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Why strategic investing trumps reaction

Glenn Freeman  |  05 Oct 2017Text size  Decrease  Increase  |  
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Missile launches, controversial election results, political upheaval, and hurricanes: such unforeseen events will always occur, but they shouldn't detract from a long-term investment strategy.


Libby Cantrill, head of US public policy at PIMCO, has been busier than ever over the last 18 months. However, she recently spoke with Morningstar.com.au about how one of the world's largest fixed-income managers perceives risk levels in the global marketplace.

While based in New York, Cantrill spoke from California, where PIMCO held a series of meetings. Issues on the agenda included: the outlook for markets in the US and Europe; Brexit; China and Japan. "And in general, we're quite constructive [in our view], but cautiously so," she says.

Cantrill uses the term "tail risk" several times during the conversation. This term refers to investment portfolio risk that arises when the possibility an investment will move more than three standard deviations from the mean is greater than what is shown by a normal distribution.

"When we think about the next 12 months or so, there's obviously been uncertainty about North Korea for a long time, including under previous administrations. Given the rhetoric from both sides, I think the tail-risk is probably fatter under this administration than under those previously," Cantrill says.

"But with that said, we have a similar view as Morningstar ... yes, we want to pay attention to it, we think about it. Especially with valuations this rich, you think of anything that could go wrong that could lead to repricing of asset valuations, but we don't have a particular edge as investors."

This last point is particularly important for individual investors: focus on the things you can control, not those you cannot. "We try to focus on the issues where we have some special insight, where we can add alpha for our clients. It's a risk, and we treat it as such, but we think that although that has increased, it's also very much a tail scenario and not in our base case scenario," Cantrill says.

Checks and balances

Speaking about the domestic situation in the United States, Cantrill emphasises the difficulty even for those on the ground to understand what's happening in such rapidly moving events, with this magnified for those offshore.

"From my perspective, as the Washington policy person, a big unknown is how the administration might influence trade policy ... given it has broad authority over this policy area and can do things that are quite broad-reaching without the approval of Congress. For instance, the administration could theoretically withdraw the United States from a free trade agreement or levy tariffs on a country without having to seek approval from Congress," she says.

"Does it increase the chances that there could be a trade mistake or a protectionist trade action with China? We do think that's also a risk ... but even internally, there are different views about the risks of ... a heated trade battle with China."

International clients who own US-dollar-based assets are quite concerned, she says, "because they don't have as much perception or insight into the checks and balances that exist, so they've understandably been very interested in what's happening".

According to Cantrill, international clients, including those in the Asia Pacific and Europe, find it particularly difficult. "Even as a US-based investor, it can be tough to separate reality from the rhetoric, and that's exacerbated the further away you get from the US."

From a political perspective, Cantrill offers some encouragement for people concerned about some of the Trump administration's rhetoric in recent months. "Like anything that's fiscally related, it's all predicated on Congress--tax reform, infrastructure, government spending--all of that needs Congressional approval."

"It's one of the reasons why we feted the Trump trade at the start of the year ... Republicans have a very small simple majority in the Senate--and most legislation needs 60 votes, not the 52 they currently have, to pass legislation, a fact that made us sceptical of the ambitious timeframe that Republican leaders had put out at the beginning of the year.

"We believed that passing many of these bills would be an uphill battle and is the reason we were more constructive on US duration when rates increased temporarily this spring," she says.

From a macro perspective, Cantrill says PIMCO has "taken advantage of some of the valuations, decreased risk in some areas, added duration in others ... growth is synchronised globally, but with some risk."

"That's what we focus on: what could go wrong, what could be a tipping point."

Morningstar's view

Cantrill's comments about focusing on variables you can influence are echoed by Andrew Lill, chief investment officer, Asia Pacific, Morningstar Investment Management.

"While these are uncharted waters politically, volatility in capital markets is nothing new ... prudence and patience will win. For this reason, we favour research over reaction, and urge investors to do the same," Lill says.

"As long-term investors, we need to appreciate and acknowledge this important difference, if we are to avoid the hype, and focus on the real drivers of investment returns. On this note, we must come back to the two variables to successful investing: the current price and the long-term fair value."

He believes the real risk a Trump government poses to investors is the potential impairment of the fair value of assets--though sees this as unlikely due to the finite nature of the political cycle.

With many commentators, at least in the earlier stages after Trump's election, drawing comparisons between his election and Britain's vote to exit the European Union (Brexit), Lill sees timeframe as one fundamental difference.

"Brexit is likely to be a permanent phenomenon, which could have a significant impact on long-term economic growth, and therefore be more likely to adversely affect our calculation of  'fair' or 'intrinsic' value," he says.

"A Trump presidency is not permanent, which lends itself to sentimental change, with less long-term significance."

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Glenn Freeman is a senior editor at Morningstar.

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