GAM’s investment experts highlight what they believe will be the key events to look out for over the course of 2018 in their specialist fields.
Larry Hatheway, group head of investment solutions and chief economist
A key development to watch out for in 2018 is the potential advent of accelerating inflation. It matters most because it is almost entirely unanticipated by markets, yet seems likely from the perspective of macroeconomic conditions. But it is also of great significance because unanticipated inflation will lead to major setbacks in both bond and stock markets, with significant aftershocks in almost all asset classes. It would undermine the efficacy of conventional ‘balanced’ multi-asset portfolios, but potentially serve well multi-asset, multi-strategy portfolios that can go short (eg target return).
Central bank policy changes
Tim Haywood, investment director for absolute return fixed income strategies
The positive news is that divergent economic growth stories and central bank policies are likely to create opportunities across global fixed income markets this year. In an environment of rising interest rates and government bond yields, that is also characterised by tight spreads, we believe investors are likely to be more cautious in the type of credit risks they take and spend more time focusing on company-specific fundamentals than they have or have needed to since the era of ultra-low interest rates began. As a rising tide lifts all boats, strong demand for corporate credit has led to the strong performance and tightening of spreads among both good and lower quality issuers. We feel this will change going forward and, while we believe value can still be extracted from this segment of the bond market, the key will be to marry old-school / accounting-based research with more modern investment techniques such as long / short and relative value trades.
A return to ‘normal’ volatility
Niall Gallagher, portfolio manager for European equities
We have witnessed very low levels of overall equity market volatility during the last 12 months, with investors seemingly unfazed by global events that would have previously caused short-term volatility or rotation within equity markets. The continued expansion of the ECB’s balance sheet has undoubtedly had a smoothing effect, but also caused extended valuations in certain ‘safe haven’ areas of the market. Fund investors have also followed this trend, witnessed by the positive net inflows into ‘low-vol’ or ‘short-vol’ packaged products. What will trigger a return to more normalised levels of volatility? We cannot know for certain, but the impending unwinding of the US Federal Reserve’s balance sheet would seem to offer a real test, particularly to the ‘bond proxy’ equities.
US tax reform
Roberto Bottoli, portfolio manager for merger arbitrage strategy
The US tax reform could be a key event to watch out for in 2018 for the mergers and acquisitions (M&A) market and for the stock market in general. If the reform kicks in, one may expect increased M&A activity, which could be bolstered by additional resources made available by tax savings and possibly cash repatriation measures. On the other hand, a limit on the deductibility of interest expenses is proposed in the same reform, which would limit the use of debt and make certain leveraged buyouts, typical of private equity companies, uneconomic, thus limiting this type of transaction.
Paul McNamara, investment director for emerging markets fixed income
In early 2018, we are likely to get more information on progress in the NAFTA negotiations, and arguably a better sense of the US’s policy direction towards global trade. The outcome of these negotiations could have profound implications for emerging markets (EM) in general and Mexico in particular. President Trump’s protectionist attitude remains a major risk for EM growth and any shift towards higher tariffs would have a material impact on all EM currencies. At the same time, elections in Mexico, the reform process and elections in Brazil, internal party politics in South Africa and developments in Turkey could all increase the volatility of EM returns as well.
After the hurricane is before the hurricane
John Seo, investment director for insurance-linked securities and managing principal at Fermat Capital Management
In 2018, we expect a 10% increase in risk-adjusted yields in catastrophe bonds and adjacent areas of the insurance-linked securities (ILS) sector. In the year just ending, active returns helped offset losses to deliver a net positive return, despite a string of loss events led by hurricanes Harvey, Irma and Maria (HIM). The ILS market has not fully come to grips with some fundamental realities, which emanate from the fact that HIM insured losses, though still substantial, will be approximately USD 60 billion, not the USD 100 billion widely assumed. In 2018, we expect to adopt a moderately offensive stance in our portfolios by selectively investing in higher yield positions. We also expect 2018 catastrophe bond issuance to break all previous records with USD 12 billion in bonds coming to market.