Royal commission, ESG and important macro themes

-- | 30/05/2018

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Glenn Freeman: In this edition of "How We Invest Your Money," I'm talking to Kerry Craig from JPMorgan. He is speaking about corporate governance and how within JPMorgan's process it's nothing new, but the Royal Commission is really putting it in the spotlight for investors and for the industry. He also speaking about how JPMorgan's global presence feeds into its local operations and how that benefits investors in this region. And lastly, on the global macro scene, one of the things he speaks about is the Italian elections that have just been held.

Kerry Craig: Well, it's been a growing area of focus for clients for a long time now. You think about the ESG mandate that's coming through and the fact that people do want to see how fundamentals are responding to these environmental and social and governance issues. But fundamentally, it's been built into the process for our equity analysts internally for a long time. When they are going through and looking at company ratings, they think about corporate fundamentals, but they are also obviously meeting the boards, meeting the directors and they will have their own internal measures to stack up on any red flags that come up on their governance.

This is particularly relevant when we think about emerging markets where obviously as the head of our emerging markets team thinks about a board, he is trying to figure out if they are lying, cheating or stealing. So, the governance plays a role there and our analysts actually have a selection of about 70 questions they will run through for every company that forms a part of their governance outlook and based on that they will start to uncover some red flags and decide whether those companies should be put in portfolios or should be the ones that are invested in.

So, it's been something that's happened for a long time, but it's just come to the fore more and more as people think about negative screening and taking out tobacco and ammunition companies from funds. I think it's going to go deeper than that and actually look at individual companies and how they can add to the ideas about being social and environmentally-friendly or indeed have solid governance.

Well, I think, that's where it comes from having JPMorgan quite a strong depth of analysts and they share that information across the network. So, it's not separate, say, equity analysts who are looking at their own market. They are looking at it in conjunction. So, you might have a sector specialist in the US who is thinking about electric vehicles, for example, but they then think about the components that go into that. So, they are talking about the sector specialists and the other analysts who are based in perhaps Hong Kong or looking at perhaps where the raw materials for these batteries are coming from, for example. So, then we think about our Australian analysts and building into a broader network. And so, that's where you get that buildup of the global picture and that drawing on the depth of analyst nature that also allows for that cross-learnings across countries and sectors and building a better picture. And again, adding into that idea about governance and making sure all parts of the supply chain for the company you are looking at do have that strength in terms of their governance for their company.

Well, there's a lot of things that I think investors are trying to grapple with. They are not really too sure which way to look. If you think about what's happening in the emerging world or Asia Pacific, immediately, trade protectionism jumps to mind; strengthening US dollar which is not traditionally good for trade and emerging markets; and then we also have what's happening in the rates markets. We've obviously seen 2 and 10-year yields start to move higher, people bringing up questions about how sustainable that is for corporate leverage and lending.

For us, a lot of this is just noise. We do think about the trade in the aspects of what you are seeing in terms of US foreign policy on trade negotiations with China leading to a situation where you are not getting a trade war. I did love the phrase. They said they put the trade war on halt. I think that was a fantastic thing to be able to do which is putting that war on halt for a minute. But that's really a signal that neither side wants to have a trade war. They know that there is no winner from having a trade war and they will reach negotiations.

Unfortunately, it just simmers away in the background and adds to nerves. The bigger one for us when we are looking at Asia and emerging markets in general is obviously the strength in the US dollar. At the start of the year, we thought about a US weakening. It's continuing of that trend that we saw in 2017. And against odds you have had a very sharp appreciation since the middle of April.

For us, again, it's a case of a dollar that's been spiking for unusual reasons. It's not about US economy that's unilaterally striving ahead in terms of growth. It's the fact that you have had the rest of the world looking a little bit weaker. So, Eurozone has been a bit weaker. Japan hasn't really grown in the last couple of quarters. But as that comes back, the US dollar will start to weaken off again. And again, you can see emerging markets perform. We do think trade will rebound and those PMI numbers will come back up showing that manufacturing is still quite healthy and that adds to the outlook for emerging market and Asia given that it's the supply chain and generally manufacturing base for most of the world.

Outside of that, we are looking at Europe a bit more closely. There's nerves about the Italian political environment given the outcome of the election and now a new government. But probably, you are seeing a lot more strength in the Eurozone. We do think inflation will come back at a core level. You are seeing unemployment rate that's still falling and that instils a bit of confidence among spenders. Then corporate spending and CapEx is also rising on the fact that you have a better credit outlook now. A lot of the banks which were a worry in the past are fundamentally at a much better position with nonperforming loans are lower and higher core Tier 1 capital ratios. So, we do look at that and say, well, the Eurozone wasn't the favorite market for a while and has had patchy performance of late, but we saw a really strong story there as their economy continues to recover, or perhaps we think about the US entering in the (end) of its cycle and moving into late cycle.

This report appeared on www.morningstar.com.au 2021 Morningstar Australasia Pty Limited

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