Deutsche Asset Management utökar sitt Xtrackers Core-sortiment med ETF inom tillväxtmarknader
Deutsche Asset Management (Deutsche AM) Xtrackers Core1 ETF:er har fått ett betydande tillskott via introduktionen av en ETF, som genom fysisk replikering ger exponering mot tillväxtmarknadsaktier. Deutsche Asset Management utökar sitt Xtrackers Core-sortiment med ETF inom tillväxtmarknader.
De nyligen lanserade db x-trackers MSCI Emerging Markets Index UCITS ETF (DR)2 ger en bred exponering mot tillväxtmarknadsaktier och har en årlig avgift på 0,2 procent. Den noterades på Deutsche Börse den 26 juni och på Londonbörsen den 29 juni.
ETF:en har redan över 200 miljoner euro i förvaltade tillgångar.
”Med en konkurrenskraftig årligt avgift och fysisk replikering för att följa underliggande index förväntar vi oss ett stort investerarintresse för vår nya tillväxtmarknads-ETF. Den kommer att utgöra en viktig del av vårt Core-sortiment av Xtrackers ETF:er,” säger Manooj Mistry, Deutsche AMs chef för passiv kapitalförvaltning, EMEA och Storbritannien.
Deutsche AMs sortiment av Core Xtrackers omfattar ETF:er som följer stora aktie- och obligationsmarknadsindex med låga årliga avgifter. Alla ETF:er i Core-serien använder direkt fysisk replikering. Mer information om Core-sortimentet, inklusive en lista över produkter, finns på www.etf.deutscheam.com.
Den 31 maj i år har Deutsche AMs Xtrackers genererat nya nettotillgångar på 4,1 miljarder Euro3.
db X-trackers creates range of low-cost fixed income Core ETFs
Deutsche Asset Management has established a range of db X-trackers fixed income Core ETFs that all use direct physical replication and have low annual all-in fees. db X-trackers creates range of low-cost fixed income Core ETFs
The fixed income Core range provides exposure to Eurozone and US government bonds, to the euro and US dollar corporate bond markets, and to the euro-denominated high-yield corporate bond market (see table below for a list of db X-trackers Core fixed income ETFs). Euro-hedged share classes of those ETFs providing exposure to USD corporate bond and US government bond markets are also available as part of the fixed income Core range.
In establishing the fixed income Core range the db x-trackers II EUR Corporate Bond UCITS ETF (DR) and the db x-trackers Barclays USD Corporate Bond UCITS ETF (DR) have had their annual all-in fees reduced from 0.2% per annum to 0.16% per annum.
“We already have low-cost db X-trackers Core ETFs covering major equity benchmarks, and investors will now welcome a similar focus on efficiency on the fixed income side,” said Simon Klein, Deutsche AM’s Head of ETF Sales, EMEA and APAC.
The db X-trackers equity Core ETFs range was established in 2014, providing major equity benchmark exposure starting at 0.07% all-in fee per annum. All db X-trackers Core ETFs use direct physical replication.
“The inclusion of a range of physical replication fixed income ETFs into the db X-trackers Core range helps give investors the exposures they need to create efficient, long-term core holdings in their portfolios,” added Klein.
For further information please contact:
Deutsche Asset Management
1 Low cost main-stream benchmark trackers that can be considered suitable (long term) ”core” holdings in investors’ portfolios.
2 Investors should be aware that in addition to the All-In Fee, the ETF may incur other costs which may negatively impact the performance of their investment relative to the underlying index. Examples include: Brokerage and other transaction costs, financial transaction taxes or stamp duties as well as potential differences in taxation of either capital gains or dividend assumed in the relevant underlying index, and actual taxation of either capital gains or dividends in the ETF. The precise impact of these costs cannot be estimated reliably in advance as it depends on a variety of non-static factors. Investors are encouraged to consult the audited annual- and un-audited semi-annual reports for details.
*Source: Deutsche Asset Management, 21 February 2017
Deutsche Asset Management
With EUR 706 billion of assets under management (as of December 31, 2016), Deutsche Asset Management¹ is one of the world’s leading investment management organizations. Deutsche Asset Management offers individuals and institutions traditional and alternative investments across all major asset classes.
¹ Deutsche Asset Management is the brand name of the Asset Management division of the Deutsche Bank Group. The respective legal entities offering products or services under the Deutsche Asset Management brand are specified in the respective contracts, sales materials and other product information documents.
Investors should note that the db X-trackers UCITS ETFs1 are not capital protected or guaranteed and investors should be prepared and able to sustain losses of the capital invested up to a total loss.
Shares in db X-trackers UCITS ETFs which are purchased on the secondary market cannot usually be sold directly back to the relevant fund. Investors must purchase and redeem such shares on the secondary market with the assistance of an intermediary (e.g. a market maker or a stock broker) and may incur fees for doing so (as further described in the applicable prospectus). In addition, investors may pay more than the current net asset value of a share in a db X-trackers UCITS ETF when buying shares on the secondary market, and may receive less than the current net asset value when selling such shares on the secondary market.
Investments in funds involve numerous risks including, among others, general market risks, credit risks, foreign exchange risks, interest rate risks and liquidity risks. The value of an investment in a db X-trackers UCITS ETF may go down as well as up and investors may not get back the full amount of their original investment.
This press release has been issued and approved by Deutsche Bank AG, London Branch and has been prepared solely for information purposes, and is not an offer or a recommendation to enter into any transaction.
Deutsche Bank AG is authorised under German Banking Law (competent authority: European Central Bank) and, in the United Kingdom, by the Prudential Regulation Authority. It is subject to supervision by the European Central Bank and by BaFin, Germany’s Federal Financial Supervisory Authority, and is subject to limited regulation in the United Kingdom by the Prudential Regulation Authority and Financial Conduct Authority. Deutsche Bank AG is a joint stock corporation with limited liability incorporated in the Federal Republic of Germany, Local Court of Frankfurt am Main, HRB No. 30 000; Branch Registration in England and Wales BR000005 and Registered Address: Winchester House, 1 Great Winchester Street, London EC2N 2DB.
Please refer to the relevant fund’s full prospectus and the latest version of the Key Investor Information Document for more information on db X-trackers UCITS ETFs. These documents are available free of charge from Deutsche Bank AG, London Branch and constitute the only binding basis for purchase of shares in the ETFs. As explained in the relevant offering documents, distribution of ETFs is subject to restrictions in certain jurisdictions. The ETFs described herein may neither be offered for sale nor sold in the USA, in Canada, in Japan to US Persons or to persons residing in the USA.
Direct replication funds. • Investors should be aware that in addition to the All-In Fee, other factors may negatively impact the performance of their investment relative to the underlying index. • Examples include: Brokerage and other transaction costs, Financial Transaction Taxes or Stamp Duties as well as potential differences in taxation of either capital gains or dividend assumed in the relevant underlying index, and actual taxation of either capital gains or dividends in the fund. • The precise impact of these costs cannot be estimated reliably in advance as it depends on a variety of non-static factors. Investors are encouraged to consult the audited annual- and un-audited semi-annual reports for details.
Deutsche AM’s db X-trackers enters ESG corporate bond ETF market
Deutsche Asset Management (Deutsche AM) has created a fixed income ETF to provide investors with environmental, social and corporate governance (ESG)-focused exposure to the euro-denominated corporate bond market. ESG corporate bond ETF db x-trackers II ESG EUR Corporate Bond UCITS ETF (DR) tracks an index of corporate debt filtered to only include companies that meet certain sustainability, social and corporate governance requirements. The fund is a physical replication ETF. “The provision of environmental, social and corporate governance investment solutions is an essential part of Deutsche Asset Management’s overall offering. More investors are starting to access fixed income exposure using ETFs, so it is important to have ESG-focused bond exposure available in ETF form alongside our existing solutions,” said Petra Pflaum, Deutsche AM’s Chief Investment Officer for Responsible Investments. The ESG index underlying the ETF – the Bloomberg Barclays MSCI Euro Corporate Sustainable and SRI Index – has similar yield and duration to its non-SRI equivalent, and is over 99% correlated with it*. For inclusion in the index bonds have to be investment-grade rated and have an amount outstanding of at least EUR 300 million, as well as meeting sustainability and SRI requirements. The db x-trackers II ESG EUR Corporate Bond UCITS ETF has an annual All-in Fee of 0.25% and is listed on the Deutsche Börse.
For further information please contact:
John Ferry Deutsche Asset Management Email: firstname.lastname@example.org *Source: Deutsche AM, January 2017: Bloomberg Barclays MSCI Euro Corporate Sustainable and SRI Index = duration of 5.3 and yield of 0.97%. Bloomberg Barclays Euro Aggregate Corporate Index = duration of 5.4 and yield of 0.98%. Five-year correlation between both indices = 99.8%.
Name of ETF: db x-trackers II ESG EUR Corporate Bond UCITS BBG Code: XB4F ISIN: LU0484968812 Fund Currency: EUR Listing Currency: EUR Annual All-in Fee: 0.25% Physical/synthetic: Physical UCITS compliant: Yes
Deutsche Asset Management
With EUR 706 billion of assets under management (as of December 31, 2016), Deutsche Asset Management¹ is one of the world’s leading investment management organizations. Deutsche Asset Management offers individuals and institutions traditional and alternative investments across all major asset classes. ¹ Deutsche Asset Management is the brand name of the Asset Management division of the Deutsche Bank Group. The respective legal entities offering products or services under the Deutsche Asset Management brand are specified in the respective contracts, sales materials and other product information documents. Key risks Investors should note that the db X-trackers UCITS ETFs1 are not capital protected or guaranteed and investors should be prepared and able to sustain losses of the capital invested up to a total loss. Shares in db X-trackers UCITS ETFs which are purchased on the secondary market cannot usually be sold directly back to the relevant fund. Investors must purchase and redeem such shares on the secondary market with the assistance of an intermediary (e.g. a market maker or a stock broker) and may incur fees for doing so (as further described in the applicable prospectus). In addition, investors may pay more than the current net asset value of a share in a db X-trackers UCITS ETF when buying shares on the secondary market, and may receive less than the current net asset value when selling such shares on the secondary market. Investments in funds involve numerous risks including, among others, general market risks, credit risks, foreign exchange risks, interest rate risks and liquidity risks. The value of an investment in a db X-trackers UCITS ETF may go down as well as up and investors may not get back the full amount of their original investment.
This press release has been issued and approved by Deutsche Bank AG, London Branch and has been prepared solely for information purposes, and is not an offer or a recommendation to enter into any transaction. Deutsche Bank AG is authorised under German Banking Law (competent authority: European Central Bank) and, in the United Kingdom, by the Prudential Regulation Authority. It is subject to supervision by the European Central Bank and by BaFin, Germany’s Federal Financial Supervisory Authority, and is subject to limited regulation in the United Kingdom by the Prudential Regulation Authority and Financial Conduct Authority. Deutsche Bank AG is a joint stock corporation with limited liability incorporated in the Federal Republic of Germany, Local Court of Frankfurt am Main, HRB No. 30 000; Branch Registration in England and Wales BR000005 and Registered Address: Winchester House, 1 Great Winchester Street, London EC2N 2DB. Please refer to the relevant fund’s full prospectus and the latest version of the Key Investor Information Document for more information on db X-trackers UCITS ETFs. These documents are available free of charge from Deutsche Bank AG, London Branch and constitute the only binding basis for purchase of shares in the ETFs. As explained in the relevant offering documents, distribution of ETFs is subject to restrictions in certain jurisdictions. The ETFs described herein may neither be offered for sale nor sold in the USA, in Canada, in Japan to US Persons or to persons residing in the USA.
db X-trackers voted best-known ETF brand in Germany
db X-trackers – the exchange traded fund (ETF) brand of Deutsche Asset Management (Deutsche AM) – has been voted best-known ETF brand in Germany for second year in a row in a survey conducted by IPE Institutional Investment, the German arm of Investment & Pensions Europe (IPE).1 The survey, ‘Institutional Investors’ needs 2016’, was conducted among 140 institutional investors in Germany accounting assets under management of around 590 bn EUR. Meanwhile, on the question of the best ETF service provider, db X-trackers was placed first, as it also was in the last survey conducted in 2014.
Erik Rotander, Head of Nordics, Passive Investments, said: “It is very important for us to deliver consistently high service levels to our clients, and investors clearly trust us for our expertise. Branding and services are important differentiation factors among ETF providers”.
The survey also found that ETFs have a high priority among institutional investor with two thirds confirming they use ETFs for tactical and strategic asset allocation purposes.
It also found that investors tend to choose an ETF provider based on a suitable product suite under the condition that the price, transparency and liquidity are also competitive.
The risks of ETFs include the following:
The value of ETF units can fall at any time below the price that the investor paid for the fund units. Losses can result.
Swap-based ETFs carry a counterparty risk of max. 10% of the net book value from derivatives transactions according to restrictions set out in OGAW/UCITS.
The value of ETF units can be negatively influenced by legal, economic or political changes, market volatility and/or volatility in the assets of the sub-fund and/or the reference object.
With EUR 739 billion of assets under management (as of March 31, 2016), Deutsche Asset Management¹ is one of the world’s leading investment management organizations.
Deutsche Asset Management offers individuals and institutions traditional and alternative investments across all major asset classes.
¹ Deutsche Asset Management is the brand name of the Asset Management division of the Deutsche Bank Group. The respective legal entities offering products or services under the Deutsche Asset Management brand are specified in the respective contracts, sales materials and other product information documents.
The limits of monetary policy: Are central banks losing their magic touch?
When markets worry about central banks, they are really fretting about two distinct things. On the one hand, there is the real economy. On the other hand, and usually of much more immediate interest is the question of how central-bank moves will impact financial markets.
For much of the period since equity markets bottomed out in 2009, those two questions have become intertwined. Not so long ago, the prices of risky assets, such as equities, seemed like a one-way bet. Bad economic news, such as lackluster U.S. job creation, led markets to expect further monetary stimulus and boosted financial assets. Meanwhile, good economic news also boosted prices of risky assets. Solid job figures, for example, suggested that the economy was healing nicely, but, given the depth of the slump, financial markets rightly expected it would still take a long time for interest rates to return to more normal levels.
This cozy era came to a close in 2015, and probably ended for good with the first U.S. Federal Reserve Board (Fed) interest-rate hike last December. Major equity markets began the new age with their worst start of the year since the 1930s, amidst growing concerns that central banks have lost their magic touch. In recent months, financial markets have increasingly seen central banks less as saviors and more as part of the problem.
What next? Of course, the range of the federal funds rate at 0.25 to 0.50% remains extraordinarily low by historic standards. What has changed, however, is the balance of risk from a market perspective. Strong U.S. economic figures are now a mixed blessing, while weak figures really are bad news. The pain caused by weakness in U.S. manufacturing, for example, is tangible enough, but the potential gain from more Fed action for now looks distant.
Following recent rate cuts, the ECB appears in no hurry to cut further
Fed Funds Target Rate
No change at next meeting, one increase in 2016
BoE Official Bank Rate
No change this year
BOJ Result Unsecured Overnight Call Rate
No further change to deposit rate
Sources: Bloomberg Finance L.P., Deutsche Asset & Wealth Management Investment GmbH; as of 03/2016
If the past year is any guide, financial markets are going to be on the edge.
Central-bank moves and market-mood swings
But why, precisely, are markets worried? To answer this question, we suggest that a closer look at the role of central banks is warranted, namely by looking at:
1. The role central banks see for themselves – and how it falls short of what markets have come to expect;
2. The limits of how much extra help central banks can and will provide.
Next, we take a more detailed look at:
3. The consequences for investors;
4. The specific challenges ahead for the ECB, the Fed and the BOJ
The report concludes by presenting some tentative solutions to the dilemma investors currently face from a multi-asset perspective.
1. The role of central banks
Sixteen years ago, Mervyn King of the Bank of England (BoE) suggested that “a successful central bank should be boring – rather like a referee whose success is judged by how little his or her decisions intrude into the game itself.”1
That’s a far cry from what central bankers have been up to in recent years. Ever since the financial crisis of 2009, markets have looked to them for salvation. The main tool used was quantitative easing – buying assets to stimulate money creation. In many market segments, this has turned central bankers from neutral observers to dominant players – earning ECB president Mario Draghi, for example, the nickname “Super Mario”.
Alas, with great power comes great responsibility, as any superhero knows. Or at least, so markets seem to think. That reflects a basic misunderstanding of what central banks can, and cannot do. And to see why, think back to what monetary policy was like not so long ago.
Not so long ago, central banks had a clear, but limited task. To be sure, there were small variations in terms of the mandate of central banks around the developed world. But essentially, monetary policy was a decision on when to adjust interest rates – ideally raising them before economic overheating and cutting them in time to mitigate or avoid a looming slump. How quickly an economy would grow in the longer term, though, was largely determined by other factors.
That last insight still looks valid. “It is important to realize that there is not much central banks can do to boost potential growth.” argues Josh Feinman, Chief U.S. Economist at Deutsche AM. “Part of what we have seen may be markets getting their heads around to the fact that potential-output growth is lower than it used to be.”
Let the blame game begin
Blaming the Fed for lackluster potential growth is a bit like blaming a referee for the lack of sporting prowess you see among the players on the field. To be sure, a central bank can mitigate the lasting impact of a slump by trying to keep recessions brief.
“When workers are unemployed for prolonged periods” notes Phil Poole, Deutsche AM’s Global Head of Research, ”they lose some of their skills.” This is particularly serious when young people struggle to find a job to begin with, hurting their prospects for many years to come. This has been a perennial problem in other parts of the world, and may be one of the root causes of economic stagnation in Southern Europe.2 Arguably, the ECB made matters worse, when it prematurely increased interest rates in 2011.
By contrast, U.S. unemployment has more than halved since peaking in 2010, thanks in large part to decisive Fed action. Unfortunately, this translated into a mere 2.4% of growth in gross domestic product (GDP) for both 2014 and 2015, according to the latest estimates of the Bureau of Economic Analysis. For 2016, we now forecast 1.8%.
Potential U.S. growth is probably quite a bit lower still. The same is true in other developed markets that embraced QE early on. At 2%, growth remains disappointingly slow in the United Kingdom, if judged by historic standards. However, unemployment has fallen to 5.1 %, suggesting there is little slack left in the labor market. It appears that the United Kingdom, just as the United States, is no longer able to sustain the sort of growth rates familiar from previous cycles, without triggering inflation.
Since 2009, monetary-policy rates were mostly stuck near zero…
… while unemployment swiftly started to decline.
(click to enlarge)
What can anyone do? Well, all U.S. monetary policy can do is to wait for the economy to heal – and hope that potential growth will eventually pick up again. “Over the medium term, I would expect potential growth to edge a bit higher (as do most of the major forecasters), as some of the lingering effects of the crisis continue to fade, and productivity and labor-force growth recover a bit.” explains Josh Feinman, Chief U.S. Economist at Deutsche AM.
By contrast, there are plenty of things governments could do. Boosting spending on education, liberalizing labor and product markets, improving incentives in tax and entitlement systems, amongst other measures, come to mind. “I know it’s a trite expression” notes Josh Feinman, “but what we would really need to boost potential growth are structural reforms.”
Implementing reforms is easier said than done – just look at Japan and the Eurozone. Politics frequently gets in the way. This has arguably been the story behind the Eurozone debt crisis and Japan’s malaise. Japan is now in the 26th year of what was at first called its lost decade. Many of the problems in both Japan and the Eurozone are structural. Monetary policy is hardly the most obvious way of tackling them – as the BOJ itself argued for much of the initial lost decade. Fiscal policy would be a more obvious bet – especially if the money is spent on the sort of infrastructure projects that will actually boost potential growth, rather than on bridges to nowhere.
Central balance sheets as percentage of GDP
All of which makes it rather odd that so many hopes should still rest on central banks. After all, Japan already tried QE from March 2001 to March 2006. According to most empirical studies, this was of limited help in either boosting output or inflation. Indeed, it may even have strengthened the performance of Japan’s weakest banks – further delaying the necessary clean-up of bank balance sheets. Markets were fairly unimpressed. Japan’s initial dose of QE simply seems to have acted as a sedative. “One down-side of loose monetary policy is that it reduces reform pressure.” argues Johannes Müller, CIO Multi Asset at Deutsche AM.
2. The limits of central banking:
So far, we have seen that there is little monetary policy can do to boost long-term growth potential. At most, it might provide breathing space for structural reforms. For investors, however, a more immediate question is whether central banks are also losing their ability to cheer up markets. Here, the evidence is mixed – and to see why, look no further than at Japan’s previous attempt at QE.
Japan’s structural problems are real enough, but they only tell half of the story. The other half is one of monetary impotence to do even the limited work central banks are usually charged with: making sure that actual economic growth is in line with potential growth rates.
Central banking can prove tricky enough in normal times. As Rüdiger Dornbusch quipped in 1997, “None of the U.S. expansions of the past 40 years died in bed of old age; every-one was murdered by the Federal Reserve.”3 But at least, central banks have plenty of historic data to rely on.
By contrast, economists looking at Japan since the early 1990s had to go back to the Great Depression to find anything remotely similar. Japan appeared stuck in a liquidity trap, the traditional bogeyman of central banking (see box). Much of the policy response in the rest of the world since 2009 can best be understood as an attempt to avoid such a fate.
Once interest rates are at zero, short-term bonds and money are close to perfect substitutes. Conventional monetary policy loses much of its potency. Even if a central bank somehow succeeds in pushing nominal interest rates on bank deposits into negative territory (an option section 2 looks at), this would simply make money even more attractive than bonds as a store of value. So, if a central bank keeps on buying short-term bonds, we would still have the same problem – it would keep on buying, without those purchases having any impact.
But what if the central bank starts buying longer-duration government bonds? Couldn’t this help by reducing the term premium? And surely, QE might squeeze spreads, either by central banks buying corporate bonds directly or by pushing private investors into higher risk assets? And finally, all this should reduce funding costs for companies building new factories, should it not? Also, might the rise in asset prices of all sorts not make households feel wealthier, boosting consumption?
Well, a resounding “Maybe” to all of the above. Something along these lines has happened in practice. “In recent years, the role of central banks has changed.” notes Christian Scherrmann, Economist at Deutsche AM. “Central banks used to be lenders of last resort. Increasingly, they have instead become the buyer of last resort.” This certainly worked in terms of reducing longer-term government bond yields – ballooning central bank balance sheets coincided with falling bond yields.
ECB balance sheet and 10-year Bund yields
(click to enlarge)
Fed balance sheet and 10-year Treasuries
(click to enlarge)
It works … but for how much longer?
For such a widely used tool, it is surprising how hard it is to make QE work in theory.6 The trouble is that any such framework must take its longer-term impact into account. Fortunately, central banks are rather keener than stage magicians to let you in on the inner workings of their latest creations. As a result, it is fairly easy to figure out what is known – and, more worryingly, what even central banks do not know.
We know from empirical studies in the United States, the United Kingdom, and, in recent years, the Eurozone and Japan, that QE “works” in the short term in terms of moving markets, and perhaps, even increasing lending. We have some ideas on why this might be so. It remains unclear, however, how QE will impact inflation, economic activity and asset prices across the economic cycle.
From a theoretical perspective, we know that households and firms will try to anticipate future central-bank actions – which risks offsetting much of what the central bank is doing through the channels described above in the here and now. To take the example of the wealth effect, let’s say that the Fed buys 30-year bonds today, drives down nominal market rates and thereby increases the nominal value of the longer maturity bonds I hold in my portfolio. On paper, this makes me wealthier. If I am rational, though, I will know that returns on any additional bond investments I make to save for my retirement will be lower. Moreover, if and when QE does its job in restoring full employment, interest rates will increase, so I will face losses in the future.
My real wealth, over my remaining life-time, has not really gone up, and there is little reason why I should boost my consumption. Instead, I might even decide to save more!
For QE to have much of an impact, you need to create somewhat ad-hoc assumptions. Translated into plain English, this means coming up with stories for why private investors will not fully adjust their portfolios to reflect recent and anticipate future actions by the central bank. Generally, such stories boil down to different assets not being perfect substitutes for different types of investors.
Insurance companies or pension funds, say, might face regulatory restrictions on which assets they can hold. There might be differential information and transaction costs for retail investors. Some investors might invest in certain ways simply out of habit. All of which might be true, but ideally, you would want to have a lot more data before betting economies worth trillions of dollars on it. To his credit, Ben Bernanke, the Fed’s chair throughout much of the crisis, has freely acknowledged as much in speeches and in his earlier academic work.7
We would argue that part of the reason the Fed was relatively successful with this policy, was because markets were ready – indeed eager – to play along. It is less clear that QE will be as helpful going forward, either in the United States or elsewhere. As the balance sheets of central banks have ballooned, private-sector debts have also been mounting, from emerging markets borrowers to U.S. corporates. In the search for yield, some of the money that actually did find its way into lending will inevitably turn out to have been misspent – perhaps sowing the seeds of the next crisis.
“To me, QE has clearly become a very inefficient channel. Compared to the amounts of monetary injections, there is likely to be only little impact in real economic activity.” notes Thomas Bucher, Equity Strategist at Deutsche AM.
And, we are hardly alone in this assessment. As Stephen Williamson, Vice President at the Federal Reserve Bank of St. Louis, noted in a recent review, taking a broader historic perspective:
“The theory behind QE is not well-developed … Evidence in support of Bernanke’s view of the channels through which QE works is at best mixed… Much of the work on the quantitative effects of QE consists of event studies, whereby researchers look for effects on asset prices close to the date of an announced QE intervention. … All of this research is problematic, as it is atheoretical. There is no way, for example, to determine whether asset prices move in response to a QE announcement simply because of a signaling effect, whereby QE matters not because of the direct effects of the asset swaps, but because it provides information about future central bank actions with respect to the policy interest rate. Further there is no work, to my knowledge, that establishes a link from QE to the ultimate goals of the Fed – inflation and real economic activity.” 8
Given such doubt, it is no wonder that the Fed is hoping for a return of more normal times – when it could count on well-understood tools to do the job. “Even in the Eurozone, central bankers probably do not see themselves quite as magical as some investors hope.” argues Stefan Kreuzkamp, CIO at Deutsche AM. That has worrying implications.
3. Consequences for investors
In 1976, the economist Robert Barro argued that an activist monetary policy gains much of its effectiveness from confusing people, clouding signals to market participants. That can secure tranquility for a while and perhaps provide a temporary boost to output. However, that stability comes at the cost of even greater variance later on.9 Eventually, you might expect inflation, GDP and also financial markets to become more volatile.
Given how much QE appears to have relied on market expectations, it is hard to say if such a tipping point has already been reached. Over the past year, the investment environment has clearly been getting trickier. “Since 2000, correlations across different asset classes were generally such that you could reap very decent returns without taking too much risk. Of course, we had two big crises. But thanks to diversification effects, we were able to mitigate the downside for our clients, without sacrificing too much performance. Now things are different.” argues Christian Hille, Head of Multi Asset EMEA at Deutsche AM.
This is especially true if we compare the period between 2010 and 2015 with the recent market turmoil. Lately, many unusual correlations have cropped up that you might not have expected. For example, major equity indices have tended to move in sync with the oil price. This might seem justifiable for the S&P 500 Index, but is less understandable for the German Dax, which does not include a single major oil producer. In any case, correlations between oil and the S&P 500 Index have historically tended to be negative, which also makes more economic sense.
Worse still, many old correlations have been swept aside. Volatility is increasing.
Historical relationship between the Dax and government bonds
These are early signs that QE euphoria has come at a cost. “Following the high returns from financial markets in recent years” advises Stefan Kreuzkamp, “investors should expect leaner times ahead.”
In the meantime, there are likely to be dramatic swings – in both directions. Over the medium term, it appears likely that confidence in the ability of central banks to stabilize financial markets will continue to erode. Just because this is likely to happen eventually, however, does not mean we are quite there yet. Central banks still have options – and willingness too, it would seem, to creatively use any readily available tool remaining.
Ever more unconventional?
However, betting on their magic touch is getting riskier. “Last December, the ECB caught investors on the wrong foot.” explains Bettina Müller, Chief European Economist at Deutsche AM. Markets had grown used to its President Mario Draghi over-delivering. Instead, the ECB underwhelmed in the short term. It only tinkered on the edges of its existing QE program. Perhaps most significantly, the ECB also cut its deposit rate from minus 0.2% to minus 0.3%, in the wake of similar decisions in several smaller European economies. Sweden, Denmark and Switzerland have increasingly relied on negative interest rates to discourage capital inflows (see box).
The evidence so far suggests that when they work, the effect from NIRP is mainly from driving down exchange rates rather than by stimulating lending. For small open economies, this might even be part of a “foolproof way” to escape the liquidity trap and deflation. The idea was for the central banks to give a commitment to higher future price levels, concrete action, such as a currency’s sharp depreciation, to demonstrate that commitment, and an exit strategy of when and how to get back to normal.10
In a small open economy, such as Sweden, a currency devaluation can go a long way in rekindling inflation. Unfortunately, using devaluation is a lot harder to manage in large economies, such as Japan and the Eurozone.
Again, it is Japan that provides the most cautionary tale on monetary impotence. In January it took markets by surprise by implementing a NIRP of minus 0.1%. The system was structured in three tiers, to reduce the impact on bank profitability, but nevertheless hit bank share prices hard and reinforced broader market weakness. This, in turn, put upward pressure on the yen, precisely the opposite of what the BOJ had been aiming for.
NIRP has suddenly brought home one implication of unconventional measures for households: it is supposed to work, in part, by depressing the future value of their savings. To a trained economist, there might not seem to be much of a difference whether that wealth transfer takes place through inflation eroding nominal returns or NIRP. To households and companies, it probably does – which risks further eroding confidence in central banks being able to “fix” the problem.
1. Currencies: Expect more currency volatility, sometimes in surprising directions, that defies what policy makers have had in mind. The underlying driver of this volatility remains divergence in monetary policy between the Fed, wanting to get back to normal, and others, particularly the BOJ and the ECB relying on increasingly unfamiliar tools, such as NIRP. Eventually, this should translate into a strengthening U.S. dollar.
2. Bonds: QE has pushed an ever growing number of sovereign bonds into negative territory. Effectively, this has destroyed positive, nominal returns on “safe” government bonds, a key element which diversified investors have long been able to rely on. This means risk-free rates can no longer serve as a portfolio cushion in a diversified portfolio. For sovereign bonds, it is worth keeping in mind that these too are far from risk-free. If you think that QE will eventually succeed in boosting inflation, rates have to go up. Holders of longer maturity bonds therefore face significant duration risk. Against this background, investment-grade debt and also high yield are probably among the more attractive alternatives.
3. Equities: For U.S. equities, most recent concerns have centered around recession fears. However, this is no longer the only risk. Continuing solid U.S. economic performance, resulting in swift further interest-rate increases, would also be worrisome. Either way, U.S. margins have probably peaked. U.S. strength would probably be reflected in consumer spending holding steady on the basis of rising wages and continuing employment growth. This could put pressure on earnings. More broadly, the above discussion suggests that further monetary adventures in other parts of the world, such as negative interest rates, come with risks attached – both in terms of their direct impact (on bank profitability, for example) and by increasing the scope for policy errors. Risk premia might rise.
4. Policy challenges ahead:
Following the latest meeting of the Governing Council of the ECB, the ECB announced on March 10 that it would reduce its deposit rate (on money deposited by Eurozone banks) by 10 bps to minus 0.4%. Its other key rates were cut by 5 bps, with one on the main refinancing operations (MRO) now at 0% and on marginal lending facility at 0.25%.
As many market participants had hoped, it also expanded QE, increasing the monthly purchases under the asset purchase program by €20bn to €80bn starting in April. More significantly, the scope of assets eligible to be included in the list of assets for regular purchases will include investment grade euro-denominated bonds issued by non-bank corporations from now on.
In our view, this will somewhat alleviate one of the issues the ECB has faced, namely the growing scarcity of government bonds of some countries, such as Germany. It comes at the cost, amongst other issues, of losses on these private sector bonds and will no doubt prove controversial. However, the alternatives would probably have been even less palatable.
In order to increase the QE program without including new sets of assets, the ECB could instead change its capital key, allowing it to purchase more bonds from more highly indebted countries such as Italy. Or it could have given up the deposit rate as a hurdle rate when it buys government bonds. However, this would have effectively resulted in an arbitrage opportunity for banks, with the ECB locking in losses with each purchase of bonds from the banking sector (which could then deposit the proceeds at a less negative rate with the ECB.
Finally, the ECB announced a new series of targeted longer-term refinancing operations (TLTRO). These are designed to stimulate lending to the real economy, by allowing banks to borrow on attractive terms from the ECB. These will now be very attractive indeed – from now on, borrowing conditions in these operations can be as low as the interest rate on the deposit facility, or minus 0.4%. (Previous TLTRO were tied to the MRO rate) prevailing at the time when each TLTRO is conducted.
In our view, the package illustrates the growing ECB concerns about the potential impact on bank profitability from cuts in its deposit rate. This impact will be alleviated somewhat by the benefits bank will get from TLTRO II. Nevertheless, we would expect minus 0.5% to be the lower limit of how much further the ECB will cut the deposit rate, which will probably be reached at the next meeting.
Meanwhile, the overall muted market reaction showed three things. First, the ECB still has some options to move markets and was able, for example to provide Eurozone equities with another boost. Second, however, the relatively modest fall in the Euro also shows that it now takes a very comprehensive set of measures, far beyond what would have seemed possible six months ago to have much of an impact. And third, there will be more beneficiaries form QE, in this case investment grade bonds, as investors swiftly try to reshuffle their portfolios.
Despite the concerns outlined above, we would stress that the U.S. economy also has several strengths. Thanks in part to QE and the temporary relief it brought, both the banking sector and households are on a more solid footing than they were a decade ago. The labor market continues to heal.
Against this background, our view is that the Fed is likely to continue on its current course. The Fed has made it clear that its decision making will be data-dependent. We expect this to translate into interest rates remaining low and increases to be slow in materializing. Our central case is a 25 bps increase in 2016 and another one early in 2017.
With financial conditions highly volatile, there are risks to this view, of course. However, it should be kept in mind that financial markets are more vulnerable to some of the recent shocks than the real economy, due to, for example, the heavy weighting of the energy sector in the S&P 500 Index.
Most concerns on the limits of monetary policy will continue to center on Japan. Its current program, known as Quantitative and Qualitative Monetary Easing (QQE), is distinctive in not just the size of its purchases but also their composition. At an annual 80 trillion yen (700 billion U.S. dollars) or 16% of GDP, it dwarfs attempts by other central banks, and it has also been buying a broad mix of assets. In January 2016, it added negative deposit rates to the mix.
“Now, it is running out of tools.” argues Sean Taylor, CIO Asia Pacific at Deutsche AM.
Part of its challenge was the very negative market reaction, when it took markets by surprise in January, by implementing a NIRP of minus 0.1% structured in three tiers. Negative interest rates risk a further destabilization of the banking sector. Having caused bank shares to fall by 28% and the broader market by 17% in the two weeks following the announcement, we doubt the BOJ has much appetite for further cuts.
“So, what can it do? Well, it cannot turn its back on QE – that would be too destabilizing. One channel is currency depreciation, though that is also trickier, with growth in the rest of the world weakening.” notes Sean Taylor.
Part of the problem is that there are simply not enough bonds left that the private sector is willing to sell. The BOJ could buy equities, after already dipping into Exchange Traded Funds last year, and, basically, anything else they can get their hands on. By contrast, the scope for fiscal policy looks limited, given already high levels of public debt.
Central bank holdings of government bonds in % of total outstanding debt
Meanwhile, it is worth pointing out that QQE has not been quite as ineffective in terms of its impact on the real economy as you might think, based on the previous experience with QE. In fact, a casual newspaper reader might be surprised when digging deeper into the data on recent price and wage trends. Disappointing inflation data partly reflects falling energy costs, as well as the somewhat harsh statistical treatment of rental cost. Strip out these factors, and core inflation has picked up in recent years. Partly, this was on the back of an increased sales tax, but it also reflects falls in unemployment to levels last seen two decades ago. Wage growth finally appears to be improving. While most jobs created are relatively lowly paid and part-time, “Even for full-time workers, unemployment rate has fallen, and labor participation has improved over the last few years.” notes Sean Taylor.
In Japan, at least, QQE appears to be working – but at what cost?
The problem in a nutshell – and solutions from a multi-asset perspective:
With confidence in monetary policy shakier than it used to be, central banks are finding it increasingly hard to manage market expectations. This, in turn, makes surprises in both directions more likely. Subdued returns will probably come with hefty doses of volatility and event risk. In that sense at least, central banks are as much part of the problem, as part of the solution.
“Imagine, for a moment, that you knew for sure, and ahead of time, that the BOJ or the ECB will announce a new surprise move and what that move will be. Even with such perfect foresight as far as central banks are concerned, you would still be left guessing how markets will react.” argues Stefan Kreuzkamp. “Part of the difficulty would be in figuring out how other market participants have positioned themselves. The bigger difficulty, however, is that it is getting ever harder to figure out which moves would be seen as decisive shows of strength – and which ones would simply be interpreted as signs of desperation.”
The ability of central banks to prevent periods of turbulence and mitigate sharp declines in financial-market valuations certainly looks more limited than ahead of previous crises. This is due not so much to central banks running out of options per se. Already, measures once considered outlandish, such as various versions of helicopter money, are once again doing the rounds. These would no doubt face practical, legal, and, in many instances, constitutional concerns. However, in recent years we have already seen that policy makers are willing to take extreme measures, if times get sufficiently desperate.
The real problem is that the longer-term implications of the remaining tools are even less well-understood than QE. Recent market turbulence in the wake of Japan’s implementation of negative deposit rates should serve as a cautionary tale that more monetary action no longer necessarily equates with better financial-market outcomes. They also reinforce doubts on how much good monetary policy could do, if things go wrong (either as a result of a new shock, or because of policy errors).
Already, many investors have shifted their focus from seeking gains to merely wanting to preserve their existing wealth. Gold is just one example of an asset benefitting from its safe-haven appeal. Given the concerns outlined above, it makes sense for risk-averse investors to hope for the best – while also preparing their portfolio for the worst. Even if we imagine a relatively benign outcome, we expect future returns to be lower, for any given amount of risk.
When it comes to risks and rewards, we have already entered a new investment world
This has already started to happen. Take a portfolio held in 2004, with an expected return of 4%. Looking at the historical data, a portfolio comprised of 15% equities and 85% bonds would have delivered just that, with volatility of just 2%. Fast forward to 2015, however, and you would have needed to allocate 50% to equities to generate the same 4% in total return. Volatility would have been 11%.
Against this background, we are re-considering risk budgets and return considerations from a professional asset management standpoint. “A review of the considered time horizon and the actual risk budget are key. This is because any hedging activity always has its cost and if volatility persists, such costs can be quite high.” notes Christian Hille, Head of Multi Asset EMEA at Deutsche AM.
In the longer-term, the new, more volatile world which we see emerging in the wake of central bank policy experimentation, should, no doubt, also generate plenty of more conventional opportunities. Already, we are seeing clear signs that the advantages from taking a world-wide perspective when making investment decisions are once again growing. For example, a few individual emerging markets have performed quite well in recent months, after years of disappointing return. Benefitting from such reversals requires a strong grasp of the trends shaping the global economy. We believe the anticipated increasingly volatile currency movements should present opportunities, not just risks for well-diversified portfolios. Equally critical is a deep local knowledge in different regions of the world, to identify structural trends early on, select assets likely to benefit and tactically select the right time to enter. As asset managers, we fully intend to help our clients make the best of what has no doubt become a more difficult investment environment.
1 “Monetary Policy: Theory in Practice”, Address given by Mervyn King, Deputy Governor of the Bank of England, 7 January 2000
2 Blanchard, Olivier J., and Summers, Lawrence H., Hysteresis and the European Unemployment Problem, NBER Macroeconomics Annual 1986, Volume 1, pp. 15 – 90.
3 Dornbusch, Rudiger. 1997. “How Real Is U.S. Prosperity?” Column reprinted in World Economic Laboratory Columns, Massachusetts Institute of Technology, December.
4 This is broadly the agrument of John Maynard Keynes, esp. chapters 15 and 23 of “The General Theory of Employment, Interest and Money.”, 1936, Palgrave Macmillan. His followers took a narrower view, looking at liquidity traps mainly by focusing on the zero lower bound of nominal interest rates.
5 Krugman, Paul R. “It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap.” Brookings Papers on Economic Activity, 1998, 29(2), pp. 137-205.
6 As a useful starting point for figuring when central-bank open-market operations do and do not impact the private sector, see Wallace, N. (1981). A Modigliani-Miller theorem for open-market operations. American Economic Review, 71(3):267-74.
7 See, for example, Bernanke, Ben, “Monetary Policy since the Onset of the Crisis”, Presented at the Federal Reserve Bank of Kansas City Economic Symposium, “The Changing Policy Landscape,” Jackson Hole, Wyoming, August 31, 2012; http://www.federalreserve.gov/newsevents/speech/bernanke20120831a.pdf
8 Williamson, Stephen D., “Current Federal Reserve Policy Under the Lens of Economic History: A Review Essay”, Federal Reserve Bank of St. Louis Working Paper Series, Working Paper 2015-015A, pp. 8-9. https://research.stlouisfed.org/wp/2015/2015-015.pdf
9 Barro, Robert J.: Rational Expectations and the Role of Monetary Policy. Journal of Monetary Economics; pp. 1-32, January 1976;
10 Svensson, Lars E.O. “Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others.” Journal of Economic Perspectives, Fall 2003, 17(4), pp. 145-66.