more capital flows,” he says. “You are starting to get this virtuous cycle developing, which I think is encouraging.”

Improved outlook 

It is a much-improved outlook compared with the rhetoric that characterised 2013 to 2015. China’s slowdown, the collapse of commodity prices and expectations of a US rate rise became synonymous with emerging market outflows. But while these macro considerations have shaped investor sentiment in the short term, Mr Turnill expects this to change – partly because the latter two factors have a very loose relationship with emerging markets over the long term. 

“Those three factors will be much less of a headwind for emerging markets going forward. Our expectation is that China will essentially muddle through a period of slower growth, the oil price will stay in that $40 to $50 range rather than move dramatically in either direction, and while the Fed will raise interest rates it will do so very gradually over time,” he says. “That starts to shift focus away from those international headwinds and prompt people to look at the domestic factors that drive emerging markets.” 

With the freedom to step out of the shadows of these external factors, which developing economies are expected to shine? “The three markets we favour are India, Thailand and Indonesia,” says Mr Turnill. “And they have three things in common that make them attractive.” First, they are at a relatively early stage in their economic and earnings cycles, particularly Thailand and Indonesia. This is in stark contrast to developed markets, which hover around their seventh year in the post-crisis cycle. Second, they have relatively strong currencies and strengthening foreign exchange reserves. In addition, the rupee, baht and rupiah all recorded growing turnover in the Bank of International Settlements’ triennial foreign exchange survey released in September. Finally, all three countries are undergoing structural reforms that are supporting economic revival.

Get active

As low yields become the new normal, investors essentially have three ways to generate return and grow their asset base: take more market risk (which includes the emerging market option), take more liquidity risk, or take a more active approach to managing their portfolio. None of these strategies are easy to pursue, but they face little alternative.

“Investors, if they stick to a traditional approach to investment, are almost guaranteed exceptionally low returns. The traditional 60/40 [stock versus bonds] approach, which was the norm for many years, is now priced to give you a nominal return of about 3% going forward – and that’s before inflation and fees,” says Mr Turnill. For the likes of pension funds and insurers, this does little to close their funding gap. 

Mr Turnill is quick to clarify his point that there is a strong case for investors to be more active. “I don’t just mean employing an active manager, but actually managing your own portfolio more actively over time – including by potentially using a combination of active and passive instruments, and looking within your portfolio to identify the opportunities for return,” he says. In the new lower-for-longer yield paradigm, being proactive is more likely to generate higher returns than relying on the historic 60/40 strategy. 

Active managers, being professional fund managers that select which stocks, bonds and other instruments to buy and sell in an effort to beat market indexes are – rightly or wrongly – suffering something of a reputational crisis. The fact a large proportion do not beat the market has made headlines over the past 12 months and prompted many investors to switch to passive strategies. Conventional wisdom is that active managers are most valuable in choppy markets as, unlike a tracker fund, they can detect underpriced and overpriced assets. On that basis, the return of volatility after years of relatively calm markets should work to their favour. 

But Mr Turnill says it is a fallacy to describe an environment as "good" or "bad" for active managers. “A more volatile environment creates more opportunity for skilled active managers, but the key question is whether you can identify them – the managers that outperform the index and generate alpha over time,” he says. Collectively, active managers map indexes pretty closely and so after accounting for fees the majority typically underperform those benchmarks. “It [volatility] doesn’t create a better environment for the median active manager; it’s always very hard to make a case for them as they will be very close to the market over time,” says Mr Turnill. 

Europe’s silver linings

Conclusions being drawn from recent purchasing managers’ indexes and other economic indicators about the impact of the vote to leave the EU on the UK economy are another set of misconceptions that need rectifying. Mr Turnill makes clear it will take many years before the implications of the referendum can be accurately measured, but like many of its peers BlackRock forecasts that the UK will fall into recession in the coming years. Real-estate and domestic equities are among the asset classes expected to be hit hardest.

Time will also tell whether Brexit spills across national borders and becomes a global economic event, but there is cause to be optimistic. “We’ve seen evidence of a material negative impact on the UK economy, but we have not seen any significant evidence of material knock-on effects to the rest of the world,” says Mr Turnill. “We haven’t seen financial contagion or an impact through the global banking system and the data so far actually suggests the global economy, if anything, is actually slightly accelerating over the past few months.”

It is a glimmer of hope given the challenges created by many influential central banks, which have dug in their heels over record-low interest rates and QE. There is angst about the artificial investment environment this has created, but also about its eventual end.

“You potentially encourage flows in the market that are riskier and less liquid over time, which potentially has material consequences in terms of misallocation of capital,” says Mr Turnill. “But there’s also the question of how to reverse that policy down the line and the consequences of that.”

It has become more topical in recent months given the growing recognition that central banks are nearing the end of what they can do to support the economy, and that fiscal policy may be a better tool for addressing issues such as underinvestment and low productivity.  

Any changes will require a long lead time though. It means investors in European bank debt and equities, which have suffered from ultra-low interest rates and minimal growth, cannot look forward to the end of their bumpy ride. “Those headwinds are large and not easing,” says Mr Turnill. “The good news is that it is primarily a profitability issue for the banks and their shareholders, rather than a solvency issue.” 

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