US Treasury Term Premium: Pricing for Disaster

Realm Investment House | Ken Liow, Head of Portfolio Risk Management
Realm Investment House

Apocalypse, War, Destruction, Damage, Fire, Smoke

The term premium is the difference between bond yields for a given maturity and the expected path of short term interest rates over the same period. By examining the term premium of the US treasury market, we find that this is now of a similar magnitude as for the OPEC oil shocks in the 1970s. The market appears to be fully pricing an event of similar magnitude to the combined effect of a US-China Trade War and a domestic demand shock in China. Investors relying on the term premium for portfolio protection may wish to consider the implied cost of doing so.

Bond yields can be divided in to two components: the expected cash rate over the term to maturity; and the term premium. The term premium can be considered as a price for bearing risk and variations in this figure provide an insight into the concerns which investors are pricing. When the term premium for bonds is negative, it implies that investors are essentially expecting to pay for protection against poor outcomes. They would rather hold a bond even if the expected yield to maturity of this bond is lower than the expected path of rates they would obtain over the same period. If economic outcomes deteriorate unexpectedly, this would provide a buffer.
The Federal Reserve of New York provides daily estimates of the term premium for US Treasuries1. The series is calculated from 1961. The term premia for the 1, 2 and 3 year maturities are shown in the following chart. The term premia have never been lower in the history of the series. The most recent plunge coincided with a deterioration in the outlook for trade negotiations:

Historical Comparison
Whilst the term premium is only one indicator of risk aversion, the only times we have observed figures in the vicinity of these outcomes were as follows:

For context, the economic impacts following the Oil Shocks and the GFC were very significant:

The ‘Kennedy Slide’ was a period during which the S&P 500 declined by over 20%. It followed an extended period of share market gains commencing from the Crash of 1929. The sharp movement in the term premium in this period was short-lived.
In relation to Brexit, the shock of the event could be readily seen in the expected inflation forecasts that accompanied the outcome. The FOMC’s preferred measure of the 5-year, 5-year forward inflation expectations at the time, of 1.4% per annum, have only been seen during events like the worst of the GFC and during the Asian Financial Crisis. At present, the expectation matches the Fed’s inflation target, implying high confidence in the Fed’s ability to successfully navigate economic circumstances.
In contrast, the US economy is currently growing ahead of trend, although inflationary outcomes have been below the mandate target of 2% per annum. Unemployment is exceptionally low. Whilst concerns have been raised about the weakening outlook for manufacturing, the uncertain outlook for trade negotiations and the persistent risk that the Chinese economy will stumble, the pricing infers that the market is fully discounting an exceptionally poor economic outcome.
It should be noted that the term premium is estimated using econometric methods and these are subject to a range of estimation and specification errors. However, cross-checking these with another principal term premium estimator utilised by the Fed2, albeit with publication history from 1990, also results in a similar conclusion. For this cross-check, the term premium is still lower than for Brexit. It was similar to the period where the Euro bond markets were fragmenting in 2012, leading Draghi to make his “whatever it takes” statement to address the deterioration in the transmission of monetary stimulus which threatened the longevity of the Euro.

Fully Pricing a Trade War, China Demand Shock…and then some
The market price for insurance, as estimated from the term premium, is fully pricing a scenario similar to the combined effect of a full scale US-China trade war and a significant deterioration (2%) in domestic demand within China. The OECD has recently3 estimated the cumulative impact on GDP from each of these events through to 2021-22. Whilst significant, the combined impact of these outcomes is unlikely to create a deep recession in the US. The US is a reasonably closed, services oriented, economy in that it is relatively resilient to international economic developments. This is one reason behind President Trump’s repeated utilisation of trade as a means of coercion in international negotiations. The following illustrates the OECD’s estimated impact for a deterioration in the trade conflict:

The OECD also estimated the impact of a significant 2% fall in domestic demand in China:

Over a two year period, a significant deterioration in the trade dispute would subtract approximately 0.9% to US growth. A significant disruption to demand in China, in isolation, would cumulatively subtract approximately 1.4% from US growth over a 2 year period. Note that the China demand slow-down scenario assumes that monetary policy is unable to act. The estimated economic impacts do not make allowance for any special fiscal support which might be forthcoming. For example, the US is supporting soy bean farmers for losses incurred as a result of the tariff dispute via subsidies. Hence, to the extent that the US would stimulate the economy fiscally during an adverse development, the scenarios would need to be even worse to justify the existing pricing. The US GDP baseline expectation is for growth in 2020-2021 to be 1.9%per annum. Even if the combined effect of a full US-China Trade War and demand shock in China were to take place, there is a significant buffer between this scenario and the outcomes which unfolded or, in the case of Brexit and the Kennedy Slide, were feared, during the only other times when the term premium was this low.

Distortions from international flows and Fed balance sheet activities
Non-conventional use of central bank balance sheets to manage the yield curve as part of stimulus efforts operate by influencing the term premium. Although the Fed has unwound some of its balance sheet, its remaining holdings would still be exerting downward pressure on the term premium, however this is most strongly influential on longer term maturities. The prospect of the ECB restarting bond purchases in the Eurozone may also be driving capital from European debt in to the US and contributing to the more recent compression in the term premium. More generally, significant monetary accommodation and associated asset inflation may have had the effect of compressing term premium since sentiment strongly deteriorated from late 2018. The above may go some way to understanding the lower premium observed following the introduction of large scale asset purchases. Nonetheless, the estimated impact of the Fed’s balance sheet activities4 would not be sufficient to negate the general observation that the term premium is pricing an extreme economic development. Even allowing for these effects, the market is acting materially more defensively than when the Euro faced an existential threat and the Brexit referendum was passed, both of which took place when the US economy was not as strong as it is presently.

There are many looming threats to the recent recovery in the US economy. The term premium for treasury bonds, which can provide an indication of the extent to which the market is concerned for downside risk, is at an extreme. Should the worst-case scenarios not develop, we may expect a significant steepening of the US yield curve. Investors relying on duration to provide a measure of protection to portfolios may wish to consider the implied price for this insurance.

Below are the Realm Investment Management fund figures as at the end of August.

Confidentiality Notice: This document is confidential and may also be legally privileged. If you are not the intended recipient you may not copy, forward, distribute, disclose or use any part of it. If you have received this document in error, please delete it and all copies from your system and notify the sender as soon as possible.
General Advice Warning: Realm Pty Ltd AFSL 421336 Please note that any advice given by Realm Pty Ltd and its authorised representatives is deemed to be GENERAL advice, as the information or advice given does not take into account your particular objectives, financial situation or needs. Therefore at all times you should consider the appropriateness of the advice before you act further. Further, our AFSL only authorises us to give general advice to WHOLESALE investors only.


2 Kim and Right (2005) Term Premium Estimate via FOMC

3 OECD Economic Outlook, Volume 2019, Issue 1

4 Bonis B, Ihrig J and Wei M; 2017; “The Effect of the Federal Reserve’s Securities Holdings on Longer-term Interest Rates”; FEDs Notes

Meet Tannille Miller

Each month we give our readers a little insight into a Powerwrap team member by asking them ten questions about their role, life and personality. This issue we speak to Tannille Miller from the Powerwrap Marketing team.

Name: Tannille Miller

Company role: Marketing Coordinator

What does your role at Powerwrap entail? I focus on increasing our brand awareness through platforms like our website, social media and digital advertising.

What nickname do you prefer to be called? Tannille is fine, no nicknames work for Tannille.

What you enjoy most about being Marketing Coordinator? I like the creativity involved with coming up with new ideas to appeal to our audience.

What do you like most about Powerwrap? The people are lovely, and it’s exciting to be part of such a unique company.

What were you like in high school? A good student, when I wasn’t getting distracted by my friends.

What’s your favorite 80-90s jam? Wannabe – Spice Girls

Which AFL team do you support? Richmond

Globalization: From Tail Wind to Head Wind

Air Bag, Wind Sock, Weather, Sky, Striped

Authors – Erik Weisman, Ph.D. Chief Economist Fixed Income Portfolio Manager | Robert M. Almeida Portfolio Manager and Global Investment Strategist |
MFS Investment Management

In brief

  • Globalization created a multi-decade tailwind for margins.
  • But there are growing signs that globalization has reached its limits.
  • As a result, margins may be at risk.
  • Changing business environments have a way of exposing corporate vulnerabilities, amplifying the importance of selectivity.

An accelerated brand of globalization, labeled by some as hyper-globalization, has been
underway for the better part of a generation. Spurred in part by NAFTA, the inception of the euro and China’s acceptance into the World Trade Organization, multinational companies have ridden the globalization wave along with its secular tailwind to margins. But with growing concern that globalization may have reached its limits, are margins at risk?

In the post–global financial crisis era, chief financial officers have become extremely adept at employing all manner of financial engineering in order to increase margins, earnings and stock prices. They’ve adopted capital-light strategies, increased leverage, engaged in debt financed mergers and acquisitions and bought back stock. Companies have also become proficient in driving down costs by managing global value chains, sourcing intermediate goods and services from around the world and assembling them in low-cost countries.

At the same time, they’ve engaged in international regulatory and tax arbitrage. But as we’ve globalized more and more, the marginal benefits of additional globalization have decreased. The value added resulting from NAFTA, the formation of the eurozone and offshoring appears to be at an end.

As good as it gets?

While globalization has ebbed and flowed for thousands of years, the post–Bretton Woods order that gave rise to today’s global value chain has been underpinned by the central role of the US dollar as the world’s reserve currency, institutions such as the World Trade Organization and the International Monetary Fund and the United States acting as the world’s enforcer.

Against that backdrop, the global value chain has been predicated on a relentless decline in tariffs. But there are growing signs that globalization may have reached it limits, with rising income inequality and a concurrent increase in populism among the symptoms.
The US–China trade war calls into question the viability of the global value chain in a world where tariff rates may be reversing their decades-long fall. If the US were to apply 25% tariffs on all imported goods from China, overall tariff levels would rise toward heights not seen since the 1960s.

However, global value chains weren’t designed for 1960s-style tariffs. At those heights,
value chains would likely fray. At the same time, non-tariff barriers are seemingly on the rise everywhere. The global value chain was built for a world of low tariffs in which free trade is seen as a public good. But recent events call that view into question, putting the multi–trillion dollar global value chain at risk.

No levers left to pull

In an environment where CFOs have already pulled all the available levers, is there any margin for error from an asset price perspective? We’d argue there isn’t much. If globalization is reversing and global value chains are undermined or forced to make expensive adjustments, gross margins are likely to be negatively impacted. Companies that generated above-average margins, profits and equity performance not because they produced superior products but because they effectively managed global supply chains may find themselves in unsustainable positions, no longer surrounded by an economic moat. And in an environment where management has few cards left to play and margins are at risk due to supply chain disruptions, companies with truly differentiated business models, unique intellectual property and strong brand equity are likely to be better positioned to deal with the shifting global conditions. Companies that are unable to quickly move production to avoid the impacts of tariffs and those without pricing power could be at risk.

This potential dislocation makes security selection increasingly important as market dispersion reasserts itself after a decade of monolithic index-driven price action. In essence, late in the business cycle investors have become much choosier, avoiding highly leveraged companies with falling gross margins as well as lower-quality cyclicals. As is often the case, changing business environments have a way of exposing corporate vulnerabilities, amplifying the importance of selectivity.

The views expressed are those of the author(s) and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice from the Advisor. Unless otherwise indicated, logos and product and service names are trademarks of MFS® and its affi liates and may be registered in certain countries. Distributed by: U.S. – MFS Investment Management; Latin America – MFS International Ltd.; Canada – MFS Investment Management Canada Limited. No securities commission or similar regulatory authority in Canada has reviewed this communication. Please note that in Europe and Asia Pacifi c, this document is intended for distribution to investment professionals and institutional clients only. U.K. – MFS International (U.K.) Limited (“MIL UK”), a private limited company registered in England and Wales with the company number 03062718, and authorized and regulated in the conduct of investment business by the U.K. Financial Conduct Authority. MIL UK, One Carter Lane, London, EC4V 5ER UK provides products and investment services to institutional investors. This material shall not be circulated or distributed to any person other than to professional investors (as permitted by local regulations) and should not be relied upon or distributed to persons where such reliance or distribution would be contrary to local regulation; Singapore – MFS International Singapore Pte. Ltd. (CRN 201228809M); Australia/New Zealand – MFS International Australia Pty Ltd (“ MFS Australia”) holds an Australian fi nancial services licence number 485343. MFS Australia is regulated by the Australian Securities and Investments Commission.; Hong Kong – MFS International (Hong Kong) Limited (“MIL HK”), a private limited company licensed and regulated by the Hong Kong Securities and Futures Commission (the “SFC”). MIL HK is approved to engage in dealing in securities and asset management regulated activities and may provide certain investment services to “professional investors” as defi ned in the Securities and Futures Ordinance (“SFO”). Japan – MFS Investment Management K.K., is registered as a Financial Instruments Business Operator, Kanto Local Finance Bureau (FIBO) No.312, a member of the Investment Trust Association, Japan and the Japan Investment Advisers Association. As fees to be borne by investors vary depending upon circumstances such as products, services, investment period and market conditions, the total amount nor the calculation methods cannot be disclosed in advance. All investments involve risks, including market fl uctuation and investors may lose the principal amount invested. Investors should obtain and read the prospectus and/or document set forth in Article 37-3 of Financial Instruments and Exchange Act carefully before making the investments.

Newmark Hardware Trust now available on Powerwrap

George Deligiannis | Head of Distribution at Newmark Capital

We are delighted to announce Newmark Hardware Trust has been added to the platform to form part of our direct property income producing investment options.

The Hardware Trust offers investors the opportunity to invest in four A-grade, high-profile properties. Well located in strong fast-growing local economies with access to excellent transport options. The buildings are well leased to national blue-chip businesses including Bunnings, Officeworks, JB Hi Fi underpinning the stable and secure rental income returns.

Introducing the Newmark Hardware Trust

  • Open-ended unlisted property trust investing in real property
  • Established track record delivering 15% total return per annum since trust inception to February 20192
  • Over 85% of the Trust’s income is underpinned by Bunnings
  • Fixed annual rent reviews of 3.00 – 4.00%
  • Geographically diversified multi asset trust
  • Delivering strong, consistent long-term income distributions
  • Daily applications
  • Tax advantaged income component
  • No entry and exit fees
  • Capital growth potential
  • Disciplined defensive investment strategy designed to reduce both market and specific risk
  • The Product Disclosure Statement dated 12 February 2019 describes the fees, costs and risks.
  • Lonsec Research 

This Trust is suited to

  • Investors seeking consistent income
  • Investors seeking tax effective income
  • SMSFs – Ideal for investors managing their own retirement
  • Investors wanting access to a diversified portfolio of unlisted Australian property

Newmark has a 5 year track record of successfully managing the portfolio

  • Strong history of tenant retention
  • 15.0% per annum total return since inception2
  • Ongoing asset management activity to ensure future competitiveness

1. Warragul is under development with an indicative value of $50.9M on completion mid 2020.

 2. Performance is based on original fully paid Units at $1.00. Past performance is not indicative of  future performance. Fund inception 2014.

About Newmark Capital

Newmark Capital Limited is an experienced property funds management business that manages approximately $975 million of real estate assets under management on behalf of wholesale and retail investors. Newmark Capital is an active property investment manager with a concentrated focus on income and has been investing on behalf of its clients in commercial real estate since 2011.

For further information call George Deligiannis, Head of Distribution at Newmark Capital on 03 9820 3344.


Newmark Capital Limited ACN 126 529 690 AFSL No. 319372 (“Newmark Capital”) is the responsible entity of the Newmark Hardware Trust ARSN 161 274 111 (“Trust”) Newmark Capital has not considered the investment objectives, financial circumstances or particular needs of any particular recipient. You should consider your own financial situation, objectives and needs and obtain professional advice. Past performance is not indicative of future performance. You should read the Product Disclosure Statement dated 15 February 2019 (as updated or replaced) before making an investment decision relating to the Trust. Forward-looking statements involve risks, uncertainties and assumptions which are beyond the control of Newmark Capital and are not guarantees of future performance.

Using equities to generate reliable yield in a low return world

Wave, Water, Spray, Sea, Splash, Liquid, Nature, Wind

Michael Price is Portfolio Manager of the Ausbil Active Dividend Fund at Ausbil Investment Management.

Regular equity income can help beat longevity risk and inflation, but finding quality income in equities is not as simple as it seems. Ausbil’s Michael Price talks us through successful active dividend investing.

Investors in the later stages of their accumulation phase, approaching retirement, and in retirement can benefit from the use of equities as part of their overall income plan. With a rolling 10 year dividend yield of 4.18%[1], equities can provide a vastly more attractive income than alternatives. Investors face two major risks that impact how much they have to fund retirement, and how long this will last: longevity risk, and the risk of inflation/rising costs over time. In simple terms, longevity risk is the risk of outliving your money. Inflation risk is the risk that rising costs (such as healthcare) reduces the purchasing power of your money each year. An equities approach to income can help outpace those rising costs, and provide long-term capital appreciation to help replenish funds.

Why does active dividend income investing work?

An active dividend investment approach can add value to a portfolio, and generate outperformance, through focusing on quality companies with strong dividends and dividend growth, companies with sustainable earnings growth, maximising the benefits available through the tax and imputation system, and tactical allocation to capture a greater share of dividend income.

Markets are efficient, but not perfect. The first and most fundamental reason that an active approach to income investing works is the fact that the market is relatively inefficient, particularly in the short term. However, some inefficiencies can be traps.

The risk of chasing yield for yield’s sake

The assumption that many income investors make regarding dividend yields is that the relationship of current dividend yield to future earnings growth is linear, that is, the higher the dividend yield, the higher the future earnings growth from which dividends are paid. This assumption does not actually hold in the market.

Figure 1: The highest dividend yields do not equate with earnings growth the year ahead
Source: Ausbil. Macquarie Equities

On average, the top dividend yield companies actually see low, or even negative, earnings growth going forward compared to companies in the 4th to 7th decile of companies, as illustrated in Figure 1. This has been true for the last 20 years. An active approach does more than simply chase the highest yield, as would a passive approach to yield. An active dividend income strategy can increase income from companies whose dividends are healthy, but maybe not the highest, because they are also investing earnings into a growing business, hence into better earnings growth in the year ahead. Another quirk of dividend investing is that the highest yielding stocks are more volatile, as illustrated in Figure 2.

Figure 2: the highest dividend payers are also the most volatile
Source: Ausbil. Macquarie Equities

Top decile dividend yielding companies tend to show higher volatility in returns, on average. An active approach to dividend income investing can seek to reduce portfolio return volatility by not chasing yield for yield’s sake, but investing judiciously on the fundamental value of future sustainable earnings growth. Finally, top dividend paying securities may not be good value-for-risk, as illustrated in Figure 3.

Figure 3: Top dividend paying securities may not be good value-for-risk
Source: Ausbil. Macquarie Equities

Chasing the highest dividend yield companies can provide poor value for risk taken when compared to the market. Lower decile stocks by dividend yield demonstrate a better performance for risk than for the top decile of dividend yield companies. High dividend payout ratios may also be indicative of a lack of equity reinvestment opportunities for a company, back into growing their own business. A company with a sustainable dividend profile usually seeks to reinvest some earnings into their business, into positive return projects that can generate earnings growth in the future. A classic example of a high dividend paying company compared to a company which has reinvested some earnings into productive opportunities for reinvestment is the difference between Telstra and CSL.

Figure 4: The dividend journeys of two very different companies
Source: Ausbil

Purely to illustrate two different journeys, take a look at the following example. Telstra was long considered a key dividend paying stock, but the burden of being the largest telco, legacy systems and infrastructure cost, rapid change and limits to growth have seen Telstra lose its status as a key dividend stock. By contrast, CSL has steadily transformed itself from also being government owned, as the Commonwealth Serum Laboratories, into a global leader in biotechnology, largely by balancing the payment of dividends with significant reinvestment into areas that can generate future growth in earnings, as illustrated in figure 4. Of course, these relationships may change over time, but it can take a long time for a company to change its course.

Astute active dividend income approaches can seek dividend yield while avoiding companies with no opportunity to reinvest to improve earnings and returns. With active dividend income approaches, investors like SMSFs, retirees, and investors approaching retirement can diversify away from traditional sources of income, like fixed income and term deposits, for a longer-term approach, diversified across high-quality Australian companies. They can do this in equities without sacrificing the potential for long-term growth.

[1] Source: S&P Dow Jones, S&P ASX 200 rolling 10-year dividend yield

About Ausbil Investment Management Ausbil is a leading Australian based investment   manager.   Established    in April 1997, Ausbil’s core business is the management of Australian equities for major superannuation funds, institutional investors, master trust and retail clients. Ausbil is owned by its employees and New York Life Investment Management a wholly-owned subsidiary of New York Life Insurance Company. As at 31 July 2019, Ausbil manage over $12.2 billion in funds under management.


Unless otherwise specified, any information contained in this publication is current as at the date of this report and is prepared by Ausbil Investment Management Limited (ABN 26 076 316 473 AFSL 229722) (Ausbil). Ausbil is the issuer of the Ausbil Active Dividend Income Fund (ARSN 621 670 120) (Fund). This report contains general information only and the information provided is factual only and does not constitute financial product advice. It does not take account of your individual objectives, financial situation or needs. Before acting on it, you should seek independent financial and tax advice about its appropriateness to your objectives, financial situation and needs. Securities and sectors mentioned in this monthly report are presented to illustrate companies and sectors in which the Fund has invested and should not be considered a recommendation to purchase, sell or hold any particular security. Holdings are subject to change daily. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Past performance is not a reliable indicator of future performance. Unless otherwise stated, performance figures are calculated net of fees and assume distributions are reinvested. Due to rounding the figures in the holdings, breakdowns may not add up to 100%. No guarantee or warranty is made as to the accuracy, adequacy or reliability of any statements, estimates, opinions or other information contained herein (any of which may change without notice) and should not be relied upon as a representation express or implied as to any future or current matter. You should consider the Product Disclosure Statement which is available at before acquiring or investing in the fund.

Searching for Diversification

Simon Wilson | PE Global FX Alpha Fund

We are currently experiencing an extended equity market cycle. While there has been much debate as to when the upward trend of equities will end, this is something that is difficult to forecast. Instead of trying to forecast something that is beyond our control, we can alternatively focus on building robust portfolios that have the greatest probability of achieving client’s longer-term objectives. Diversification within an investment portfolio can help achieve a more consistent long-term absolute return profile with lower drawdowns than equity indices. Allocating to investments uncorrelated to equity markets, meaning investments that have the ability to deliver returns irrespective of equity market direction, is one of the best ways to achieve diversification.

Alternative investments are a diverse and evolving universe of strategies that do not share the same risk and return characteristics as traditional bond and equity investments, making them ideal candidates for diversification. There is a large number of potential investments, each differing significantly in terms of market maturity, liquidity, exposure to equity market risk, as well as many other factors. There is a world of opportunities, but each potential alternative investment requires individual assessment to ensure it meets broader portfolio objectives. How do we get started? A clear criteria by which to evaluate your investments is a good place to start.

Key criteria to consider when selecting alternative investments as part of a diversified portfolio

  1. It has a low correlation to traditional asset classes, such as equities and bonds, due to the underlying drivers of return being unique and independently sourced
  2. The liquidity profile of the investment matches the client’s liability needs
  3. The investment improves the overall risk/return profile of the portfolio

A number of different strategies can be employed in order to achieve the above criteria, a common one being investing in different markets such as currency markets. Currency markets can move independently of equity and bond markets because they are often driven by different factors. Currencies can be influenced by different monetary or fiscal policies in different countries, the shape of relative yield curves and the dependence of certain currencies upon the price of commodities and economic momentum.

Investing in currency markets can bring a new source of uncorrelated risk and return to investors’ portfolios, however it is important to look for an investment manager with extensive experience navigating these markets. One that has a clear and disciplined investment rationale, a proven ability to generate alpha over the long term while effectively managing the additional associated risks of investing in these markets.

Macquarie Professional Series brings the P/E Global FX Alpha Fund to Australian Investors

In 2017 Macquarie Professional Series (MPS) launched the P/E Global FX Alpha Fund, which accesses the investment capabilities of P/E Global LLC based in Boston. MPS started in 2004 with the aim of providing Australian investors access to differentiated investment solutions that can make a real difference to their portfolios.

P/E Global LLC (P/E) is a specialist currency manager that aims to provide investors with uncorrelated, absolute returns to traditional asset classes via a disciplined and dynamic quantitative model. It was founded in 1995 with the underlying investment philosophy that ‘Factors drive currency markets and that the importance of these factors can be identified using a systematic statistical process’. Underlying this is a belief that the relative influence of factors changes over time, and this influence can be identified and exploited to generate returns.

Strong Long Term Performance

Since 2003, P/E has achieved a return of 10.4% per annum in AUD (after all fees), outperforming the Australian equity market by 0.9% per annum over the same period. The chart shows the cumulative performance of P/E against that of the ASX300. The light blue shaded areas highlight the significant drawdowns of the ASX 300. In each case P/E generated strong positive returns.

As a measure of its power to diversify traditional portfolios, P/E has achieved, a correlation to equity and fixed income markets, of close to zero since 2003. Importantly P/E has a correlation of -0.3 in down equity markets; demonstrating its potential to protect investors’ capital when they need it the most. The P/E Global FX Alpha Fund offers daily liquidity and is available on the PowerWrap platform. It sources its alpha from the movements of fifteen currency markets based on seven underlying factor drivers.  

This is general information only and does not take account of investment objectives, financial situation or needs of any person. It should not be relied upon in determining whether to invest in the Funds. In deciding whether to acquire or continue to hold an investment in a Fund, you should consider the Fund’s product disclosure statement, available at the links above or by contacting us on 1800 814 523. Past performance information is not a reliable indicator of future performance.

Other than Macquarie Bank Limited (MBL), none of the entities noted are authorised deposit-taking institutions for the purposes of the Banking Act 1959 (Commonwealth of Australia). The obligations of these entities do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of these entities, unless noted otherwise.

Why now is the right time for value

Reece Birtles | Chief Investment Officer, Martin Currie Australia

Man Wearing Black and White Stripe Shirt Looking at White Printer Papers on the Wall

“ Asset allocators need to be positioned in Value stocks ahead of the inflection point to capitalise on future narrowing spreads”

The past two years has seen poor performance for value style indices and typical value managers globally, and stronger performance for Momentum, Growth and Quality factors. There have been recent comments in the market that Value is broken or that this could be the death of Value. Or, given how expensive the market has become, is now actually the time to overweight the style? Below I discuss what value spreads really tell us about what lies ahead for the Value style, and value managers like Martin Currie Australia.

Globally, the value style (based on the MSCI World Value Index) has underperformed the broader market (MSCI World Index) in the last few years. But on a rolling 10-year basis, the level and persistence of this underperformance looks quite extraordinary in contrast to the long-term. Similarly, if you think about this in the inverse, the persistent outperformance of the Growth style (based on MSCI World Growth Index) is also peculiar, as it is historically known to underperform Value over the long-term. This is backed up by research studies by Fama and French, Kahneman and Tversky.

A key reason why Value typically outperforms Growth in the long run is Value’s superior EPS growth relative to Growth stocks. Investors have a bias towards trend extrapolation and over optimism of future EPS, but the reality is that paying more for
an unmet expectation doesn’t add value, and Value’s fundamentals prevail in the end. The continued trend of superior EPS, despite poor value style performance in the last few years, gives us confidence that the value style works when the market focusses on underlying fundamentals.

The relative valuation of the style indices, i.e. a value spread, can give us another way to look at the behaviour of Value and Growth stocks over time and how recent behaviour is out of kilter. I’ve measured a value spread for the MSCI World using a naive average of the log of the spread between the two indices, for P/E, P/E NTM, dividend yield and P/B valuation measures.

Historically, data suggests that widening value spreads usually go hand in hand with poor Value style performance. Wide value spreads have then historically preceded strong future alpha for Value-biased managers.

Unusually, despite Value underperforming Growth throughout 2013-2017, the value spreads did not immediately widen due to falling relative EPS growth for Value, making the Value superiority appear to be “broken”. The persistently narrow spread situation through to 2017 made it hard to “pound the table” for asset allocators to be overweight Value and be ready for the rebound that should occur when spreads begin to narrow again. The situation dramatically changed in 2018, with spreads exploding out to greater than GFC and Tech bubble levels across all metrics. The relative EPS issue to Growth is now no longer an issue, so we do not believe it is justified to call the death of Value.

Our 20+ years of in-house discounted cashflow valuations of Australian companies provides us with great insight in understanding the Australian market. Therefore, for analysing the Australian market, we have used Martin Currie valuations data instead of MSCI index data. We use our proprietary valuation of the 80th percentile stock (representing cheap stocks) versus the 20th percentile (representing expensive stocks).
Consistent with my long-held thesis that factor performance of the Australian market is strongly dominated by global macro and factor performance, I have found that the Australia value spread is also highly correlated with the World value spread, with notable and understandable exceptions around the Asian crisis, Tech bubble and naughties China boom. This relationship between MSCI World value spread and that for Australia has only strengthened over time, especially since the GFC. This is explainable by the low growth/Quantitative Easing world, and financial market weaponisation (or development) of, for example, commodity futures trading (CTAs) that allows trading of common factors on a global basis.

I have looked at what has been really driving changes in value spreads, and my analysis shows that the level and change in economic growth (e.g. based on our in-house business cycle indicator or PMI), bond yields (e.g. the US 10yr) and the yield curve, have all generally moved in concert with value spreads. This tells us that value style performance should turn around when economic growth stabilises, bond yields are no longer falling, and central banks cut rates to stimulate the economy. In other words, when the world doesn’t remain in a constant state of deterioration.

Based on the historical relationship between value spreads and macro data, current value spreads imply that there are no further Fed rate cuts, PMI is set to trend below 50, and further falls in bond yields are on the way. But the world doesn’t retain a state of panic/euphoria for an extended period. The bottom of a cycle is notoriously hard to time. The value spread based on the holdings in our Legg Mason Martin Currie Select Opportunities Fund1 versus the S&P/ASX 200 Index, appears to already be pricing recessionary outcomes and no response by policy makers. As such asset allocators need to be positioned in value stocks ahead of the inflection point to capitalise on future narrowing spreads.

Wide value spreads in the Tech bubble were associated with an expensive market, whereas in the GFC, wide spreads were associated with a cheap market. Post the Tech bust, when spreads again started to narrow, value stocks were attractive as they were considered defensive/low beta and provided strong alpha, but post GFC, value stocks became less attractive as their correlation to beta rose. Today’s situation of high value spreads and an expensive market looks more like the Tech bubble than the GFC. Therefore, in the coming cycle, it is more likely today’s cheap stocks prove more defensive than expensive Growth stocks which have been low beta in recent years. The Legg Mason Martin Currie Select Opportunities Fund is positioned away from the overvalued ‘High Growth/High PE/ High Momentum’ part of the market to maximise long-term income and returns.

Now is the time to position for Value, not to chase expensive stocks. We believe that our Legg Mason Martin Currie Select Opportunities Fund is able to capture alpha for clients based on three sources:

  • The long-term Value premium available because of the market’s behavioural bias towards over optimism;
  • Our tactical allocation approach to style and risk based on our deep understanding of value spreads and the Value
  • Superior stock selection over time from our experienced research team’s fundamental and quantitative insights into company Valuation, Quality and Direction.


Past performance is not a guide to future returns. Source: Martin Currie Australia, FactSet, as at 30 June 2019. Legg Mason Asset Management Australia Ltd (ABN 76 004 835 849 AFSL 240827) is part of the Global Legg Mason Inc. group. Any reference to ‘Legg Mason Australia’ or ‘Martin Currie Australia’ is a reference to Legg Mason Asset Management Australia Limited. ‘Martin Currie Australia’ is a division within Legg Mason Asset Management Australia Limited. Legg Mason Australia is the responsible entity of the Legg Mason Martin Currie Select Opportunities Fund (ARSN 122 100 207)(Fund). Martin Currie Australia is the fund manager of the Fund. Before making an investment decision you should read the Product Disclosure Statement (PDS) for the Fund carefully and you need to consider, with or without the assistance of a financial advisor, whether such an investment is appropriate in light of your particular investment needs, objectives and financial circumstances. The PDS is available and can be obtained by contacting Legg Mason Australia on 1800 679 541 or at This product has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person. Neither Legg Mason Australia, nor any of its related parties guarantees any performance or the return of capital invested. Past performance is not necessarily indicative of future performance. Investments are subject to risks, including, but not limited to, possible delays in payments and loss of income or capital invested. These opinions are subject to change without notice and do not constitute investment advice or recommendation. The information contained in this paper has been compiled with considerable care to ensure its accuracy. But no representation or warranty, express or implied, is made to its accuracy or completeness. Market and currency movements may cause the capital value of shares, and the income from them, to fall as well as rise and you may get back less than you invested. Martin Currie has procured any research or analysis contained in this presentation for its own use. It is provided to you only incidentally, and any opinions expressed are subject to change without notice. The opinions contained in this document are those of the named manager(s). They may not necessarily represent the views of other Martin Currie managers, strategies or funds. Please note the information within this report has been produced internally using unaudited data and has not been independently verified. Whilst every effort has been made to ensure its accuracy, no guarantee can be given. Some of the information provided in this document has been compiled using data from a representative account. This account has been chosen on the basis it is an existing account managed by Martin Currie, within the strategy referred to in this document. Representative accounts for each strategy have been chosen on the basis that they are the longest running account for the strategy. This data has been provided as an illustration only, the figures should not be relied upon as an indication of future performance. The data provided for this account may be different to other accounts following the same strategy. The information should not be considered as comprehensive and additional information and disclosure should be sought ahead of any planned investment. The distribution of specific products is restricted in certain jurisdictions, investors should be aware of these restrictions before requesting further specific information.