Andrew Cole

Baring Asset
Management Limited


                                  Tax , Inflate, Confiscate
155 Bishopsgate...
The New Policy Directive



               TAX


               INFLATE


               CONFISCATE




                  ...
Not just in the UK



Our forecast


  Every G7 sovereign will pursue Fiscal Austerity (Tax)


  Every G7 sovereign will P...
The issues? Which way out of a debt crisis?
                                                                Sovereign Debt...
In theory, 4 ways out

 A higher growth rate of GDP

 Fiscal pain, meaning an increase in taxes and/or a cut in public spe...
Actually, only 3 ways out


 A higher growth rate of GDP

 Fiscal pain, meaning an increase in taxes and/or a cut in publi...
Debt Crisis, ways out. Option #1:
Fiscal Pain
                   Government Primary Balances                              ...
Debt Crisis, ways out. Option #1:
     Fiscal Pain
                                                                       ...
Debt Crisis, ways out. Option #2:
Print
                         Central Bank Total Balance Sheet as % of Annual Nominal G...
Debt Crisis, ways out. Option #2:
               Print
                                                      China Real M1...
Debt Crisis, ways out. Option #2:
    Print
          YoY Change in PPIs for China, US, EU & UK                           ...
Debt Crisis, ways out. Option #2:
Print
                                                                      Breakeven In...
Debt Crisis, ways out. Option #3:
Default

                                              5yr Credit Default Swap Spreads –...
Debt Crisis, ways out. Option #3:
Default

                                                         5yr Credit Default Swa...
Debt Crisis, ways out. Option #3:
  Fiscal Pain
                GDP Growth vs Previous Trend                              ...
Summary


 There is no easy way to deleverage
 Although markets are busy deciding which will be the route of choice, gover...
Forecast returns & risk
10 year asset class forecasts (GBP)
               Return (% per annum)
    14
                   ...
Best and worst performing asset classes

2005                          2006                       2007                    ...
Irish Bond Risk vs. Return

              15

              10

                5
 Return - %




                0

     ...
Irish Bond Equity Correlation vs. Irish Bond Returns

                           15


                           10


    ...
Risk Premia on offer today in the UK


            Inflation Linked                       Breakeven Inflation         Cred...
Your Multi-Asset Fund Manager




                                Casting his net far and wide!


                        ...
Multi Asset Fund & RPI+4%




                                                  Past Performance is not a guide to future ...
Dynamic Asset Allocation Fund vs. Cautious Managed



                                  17/01/2007      01/01/2008    01/0...
Baring Dynamic Asset Allocation –Return & Risk:
16/01/2007 – 31/12/2010

 Return (%)                                      ...
Biography

Andrew Cole
            Member of the Multi-Asset Team

            Location: London
            Investment Exp...
Important Information
For Professional Investors/Advisers only. This document is approved and issued by Baring Asset Manag...
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Barings

  1. 1. Andrew Cole Baring Asset Management Limited Tax , Inflate, Confiscate 155 Bishopsgate, London EC2M 3XY Tel +44 (0)20 7628 6000 Fax +44 (0)20 7638 7928 www.barings.com NMA Conference Authorised and regulated by the Financial Services Authority January 2011
  2. 2. The New Policy Directive TAX INFLATE CONFISCATE What Governments have in store for us all and our savings. Source: Barings as at 2nd November 2010 1
  3. 3. Not just in the UK Our forecast Every G7 sovereign will pursue Fiscal Austerity (Tax) Every G7 sovereign will Print (Inflate) Every G7 sovereign will Default (Confiscate) Every G7 Government struggling with the same issues. Source: Barings, as at 2nd November 2010 2
  4. 4. The issues? Which way out of a debt crisis? Sovereign Debt to GDP for G7 nations 120 1950 - 2009 100 80 Debt/ GDP (%) 60 40 20 0 1950 1960 1970 1980 1990 2000 2010 Sovereign Debt to GDP in the G7 Source: Fathom and OECD, June 2010 3
  5. 5. In theory, 4 ways out A higher growth rate of GDP Fiscal pain, meaning an increase in taxes and/or a cut in public spending Increased Seigniorage, the increased printing of money by the central bank leading to inflation. Default, including every form of non-compliance with the original terms of the debt contract, including repudiation, standstill, moratorium, restructuring, rescheduling of interest or principal repayment etc. Source: Barings 2010 4
  6. 6. Actually, only 3 ways out A higher growth rate of GDP Fiscal pain, meaning an increase in taxes and/or a cut in public spending Increased recourse to seigniorage (printing money) by the central bank Default, including every form of non-compliance with the original terms of the debt contract, including repudiation, standstill, moratorium, restructuring, rescheduling of interest or principal repayment etc. Tax, Inflate, Confiscate Source: Buiter (2010) 5
  7. 7. Debt Crisis, ways out. Option #1: Fiscal Pain Government Primary Balances Govt Primary Balances to Stabilise 1970 – 2009 (%GDP) Debt/GDP by 2020 15 15 10 10 5 5 0 0 -5 -5 -10 -10 -15 -15 15yr Av 2010 60% 80% 1970 1980 1990 2000 2010 2020 to ‘07 Target Target UK Japan US Germany UK US Japan Germany Source: OECD and Barings, June 2010. Primary surplus targets to stabilize government debt/ GDP ratios assume Barings trend real growth rates of 1% in Japan, 2.3% in US, 2.2% in UK, and 1.5% in Germany. It is assumed that real interest rates are 1%. The projections take IMF assessments of current government debt. Net debt has been used for Japan, gross debt for others. 6
  8. 8. Debt Crisis, ways out. Option #1: Fiscal Pain Ten Year Government Bond Yields June 2007 – October 2010 6 2.1 5.5 1.9 Yield to Maturity (YTM) (%) 5 1.7 Japan YTM (%) 4.5 1.5 4 1.3 3.5 1.1 3 0.9 2.5 0.7 2 0.5 Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep 07 07 07 08 08 08 08 09 09 09 09 10 10 10 10yr US Treasury 10yr Germany 10yr UK Gilt 10yr Japan (RHS) Source: Bloomberg, as at 1st November 2010 7
  9. 9. Debt Crisis, ways out. Option #2: Print Central Bank Total Balance Sheet as % of Annual Nominal GDP APF Federal Reserve 25 Lehman Phase II Euro System 20 Bank of England (a) 15 10 5 0 Jun Oct Feb Jun Oct Feb Jun Oct Feb Jun Oct 2006 2007 2008 2009 Source: Bank of England, http://www.bankofengland.co.uk/publications/speeches/2009/speech413.pdf , 2nd December 2009. (a) Excludes loans and associated deposits in course of settlement. 8
  10. 10. Debt Crisis, ways out. Option #2: Print China Real M1 Growth (yoy) & Chinese Producer Price Inflation (yoy) lagged by 9 mths 40 40 35 Producer Price Inflation (%) 30 30 20 25 Real M1 YoY 20 10 15 0 10 5 -10 0 -20 -5 Dec 98 Dec 00 Dec 02 Dec 04 Dec 06 Dec 08 Dec 10 PPI (9mth Lag) China Real M1 Source: Barings as at 31st May 2010 9
  11. 11. Debt Crisis, ways out. Option #2: Print YoY Change in PPIs for China, US, EU & UK Correlation of PPI annual changes 1999 – 2010 2000 – 2010 10 20 8 15 6 CH US EU UK China PPI yoy % chg 10 YoY % Change 4 CH 2 5 0 0 US 0.82 -2 -5 EU 0.82 0.81 -4 -10 -6 UK 0.57 0.67 0.53 -8 -15 -10 -20 Aug 99 Aug 02 Aug 05 Aug 08 US PPI Eurostat PPI Eurozone UK PPI China PPI (RHS) China inflates the World Source: Bloomberg and Barings, 30th June 2010 10
  12. 12. Debt Crisis, ways out. Option #2: Print Breakeven Inflation Rates 30th June 2007 – 1st November 2010 Japanese Breakeven Inflation Rate (%) 4.5 1 Breakeven Inflation Rate (%) 4 0 3.5 3 -1 2.5 2 -2 1.5 -3 1 0.5 -4 0 -0.5 -5 Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep 07 07 07 08 08 08 08 09 09 09 09 10 10 10 US 5y5y Fwd Breakeven Inflation UK 10yr Breakeven Inflation Italy 10yr Breakeven Japan 8yr Breakeven Inflation (RHS) Source: Bloomberg and Barings, as at 1st November 2010 11
  13. 13. Debt Crisis, ways out. Option #3: Default 5yr Credit Default Swap Spreads – Eurozone Periphery 1200 5 year CDS Spread (bps) 1000 800 600 400 200 0 Jun Aug Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct 07 07 07 07 08 08 08 08 08 08 09 09 09 09 09 09 10 10 10 10 10 Greece Portugal Ireland Spain Italy Source: Bloomberg, as at 1st November 2010 12
  14. 14. Debt Crisis, ways out. Option #3: Default 5yr Credit Default Swap Spreads – G5 180 160 5 year CDS Spread (bps) 140 120 100 80 60 40 20 0 Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep 07 07 07 08 08 08 08 09 09 09 09 10 10 10 France Germany UK US Japan Source: Bloomberg, as at 1st November 2010 13
  15. 15. Debt Crisis, ways out. Option #3: Fiscal Pain GDP Growth vs Previous Trend Real Growth by Deleveraging Strategy 7 105 6 5 100 4 GDP Growth (%) 95 3 2 90 1 85 - 80 -1 -2 75 -3 70 -4 t=0 t+2 t+4 t+6 t+8 t+10 t+12 t+14 10yr pre 1-2 yrs 2-3 yrs 4-5 yrs Trend +10yr Belt tightening Inflation Default Belt tightening Inflation Default Source: McKinsey & Matt King - Citigroup, Arresting the Sovereign Avalanche?, June 2010. 14
  16. 16. Summary There is no easy way to deleverage Although markets are busy deciding which will be the route of choice, governments will commit the all three sovereign sins: Taxation Inflation Confiscation For Investors and Savers, the outcomes have quite different portfolio implications (often represented by the inflation/deflation debate) Markets will likely swing from one extreme to the other as evidence emerges supporting each route Understanding the risk premium on different assets will be an increasingly important discipline. Source: Barings, as at 2nd November 2010 15
  17. 17. Forecast returns & risk 10 year asset class forecasts (GBP) Return (% per annum) 14 Emerging Asia Equities 12 10 Emerging Bonds Emerging Europe Equities FTSE All share 8 Latin America Equities Property US Equities 6 Fund of hedge funds UK Corporate Credit Japanese Equities 4 UK Gilts European Equities UK Index Linked UK 3 Mth Cash Gold 2 0 0 4 8 12 16 20 24 28 32 Risk (% per annum) Strategic thinking helps identify areas of focus * Source: Barings. Risk= standard deviation of annualised return. As at 15th June 2010 Source: Barings as at 1st May 2010 ** Barings data, gross of fees, 10 year strategy derived from index returns of all the * Risk (standard deviation of annualised returns) ingredients of the annually revised strategy 2008 calendar year, 10 year strategy: -22.4%, portfolio: -4.6% 16
  18. 18. Best and worst performing asset classes 2005 2006 2007 2008 2009 2010 Emerging Equity 50.5 Europe Equity 19.7 Emerging Equity 37.4 Overseas Bonds 58.1 Emerging Equity 59.4 Gold Bullion 33.4 Japan Equity 39.6 Property 18.1 Gold Bullion 29.6 Gold Bullion 42.8 Asia ex Japan 53.3 Asia ex Japan 24.0 Asia ex Japan 35.0 UK Equity 16.8 Asia ex Japan 29.0 UK Bonds 12.8 UK Equity 30.1 Emerging Equity 22.9 Gold Bullion 30.8 Emerging Equity 16.3 Europe Equity 15.3 Cash 4.7 Europe Equity 19.4 N. America Equity 19.0 Overseas Bonds 4.3 Overseas Bonds -7.5 Japan Equity -6.5 Emerging Equity -35.2 Overseas Bonds -9.7 Cash 0.4 Cash 4.6 Japan Equity -7.4 Property -5.5 Asia ex Japan -31.3 Japan Equity -5.9 Hedge Funds 4.8 UK Bonds 7.9 UK Bonds 0.7 Corporate Bonds 1.8 UK Equity -29.9 UK Bonds -1.2 Europe Equity 5.3 Corporate Bonds 8.7 Corporate Bonds 0.8 Hedge Funds 4.5 Europe Equity -24.4 Cash 0.5 UK Bonds 7.2 Tactical asset allocation protects capital and seeks to maximise return Source: Barings as at 31st December 2010 17
  19. 19. Irish Bond Risk vs. Return 15 10 5 Return - % 0 -5 -10 -15 November 2010 -20 0 1 2 3 4 5 6 Risk - % “It’s not what we don’t know that hurts us; it’s what we know for sure that just ain’t so.” Mark Twain – Nobel Prize Laureate (Literature) Source: Barings, Bloomberg & Merrill Lynch as at 17th December 2010 – 6 month annualised returns 1995 - 2010 18
  20. 20. Irish Bond Equity Correlation vs. Irish Bond Returns 15 10 5 Returns - % 0 -5 -10 -15 November 2010 -20 -1.00 -0.50 0.00 0.50 1.00 Correlation - % Source: Barings, Bloomberg & Merrill Lynch as at 17th December 2010 – 6 month annualised returns 1995 - 2010 19
  21. 21. Risk Premia on offer today in the UK Inflation Linked Breakeven Inflation Credit Spreads Equities Bonds Rates 8% 4.1 179 2.5 3.9 7% 3.7 2.0 3.5 129 6% 3.3 1.5 3.1 5% 2.9 79 1.0 2.7 4% 2.5 0.5 2.3 29 3% Source: Barings, as at 30th November 2010 20
  22. 22. Your Multi-Asset Fund Manager Casting his net far and wide! 21
  23. 23. Multi Asset Fund & RPI+4% Past Performance is not a guide to future performance Source: Financial Express as at 31/12/2010, Net Returns, Bid To Bid. Fund Inception date 20th March 2009 22
  24. 24. Dynamic Asset Allocation Fund vs. Cautious Managed 17/01/2007 01/01/2008 01/01/2009 01/01/2010 17/01/2007 31/12/2007 31/12/2008 31/12/2009 31/12/2010 31/12/2010 Group/Investment Return Return Return Return Return DAA vs IMA Cautious Managed Baring Dyn Asset Alloc I GBP 8.86 -5.44 20.23 10.29 36.50 IMA OE Cautious Managed 1.57 -15.54 16.18 9.86 8.64 Past performance is not a guide to future performance Source: Morningstar 06/01/2011 23
  25. 25. Baring Dynamic Asset Allocation –Return & Risk: 16/01/2007 – 31/12/2010 Return (%) Risk (%) 36.5 33.3 26.4 18.24 18.92 10.1 8.1 0.7 Baring DAA LIBOR +4% FTSE All Share FTSE All World Past performance is not a guide to future performance Source: Barings as at 31st December 2010 Net of fees. Reference to the index is for comparative purposes only. The DAA returns should be considered as supplemental information which complements the Multi Asset Strategy GBP 24
  26. 26. Biography Andrew Cole Member of the Multi-Asset Team Location: London Investment Experience: 29 Years Andrew is a member of the Multi Asset Team responsible for the management of multi asset portfolios. He is lead manager on a number of segregated portfolios. Andrew was appointed to the Strategic Policy Group (SPG), the company’s global macro research and asset allocation team in 2005. He is chair of the SPG Risk Sub Group and is a member of the Economic Group. Both groups provide key inputs to the debate of the monthly SPG meetings. Andrew joined the Fixed Income department at Baring Asset Management in 1986. He was appointed a Director in 1994 and joined the Multi Asset portfolio team in 1995. 25
  27. 27. Important Information For Professional Investors/Advisers only. This document is approved and issued by Baring Asset Management Limited and in jurisdictions other than the UK it is provided by the appropriate Baring Asset Management company/affiliate whose name(s) and contact details are specified herein. The information in this document does not constitute investment, tax, legal or other advice or recommendation. It is not an invitation to subscribe and is for information only. The value of any investments and any income generated may go down as well as up and is not guaranteed. Past performance is not a guide to future performance. Quoted yields are not guaranteed. Changes in rates of exchange may have an adverse effect on the value, price or income of an investment. There are additional risks associated with investments (made directly or through investment vehicles which invest) in emerging or developing markets. Investments in higher yielding bonds issued by borrowers with lower credit ratings may result in a greater risk of default and have a negative impact on income and capital value. Income payments may constitute a return of capital in whole or in part. Income may be achieved by foregoing future capital growth We reasonably believe that the information contained herein from 3rd party sources, as quoted, is accurate as at the date of publication. The information and any opinions expressed herein may change at any time. Companies and employees of the Baring Asset Management group may hold positions in the investment(s) concerned. This document may include internal portfolio construction guidelines. As guidelines the fund is not required to and may not always be within these limits. These guidelines are subject to change without prior notice and are provided for information purposes only. This document must not be used, or relied on, for purposes of any investment decisions. Before investing in any product, we recommend that appropriate financial advice should be sought and all relevant documents relating to the product, such as reports and accounts and prospectus,( which specify the particular risks associated with a product, together with any specific restrictions applying and the basis of dealing) should be read. Compensation arrangements under the Financial Services and Markets Act 2000 of the United Kingdom will not be available in respect to any Offshore Fund. Research Material Baring Asset Management only produces research for its own internal use. Where details of research are provided in this document it is provided as an example of research undertaken by Baring Asset Management and must not be used, or relied upon, for the purposes of any investment decisions. The information and opinions expressed herein may change at anytime. For data sourced from Morningstar: © Morningstar, Inc. all rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Version 03/2009 Compliance (London) 7th January 2011 26

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