Month: August 2016

August 19 – August 25, 2016

It’s getting hot out there. When picking your emerging market investments, be mindful of its exposure.

Headlines

Briefs

    • The nontraded REIT industry is having a hard look at itself.  Inland is eliminating its transaction fees and new entrant to the sector – but definitely not to institutional real estate investment – Blackstone Group has not committed to a specific yield – the primary attribute for selling these investments.
    • The thing is “Cap rates, a key valuation measure for real estate, have decreased dramatically since the credit crisis, while valuations of quality properties have increased. That means commercial real estate is simply too pricey to generate the promised returns (generally 6-7%) brokers need to pitch nontraded REITs to clients.”
    • “The math of these programs is much more challenging today. Cap rates are lower and I think the dividend yields have to come down. The publicly traded REIT market is paying a 3.5% dividend yield, on average.” – Allan Swaringen, president and CEO of JLL Income Property Trust
    • And with a lower fee structure I might add…
    • One thing to be mindful of in investing in nontraded REITs are their dividend coverage ratios.  “That ratio, a REIT’s cash flow versus its dividend, or distribution, is one of the most important metrics for investing in nontraded REITs, which often resort to returning investor cash to pay for or cover the 6% or 7% dividend. Any return of investor money diminishes the REIT’s ability to perform in the long term.”
    • Bottom line, “nontraded REIT sponsors and advisers who sell them can say au revoir to the product’s most important marketing component: the promise of generating annual returns of 6% or 7% to yield-starved investors.”
    • “Trends that slammed profit in the first quarter – a stronger yen, negative interest rates and slumping China growth – haven’t reversed. At stake is a second straight year of earnings decline that could buy Prime Minister Shinzo Abe’s push for companies to boost capital spending and raise wages to spur economic growth.”
    • “With negative interest rates grinding away bank profits and a stronger yen bearing down on carmakers, aggregate operating income plummeted 17% in the June quarter, the biggest quarterly decline since 2011. That’s the year an earthquake in Fukushima and subsequent tsunami caused the yen to gain and stocks to drop.”
    • Bloomberg_Japan Inc profit slump_8-21-16
    • Airbnb has changed the short-term rental business in a big way. The company “now operates in 34,000 cities around the world and was recently valued by investors at $25.5 billion.”
    • On top of that, Airbnb has created an ecosystem of other companies that help landlords rent, maintain, and operate their units…
    • Well one of the recent companies created, Host Compliance, is the ‘tit for tat.’  Rather than assist people to attain the most out of their Airbnb listings, the company actually is set up to help cities and municipalities in the policing of their short-term rental regulations by sifting through the vast amount of listings data and providing reports on violations.
    • No surprise, most governments are overwhelmed and not truly set up to properly track abuses to their rules, hence they’re always playing catch up to tech innovators.  I suppose it won’t be long that other tech innovators will pop up to “check-in” on other tech disrupters…
  • Eliot Brown of the Wall Street Journal focused his spot light on the real estate market of San Francisco and the effects of the surging tech market.
    • As the tech industry continues to boom, its companies continue to crowd out other businesses from San Francisco’s office market, ultimately reducing the city’s “economic diversity, giving it an enormous concentration in an industry that is particularly prone to economic swings.”
    • “Tech companies now occupy more than 29% of the city’s occupied office space, according to real-estate-services firm CBRE Group Inc. That is roughly double what the industry occupied in 2010 as well as the height of the dot-com bubble in 2001, CBRE said.”
    • “What’s more, the bulk of those occupying that office space are startups or those that recently went public, typically unprofitable companies that are considered some of the most volatile.”
    • “Looming in the minds of many in San Francisco is the city’s experience after the dot-com bust of 2001. Even though the tech sector was centered more in Silicon Valley to the south, the local economy was pummeled. Office vacancies soared above 20% from less than 4%, according to Cushman & Wakefield.”
  • Gabriel Wildau of the Financial Times reports that it was only a matter of time that Chinese regulators would tighten the noose on the P2P market.
    • China has just formalized new regulations for the Peer-to-Peer (P2P) market in the country. “Regulators and courts have previously issued many of the prohibitions contained in the latest rules in different forms, but the latest regulations mark the first comprehensive framework for regulating P2P lenders in China.”
    • “The rules, issued on Wednesday, forbid online lenders from accepting deposits or guaranteeing principal or interest on loans they facilitate. They ban P2P platforms from securitizing assets or offering debt transfer mechanisms that mimic securitization. Companies are prohibited from using P2P platforms to finance their own projects.”
    • “Their fundamental nature is information intermediation, not credit intermediation.” – banking regulator
    • “Outstanding loans from 2,349 P2P platforms totaled Rmb621bn by the end of June, the banking regulator said in a statement on Wednesday. But an additional 1,778 ‘problem platforms’ have also been established, equal to 43% of all platforms.”
    • “The latest rules also prohibit P2P groups from operating ‘fund pools’ in which investor funds are not matched with specific loan assets. The banking regulator noted that ‘Ponzi schemes’ – in which inflows from new investors are used to finance payouts on maturing obligations – have been a problem for the industry.”

Special Reports

Graphics

CBO – Trends in Family Wealth, 1989 to 2013 8/18

CBO_Trends in Family Wealth_8-18-16

FT – Pensions: Low yields, high stress – John Authers and Robin Wigglesworth 8/22

FT_Pension liabilities growing faster than assets_8-22-16

FT – US charitable foundations hit by plunging returns 8/23

FT_US charitable foundations investment returns struggle_8-23-16

Featured

*Note: bold emphasis is mine, italic sections are from the articles.

Think It’s Hot Now? Just Wait. Heidi Cullen. New York Times. 20 Aug. 2016.

“July wasn’t just hot – it was the hottest month ever recorded, according to NASA. And this year is likely to be the hottest year on record.”

“Fourteen of the 15 hottest years have occurred since 2000…”

NYT_Heat Map of US - 1991-2010_8-20-16

NYT_Heat Map of US - 2060_8-20-16

NYT_Heat Map of US - 2100_8-20-16

NYT_Number of Days over 95 degrees_8-20-16

Silver lining…good for solar.

As China nears exhaustion investors must look elsewhere. James Kynge. Financial Times. 24 Aug. 2016.

As yield is vanishing from developed world economies – there is $13tn in negative-yielding debt outstanding at the moment – emerging market economies have seen a lot of interest of late… however, try to see it in context.

“The drive behind this intense demand for EM has nothing to do with EM. The one thing that emerging markets have that everyone wants right now is not raw materials or cheap labor, it’s yield. When you have negative interest rates in Europe and Japan, and zero rates everywhere else, the politics and economics of these countries becomes irrelevant.” – Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch

“Thus, emerging markets are flattered by a perception they are the least bad option for investors.”

However, investors need to be wary of the exposure that many EMs have to China.

China is having ever greater difficulty in producing economic growth – at least of the levels of the past few decades (which is to be expected).  “Before the global financial crisis in 2008, China needed just over one dollar of credit to deliver one dollar of gross domestic product growth, the ratio is now six to one, according to Morgan Stanley.”

“Although the economy is said to be growing at 6.7%, investment growth by private companies slowed to 2% in July, demonstrating that the most potent force in the Chinese economy sees scant hope of a return.”

“Scarcity of opportunity amid an abundance of growth defines China’s enervated state. So generous have banks, capital markets and shadow financial institutions been to virtually anyone who wishes to borrow that almost every industry is in a state of oversupply, slashing profits.”

“Standard & Poor’s, the credit rating agency, is the latest to raise the alarm. The anemic profits of Chinese companies is likely to intensify their need to borrow more merely to repay maturing debts, helping to drive global corporate debt levels to worrying levels by 2020.”

“Corporate debt is set to expand by half to $75tn over the next five years, according to S&P. China’s share of this debt is likely to rise to 43% in 2020 from 35% in 2015, the rating agency said, largely through companies borrowing to repay debts that are coming due.”

Bottom line, don’t throw out your fundamental analysis models just yet…

Other Interesting Articles

The Economist

Bloomberg – Why It’s So Hard to Build Affordable Housing: It’s Not Affordable 7/26

FT – We must protect shareholders from executive wrongdoing 8/18

FT – Retailers reveal why US earnings season was fundamentally weak 8/18

FT – Paul Singer says bond market is ‘broken’ 8/18

FT – Venezuela’s problems can no longer be ignored 8/18

FT – Is greed good? No, it’s seriously bad for your wealth 8/19

FT – Hackers expose holes in road for smarter cars 8/19

FT – Oil company dividends: flare-up ahead 8/21

FT – #fintech Sidelining the mobsters in China 8/22

FT – Forget Fed rate calls – be ready for the return of inflation 8/22

FT – China close to launching credit default swap market 8/22

FT – Mongolia tightens belt as debt payments loom 8/24

FT – The canary in the coal mine for China’s currency 8/24

IPE – Redemption requests begin to build among core US property funds 8/24

National Real Estate Investor – Drop in 10-year Treasury Gives Real Estate Pricing a Lift 8/24

NYT – Chilling Tale in Duterte’s Drug War: Father and Son Killed in Police Custody 8/19

NYT – More of Kremlin’s Opponents Are Ending Up Dead 8/20

NYT – The Housing Market Is Finally Starting to Look Healthy 8/23

WSJ – Chinese Bank Shows How To Move Risks Around 8/19

WSJ – One Policy to Rule Them All: Why Central Bank Divergence Is So Slow 8/22

WSJ – China’s Online Lenders Face Peer-to-Peer Pressure 8/25

WSJ – What to Learn From the ECB’s Great European Corporate Bond Squeeze 8/25

 

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August 12 – August 18, 2016

Coming to a bank near you – fees on big deposits

Headlines

Briefs

    • “Almost half of the shadow banking products that have fueled China’s credit boom carry an ‘elevated’ risk of default, the International Monetary Fund has warned in its annual review of the world’s second-largest economy.”
    • “‘Wealth management products’ that allow banks to channel credit to local governments, property developers and industries struggling to access normal bank loans grew almost 50% to Rmb40tn ($6tn) last year, according to the IMF’s annual ‘Article IV’ review.”
    • “While the IMF noted that China’s big four state banks have relatively small exposure to wealth management products, it added that ‘several other listed banks and [unlisted banks] in aggregate have exposures that are several times their capital.’ Just over Rmb15tn of China’s outstanding wealth management products are held by banks, accounting for 8% of their assets and more than 90% of the capital buffers that protect them from losses.”
    • It’s not all bad, just part of the process of the downshift.
    • “All told, there have been 188 settlements since 2009, costing $219 billion, according to KBW, an investment bank. “
    • “Eleven firms have paid fines in excess of 10% of their market capitalization, with Bank of America having spent the most in absolute terms ($77 billion) and in relation to its net worth (50%).”
    • Economist_Bank settlements_8-13-16

Special Reports

Graphics

FT – Banks look for cheap way to store cash piles as rates go negative – Claire Jones and James Shotter 8/16

FT_Negative rates in Europe_8-16-16

FT_How to store the cash_8-16-16

The Economist – Purchasing power: More bang for your buck 8/13

Economist_US purchasing power by state_8-13-16

Bloomberg – Norway Oil Fund Looks Into Trimming $520 Billion Stock Portfolio – Mikael Holter and Sveinung Sleire 8/17

Bloomberg_Norway SWF flows_8-17-16

Economist – The world’s most liveable cities 8/18

Economist_World's most liveable cities_8-18-16

Featured

*Note: bold emphasis is mine, italic sections are from the articles.

German bank charges negative rates on large deposits. James Shotter. Financial Times. 11 Aug. 2016.

The longer negative rates stick around and the deeper they go, expect more of this to follow…

“A Bavarian bank has become the second German lender to say it will levy a negative interest rate on private customers’ deposits, in the latest sign of the strain that the European Central Bank’s monetary policy is putting on the country’s financial system.”

“In an effort to boost the eurozone’s flagging economy, the ECB has slashed interest rates to record lows, and, since March, has charged a 0.4% fee on excess deposits left with it by eurozone banks.”

“The co-operative bank in Gmund am Tegernsee, a small municipality about 50km south of Munich, said that from September 1, it would levy a ‘custodian charge’ of 0.4% on deposits above 100,000.”

“The decision follows a similar move by Skatbank, a small German co-operative bank in the east of the country, which introduced negative interest rates for private clients on balances above 500,000 in 2014.”

“German banks are considering a variety of strategies in response to the low interest rate environment. These range from introducing fees for services previously offered for free, such as paper account statements, to keeping cash in vaults rather than parking it with the ECB.”

Other Interesting Articles

The Economist

Bloomberg – Barrack Says U.S. Real Estate Market Is Getting ‘Bubblicious’ 8/15

Contra Corner – The Daily Data Dive: Since 2007 Stocks Up 54%, Industrial Production Up 0.6% 8/18

Economist – Vladimir Putin’s powerful right-hand man steps down 8/12

FT – Investors stockpile cash to offset economic despair 8/11

FT – Record-breaking US stocks are a sideshow next to bond bonanza 8/12

FT – ‘Irrational exuberance’? Beware Bond Tantrum II – BAML 8/12

FT – London rents fall for first time in six years 8/15

FT – The end of deflation in China will be felt around the world 8/15

FT – Irrational exuberance begins to surface in US stock market 8/17

FT – Dollar hedging costs rise for yen and euro investors 8/17

FT – Hedge fund investors push for ‘hard hurdles’ 8/17

FT – If peak oil (demand) arrives, investors will need to get smarter 8/18

FT – South Korea in show of power as tensions rise with North 8/18

GlobeSt.com – SL Green Sells Stake In Midtown South Office Tower 8/11

NYT – Trillions in Murky Investments Could Rock China’s Economy 8/12

Reuters – Billionaire investors turn bearish as U.S. stocks hit record highs 8/15

WSJ – Pumped Up: Renewables Growth Revives Old Energy-Storage Method 7/22

WSJ – How Junk Bonds Can Look Attractive and Scary at the Same Time 8/17

 

August 5 – August 11, 2016

It’s a low-growth world for us…instead of high returns, we get zilch… Thus it is no surprise that funds are being pushed back to emerging markets in a big way.

Headlines

Briefs

    • Blackstone Group ($356bn in assets) is getting into the nontraded real estate investment trust business. Its first nontraded REIT – The Blackstone Real Estate Income Trust Inc. – was just registered on Wednesday.
    • The REIT is looking to raise $5bn and its manager “will receive a fee of 12.5% of the REIT’s total return after meeting a 5% hurdle.”
    • “Capped at close to 9%, the cost structure of the new Blackstone REIT is clearly different than the traditional full-commission nontraded REIT sold mainly by independent broker-dealers such as LPL Financial and Ameriprise Financial Services Inc. Such REITs typically carry loads of 12%, including a 7% (fee) to brokers at the time of sale. Nontraded REITs have been routinely criticized for their high fees and opaque cost structures.”
    • “Look for Blackstone to shun the traditional marketplace of independent broker-dealers and turn to wirehouses such as Merrill Lynch and Morgan Stanley, with whom they already have business relationships…”
    • “Central banks have always been able to make waves in markets. But never have they had such far-reaching effects, nor so quickly. The world of bonds is being turned upside down as a result.”
    • “The pull to par has become a drag: a buy-and-hold investor is guaranteed to lose money, even before taking inflation into account. The only way to make money is to find another buyer willing to pay a higher price – but that implies a bigger loss down the road.
    • “Germany now has more than 160 billion of zero-coupon bonds in issue. All of its two-year notes pay no interest, along with three of its five-year notes; all of them trade above face value.”
    • WSJ_German bonds becoming pricier_8-10-16
    • “The crucial thing to understand is that these instruments are no longer bonds – at least not in the traditional sense. With no income attached to them, they are simply bets on the price another investor is willing to pay. They will also be more volatile: the long wait for repayment means small changes in yield will have a big effect on current prices.”
  • Liyan Qi of the Wall Street Journal added context to China’s efforts to reduce the population of Beijing.
    • In an effort to reduce the problems from rapid growth and overpopulation, Beijing is seeking to push out residences to neighboring provinces such as Hebei and Cangzhou (see map).
    • WSJ_Cutting China’s Capital Down to Size_8-10-16
    • “Despite the city’s efforts to keep a lid on population growth, greater Beijing now has almost 22 million people, an increase of some 6 million in a decade, official data show. The central area, comprising of six districts grew at an average rate of 414,200 a year over the same period to about 13 million.”
    • “Municipal leaders’ latest five-year plan aims to keep greater Beijing’s population under 23 million and to shrink the urban center by 15% by 2020, effectively pushing out some 2 million people – roughly equivalent to excising more than the population of Manhattan from New York City and dispersing those people elsewhere.”
    • “The strategy is to move low-end businesses such as wholesale markets, to Hebei-the province surrounding Beijing where growth has flagged-and coax people to follow.”
    • Just think what will happen to real estate prices when you push out that much demand…but then again, the laws of economics are generally suspended in China.

Special Reports

Graphics

WSJ – Companies Routinely Steer Analysts to Deliver Earnings Surprises – Thomas Gryta, Serena Ng and Theo Francis 8/4

WSJ_Managing earnings expectations_8-4-16

FT – Best coast tech is top and looking to the clouds for growth – Richard Waters 8/4

FT_Rise of the tech giants_8-4-16

Bloomberg – Manhattan Luxury-Condo Glut Ends Developer Rush for Land Deals – Sarah Mulholland and David M Levitt 8/3

Bloomberg_Manhattan Land Deals_8-3-16

FT – US economy: Decline of the start-up nation – Sam Fleming 8/4

FT_US Startup density_8-4-16

FT_20 counties generating new business_8-4-16

FT_Fewer young companies_8-4-16

WSJ – American Paradox: It’s Never Been Cheaper for Cities and States to Borrow Money…And They Refuse to Do It – David Harrison and Heather Gillers 8/7

WSJ_US Municipal borrowing_8-7-16

WSJ – Are Negative Rates Backfiring? Here’s Some Early Evidence 8/8

WSJ_Negative rates having unintended effects_8-8-16

WSJ – Productivity Slump Threatens Economy’s Long-Term Growth – Ben Leubsdorf 8/9

WSJ_Declining US Labor Productivity_8-9-16

FT – US bonds: where credit is due – Lex 8/11

FT_Credit Statistics for US debt issuers_8-11-16

Featured

*Note: bold emphasis is mine, italic sections are from the articles.

We’re in a Low-Growth World. How Did We Get Here? Neil Irwin. New York Times. 6 Aug. 2016.

“Slow growth is not some new phenomenon, but rather the way it has been for 15 years and counting. In the United States, per-person gross domestic product rose by an average of 2.2% a year from 1947 through 2000 – but starting 2001 has averaged only 0.9%. The economies of Western Europe and Japan have done worse than that.”

NYT_Growth lower than projected_8-6-16

According to a new analysis by the McKinsey Global Institute, 81% of the United States population is in an income bracket with flat or declining income over the last decade. That number was 97% in Italy, 70% in Britain, and 63% in France.”

NYT_Annual per capita GDP over preceding 10yrs_8-6-16

“An entire way of thinking about the future – that children will inevitably live in a much richer country than their parents – is thrown into question the longer this lasts.”

Bottom line, people are working fewer hours and there is less “economic output being generated for each hour of labor.”

Investing: The great escape. Jonathan Wheatley and James Kynge. Financial Times. 7 Aug. 2016

“The latest growth forecasts from the International Monetary Fund offer some optimism. It expects the pace of gross domestic product growth in emerging markets to increase every year for the next five years while developed markets stagnate.”

“But in truth emerging markets are growing from a shrunken base and a big part of the upturn is not due to things getting better but to things no longer getting worse. Big economies such as Russia and Brazil, for example, in deep recession for the past two years, are finally heading back to growth.”

FT_Investors flood into EMs_8-7-16

“Fund flows to EMs have gone through the roof, but this is best described as [the result of] push factors rather than pull factors.” – Peter Kinsella, head of EM research at Commerzbank

“The EM bond rally is really a global fixed income rally.” – David Hauner, head of EM strategy at Bank of America Merrill Lynch

BlackRock’s ($4.6tn money manager) Sergio Trigo Paz, head of emerging markets fixed income, “who changed his view on EM bonds in February, describes what is happening now as a ‘capitulation’ – a realization by big institutions that they can no longer afford to ignore the returns on offer in emerging markets, which have been as high as 13% in the year to date.”

“The impact of such flows on EM sovereign bond prices, which have risen 15% this year, has been amplified by the fact that the asset class is small. An estimated $12tn of developed market government bonds now offer yields of less than zero, while their emerging market equivalents add up to about $800bn, so their ability to offer an alternative is limited.”

“For now, the pressure on prices has all come from buyers and for those who got in early the returns have justified the risks. The trick will be to know when to head for what could quickly become a very crowded exit.”

Other Interesting Articles

The Economist

Bloomberg – Retail Outlets Are on the Outs 8/4

Bloomberg – There Are All Kinds of Signs of a High-End Real Estate Slowdown 8/10

Bloomberg – Blackstone Enters Nontraded REIT Market With $5 Billion Fund 8/10

FT – I’m from the central bank and I’m here to help 8/4

FT – Oil and gas downturn spells trouble for Singapore 8/7

FT – Demand drives $3bn Mexico bond deal at record rate 8/9

FT – Advisors quash Puerto Rico creditor differentiation 8/9

FT – China takes a gamble in scapegoating the west 8/11

InvestmentNews – Inland Real Estate Investment Corporation eliminates transaction fees on its nontraded REITs 8/9

NYT – New Photos Cast Doubt on China’s Vow Not to Militarize Disputed Islands 8/8

NYT – Chinese Tech Firms Forced to Choose Market: Home or Everywhere Else 8/9

WP – Venezuela’s death spiral is getting worse 8/8

WSJ – When Chinese State Support Evaporates on Investors 8/8

WSJ – New Rules and Fresh Headaches for Short-Term Borrowers 8/8

WSJ – WeWork Misses Mark on Some Lofty Targets 8/9

WSJ – The Typical Home in San Jose Now Costs More Than $1 Million 8/10

WSJ – Lopsided Housing Rebound Leaves Millions of People Out in the Cold 8/10

WSJ – Why China’s Bond Market Rally Is Risky Business 8/10

Yahoo Finance – Macy’s plans to close 100 stores, boost online investment 8/11

Zero Hedge – August Corporate Bond Issuance Breaks All Records Thanks to Relentless Demand For Yield 8/8

 

July 29 – August 4, 2016

Insurers having to rethink their business model. India makes a giant leap forward in tax reform.

Headlines

Briefs

    • “Sovereign wealth funds are investing less money directly than at any time in the past five years. This marks the end of a safety net whereby state-backed vehicles mopped up assets in times of market stress, according to research.”
    • “The Bocconi report found that state funds invested 48bn directly last year, down 57% from 112bn in 2008.”
    • “Given the low oil-price environment and lower revenues for oil producers, [state funds] no longer have the cash positions to get into the markets once they correct.” – Sven Behrendt, managing director of GeoEconomica, a consultancy
    • “What if all Londoners, no matter how young or frail, smoked for at least six years? In effect, they already do. The city’s air pollution exacts an equivalent toll on each resident, cutting short the lives of nearly 10,000 people each year and damaging the lungs, hearts and brains of children.”
    • Bottom line, more needs to be done to track and publish long-term air-quality indexes similar to the existing short-term gauges that people and cities can utilize to alter behaviors and make informed life choices.
  • Jonathan Wheatley of the Financial Times called attention to the demand that Emerging Market bonds have seen as the world has become devoid of ‘safe’ income yielding products.
    • “With an estimated 30% of global government debt now offering yields of less than zero, he (Daniel Senecal, head of credit research at Newfleet Asset Management) says traditionally conservative investors are being pushed into new areas.”
    • “If you’re a pensions guy you have to do something. With German 10-years at zero, you need to change your mindset. Your whole view migrates into US high-yield and EMs.” – Daniel Senecal
    • Geez it’s a tough world to invest in right now…

Special Reports

Graphics

WSJ – Why Bank of Japan Dipped Into Bag of Small Tricks 7/29

WSJ_Why Bank of Japan Dipped Into Bag of Small Tricks_7-29-16

Visual Capitalist – The Rise and Fall of Yahoo 7/29

Visual Capitalist_The rise and fall of Yahoo_7-29-16

Economist – Comparing urban air pollution 8/1

Economist_Nitrogen dioxide city comparison_8-1-16

FT – Japan launches $45bn stimulus package – Robin Harding 8/2

FT_Japan stimulus_8-2-16

FT – Emerging market bonds lure investors seeking yield – Jonathan Wheatley 8/2

FT_EM sovereign rally_8-2-16

WSJ – Bank of England Cuts Key Interest Rate to New Low 8/4

WSJ_Bank of England rate reaction_8-4-16

Featured

*Note: bold emphasis is mine, italic sections are from the articles.

Insurers: Forced to dig deep. Oliver Ralph and Alistair Gray. Financial Times. 1 Aug. 2016.

“Insurers globally are having to come to terms with the idea of ‘lower for longer’ interest rates, making deep changes to business models that had been unaltered for decades. Whereas previously they might have clung to the hope that higher rates were around the corner, there is a realization that the industry has to do things differently – from investing in assets that might once have been seen as too risky, to experimenting with new products.”

As to how much cash are we talking about, PwC estimates that by 2020, insurance companies will manage about $35tn worth of assets.

“Traditionally, much of that has gone to relatively safe homes, such as bonds. At the end of last year, bonds made up about 68% of US property insurers’ total investments and 76% of life insurers’, according to S&P Global Market Intelligence. When those bonds offered decent yields there was no problem. Insurers could fulfill promises to customers and still have plenty left for shareholders.”

But “by last year the net yield on US life insurers’ overall invested assets had fallen to 4.7% – about a quarter lower than 2002 levels.”

Hence, the performance of US life insurance companies has tended to move in tandem with the 10-year Treasury yield…

FT_US life insurance companies and bond yields_8-1-16

In regard to attaining higher returns, insurers can either take on higher risks or tie up cash for longer.  “Many prefer the latter, investing in more illiquid assets such as property. UK insurer Aviva says 80% of the new investments it is making to back its annuity business will be in long-duration assets rather than traditional gilts or corporate bonds.”

“Infrastructure investments are particularly popular as they offer the long-term cash flows life insurers need to back their promises. Germany’s Allianz, for example, is one of the main backers of London’s £4.2bn supersewer.”

Consider the alternative…“Nobody likes to invest at negative yields but life insurers have so much cash that they need to invest, and they need to do something with it.” – James Peagam, head of global insurance solutions at JPMorgan Asset Management

As to the other side of the equation, ‘new products’ or raising premiums, this is already underway.

“Life assurance customers may see the biggest changes. For decades, the industry has offered savings and retirement products that offer guaranteed minimum returns. In the future, these may no longer be on offer.”

“This would be a major shift. In the US, products with guarantees account for 60-80% of the US life insurers’ balance sheets, Moody’s estimates. The average outstanding guarantee is returning between 2% and 4%.”

The replacement product: “unit-linked products. These make no promises: customers’ investments simply rise and fall with the markets. They are similar to traditional asset management products.”

Which of course puts them in direct competition with traditional asset managers that are facing a major business model challenge from low-cost index fund companies like Vanguard and BlackRock.

“As Jon Hocking, an analyst at Morgan Stanley, points out, the unit-linked model distances insurers from their customers. ‘The risk is that you open Pandora’s box and the industry loses its dominant position in the long term savings market. The customer chooses between products and the only distinction is the fund performance” and fees…

So which insurers are under particular pressure, in the US these are the companies specializing in long-term care (“low interest rates have exacerbated the problems caused by rising treatment costs”) and those that have sold ‘universal life’ protection (“policies that combine death benefits with tax-advantaged savings”).

“Transamerica, a large US provider, is being sued by the advocacy group Consumer Watchdog on behalf of policyholders who bought coverage decades ago. It said consumers who had been offered guaranteed interest of at least 5.5% a year had been stung by premium increases of almost 40%.”

India’s economy: One nation, one tax. Economist. 4 Aug. 2016.

India just passed a new goods-and-services tax (GST) that will “unify the country’s 29 states and 1.3 billion people into a common market for the first time.”

“Few countries are fiddlier than India when it comes to paying taxes; the World Bank ranks it 157th out of 189 for simplicity… Because the rates differ between states, making stuff in one and selling it in another is often harder within India than it is in trade blocs such as NAFTA or the European Union.”

“That should change with the GST, essentially an agreement among all states to charge the same (still to be decided) indirect tax rates.”

“Better yet, the GST will be due on the basis of value added. That avoids businesses being thwacked by taxes on the entire value of the products they buy and sell rather than the value they create – a situation that often made it cheaper to import stuff rather than make it locally. Just as importantly, by requiring businesses to document the prices at which they buy inputs and sell products, it will force vast swathes of the economy into the reach of the taxman.”

The tax is supposed to be enacted in April 2017. There is a lot to be buttoned up by then and chances that exceptions will be inserted; however, it is good step forward and has the chance of boosting India’s GDP by 1-2 percentage points.

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