Looking into 2018 with Hermes - Hermes Investment Management
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2018 Outlook
Hermes Investment Management
Looking into 2018 with Hermes
2018 is likely to be an unusual year for markets. So far in 2017, the when the risk free rate of return is only marginally above zero against
MSCI world index is up some 18% and stands on a P/E of just over a background of negligible inflation (the result of the rise of the new
21x. We are now in the 9th year of the bull run since the trough of economic powers).
2008. By all traditional measures, market participants would expect
a correction at some stage, and the question would be whether it The consensus therefore is settling around a median view that markets are
would be what we in Hermes term a black bear (traditionally the less fully valued, but not stretched and that with the interest rate background
aggressive of the species) of circa 25% as in 1957, 1962, and in 1978; this state can sustain itself for some considerable time. There are strains,
a brown bear (the more aggressive of the species) of circa 45% as in evidenced by the severe punishment of any stock whose earnings
1973, 2001 and 2008 or a mere correction of anywhere between 5% disappoint, but the strains are specific and apparently not systemic.
and 17% as in 1956, 60, 66, 77, 81, 90, 2008 and 2011.
So the question must be, what kind of shock could interrupt this
But, and there is a but, we live in unusual times. The great monetary steady state in 2018? I can only think of three. First, a political one.
easing following the crash of 2008 is still with us and yields on The markets were quite sanguine about the election of President
government bonds remain absurdly low by historical standards with Trump, Brexit and the rise of the far right but might take exception
the consensus that even when they eventually start to rise (and they to the Trump administration failing to deliver the Republicans long
will likely start to rise in the US but slowly and in small increments) term dream of tax cuts (even though corporate America actually
they will peak at much lower than historical levels, so that the pays only 22% in tax in aggregate, only marginally above the 20%
calliper used to value equities (the relationship between government proposed by President Trump). We could also see increasing pressure
bond yields and equity P/Es) imply full but not overstretched from the fissures in developed economies (the Catalan revolt? The
valuations as even the arch priest of value investing, Warren Buffett, Austrian vote?) on market sentiment or external shocks (North Korea,
acknowledged recently. President Xi’s revival of Communist ambitions, the disintegration of
the Middle East created in the aftermath of WW1). Secondly, we could
We are also contending with a strange phenomenon in the Anglo- be wrong about inflation. Like balloon sculptures made by entertainers
Saxon markets of high employment levels with no wage inflationary in children’s parties, where the ballon is mostly flat except for areas
pressures, so that as the economies continue to strengthen, the highlighted by the entertainer’s sculpture, we already see some
employee share of the take remains low by historical standards, evidence of hidden inflation in prime property in international cities
partly because of the great migratory waves of the last two decades for example, or even arguably the price of equities, which may hint at
and partly due to the advances in robotics which are predicted to a hidden reserve of inflation that will eventually manifest itself in the
accelerate over the next two decades, which implies resilience in wider economy. Finally, there is a small possibility that with the rise of
corporate earnings. The result is a recovery in company earnings, in digital currency and of protectionism (the Bombardier affair) the whole
the emergence of new technology companies, of the so called digital system of a post Bretton Woods free floating fiat currency system
economy and an ever increasing disparity in the distribution of wealth might slowly begin to be questioned.
which is manifesting itself in fissures in the political arena. All this
against a background of moderate but steady and even accelerating None of these can be modelled or predicted, so the best that a long
growth in the US and mainland Europe. term investor can do, therefore, like Mr Buffett, is to assume that the
valuation metric we are using (bond yield to Equity P/E) continues to
One can argue that we are seeing the dual long term effects of the work for now until it doesn’t, and when it breaks down look at it (in
Nixon shock in 1971 that ended the Bretton Woods accord (with the his words) as a ‘sale’ of assets we want to accumulate over the long
very nature of free floating fiat currency now being challenged by the term. In other words, steady as she goes but with
rise of digital currency, such as BitCoins, entirely outside the control an increasing awareness that all parties must
of central banks) and the collapse of the Soviet bloc in 1992, which come to an end sometime.
ushered in an era of unfettered globalisation. The combination of both
these tectonic shifts in the system resulted in a system anchored only
in investor sentiment and perception which is today struggling to make Saker Nusseibeh
sense of the relationship of valuation of assets in relation to each other Chief Executive
For professional investors only www.hermes-investment.com2 2018 OUTLOOK
INVESTMENT
The investment landscape of 2017 was dominated by geopolitical This coming year will be dominated by how the markets respond to
shocks (North Korea, Russian links to the Whitehouse, populism the kick-starting of a gradual reversal of unconventional monetary
rearing its head once again in Europe), but none of that translated policy stimulus that was injected into the economy over the last
into market uncertainty. Seemingly only macroeconomic volatility will eight years in response to the Global Financial Crisis. This less
translate into financial market ructions, and with steady, if somewhat accommodative stance will challenge investors to re-examine the
uninspiring, growth everywhere, and liquidity aplenty, even as the fundamentals of all their investments – leverage and complacency
Fed takes its first steps to shrink its balance sheet, risk assets have should be avoided at all cost, with nimble investors best placed to
continued to reach new highs. navigate an investment outlook in which caution is warranted.
That global growth is better and more synchronized than it has been Eoin Murray
in years is uncontroversial, yet the second-longest equity market run Head of Investment
in post-war history remains thoroughly unloved, with greater evidence
of investor behaviour being largely driven by a fear of missing out than
true conviction. Markets seem unwilling to believe the Federal Reserve’s
dot plot of forecast rate rises in the US, but if inflation starts to come
through in 2018, the markets have the potential to react badly.
MACROECONOMICS
Despite ‘muscle flexing’, the road to policy normalisation will be long Even if China’s President Xi addresses asset-price bubbles, corporate
and slow – offering another two years of negative real rates in the US, debt and shadow banking, its tightening should be limited. The more
UK, Japan, and euro-zone. serious risk is US trade tariffs which, if like the 1930s, could spread
like bushfire. It remains to be seen how more combative US/China
The frustration is that with output gaps slow to close and wage relations become over North Korea.
growth capped, recoveries have yet to generate enough inflation
to trigger central banks’ usual reaction functions. Many may seek So, a decade on, these give credence to the ‘new normal’ view of
paradigm shifts. low for-longer rates and yields – rather than an imminent return to
precrisis levels. In which case, the most we might expect in 2018 is not
The question after $14trn of central bank QE is how they can drain for policy to become tight again, just less loose.
the sink without unintended consequences? Their ‘skin in the game’
suggests they cannot take us by surprise. The Federal Reserve will take Neil Williams Silvia Dall’Angelo
baby steps pushing its second lever, QT, to take the pressure off rates, Group Chief Economist Senior Economist
allowing them to peak out far lower than we’re used to.
The one big economy with inflation is the UK, yet Bank of England
hikes will be limited during Brexit. The ECB is planning to whittle
down further its QE in 2018, but would doubtless backtrack if Europe’s
growing political tensions unravel the economic union that monetary
union demands.
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EQUITIES
Global Equities
In 2018 we expect a broadening market, with more opportunity for Despite political uncertainty in the form of Brexit and the “illegal”
stock-pickers. Globally we are seeing strong estimate revisions and Catalonia independence referendum dominating the headlines we
macro-economic data and in this environment, we expect the financial remain positive on Europe. There is real evidence of an improving
and industrial sectors to perform well. The next quarter could herald the economic backdrop and European corporates are at an earlier stage in
start of the “Great Unwinding” as the Federal Reserve, ECB and Bank of the cycle than their US peers, and with more attractive valuations.
England set the stage for the normalisation of monetary policy. While
the direction of travel is clear, we expect the unwinding to be gradual as In the US, the retail and real estate sectors look challenged. Low mall
central banks remain in unchartered territory and political uncertainty traffic, as consumers shift from bricks and mortar to e-commerce, is
could further slow the pace. Regardless of the pace, the rises will be affecting the traditional retail sector and this will negatively impact
beneficial for the banking sector, while high dividend names and stable, retail focused REITs. In the real estate sector, rising home prices, that
consumer staples companies likely to lose out. are outstripping wage growth, are making a broader
swathe of housing unaffordable.
The information technology sector continues to look attractive,
despite a strong run over the past 18 months. The sector continues to Geir Lode
boast strong growth, huge cash stockpiles and fiercely loyal user bases Head of Global Equities
creating an ever-widening economic moat, meaning that the strong
continue to get stronger.
European Equities
The key question for European markets in 2018 is whether the earnings No discussion of the European outlook is complete without a
renaissance we’ve seen this year can be sustained. After a decade when reference to politics, and the seemingly endless cycle of European
Stoxx 600 earnings have declined, 2017 is set to break that trend and elections continues in Italy in the first half of 2018. The UK’s
deliver double-digit earnings growth. Estimates for 2018 are rapidly negotiations with the EU will continue, where intransigence is likely
changing, but current consensus is around 8% growth. Delivery of to be the over-riding theme.
earnings growth is paramount for investor confidence.
Overall, though, we retain a sense of cautious optimism as we enter
Economic growth has been returning to the Eurozone and we believe 2018. Europe remains at an earlier stage of the cycle than the US, and
the 2017 GDP print will be 2.2%, which would mark a post financial- while mindful that a strong Euro could be a headwind, there is enough
crisis high. Hard and soft economic data points are encouraging, latent earnings momentum in Europe to carry markets higher.
unemployment is near lows and the recovery is broadly spread. This
renewed confidence is feeding through to corporates, M&A has James Rutherford
picked-up, IPO’s continue to come to market and investment decisions CIO, European Equities
are being made. Allied Irish Bank’s successful return to market in 2017
is a great barometer of European economic progress and renewed
confidence. One of the biggest casualties of the crisis, bailed out by
the Irish government, buried under a mountain of non-performing
loans but now back trading, and at a slight premium to peers.
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Emerging Markets
The environment for emerging markets is healthy at present. The global keep markets on edge, or topple them over, should matters worsen
economy, bolstered by continued non-inflationary US and European substantially. The ability of markets to shrug off politics will be tested,
recoveries, looks set to continue growing into next year. Interest rates especially given the high level of unpredictability in Washington. Thus
will rise, and QE will taper off, but at this point most economies can we look at 2018 under a variety of scenarios, some of which could
take this in their strides. see current global bullishness reverse. However, as a base case, mild
interest rate hikes by the Federal Reserve and the commencement of
In emerging markets themselves, current accounts, inflation, and a gradual unwind of its balance sheet does no more than put clouds
growth are generally supportive. Foreign indebtedness makes Turkey on the horizon of an otherwise sunny landscape. It will be important
and South Africa particularly vulnerable, but most emerging markets to test the wind frequently.
have built strong defences against foreign rate rises and investor panics.
Microeconomic fundamentals such as valuation, earnings growth Earnings growth in emerging markets has been strong this year. We
and cash flow generation also argue for continued progress at the expect it to remain positive but more moderate in 2018. The valuation
benchmark level. The Chinese authorities have introduced measures to of the emerging market sector is fair: it can improve if earning growth
slow the property market, with mixed success so far. India’s growth is accelerates, but it will have to do so against what we at present assess
expected to reaccelerate in their new fiscal year; Russia and Brazil are as a mild headwind of US tightening. Multiples do expand in the early
already seeing economic recoveries, which is being reflected in earnings stages of Fed rate hike cycles, but at a certain point start to struggle.
estimates and the indices themselves. From our work, the stocks we own offer reasonable upsides, and
despite good inflows into global emerging markets this year, global
Although the current situation is about as calm as emerging markets funds were equal weight in emerging markets at the
get, a shock from the developed world would be felt in emerging end of the third quarter, hardly a sign of euphoria,
markets as well. Rising US rates will compete with earnings and share though not a sign of panic either.
buybacks to set the tone of the US, and by extension, global markets.
The possibility of military escalation of conflicts in the Korean Gary Greenberg
peninsula, the Straits of Taiwan, or in the Middle East will continue to Head of Emerging Markets
Asia ex Japan
In the three years to the end of October 2017 the MSCI Asia ex Japan stocks have significantly underperformed that we are finding the
benchmark is up by 28% in US dollars. However, the variance in most compelling opportunities. The reasons for smaller and mid cap
performance of underlying parts of that benchmark (by size, sector and stocks doing so poorly are varied but we think is partly because of a
county of listing) has been stark. progressive and accelerating supplanting of actively managed money
by passively managed money. The smaller stocks being sold by active
Size wise, the largest ten stocks (which includes particularly strong managers to meet redemptions are not being bought by passive fund
performers Alibaba, Tencent, Samsung and TSMC) are up in aggregate managers, who can achieve an acceptable degree of index replication
93% over that period. On the other end of the spectrum small cap by buying only the larger cap stocks that dominate relevant indices.
stocks are up only 8% (with mid cap stocks being up a still modest
12%). Country wise, Asian benchmark stocks listed in the US have risen We are now finding a number of terrific stock picking opportunities in
25% (dominated by the same top stocks) with South East Asia stocks small- and mid-cap stocks, especially in the ‘value’ space within Korea,
underperforming. Finally, by sector, information technology – again which we expect to sharply outperform
dominated by many of the same large names – has risen 82% while from here.
the laggard telecommunications services sector has fallen by 13%.
Jonathan Pines
Looking at current valuations, we believe that despite the steep rises, Portfolio Manager,
many of the largest ten stocks still represent good value. Indeed, we Asia Ex Japan
hold some of these in our fund. However, it is in the areas where
For professional investors only www.hermes-investment.com5 2018 OUTLOOK
Small and Mid Cap
Writing market outlooks at present feels rather like being in the film established players; here also, with so many stocks to choose from,
Groundhog Day. Another year has come round but the same big there is a greater chance of finding mispriced opportunities. Look back
picture thoughts are front of mind: equity markets are priced on the at the relative performance since March 2009, when markets reached
high side; we need earnings growth to come through to justify those their nadir, to the end of Q3 this year – small caps returned 17.2%
ratings; but it’s not coming as economic growth is so anaemic; and, annually versus 13.0% for large caps. Yes, risk is higher on an absolute
most importantly perhaps, what’s going to happen when rates rise basis, but the risk-adjusted profile is superior.
meaningfully?
The opportunity set may even improve further in 2018 and beyond.
This year it has paid off to be in high growth areas of the market. Not MiFID II regulations mean that a vast amount of free research will from
just the so-called FANG stocks, but wherever there is good headline the start of next year disappear from fund managers’ screens in Europe.
growth. Lack of growth overall has pushed interest to those areas Indeed, this may extend beyond those shores as fund managers
where there is growth. Combined with low rates boosting market bear research costs themselves rather than pass it onto their clients.
prices via the discounting effect, the market’s positioning is logical, Those managers who are used to doing the hard graft
albeit not leaving much room for error. themselves will be looking forward to this.
Equity investors must make the most of the stasis that exists. Small Hamish Galpin
and mid cap stocks are one place to look for excess returns, and for Head of Small & Mid Cap
all the classic reasons; here you can find growth when there is a lack
of growth elsewhere, as nimble small caps take market share from
US SMID
The underlying US domestic economy remains strong with low With regards to the market, our base case is for US small and mid caps
levels of unemployment, modest inflation and wage growth and a stocks to move up in line with earning growth. As the Fed tightens,
substantially delevered consumer. Against this supportive backdrop, we would expect flows into more speculative areas of the market to
the more domestically focused small and mid cap companies should slow and some resurgence in the performance of ‘value’ style stocks.
continue to do well. Excluding exogenous geopolitical events, it is hard The portfolio retains exposure to economically sensitive sectors
to see the US economy tipping into outright recession in the near (industrials, materials) as well as the more traditionally defensive areas
future, supported as it is by a synchronised global economic recovery. of the market. As ever, stock picking is key, and we continue to focus
on high quality companies that should benefit if markets move higher
President Trump’s stalled legislative agenda may, or may not, but protect investors’ capital in market pullbacks.
result in tax reform or tax cuts over the next twelve months. While
any such cuts would be beneficial for company earnings (and the Mark Sherlock
amount available for reinvestment or to be returned to shareholders) Lead Portfolio Manager,
expectations of success in this area remain modest. The Federal US SMID
Reserve has begun on the pathway towards gradual interest rate
normalisation and the reduction of its balance sheet. Whomever is
selected as the new Chair of the Fed, we expect a continuation of this
policy, based on confidence in the underlying economy.
For professional investors only www.hermes-investment.com6 2018 OUTLOOK
US All Cap
In 2018, the US economy has an opportunity to emerge from the Within financials, we think banks and insurance companies should
low inflation, low growth trend of recent years. The corporate sector, benefit from higher rates combined with a more benign regulatory
particularly small businesses, have an upbeat outlook post the election, framework. We expect investors to derate companies that have over
however this has not translated into new investments. The key to stretched in terms of debt. Our US All Cap portfolio holds stocks with
unlocking this demand might be changes to corporate tax related to lower financial leverage than the benchmark and only has one REIT
President Trump’s tax reform plan. holding in American Tower, which is very defensive.
At the same time, market valuations have moved up to the high end of In summary, we expect the market to make progress in 2018 with
historical averages supported by a benign environment for credit. We gains likely driven by earnings growth. We believe our portfolio is well
expect further gains will likely be driven by earnings growth. Therefore positioned with holdings in companies that have wide economic moats,
we believe it is important to be selective in terms of stock picking. skilled management and strong balance sheets.
The growth outlook for the technology sector which accounts for 25% Michael Russell
of the market looks strong for example. The so called FANG companies Portfolio Manager,
look like winner take all industry models. In contrast, we are concerned US All Cap
that many consumer companies face technological disruption from
the rise of e-commerce and digital advertising.
MULTI ASSET
Global economic activity is firming up. While setting a gradual protectionism, the brewing assertion of China as a superpower and the
tightening path, central banks are likely to remain proactive in rethinking of the US role in the world are all potentially disruptive trends.
supporting the recovery, pursuing risk-mitigating policies and
communicating their intention profusely. Yet, active allocators look Lastly, the financial system is ever more complex and with complexity
underweight equity risk as caution prevails. Our base case is for the comes fragility. The increased importance of passive and machine-led
market to remain supportive for growth assets. strategies enhances the impact of automatism and momentum. Like
in October 1987, May 2010, or August 2015, when arbitrary lines are
However, the further we progress along with the current market crossed, the market is likely to experience sudden and uncomfortable
regime, the more conscious of the implications of a regime shift we air pockets.
need to be. Inflation surprises could be a trigger point. The multi-
decade stability of the stock-bond relationship has led to the gradual This challenge calls for forward-looking, agile and adaptive risk
adoption of the flight-to-quality narrative, and such investment management. While maintaining our inflation hedges and focus on
narratives can be mistaken for absolute truths. In a reflationary liquid assets, we will continue to rely on alternative
scenario, bonds would not only disappoint from a return perspective sources of de-correlation such as cross-asset
but also as a hedge as the stock-bond correlation would most likely momentum and relative value strategies to
turn positive. maintain a balanced portfolio.
Major political events of the past few years have also the potential to Tommaso Mancuso
shake the current geopolitical regime. Among others, the gradual rise of Head of Multi Asset
For professional investors only www.hermes-investment.com7 2018 OUTLOOK
FIXED INCOME
It would be hard to overstate the lack of volatility within credit There is little doubt that a correction of some sort will eventually
markets in 2017 against a backdrop of elevated geopolitical and arise but given current positioning, far from extreme interest
financial risk. Liquid credit markets have tightened and compressed. coverage ratios and a potentially more predictable year (did I just
Less liquid markets have seen more investors seeking complexity, write that!) for growth in major economies, we may be waiting
illiquidity and any other “risk premia” they can find. On the supply for some time. That said shorts are cheap and credit spreads are
side, we have seen credit in formats that no longer fit for banks and bounded at zero (even if interest rates are not).
insurers in the post Solvency II and Basel III era beginning to surface.
Andrew Jackson
A number of markets feel like coiled springs and perma-bears have Head of Fixed Income
been burnt so often that even they are tending to a consensus long
position. For us at Hermes this means that our 2018 in credit markets
will be broadly characterized by less beta more alpha, seeking returns
through security and borrower selection rather than through leverage,
and casting our nets even more widely in order to capture as many
opportunities to analyse as possible.
Credit
As we look into 2018, we like what we see from an underlying, Despite this year’s unbridled rally, we see plenty of opportunities
fundamental point of view: moderate but steady economic growth; in 2018. However, dynamic, nimble management and the sizing of
low default outlook; modest financial risk after years of debt maturity positions in the riskier parts of the market will be necessary, whilst
extensions and refinancings; solid corporate earnings; supportive market ongoing, historically low volatility puts increasing value on having a
technicals; and, finally, convergence in central bank policies. Having long memory.
said that, valuations have overshot in certain pockets of the market.
For example, as asset allocators have increasingly sought ‘duration- Because valuations are doing little to separate the wheat from the
lite’ credit solutions and investment banks have structured primary chaff, perhaps now more than ever it is vital to price the ESG risks of a
market activity to meet this demand, the front end of credit curves have company and to engage with them when making investment decisions.
aggressively steepened. As a result of this technical, there is attractive Certainly now is not the time to be complacent. By paying acute focus
value at the long end of credit curves, where relative under-ownership, on the fixed-income aspects of credit – duration, convexity, security
combined with superior roll-down and convexity profiles shine bright selection, call structure, subordination – we see plenty of opportunity to
deliver superior total returns. But, in order to do so, one must eschew a
Moreover, the global hunt for yield has caused dramatic demand for myopic approach to credit management and widen the investment lens
bank loans of late. As the bond markets continue to suffer call protection to uncover opportunities across jurisdictions, capital strictures, credit
erosion whilst the loan market becomes increasingly “covenant-lite”, the curves and security type.
two markets are converging. This benefits issuing companies and their
sponsors, because optionality and pricing power are gifted to them for
little or no cost.
Fraser Lundie, CFA Mitch Reznick, CFA
Also we believe that the spread between low quality and high quality Co-Head of Credit Co-Head of Credit
precludes us from being too excited about chasing returns in the lower
quality pockets of the market. The key to managing under these market
conditions is to be a forced buyer of nothing. In this context, to achieve
superior, risk-adjusted returns, one must have the ability to invest in
credit across the globe and by security type.
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Private Debt
2018 is going to be a year of continuing competition amongst lenders As covenants start to tighten on earlier vintages of loans, we could
as a result of a reduced primary pipeline, subdued M&A activity, and see a slight uptick in defaults, although these will remain very low as a
continued high competitive lending from the banks and high levels of result of the benign economic environment and low interest rates. The
dry powder amongst the direct lending funds. slight rise in defaults could mean that some lenders are less present in
the primary markets whilst these issues are managed.
Yields will remain attractive as competition amongst lenders will be
centred on loan terms rather than pricing. However with improving This will be a year where strong loan origination and lending discipline
economic fortunes in continental Europe and uncertainty in UK over will be key to success.
Brexit, we are likely to see a continued rise in the Sterling premium on
loans when compared to Euro denominated loans. This could reach as Patrick Marshall
much as 100bps on certain like for like transactions. Head of Private Debt and CLOs
In the large cap market, lenders, who compete with the capital
markets for providing financing, will continue to have to accept weaker
protections such as cov-lite structures. This is unlikely to happen to
the same extent in the mid-market, where the companies are unable
to access the capital markets and are dependent on more traditional
forms of financing. The mid-market will continue to offer lenders with
the best protections.
PRIVATE MARKETS
Real Estate
Global liquidity levels across real estate markets show no signs of externalities on the environment and society at large. At King’s Cross
abating yet as the craving for the yield premium still available from and Paradise, Birmingham we have been able to deliver these positive
real assets potentially offers investors relative value. externalities and a sense of civic pride and belonging by creating
world class place-making in a socially inclusive manner, working in
However, we remain cautious on absolute levels of pricing across partnership with the public sector.
core real estate markets and will continue to rely upon our
fundamental analysis of occupational markets as the key driver of 2018 will see us continue to deliver on these sustainable places as a
returns. Therefore, as a long-term responsible investor we will adopt focus for deploying capital and move away from merely investing in
thematic investment strategies which not only anticipate the real ‘buildings’ in accordance with backward looking industry benchmarks.
estate cycle but also consider the impact upon occupational demand
arising from profound structural forces we observe; those include Chris Taylor
disruptive technologies, urbanisation, globalisation, sustainability Head of Private Markets
and demographic lifestyle trends.
By adopting an holistic approach to investing in real estate and a
fundamental understanding of future occupational demand drivers
we are increasingly focused upon our responsibility as investors to not
only deliver an attractive financial return to our savers but positive
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Infrastructure
Infrastructure investments generate long-term, predictable inflation- Importantly, the breadth and depth of prospective investment
linked cash flows providing investors with real rates of return and in opportunities remains solid, allowing us to adopt a selective approach
turn a good fit for pension fund liabilities. However, infrastructure to investing over our typical 5+ year investment deployment period.
is not immune from economic cycles and, like all asset classes, has Whilst the outcome of Brexit remains unclear, we believe it may
benefitted strongly from the long-running fall in real interest rates. This produce an attractive investment environment for long-term investors,
has resulted in a steady decline in nominal investor returns consistent enabling access to the long established UK market at interesting
with the decline in long-term real interest rates. valuation levels.
But change is coming as central banks globally move to normalise Finally, we intend to continue to drive engagement on responsible
policy after years of easy money. Like listed equities, we feel that investing in the asset class, reflecting our beliefs and the increasing
valuations for private direct infrastructure assets are at or near peak institutional focus on the prospective quality of life for
levels, as such we continue to be cautious on valuations. pensioners as well as financial returns.
To prepare for the impending change we have focussed on new high Peter Hofbauer
conviction investments only at this point in the cycle and constructed Head of Infrastructure
our existing portfolio to maintain real returns under different inflation
and real interest rate environments.
RESPONSIBILITY, SUSTAINABILITY AND STEWARDSHIP
Responsibility
In 2018, we expect to see a continued ratcheting up of pressure we do expect to see better ESG disclosure by investee companies
from regulators, governments and society for investment houses and some funds building innovative tools to lay the foundation for
to justify the value delivered to the beneficiaries they serve. We effective integration in the future.
believe this will go beyond the likely scramble in early 2018 to
provide a clear exposition of expenses to clients and encouragement We would propose that Stewardship either as an overlay to a
to take responsibility on one’s own P&L for costs such as research. passive fund or an integral part of an active strategy will be key
In addition, we believe that we will see a number of investment to demonstrating holistic value to beneficiaries. Whilst we expect
houses reconsidering their approach to fees in an effort to defend the more resources will be applied in 2018 from the currently low levels,
industry’s high staff remuneration and firm profitability. with some notable exceptions, we do not expect to see stewardship
properly resourced (engagers, relevant skills and
Investment firms will continue to be at pains to demonstrate the experience) for some time yet.
efforts being taken to integrate ESG factors into investment decision-
making. However, we expect that for all the noise made, progress will Leon Kamhi
remain slow with many firms simply procuring greater quantities of Head of Responsibility
ESG data rather than meaningfully integrating the information. More
positively,
For professional investors only www.hermes-investment.com10 2018 OUTLOOK
Sustainability
No longer is sustainability an option: it is an imperative. We live in represented by the UN Sustainable Development Goals (“SDGs”), are
an uncertain world that is undergoing profound transformations in innovators, tapping into emerging future growth opportunities that
technology, demographics, geopolitics and in the climate. These forces should also help create a fairer and more sustainable and resilient
are already disrupting the way we live and have the power to change world. Over the course of next year, we expect significant growth in
life on the planet. As investors, individuals and businesses, we have the awareness of the SDGs and their role in mainstream investing.
a complex series of impacts on society and the environment that we
need to manage if we are to provide a more resilient and equitable Not least, this will be recognising that engagement is the truest
system for future generations. The investment industry is well placed form of impact investing for public market investors. Through active,
to influence the outcome of this endeavour as it touches every part constructive engagement with companies it is possible to deliver
of the global economy. The good news is that investors are slowly real change that can improve the lives of many. A
waking up to their responsibilities and beginning to recognise their sustainable world is within our grasp and let’s use
wider obligations. our influence as investors to make this happen in
2018.
Delivering a more sustainable world is not just about doing good, it
also represents an opportunity to deliver attractive long-term growth. Andrew Parry
Companies that are meeting otherwise unmet needs of society, as Head of Sustainable Investing
EOS
Stewardship codes spread further in 2017, launching in Australia and After a year of hurricanes and other extreme weather events, climate
even in the US. As they encourage investors to monitor the companies change remains top of the investor agenda. There will be a push for
they invest in, engage with them on a wide range of ESG issues and to more standardised disclosures, based on the recommendations of the
exercise their votes at shareholder meetings, they have been a crucial Task Force on Climate-related Financial Disclosures and increasing
driver of stewardship. collaboration between investors globally in an attempt to move
companies in the right direction.
Board diversity caught the eye of investors in 2017. In the UK,
we systematically opposed nomination committee chairs, if the We expect ongoing focus by companies and investors on the UN
proposed board composition did not meet our expectations on Sustainable Development Goals. In support of these, engagement on
the representation of women. In 2018, we will increase our efforts human and labour rights, as well as supply chain management, will
on diversity by moving beyond gender and looking at diversity remain an important part of stewardship in 2018.
at companies below the board level.
Dr Hans-Christoph Hirt
Competition has increased between stock exchanges for IPOs. As a Head of EOS
result, several stock exchanges in Asia have been considering whether
to soften their approaches to listings of companies with differential
voting rights. We have argued for adherence to the one-share one-
vote principle, which is a prerequisite for effective stewardship, and
will continue to do so.
For professional investors only www.hermes-investment.com11 2018 OUTLOOK
BUSINESS DEVELOPMENT
2018 will be a seminal year for the industry. The raft of regulatory While the gaps are huge, and Hermes is sadly no exception, I see
change mentioned elsewhere, but including MiFID II and GDPR and some encouraging signs of movement. In the same way that ESG
preparing for Brexit, will occupy investment managers’ time and integration was a fringe activity five years’ ago that has now become
absorb resources that could, in less challenging times, be focused central to winning business, I believe 2018 will mark the start of firms
on finding new investment solutions for asset owners, savers and commitment to addressing diversity.
beneficiaries.
Brexit
I see three big changes and, optimist that I am, opportunities for 2018: While the clock is rapidly running down, I am optimistic that the
EU and UK will reach sensible compromises that work in everyone’s
Integrated engagement – Beyond ESG interests. We plan for the worst, but expect a reasonable outcome.
ESG has hit the mainstream, with most asset managers now stating London as a financial centre, for its many shortcomings (see above!)
that they consider ESG factors in their investment processes. This is has shown, over the centuries, a resilience and ability to adapt to – and
encouraging, but the industry needs to go further. Factoring ESG into benefit from – changing circumstances. While there will be turbulence,
your decisions is entry-level and the winners in 2018 will be those I am optimistic that it will also be true this time.
firms that go much further in their integration, including the crucial
component of Board-level engagement, which few firms are currently Harriet Steel
equipped to deliver. Expect rapid growth in impact strategies as Executive Board Director,
investors around the world really start to challenge investment firms Head of Business Development
to go beyond pure performance.
Diversity
Initiatives such as the Women in Finance Charter and Gender Pay
Gap reporting show the uncomfortable truth that the investment
industry is still heavily dominated by white males at a senior level.
STRATEGIC RISK & COMPLIANCE
One thing which will not change in 2018 is the unrelenting pace of It is difficult to explain financial products simply and in a way investors
regulatory change. This seems especially true for asset managers. The can understand. Reams of regulatory disclosures do not help. There is
winners will be those who can make a virtue out of a necessity. an advantage to be had in meeting this challenge.
Building on the disclosure requirements of MiFID II, fee transparency The Senior Managers Certification Regime (SMCR) has instilled fear
remains a key issue. The FCA’s Institutional Disclosure Group, chaired into the hearts of many. However, those who are entrusted with
by Chris Seir, is due to make its first report to the FCA in time for the the responsibility of looking after the assets of pension schemes and
New Year. They are charged with producing a disclosure template individuals must be accountable for their actions. One challenge
which is jargon-free, will foster consistency and allow for comparisons of the proposals appears detailed prescription and a consequently
between managers and products. The industry should acknowledge high evidential burden. The sensible approach will be a streamlined
that despite many previous initiatives, these requirements have not organisation and as simple a responsibilities map as
yet been met. possible.
The Asset Management Market Study promises a prescribed Gill Clarke
responsibility to act in the best interests of investors including Strategic Risk & Compliance Director
assessing value for money, specific requirements on the use of
benchmarks, the setting of objectives and performance measurement.
For professional investors only www.hermes-investment.com12 2018 OUTLOOK
PRODUCT STRATEGY & DEVELOPMENT
2018 brings a watershed of client-friendly regulatory reform, namely and we view this as a clear differentiator for active management in the
MiFID II, PRIIPs and the still to be finalised after-effects of the year ahead. In the European fund market, the trend towards ESG has
FCA asset management review (amongst others), impacting asset been particularly strong with 40% of YTD net flows into global equity
managers and their distributors. With this comes an expectation of directed towards funds with an ESG label (per Morningstar Direct);
increased transparency, customer-outcomes driven strategies and, while the group of ESG funds in the EUR-denominated global high
for active managers such as Hermes, a need to evidence value for yield credit category attracted notable inflows, despite asset raising
money and alpha generation after fees – a welcome renewed focus in the category as a whole remaining relatively flat.
on client centricity.
We anticipate that the broad debt category, which has led asset raising
Against this backdrop, whilst there is no doubt that passively-managed so far this year, as a result of strong interest in the global bond and
equity funds have been a key component of 2017’s asset raising emerging market debt sectors, will continue to attract assets. Within
dynamics, allocations to actively-managed products continue to defy this, we see a trend towards specialist strategies that offer global,
the low expectations set by many commentators, a trend we expect to unconstrained, higher-yielding returns as investors seek income and
continue in 2018 as active managers respond to the aforementioned portfolios that provide some downside protection.
regulatory change with innovative product and pricing. Emerging markets
equity has been a key driver of the active equity allocation trend in 2017, In the year ahead, investors will benefit from
and the emerging markets factor has been important in supporting the allocating to managers who can source interesting
strong interest in actively-managed global equity strategies. investment opportunities and deliver dynamic
allocation strategies.
We have also seen investors increasingly assign value to ESG
considerations, seeking sustainable and responsible investment ‘baked Claire Aley
in’ to strategies as well as standalone thematic and impactful offerings, Head of Product Strategy & Development
The views and opinions contained herein are those of the author and may not necessarily represent views expressed or reflected in other
Hermes communications, strategies or products.
For professional investors only www.hermes-investment.comHERMES INVESTMENT MANAGEMENT
We are an asset manager with a difference. We believe that, while our primary purpose is to help
savers and beneficiaries by providing world class active investment management and stewardship
services, our role goes further. We believe we have a duty to deliver holistic returns – outcomes for
our clients that go far beyond the financial – and consider the impact our decisions have on society,
the environment and the wider world.
Our goal is to help people invest better, retire better and create a better society for all.
Our investment solutions include:
Private markets
Infrastructure, private debt, private equity, commercial and
residential real estate
High active share equities
Asia, global emerging markets, Europe, US, global, and small
and mid cap
Credit
Absolute return, global high yield, multi strategy,
global investment grade, real estate debt and direct lending
Multi asset
Multi asset inflation
Stewardship
Active engagement, advocacy, intelligent voting and
sustainable development
Offices
London | New York | Singapore
For more information, visit www.hermes-investment.com or connect with us on social media:
Disclaimer
This document is for Professional Investors only. The views and opinions contained herein are those of the authors, and may not necessarily represent views expressed or reflected
in other Hermes communications, strategies or products. The information herein is believed to be reliable but Hermes does not warrant its completeness or accuracy. No responsibility
can be accepted for errors of fact or opinion. This material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations.
This document has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. This document is published solely for informational
purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Figures, unless otherwise indicated, are sourced from Hermes.
The distribution of the information contained in this document in certain jurisdictions may be restricted and, accordingly, persons into whose possession this document comes are required
to make themselves aware of and to observe such restrictions.
Issued and approved by Hermes Investment Management Limited (“HIML”) which is authorised and regulated by the Financial Conduct Authority. Registered address: Lloyds Chambers,
1 Portsoken Street, London E1 8HZ. HIML is a registered investment adviser with the United States Securities and Exchange Commission (“SEC”).
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