Political dynamics are undergoing transformational change as voters focus on divisive issues such as immigration, alongside other macro issues such as increased globalization, and deepening economic uncertainty.
Global asset managers need to prepare for a changed macro-environment in relation to economies, trade relations and industry regulation.1
This climate has impacted assets and business sectors in markets around the world as the European Union (EU) prepares to start discussions with the United Kingdom (UK) over its withdrawal from the bloc and while the policies of US President Donald Trump’s administration continue to take shape. In the UK, for example, the prospect of Britain leaving the EU has caused severe downwards pressure on the pound and increased worries about imported inflation.
These disruptions may profoundly affect asset managers’ investment strategies, operational structures and potentially their domiciliation choices.
These disruptions may profoundly affect asset managers’ investment strategies, operational structures and potentially their domiciliation choices
Britain's decision to leave the EU casts doubt over its right to passport its provision of financial services across borders in the bloc.2 The termination of these rights is made more likely by the British government's message that it needs to enforce a popular mandate to restrict immigration from other EU Member States.
This policy stance contravenes existing agreements with the EU and could provoke an unsympathetic response from Brussels when considering whether asset managers based in the UK should continue to have the right to distribute EU-compliant fund products into EU markets. It is also prompting global asset managers and other financial services firms to reconsider whether Britain will remain an appropriate base for distributing financial services across the EU.
In the US, President Trump has pledged to increase defence spending, cut regulation and deliver big tax cuts for businesses, notably for those with overseas earnings that could be repatriated for investment in new jobs in the US.
One of his first acts was to withdraw the US from the Trans Pacific Partnership (TPP), which may have a significant impact for economies in the Asia Pacific region. The TPP would have put in place a wide-ranging trade agreement between the US and 11 nations along the Pacific Rim, including Australia, New Zealand, Canada, Japan, Singapore, and Malaysia. The TPP had been part of a broader strategy to increase the US’s trade activity in APAC and was also seen as a counter to China’s economic ambitions. A Republican-controlled Congress means the prospects of these policies being implemented are good, and this has sparked a rally in the dollar and in the stock prices of companies and sectors that stand to benefit from deregulation, lower taxes or increased federal government spending on defence and infrastructure.
But the inflationary implications of this growth-oriented agenda have also caused yields on US government bonds to rise sharply amid concerns that interest rates will also need to rise in 2017 to offset this risk.3
Rising interest rates in the US would not only make it more expensive for domestically based businesses and individuals to borrow, but also have implications for global growth because many emerging market-based businesses and governments rely on dollar-based borrowing to support new investment or refinance existing debt. As interest rates rise, the stronger dollar makes it more expensive for emerging economies to borrow, which could slow global growth.
As a consequence of these concerns, many global asset managers that have investments in emerging market equities or debt have suffered significant weakness in the wake of the US election.
Risking regulatory confusion
The increase in regulatory oversight, particularly since the financial crisis of 2008-2009, is a serious matter for asset managers. The cost of compliance with international capital adequacy frameworks such as Basel III, as well as US-specific regulations and regionally mandated EU Directives, is a requirement that asset managers have adapted to.
But the possibility of UK withdrawal from the EU's financial governance framework, together with a proposed rollback of the Dodd-Frank legislation in the US, could add to their compliance challenges by revisiting agreements on multi-jurisdictional rules and enacting local rules with extra-territorial effects.4
Increasing protectionist talk in Washington D.C, particularly where it could lead to higher tariffs on imports from emerging market countries, is also impacting international investment portfolios. Here, the impact of the Trump administration is being felt particularly heavily in Latin American countries such as Brazil and Mexico, where growth and earnings were relatively weak in 2016 before November's US election.5 The added strain brought about by the possibility of increased tariffs and other trade sanctions has only added to investors’ uncertainty.
The possibility of US sanctions may be less of a challenge for global asset managers in China, which has often been the target of populist rhetoric. Besides being a market where growth is increasingly generated from domestically-focused services rather than industrial exports, many small- and medium-sized Chinese companies may offer attractive opportunities for investors at current valuations.
China is in a strong position to react to US companies selling into the Chinese market should the US impose tariffs on Chinese imports.6 China's trade surplus with the US, along with its substantial holdings of US government debt, also give it leverage with Washington that may bolster its position in any bilateral trade negotiations.
Asset managers may also find good opportunities to invest in other emerging markets in 2017, particularly where there are healthy domestic economic prospects and pro-growth government policies in place.7 These allow investors to look beyond near-term Western politics and focus instead on exploring long-term investment strategies based on macro-fundamentals and bottom-up company analysis.
1. Pinsent Masons (December 5, 2016) - BREXIT: Financial Times survey shows scale of asset managers' Brexit fears
2. Newsweek (September 23, 2016) - EU's Martin Schulz casts doubt on U.K. free movement deal
3. Bloomberg (November 9, 2016) - Investors are betting that Trump will be the inflation President
4. European Parliament (2012) - The Extraterritorial Effects of Legislation and Policies in the EU and US
5. Market Realist (November 11, 2016) - How could Trump's victory affect Europe?
6. theguardian (November 24, 2016) - China will defend trade rights in face of Trump tariff threats, says official
7. Forbes (December 5, 2016) - What 'Trumponomics' Will Mean For Emerging Markets In 2017