Advisers agree the U.S. and Europe are probably 2018’s best bets, while forecasting modest returns in China and Japan, pondering the risky promise of “emerging” economies and minimizing the headwinds of inflation and unemployment.
And for the cynics who think financial advice is a rigged game or a fool’s errand – or possibly both – Cayman boasts at least 133 qualified, licensed professionals, duly educated, instructed and dedicated to the “fiduciary rule” that investment advisers must act in the best interests of clients rather than generating profits for themselves.
They are tested, approved and “licensed” by the Chartered Financial Analyst Institute, and its local Cayman society.
Putting investors first
“Ethics is at the core of what the CFA Institute and its member societies stand for in the investment management and financial services industry,” says Jessica Jablonowski, president of Cayman’s CFA. “Putting the client first is at the core of the CFA ethical curriculum, before company and practitioner interests.”
As an operating parameter, the fiduciary rule seems obvious, but it is not always, and in February, lawmakers moved to suspend the rule, enacted after the 2008 financial crisis, fearing it could hinder free discussion and advice, generate expensive lawsuits and raise costs to consumers.
Philadelphia-born Jablonowski points to the group’s remarks on the subject, which is more complex than one might imagine.
The CFA, says its Director of Capital Markets Policy Linda Rittenhouse, seeks to ensure “clients’ interests come first and that they receive advice that is impartial and transparent.” She worries, however, the rule could create “high compliance costs, increase concerns about when legal liability could attach, impose excessive point-of-sale disclosures, and potentially result in different standards for advice providers.”
Ultimately “investors win,” she says. “The issue of what duty is owed to investors by all advice providers has finally come to the forefront.” The final review of the rule has been delayed until July 2019.
“The mission of [the] CFA Institute,” Jablonowski says, “is to lead the investment profession globally by promoting the highest standards of ethics, education and professional excellence,” gained through university-level classes, speakers, large-scale events such as the annual Cayman Investment Forum and literacy and advocacy initiatives, including CFA’s “Putting Investors First.”
Specific advice comes from RBC Dominion Securities’ nine-member “Price Team” chief Stephen Price, vice president and portfolio manager, and Butterfield Bank Chief Investment Officer Andrew Baron.
Price is a ninth-generation Caymanian and has been advising individuals, institutions, corporations, captive insurance companies and not-for-profits for RBC since 2001, managing nearly $2 billion.
Baron has been at Butterfield 11 years. For the first nine he was head of fixed income, focusing on bond markets. Two years ago he moved to CIO. Butterfield Asset Management, he says, handles 350 clients and $5 billion in three offices: Cayman, Bermuda and Guernsey.
“We have a wealth-management focus that serves high net worth individuals, but we manage several hundred million dollars of pension assets and we have a large presence in the captive [insurance] space both in banking and asset management,” he says.
Both speak of “bespoke investments,” strategies tailored to each client, meaning, says Price, “we base our investment decisions and advice on the particular clients’ investment objectives, risk tolerance and time horizon.”
Baron says he implements “our skill at active management in a similar manner across all of the accounts of clients … In other words, we operate a group investment philosophy and process.
Among Asset Management clients, Baron counts “several hundred million dollars of pension assets and we have a large presence in the captive space both in banking and asset management.
“Captive insurance has applications across a wide variety of industries and coverage lines and our clients reflect that diversity,” Baron says, although healthcare predominates. “In Bermuda we have had a pretty wide variety of industries represented, from large retailers to mining companies and everything in between.”
Captive invstment trends
By nature, he says, captives are conservative, focused on “its insured lines and underwriting, and there is generally a lower focus on return in a captive than on principal preservation and liquidity. After all, the assets are meant to be claims-paying resources, if required.”
However, in the face of sustained low global interest rates, Baron detects signs of change: “We have seen some clients searching for better-yielding investments and branching out into riskier fixed-income asset classes.
“Additionally, we have seen much more recognition amongst captives that a more-global approach to investment in equities is more appropriate than a traditional ‘home bias’ to the U.S.,” a positive development, he says, for the overwhelming number of U.S. captive parents – combining with Canadians to form nearly 90 percent of Cayman’s 665 international insurance companies.
Butterfield’s “group investment philosophy” means a couple of things, Baron says: “For example, if we as a group are recommending that clients be positioned to be underweight fixed income, our clients will be positioned to be tactically underweight across all client types – whether they are individuals or captives and whether they are managed in Guernsey or the Cayman Islands.”
The Bermuda-based bank’s “bespoke basis” means advice differs slightly among clients, but the sense of collective effort ensures that “thematically, strategically and tactically, we are all ‘rowing in the same direction.
“No client should be left behind or only receive a reduced level of service or scrutiny regardless of asset size or type,” Baron says.
Cayman and Barbados managers at RBC Dominon Securities also focus on captiveclients, overseeing millions of dollars for the mostly U.S. and Canadian parent companies.”
Conservative investment mandates govern management of high-priced, low-yield U.S.-dollar denominated holdings, he says, also detecting signs of change: “In the current low-interest-rate environment and the expectation for below-average returns, we work with captive insurance managers and owners to diversify their portfolio and seek opportunities into other areas, namely dividend-paying equities, alternative-yield structures, capital-protected structured notes or structured cash alternatives.
Like Baron, Price declines publicly to recommend specific investments, but reflects on broad economic trends, seeing a “synchronized, durable upswing in most major economies” in 2018.
“RBC Wealth Management’s view,” he says, “is optimistic, invested, but still vigilant toward global equities,” fulfilling expectations that “the global economy would gradually return to something approaching normal, led by the US.
“This has finally occurred, as major regions are in sync for the first time during the eight-year recovery cycle … We believe the U.S., Europe, China, and Japan have the potential to grow GDP at trend rates or better in 2018. Assuming U.S. recession risks remain low, [and] we think they will, the stage seems set for worthwhile gains in developed equity markets and select opportunities in the credit segment of fixed income.”
Global GDP “trend rates,” according to the World Bank and OECD, have averaged 2.6 percent growth since 2012.
China grew 6.7 percent in 2016; the UK, 1.8 percent; the US, 1.6 percent; and Japan, 1 percent. US economists have, however, made much of 2017 second-quarter GDP growth of 3.1 percent and third-quarter growth of 3 percent, beating forecasts and raising 2017 growth projections to 2.5 percent.
For the balanced investor able to take on risk to capital and handle volatility, Price suggests a “moderate overweight position” in global equities, informed by “low recession risks and relatively tame monetary policies” while “corporate revenues, earnings and estimates should continue to rise.
“Valuations of major markets have pushed higher, but are not high enough to foreclose further gains, and remain attractive compared to bond prices,” he says.
Baron points to GDP growth in China and the U.S., and a 2 percent Eurozone rate, but calls that “relatively simplistic,” looking instead toward “sustainable growth,” or the maximum growth rate that a company can sustain without having to increase financial leverage.
“In essence, finding a company’s sustainable growth rate answers the question: how much can this company grow before it must borrow money?”
In terms of a “sustainable trend,” Baron says, “both the U.S. and Eurozone appear to be in very good health, with the Eurozone in particular growing at roughly double its long-term sustainable pace after many years of moribund results.”
China, however, “has seen growth decline sequentially over a number of years, approximately mirroring the decline in its own ‘sustainable’ growth rate after two decades of industrialization.”
Baron echoes Price’s description of global growth as “relatively well synchronized at the moment,” but sees, “pockets of relative weakness globally,” naming Brazil as “barely positive year-on-year, for example.”
However, he says, “at present, there are no OECD-member countries showing negative GDP.
“We remain believers in the long-term investment thesis that emerging markets will continue to grow,” he says. “This can remain an investment theme both near-term and far into the future. The demographic and income profiles of countries that qualify as ‘emerging’ is changing rapidly in the information age.
“There probably isn’t a tremendous industrialization tailwind looming in the future, as was experienced in China in the earlier part of this century, but hundreds of millions can still be lifted out of subsistence and into the global economy over the next decade,” Baron says.
In a startling set of figures, Manhattan-based monthly Global Finance on Nov. 22 listed International Monetary Fund details of soaring GDP rates in dozens of emerging economies, led by Pacific island nation of Nauru with 16 percent growth through the last two decades, driven by enormous, if now depleted, phosphate deposits.
Ethiopia tops the next four slots, recording 10-year average growth of 9.8 percent. Third on the list is Turkmenistan with 9.5 percent; followed by Qatar with 8.2 percent; and Uzbekistan at 8 percent. Asian and African countries lead the rankings, even including hapless Rwanda in eighth place with 7.4 percent.
Panama, in 13th place and growing at 6.6 percent in the last decade, tops the rest-of-the-world list.
Baron reacts cautiously, however, saying his enthusiasm for emerging markets, marked by equity investments, is tempered “on the fixed-income side. We recently sold all of our clients’ exposure to US dollar-denominated emerging-market debt,” he says.
“We held a positive view of this asset class for [more than] four years, but valuations in the market had risen to a point where continued investment there presented a poor reward for the risk and volatility.
“Our analytical framework is led by a relative risk assessment, as opposed to thinking first of an estimate of the potential return of an asset class. This would be one of those cases where a reduction of risk was more important,” he says, than diminution in yield.
Still, U.S. economic expansion remains the global benchmark, and Price says that while it has been “more muted than usual,” he is impressed by its duration: “We think there’s wind left in the sails – good news for the global economy and for equities – in 2018 and probably beyond.”
By most traditional measures, market reverses and recession remain remote.
“The stock market has typically peaked right before a recession or in the early stages of one. Most other equity markets tend to follow the same pattern,” Price says.
Comparative interest rates are another indicator: “Since World War II, U.S. recessions have always been preceded by the arrival of restrictive credit conditions when loans have become prohibitively expensive for borrowers and difficult to get at any price.”
Long-term rates are usually higher than short-term rates, he says, but “during Fed tightening, the gap between short-term rates and longer-term bond yields usually narrows, indicating that credit (liquidity) is in short supply.
“In the postwar era, whenever the gap between 90-day Treasury Bill rate and the 10-year Treasury Note yield has narrowed to less than 30 basis points, the economy has weakened significantly. All recessions since the war were preceded by such a tightening.
“Today,” Price says, “the gap is about 115 basis points, comfortably above the ‘less-than-30 bps’ danger zone, and is still within the range that historically delivered attractive equity returns.”
Additionally, low U.S. unemployment augurs well globally: “In our opinion, the unemployment rate tells the tale. The unemployment rate tends to move steadily upwards in recessions and downwards through economic expansions.
“The unemployment rate has been trending lower since shortly after this economic expansion began in late 2009. Today, at 4.1 percent, it is about one-tenth of a percentage point away from an 18-year low, and only six-tenths above a 50-year low.”
Baron is similarly sanguine: “We would categorize the probability of a near-term global recession as very low at present. In the U.S., we are much more worried about growth and employment being too fast than too slow at this point in the cycle.
“We are confident that the positive-growth environment can continue in the three main growth engines of the world, the U.S., China and the Eurozone,” extending, he says, beyond “our forecast period, which is 12 months to 18 months. Beyond this time horizon, as most economists will freely admit, it’s much more of a guessing game.”
As an example of an immediate “positive-growth environment,” Baron points to healthcare as a “longer-lasting top-down theme.
“Consequently,” he says, “we currently overweight the global healthcare sector. Global demography supports this long-term theme, with ageing populations in Continental Europe, the UK, Japan and China – remember the one-child policy?” The sector is “geared toward higher healthcare expenditure whether by individuals or governments.”
Finally, says Price, global central banks will be a 2018 focus “as they gradually follow the Fed in normalizing monetary policy.
“Slow growth, low inflation and shifting demographics should ensure this is a gradual process,” he says, further restraining interest rates.
Price expects Jerome Powell – U.S. President Trump’s nomination to replace Janet Yellen as Fed chairman – to be confirmed, indicating “no major monetary policy shifts,” although, Price adds, Powell could promote a lessening of financial regulations.
“Credit will continue to provide selective opportunities, but investors will be challenged by rich valuations,” he said. “The dollar is poised to gain ground in 2018 after broadly underperforming through 2017. The ongoing tightening cycle set against firm economic growth should underpin USD strength with the market underpricing the trajectory of rate hikes.
However, he names the uncertainty of Washington’s tax reform as “the chief source of downside risk.”
Tax reform efforts dominate Washington’s end-of-year legislative landscape – and Republican hopes to reconcile House and Senate versions in time for Christmas passage. Vocal Democratic opposition seeks to derail the move, however.
Both Price and Baron illustrate Jablonowski’s recommendations regarding financial advisers: “Investors should seek out advisers that have investment strategy expertise, integrity and are clear communicators.”
Best-in-class advisers balance technique with emotional intelligence, meaning they understand behavioral biases common in investing and are able to educate their clients when such biases are exhibited, she says.
Jablonowski draws a distinction among financial counsellors, too-often insufficiently understood among investors, who should avoid hiring an adviser based on performance only.
“It’s important an adviser asks questions of your situation and future goals, in order to design a suitable investment strategy,” she says. The investor-adviser relationship “should have open two-way communication,” which is likely to determine “how your portfolio will be managed, how the fee structure is set up and how they will measure progress.