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COLUMBIATHREADNEEDLE.COM
GLOBAL ANNUAL PERSPECTIVES 2016
1
Global Annual Perspectives 2016
CONTENTSINTRODUCTION AND OVERVIEW Robert McConnaughey, Global Head of Research ......................................................................................3
2016: A YEAR OF POLICY DIVERGENCE Mark Burgess, CIO EMEA and Global Head of Equities ..............................................................................4
EQUITY VIEWPOINTS
OPTIMISM IN CAUTIOUS TIMES William Davies, Head of Global Equities ....................................................................................................7
STAYING ADAPTABLE AS MARKETS EVOLVE Leigh Harrison, Head of Equities, Europe ................................................................................................10
ASIAN EQUITY OUTLOOK Soo Nam NG, Head of Asian Equities ......................................................................................................13
ACTIVELY BUILDING PROFITABLE PORTFOLIOS Melda Mergen, Director US Equities ........................................................................................................15
ARE ENERGY STOCKS HEADED FOR A FIFTH YEAR OF UNDERPERFORMANCE? Jonathan Mogil, Portfolio Manager and Senior Analyst ............................................................................ 17
FIXED INCOME VIEWPOINTS
2016 – A YEAR FOR TREADING CAREFULLY Jim Cielinski, Global Head of Fixed Income .............................................................................................19
DURATION, LIQUIDITY, AND DEFAULTS, OH MY! Colin Lundgren, Head of US Fixed Income and Gene Tannuzzo, Senior Portfolio Manager .......................22
ASIAN FIXED INCOME OUTLOOK Clifford Lau, Head of Fixed Income, Asia Pacific ...................................................................................... 24
EMERGING MARKETS STARTING TO LOOK ATTRACTIVE Jim Carlen, Senior Portfolio Manager .......................................................................................................26
MULTI-ASSET/ALTERNATIVE AND OTHER VIEWPOINTS
WILL OUTCOMES IMPROVE FOR DIVERSIFIED INVESTORS IN 2016? Jeff Knight, Global Head of Investment Solutions, Co-Head of Global Asset Allocation ...........................28
ALTERNATIVE BETA AS TRUE DIVERSIFIERS William Landes, Deputy Head of Global Investment Solutions and Head of Alternative Investments ....... 31
AN UNDERAPPRECIATED OPPORTUNITY FOR INCOME INVESTORS David King, Senior Portfolio Manager ......................................................................................................34
CAPITALIZING ON DISRUPTIVE TECHNOLOGIES Robert McConnaughey, Global Head of Research ....................................................................................36
DC WORKPLACE PENSIONS: TARGETING GOOD FINANCIAL OUTCOMES Chris Wagstaff, Head of Pensions and Investment Education ..................................................................38
SUNNY DAYS AHEAD FOR CLOUD COMPUTING John Golden, Senior Analyst ....................................................................................................................40
MARKET CONTROVERSY + SKILLED INVESTMENT TEAMS = OPPORTUNITY
Global Annual Perspectives 2016
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INTRODUCTION AND OVERVIEW
THERE IS NO SHORTAGE OF THINGS TO WORRY ABOUT, BUT INVESTORS WILLING TO LOOK BEYOND THE HEADLINES MAY FIND OPPORTUNITIES IN 2016
n �Seven�years�after�the�depths�of�the�financial�crisis,�macroeconomic�growth�rates�are�stubbornly�low�despite�unprecedented�central�bank�interventions�and�increased� global�leverage.
n ��Interest�rates�are�rising�for�the�first�time�in�almost�10�years.�
n �Technological�change�and�globalization�are�challenging�traditional�patterns�of�pricing�power�across�many�industries.�
n �Emerging�markets,�having�played�such�a�large�role�in�boosting�global�growth�rates,�have�shown�signs�of�weakness.
n �Commodity�prices�have�plummeted�with�no�clear�path�towards�recovery.
n �All�of�this�has�elevated�levels�of�fear�and�uncertainty�about�economic�prospects,�feeding�geopolitical�tensions.
2015�was�a�challenging�overall�market,�and�we�do�not�see�a�rising�tide�changing�that�dynamic�to�lift�all�boats�in�2016.�If�anything,� we�suspect�there�will�be�increased�volatility�in�the�year�to�come.� But,�ultimately,�investing�is�about�gauging�the�magnitude�of�market�fears�and�optimism�to�find�situations�where�the�reality�is�different�to�the�embedded�market�assumptions.�Despite�the�doom�and�gloom�headlines,�there�is�actually�a�fairly�rich�array�of�opportunities.� We�believe�that�skilled�teams�can�attack�those�areas�of�uncertainty�in�order�to�take�prudent�risks�and�gain�exposure�to�exploitable�market�inefficiencies.�
A�portfolio�that�uses�a�diversified�palette�of�specific,�rigorously�researched�positions�(including�alternative�strategies)�can�find� ways�to�turn�what�might�appear�to�be�a�confusing�and�intimidating�market�backdrop�into�a�smoother�path�towards�one’s�investment�goals.�In�the�following�pages,�our�investment�team�provides�insights�into�where�we�see�some�of�those�opportunities�as�well�as�risks.� As�always,�our�priority�is�the�investment�success�of�our�clients,� and�we�hope�these�articles�help�you�hone�your�investment�strategy�for�2016�and�beyond.
Finally,�on�behalf�of�everyone�at�Columbia�Threadneedle�Investments,�thank�you�for�your�interest�and�continued�support.�Best�wishes�for�a�healthy�and�prosperous�2016.�
Robert McConnaughey Global Head of Research
Global Annual Perspectives 2016
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2016: A YEAR OF POLICY DIVERGENCEPolicy�divergence�will�continue�to�dominate�in�2016.�Interest�rates�will�move�away�from�emergency�settings�in�the�US�but�monetary�policy�in�Europe�and�Japan�will�remain�very�accommodative,�and�the�European�Central�Bank�and�Bank�of�Japan�may�decide�to�do�more�to�support�growth.�In�the�UK,�current�pricing�in�the�bond�market�suggests�that�we�won’t�see�any�interest�rate�rises�before�2017.�
2016�will�see�a�low�growth,�low�return�world�with�corporate�margins�pressured�by�weak�end�demand�and�overcapacity�in�a�number�of�industries.�Successful�investors�will�be�those�that�can�find�companies�with�the�ability�to�demonstrate�organic�growth�–�these�prized�stocks�should�trade�at�a�premium�to�their�peers.
The�outlook�for�the�emerging�markets�(EM)�remains�challenging,�particularly�for�those�countries�that�have�built�their�economies�to�serve�Chinese�demand�for�commodities.�The�outlook�for�these�countries�is�downbeat,�and�weaker�currencies�may�not�help�to�lift�demand�for�EM�exports�where�consumer�and�corporate�demand�is�subdued.�A�world�where�the�US�tightens�policy�but�other�central�banks�retain�an�accommodative�stance�should�mean�a�stronger�dollar,�all�else�being�equal.�That�is�likely�to�be�a�further�headwind�for�EMs,�as�there�is�a�strong�inverse�correlation�between�the�dollar�and�emerging�markets.
In�terms�of�valuations,�we�still�regard�equities�as�more�attractive�than�bonds�and�expect�to�retain�that�positioning�for�now�in�our�asset�allocation�portfolios,�although�with�less�conviction�than�we�have�done�for�some�time.�However,�compared�to�their�longer-term�history,�equities�still�offer�better�value�than�bonds.
Mark Burgess CIO EMEA and Global Head of Equities
Global Annual Perspectives 2016
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A time for active investors where fundamentals will prevailIn�2016,�we�expect�opportunities�for�active,�discerning�investors�to�increase�–�the�rising�tide�of�global�QE�that�had�lifted�all�boats�will�begin�to�ebb,�and�in�that�environment�it�will�make�sense�to�differentiate�within�and�across�asset�classes.�In�this�world,�a�focus�on�valuations�and�fundamentals�–�‘old�school’�investing�if�you�like�–�should�be�more�important�than�it�has�been�in�recent�years,�when�markets�were�backstopped�by�abundant�and�growing�liquidity.
M&A continuesCompanies�remain�reluctant�to�commit�to�large-scale�or�long-term�investment�capital�expenditure,�and�as�a�result�companies�that�do�have�spare�cash�are�likely�to�return�it�to�investors�or�use�it�to�fund�M&A,�as�they�have�been�doing�recently.�In�a�low-growth,�low-return�world,�it�may�make�more�sense�for�companies�to�buy�or�eliminate�their�competition,�rather�than�pursue�organic�growth,�which�is�hard�to�find.�M&A�is�generally�supportive�of�equities�and�other�‘riskier’�assets�such�as�high�yield,�but�it�is�usually�negative�for�investment-grade�companies�as�it�often�involves�some�re-leveraging�of�investment�grade�corporate�balance�sheets.�For�that�reason,�we�have�been�adjusting�our�exposure�to�corporate�credit�in�our�asset�allocation�portfolios,�with�a�preference�for�European�high�yield�over�investment�grade.
At�a�regional�level,�we�continue�to�see�good�opportunities�in�Japanese�equities�and�we�have�also�reflected�this�in�our�asset�allocation�portfolios.�Japan�has�delivered�good�levels�of�earnings�growth�and�this�has�meant�that�equity�valuations�have�remained�attractive,�even�though�the�stock�market�has�performed�strongly.�This�contrasts�with�the�rest�of�the�world,�where�equity�valuations�are�no�better�than�fair�in�most�instances�and�where�corporate�news�flow�is�deteriorating�at�the�margin.
Conditions turn favourable for European equitiesQE,�lower�energy�prices,�euro�weakness�and�loosening�credit�conditions�are�all�enhancing�the�trading�environment�for�European�companies.� There�are�now�signs�of�improvement�in�several�eurozone�economies,�
and�we�anticipate�that�domestic�European�earnings�will�continue�to�contribute�strongly�to�overall�corporate�profitability.�On�the�international�front,�we�are�monitoring�the�economic�outlook�for�China,�and�evaluating�the�potential�impact�on�European�exporters�and�global�growth.�
Many�companies�in�Europe�(outside�the�financial�sector)�have�strong�balance�sheets�and�cashflow,�leading�to�the�likelihood�of�further�dividend�growth,�cash�returns�and�M&A�activity.�We�continue�to�favour�companies�with�robust�earnings�prospects�and�pricing�power.�Heightened�volatility�in�equity�markets�is�providing�us�with�attractive�investment�opportunities.
The unknown consequences of raising rates in a low growth environment Perhaps�the�biggest�threat�for�2016�is�that�the�macro�and�company�indicators�that�we�are�seeing�at�the�moment�–�subdued�growth�and�inflation,�soft�final�demand�and�a�deteriorating�outlook�for�corporate�earnings�–�are�not�the�kind�of�the�things�that�one�would�expect�to�see�when�the�world’s�most�important�central�bank,�the�US�Federal�Reserve,�is�starting�an�interest-rate�tightening�cycle.�It�is�clear�that�the�Fed�is�very�keen�to�start�normalising�interest�rates,�but�if�one�simply�looked�at�the�data�in�isolation,�it�is�hard�to�come�to�the�conclusion�that�the�Fed�needs�to�raise�rates�quickly�or�aggressively.�The�recent�US�jobs�data�releases�have�been�strong,�but�they�need�to�be�set�in�context�–�labour�participation�rates�in�the�US�are�still�at�40-year�lows.�
Markets�do�expect�the�Fed�to�act,�and�we�expect�the�FOMC�to�raise�rates�in�a�controlled�and�sensible�manner.�Nonetheless,�given�the�heavy�emphasis�that�markets�have�put�on�forward�guidance�and�the�Fed’s�‘dot’�plots,�there�is�still�the�risk�that�the�Fed�could�lose�control�of�its�own�narrative,�as�it�has�done�at�some�points�in�2015.�Markets�tend�to�become�unsettled�when�policymakers�flip�flop,�and�for�that�reason�it�is�important�that�the�Fed�remains�in�control�of�its�messaging�in�2016.
Global Annual Perspectives 2016
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The China slowdown – a continuing challenge for some emerging marketsThe�other�big�unknown,�from�our�perspective,�is�China.�An�economic�slowdown�is�ongoing�but�no-one�can�judge�with�any�certainty�in�terms�of�how�long�or�how�bad�it�could�be.�Our�own�assessment�is�that�economic�growth�will�be�below�the�7.5%�level�seen�in�prior�years,�but�will�remain�in�positive�territory,�supported�by�domestic�consumption.�For�growth�to�slip�below�0%�would�require�a�collapse�in�consumption�and�the�government�choosing�to�stand�aside�and�do�nothing�to�support�the�economy.�That�is�not�likely,�in�our�view.�Nonetheless,�the�slowdown�in�China�is�likely�to�be�challenging,�particularly�for�some�of�China’s�EM�peers,� and�there�are�no�examples�in�history�of�the�kind�of�credit�expansion�that�we� have�seen�in�China�having�a�happy�ending.
Are we closer to the next crisis than the last?The�main�issue�that�I�think�investors�need�to�consider�is�that�of�economic�growth,�and�why�it�is�still�so�low.�The�Lehman�crisis�was�more�than�seven�years�ago,�and�yet�outside�of�the�US,�growth�is�elusive.�In�2016,�we�think�that�investors�will�begin�to�question�some�of�the�policies�enacted�by�central�banks�and�whether�those�policies�are�helping�growth�or�hindering�it.�
There�is�a�growing�body�of�opinion�which�suggests�that�while�QE�has�created�the�conditions�for�companies�to�borrow�and�invest�in�their�businesses,�it�has�also�meant�that�‘zombie’�companies�that�should�have�failed�a�long�time�ago�have�been�kept�alive.�To�put�this�another�way,�the�process�of�‘creative�destruction’�has�not�been�allowed�to�run�its�usual�course�following�the�Great�Financial�Crisis,�and�as�a�result�the�world�now�finds�itself�awash�with�excess�capacity.�The�adverse�effects�of�this�are�being�amplified�by�the�ongoing�macroeconomic�slowdown�in�China.�Companies�with�differentiated�products�and�high�barriers�to�entry�can�still�prosper,�but�for�everyone�else�life�is�very�difficult.�The�fact�that�Lehman�occurred�over�seven�years�ago�also�means�that,�in�all�likelihood,�we�are�closer�to�the�next�crisis�than�we�are�to�the�last�one.�That�is�something�investors�should�keep�in�mind�when�they�are�building�portfolios�for�2016.
Continued low oil price may mean that some producers start to failOne�thing�that�we�can�say�for�certain,�assuming�that�everything�remains�the�same,�is�that�the�downward�pressure�on�headline�inflation�from�low�oil�prices�should�drop�out�of�the�reported�numbers�in�2016.�Indeed,�inflation�and�whether�it�moves�closer�towards�the�level�targeted�by�central�banks�will�be�crucial�as�that�is�likely�to�determine�whether�or�not�we�see�further�policy�support�from�the�Bank�of�Japan�and�European�Central�Bank.�
We�will�continue�to�monitor�the�oil�price�closely.�At�current�prices,�higher-cost�producers�and�some�of�the�more�marginal�shale�producers�are�losing�money,�but�some�will�keep�producing�in�order�to�generate�cash�flow.�While�these�producers�had�been�able�to�hedge�production�for�delivery�in�a�year’s�time�at�levels�materially�above�the�spot�price�(on�the�basis�that�oil�prices�would�bounce�back),�that�is�no�longer�the�case.�Indeed,�you�have�to�look�quite�a�long�way�along�the�oil�curve�to�find�prices�for�future�delivery�that�are�materially�above�where�prices�are�today.�It�is�therefore�likely�that�we�will�see�some�of�the�weaker�and�higher-cost�producers�fail�in�2016.�Energy�is�a�meaningful�component�of�the�US�high�yield�universe,�so�this�is�something�that�investors�need�to�watch.
Brexit uncertainty may increase volatilityOne�subject�that�will�occupy�more�airtime�in�2016�is�that�of�‘Brexit’�–�the�UK’s�potential�exit�from�the�European�Union.�Markets�are�currently�very�relaxed�about�this�issue.�As�we�saw�with�Scotland’s�referendum�on�its�membership�of�the�UK,�markets�can�become�complacent�in�the�run-up�to�a�referendum�and�this�can�create�short-term�volatility�when�investors�begin�to�realise�that�a�‘good’�outcome�is�no�longer�as�certain�as�it�once�seemed.�At�the�moment,�polls�suggest�that�most�Britons�would�vote�to�stay�in�the�European�Union,�but�such�an�outcome�cannot�be�taken�for�granted.�
Global Annual Perspectives 2016 | EQUITY VIEWPOINTS
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EQUITY VIEWPOINTS
William Davies Head of Global Equities
EQUITY VIEWPOINTS
OPTIMISM IN CAUTIOUS TIMESCaution aboundsMarkets�enter�2016�with�expectations�for�equities�generally�low.�Investors�appear�fearful�that�valuations�are�not�particularly�cheap,�industrial�spending�is�under�pressure�(due�to�the�low�oil�price)�and�there�is�growing�discussion�about�2017�heralding�an�albeit�mild�US�recession.�
In�emerging�markets,�commodity�exporters�have�been�pummelled�by�the�rout�in�the�commodity�markets�and�although�the�worst�fears�about�the�Chinese�slowdown�have�not�yet�been�realised,�concerns�remain.�Politically,�the�Middle�East�remains�the�proverbial�‘riddle,�wrapped�in�a�mystery,�inside�an�enigma’.� We�appear�no�closer�to�any�solution.�However,�in�Europe,�we�were�hypothesising�about�Greece�leaving�the�eurozone�a�year�ago.�This�now�seems�less�likely�although�nationalism�remains�a�threat.
Hence�there�are�many�reasons�to�be�cautious.�However,�I�am�of�the�view�that�whilst�the�global�economy�has�not�yet�reached�‘normality’�following�the�deep�recession�of�2008/9,�there�are�signs�of�normalisation�and�even�reasons�to�be�cheerful.�
USWhat�if�the�US�Fed�has�actually�‘played�a�blinder’�since�the�depths�of�the�recession?�QE1�provided�liquidity�and�financials�were�recapitalised.�QE3�helped�provide�stimulus�to�the�housing�market,�the�announcement�of�tapering�raised�yields,�and�actual�tapering�dampened�economic�growth�without�inducing�a�recession.�Now�interest�rates�have�started�to�rise.�I�would�expect�the�Fed�under�Janet�Yellen�to�do�as�it�says�and�only�raise�rates�whilst�the�US�economy�can�stand�it.�There�are�those�who�believe�that�the�Fed�will�need�to�reverse�its�December�2015�rate�rise�in�2016�and�those�who�believe�the�further�rate�rises� in�2016�will�help�bring�about�a�slowdown�and�potential�US�recession�in�2017.�
Global Annual Perspectives 2016 | EQUITY VIEWPOINTS
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EQUITY VIEWPOINTS
Perhaps�my�view�is�somewhat�Panglossian�but�I�believe�the�central�and�most�likely�scenario�for�the�US�economy�is�of�gentle�rate�rises�and�of�growth�somewhere�between�1.5�and�2.5%�over�the�next�couple�of�years,�fuelled�by�a�consumer�benefitting�from�lower�commodity�prices�(akin�to�a�tax�cut).�I’m�sure�there�will�be�bumps�along�the�way�but�this�central�scenario,�along�with�mild�inflation,�should�be�a�pretty�supportive�environment�for�equities.�Maybe�the�US�presidential�election�of�2016�will�provide�one�of�those�‘bumps’,�but�I�presume�the�more�radical�policies�mooted�to�get�candidates�elected�for�their�respective�parties�will�be�diluted�in�order�to�appeal�to�the�centre�and�therefore�makes�candidates�electable.�Hence�the�US�economy�seems�to�me�the�most�advanced�towards�‘normality’.�In�the�context�of�previous�cycles,�the�recovery�is�gentler,�interest�rates�will�be�lower�and�earnings�growth�will�be�more�modest,�but�on�the�flipside�the�pressures�of�higher�labour,�interest�and�commodity�costs�are�likely�to�be�less�severe,�so�maybe�in�this�cycle�current�elevated�profit�margins�can�stay�higher�for�longer.��
EuropeIf�the�US�economy�is�heading�towards�a�more�‘normal’�state,�other�developed�regions�lag.�In�the�eurozone�QE�continues,�but�at�least�there�is�now�positive�economic�growth,�i.e.�progress�from�2012/13.�This�growth�is�expected�to�continue,�although�probably�only�around�the�1.5%�rate,�and�that’s�with�the�help�of�QE�and�negative�interest�rates.�Politically,�the�EU�remains�a�mess,�but�the�mid-year�change�to�label�‘immigrants’�as�‘refugees’�helped�improve�acceptance�of�the�current�situation.�One�of�Europe’s�challenges�remains�the�demographic�headwind.�Immigration�has�helped�reverse�this�in�2015�and�this�trend�can�be�expected�to�continue�in�2016�and�beyond.�Although�improving�GDP�is�not�the�same�as�GDP�per�head,�it�nonetheless�helps�economic�activity�in�the�region�and�European�nominal�growth�in�aggregate.�Nevertheless,�although�acceptance�of�immigration�has�improved,�it�still�divides�opinion�and�helps�drive�support�for�more�nationalistic�and�less�inclusive�political�parties.�Globalisation�and�inclusivity�have�been�significant�contributors�to�global�economic�growth�over�the�past�decades.�It�would�be�disappointing�were�this�to�reverse.�Britain’s�vote�to�remain�in�the�European�Union�will�be�a�test,�as�could�elections�in�France�and�Germany�in�2017.�
JapanIn�2015�US�earnings�growth�failed�to�meet�expectations,�and�although�Europe�ex-UK�earnings�growth�will�probably�be�in�double�digits,�it�failed�to�meet�some�of�the�loftier�forecasts�made�mid-year.�Currency�factors�helped�in�Europe�and�hindered�the�US.�However,�in�Japan,�the�stock�market�enjoyed�a�third�year�of�strong�earnings�growth.�Obviously�the�weakness�of�the�yen�and�lower�commodity�prices�have�helped�over�that�time�but�more�recently�the�currency�tailwind�has�been�less�pronounced,�yet�companies�have�continued�to�deliver,�helped�by�improved�corporate�governance.�Japanese�valuations�do�not�look�stretched,�growth�is�expected�to�continue�and�the�outlook�appears�good.
Growth countriesEmerging�economies�have�attracted�much�attention�over�the�last�year.�The�commodity�exporters�such�as�Russia,�Brazil�and�South�Africa�have�been�under�extreme�pressure,�whilst�importers�such�as�India�have�enjoyed�a�better�time.�China�has�attracted�much�attention.�The�stock�market�boom�and�bust�added�to�instability�but�the�worst�fears�of�slowdown�failed�to�materialise.�The�authorities’�move�to�an�economy�less�driven�by�fixed�asset�investment�but�with�a�continued�strong�consumer�appears�to�be�under�control,�but�there�remain�fears�that�this�‘control’�is�illusory�and�the�decline�in�real�estate�investment�in�particular�will�lead�to�a�sharper�economic�slowdown�than�anticipated.�The�managed�decline�in�the�value�of�the�yuan�also�prompts�excitement.�My�view�is�that�its�value�versus�the�dollar�is�likely�to�decline�further,�but�not�at�a�rate�which�will�meaningfully�impact�stability.�Hence�the�slowdown�in�China�will�continue,�but�not�alarmingly�so,�and�consumption�growth�should�remain�strong.
So�my�view�of�the�world�is�that�economically�2016�will�bring�more�of�the�same�in�aggregate�–�gentle�growth�with�benign�inflation�and�low�interest�rates,�but�now�rising�in�the�US.�Not�terribly�exciting�really,�but�this�will�provide�support�for�equities�which�are�likely�to�enjoy�positive�but�not�excessive�returns.�To�my�mind,�this�is�a�more�constructive�view�than� that�of�many�market�participants.
Global Annual Perspectives 2016 | EQUITY VIEWPOINTS
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EQUITY VIEWPOINTS
RisksSo�what�could�derail�Pangloss?�Many�cite�the�decline�in�energy�and�more� broadly�commodity-related�capital�expenditure�as�being�an�indication�that� further�downward�economic�pressures�are�to�come.�I�agree�that�within�this�sector�there�will�continue�to�be�pressures.�I�also�agree�that�in�2016�this�will�likely�spread�so�that�bankruptcies�in�this�area�will�infect�a�number�of�banks�and�supporting�industries.�Nonetheless,�I�still�can’t�get�out�of�my�mind�that�for�developed�economies�which�are�generally�importers�of�commodities,�lower�commodity�prices�are�a�net�benefit.�Admittedly,�if�the�declines�were�gentler�the�destabilising�effects�of�the�hits�to�parts�of�the�economy�would�be�less�extreme,�but�the�consumer�is�undoubtedly�a�beneficiary.
We�have�discussed�rising�nationalism�and�populism�as�being�a�threat�to�economic�growth.�Certainly�rising�immigration�touches�nerves�in�certain�countries.�Over�the�past�year�global�trade�growth�has�come�under�pressure.� The�relationship�between�demand�for�commodities�and�trade�volumes�has� been�important�as�China’s�place�in�world�trade�has�ballooned�over�past�decades.�I�believe�the�shift�towards�a�more�balanced�Chinese�economy�is�depressing�the�growth�of�world�trade�volumes�versus�expectations�a�couple�of�years�back.�However,�whilst�in�2014�we�saw�the�breakdown�of�WTO�talks,�in�2015�we�saw�the�Trans-Pacific�Partnership,�Japan�improving�its�relations�with�China�and�South�Korea,�and�India�in�talks�to�boost�trade�with�many�nations.�Hence�whilst�OPEC�may�be�struggling�and�certain�nations�may�seem�increasingly�nationalistic,�there�has�also�been�evidence�of�improving�trade�relations�in�2015,�a�welcome�trend.
Linked�to�trade�are�political�risks.�They�remain�elevated�as�we�enter�2016,�especially�in�the�Middle�East.�In�Syria,�Bashar�al-Assad’s�government�battles� with�IS,�other�opposition�forces�and�the�Kurds.�It�used�to�be�said�that�your�enemy’s�enemy�is�your�friend.�However,�the�level�of�complication�in�the�Middle�East�is�extreme.�The�US�would�not�have�been�happy�with�Russia’s�annexation� of�Crimea�in�2014,�nor�Russia’s�support�of�the�Syrian�government,�which�Obama�asked�permission�to�fight�previously.�However,�the�US�would�support�Russia’s�fight�against�IS,�whom�the�US�is�also�at�conflict�with,�and�whom�the�Syrian�government�forces�battle.�The�Turks�battle�with�the�Kurds�and�IS,�but�shot� down�a�Russian�fighter�jet.�The�potential�for�escalation�remains,�but�if�anything�one�common�theme�is�emerging:�IS�is�the�common�enemy.�No�doubt�there�will�
be�many�twists�and�turns�in�2016,�and�there�remains�the�possibility�that�further�Paris-type�atrocities�will�occur�and�derail�confidence.�Thus�far�people�have�been�most�resilient�and�the�economic�impact�limited.
Rising equitiesHence�there�are�risks�to�my�somewhat�benign�view�that�equities�can�rise�in�2016.�Geopolitical�risk�will�not�disappear�and�it�remains�possible�that�the�Fed�‘gets�it�wrong’�and�growth�stalls�in�the�US�or�maybe�in�China,�Europe�or�Japan.�Nonetheless,�I�believe�a�central�view�that�growth�in�the�major�economies�remains�intact�and�that�earnings�can�also�grow�is�perfectly�credible.�Given�the�low�cost�of�debt,�companies�will�continue�to�buy�their�own�shares�and�each�other.�Consensus�2016�earnings�growth�forecasts�of�8%�in�the�US,�6%�in�Europe�as�a�whole,�11%�in�Japan�and�5%�in�Asia�ex-Japan�do�not�look�especially�demanding,�leaving�2016�PE�multiples�of�16.5x�in�the�US,�15.0x�in�Europe,� 14.0x�in�Japan�and�12.5x�in�Asia�ex-Japan,�or�15.2x�for�global�equities�as�a�whole�–�not�eye-wateringly�cheap�nor�especially�expensive.�In�my�view,�this�leaves�room�in�2016�for�high-single-digit�upside�for�global�equities,�giving�a�total�return�of�around�10%�(including�dividends)�on�the�back�of�my�expectation�that�the�central�case�of�gentle�economic�growth�should�be�delivered.
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STAYING ADAPTABLE AS MARKETS EVOLVEOpportunitiesAs�Mark�Burgess�has�discussed�in�his�article,�we�think�that�2016� should�provide�further�opportunities�for�active�investors.�In�2015,� active�managers�were�able�to�add�value�for�their�clients�by�avoiding� areas�such�as�mining�and�energy,�which�were�hit�hard�by�the�weakness� in�commodities�markets�and�the�economic�slowdown�in�China.�
Concerns�about�China�will�continue�into�2016,�as�the�slowdown�there�is�a�multi-year�phenomenon.�This�will�pose�further�challenges�for�the�mining�companies�and�other�commodity-related�firms.
One�thing�that�we�have�seen�return�with�a�vengeance�is�idiosyncratic�or�stock-specific�risk�–�Glencore�and�VW�are�just�two�recent�examples�in�Europe,�but�there�are�plenty�of�others.�Owning�the�broad�market�has�been�very�rewarding�over�the�past�few�years�as�US�and�UK�asset�prices�have�been�boosted�by�QE,�but�we�think�that�story�has�run�its�course.
To�put�this�another�way,�we�think�that�investors�will�have�to�work�very�hard�to�find�‘winners’,�as�organic�growth�is�likely�to�be�very�scarce�in�2016,�but�equally�investors�will�need�to�make�sure�that�they�avoid�company-specific�disappointments.�
Threats2016�is�likely�to�represent�a�transition�point�for�the�global�economy�as�the�US�Federal�Reserve�raises�interest�rates�from�extremely�low�levels.�Such�transition�points�are�usually�accompanied�by�a�pick-up�in�volatility,�and�that�is�why�we�are�relatively�cautious�about�the�outlook.�Cynics�say�that�the�Fed�is�only�raising�rates�so�that�it�has�room�to�cut�them�again�when�the�next�slowdown�arrives,�but�that�is�a�topic�for�another�day.
In�China,�the�authorities�will�have�their�work�cut�out�to�mitigate�the�effects�of�the�economic�slowdown.�In�the�interim,�Chinese�firms�will� try�to�export�their�excess�capacity�to�the�rest�of�the�world,�resulting�
Leigh Harrison Head of Equities, Europe
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in�a�tough�pricing�environment�for�many�companies�across�a�range�of�industries�and�sectors.�This�will�put�downward�pressure�on�companies’�earnings�and�profit�margins.�There�has�been�a�huge�credit�boom�in�China�and�the�way�in�which�the�authorities�deflate�the�credit�expansion�is�likely�to�have�a�significant�impact�on�how�financial�markets�perform�in�2016.�It�also�remains�to�be�seen�whether�China�will�maintain�its�currency�peg�to�the�US�dollar.�Concerns�that�China�could�further�devalue�its�currency�may�cause�some�uncertainty,�which�is�likely�to�be�unhelpful�for�stock�markets.
We’ve�already�seen�the�adverse�effects�of�China’s�slowdown�on�companies�that�produce�equipment�for�the�mining�industry,�but�now�the�weakness�is�spreading�out�to�other�industrials.�Indeed,�some�analysts�are�talking�about�a�recession�in�industrial�profits.�This�is�not�the�same�thing�as�an�economic�recession,�but�it�does�show�that�the�environment�for�some�companies�is�extremely�difficult.
As�William�Davies�and�others�have�noted�in�their�outlooks,�geopolitical�risks�are�rising�and�we�believe�that�they�are�likely�to�play�a�part�in�determining�the�performance�of�markets�in�2016.�There�is�a�growing�consensus�that�more�needs�to�be�done�to�tackle�terrorism�and�extremism�but�it�is�hard�to�see�any�quick�or�easy�solutions.�Markets�like�some�degree�of�certainty�and�that�is�something�that�the�current�geopolitical�environment�cannot�provide.�There�will�be�a�US�presidential�election�in�2016�and�that�may�also�unsettle�markets.
Other things to watch for in 2016The�one�thing�that�2015�has�shown�is�that�even�highly�respected�companies�can�come�unstuck.�Technology�is�changing�at�a�rapid� pace�and�affecting�industries�in�a�manner�that�few�of�us�would�have� been�able�to�anticipate�just�two�or�three�years�ago.�For�example,�the�flipside�of�the�emissions�scandal�in�the�autos�sector�is�that�it�could� lead�to�a�whole�new�range�of�products�and�innovations�that�allow� auto�manufacturers�to�meet�ever-tightening�emissions�requirements� without�them�having�to�resort�to�subterfuge.�That�could�throw�up� some�interesting�investment�opportunities.
Unfortunately,�assessing�the�impact�of�technological�change�is�far�from�straightforward;�‘killer’�and�ground-breaking�technologies�will�emerge,�but�there�will�also�be�failures,�and�it�is�difficult�to�identify�these�with�certainty.�Moreover,�there�may�be�longer-term�dynamics�–�such�as�the�advent�of�self-driving�cars�–�which�will�change�industries�in�a�manner�that�is�very�hard�to�judge�accurately.�For�example,�self-driving�cars�won’t�just�affect�car�manufacturers,�but�a�whole�raft�of�associated�industries�such�as�electronic�and�safety�equipment�manufacturers,�battery�and�power�supply�manufacturers�and�insurers.�The�perfect�driver,�from�an�insurer’s�perspective,�is�one�who�always�pays�his�or�her�premium�on�time�and�never�has�an�accident.�In�future,�cars�could�be�regarded�in�much�the�same�way�that�taxis�or�other�private�hire�vehicles�are�now,�and�older�drivers�who�would�have�had�to�give�up�their�driving�licence�altogether�will�be�able�to�get�around�more�easily�(and�more�safely)�than�they�do�now.�
Climate�change�is�another�subject�where�the�long-term�investment�consequences�could�be�profound.�The�coal�industry�is�feeling�the�full�force�of�climate�change�legislation�and�institutional�reluctance�to�hold�assets�related�to�coal�mining�and�hydrocarbons�at�the�moment,�but�it�won’t�be�the�only�area�to�be�affected.
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Of�course,�some�of�the�companies�that�will�change�the�investment�landscape�in�the�future�won’t�be�investable�for�equity�investors�yet�–� a�lot�of�them�are�start-ups�and�not�traded�on�any�stock�exchange.�However,�there�will�be�opportunities,�as�well�as�winners�and�losers� as�the�process�of�change�occurs.�This�is�where�an�active�and�selective�investment�approach�can�make�a�difference,�in�our�view.
What else should investors consider?Investors�must�keep�their�eyes�and�ears�open�and�be�able�to�differentiate�between�what�is�important�and�what�is�just�market�‘noise’.�Unfortunately,�we�live�in�an�age�of�information�overload�where�crucial�pieces�of�information�are�sometimes�buried�in�other�pieces�of�information�that�may�have�little�or�no�consequence�from�an�investment�perspective.�Investors�need�to�work�out�what�is�important�and�then�position�themselves�appropriately,�and�crucially�it�is�best�if�this�can�be�done�before�other�investors�have�adopted�the�same�positioning.�For�example,�growth�and�momentum�strategies�have�worked�very�well�in�2015,�but�that�may�not�be�the�case�in�2016.�At�the�moment,�it�appears�that�companies�with�strong�balance�sheets�and�good�earnings�visibility�will�be�in�demand�in�2016�as�we�move�into�a�more�uncertain�economic�environment�where�growth�remains�challenged.�At�the�same�time,�however,�investors�still�need�to�think�about�what�a�business�is�likely�to�be�worth�in�the�longer�run�so�that�they�don’t�overpay�for�the�shares.
In�short,�investors�need�to�be�adaptable�and�realise�that�financial�markets�evolve�continuously.�Working�out�when�things�are�about�to�change,�and�being�positioned�for�those�changes�before�the�wider� market�has�reacted,�is�very�important.�The�English�economist,� John�Maynard�Keynes,�summed�up�this�challenge�very�well:� “It�is�largely�fluctuations�which�throw�up�the�bargains�and�the� uncertainty�due�to�fluctuations�which�prevents�other�people�from� taking�advantage�of�them.”
Thus in a nutshell, 2016…Overall,�we�believe�that�2016�could�be�quite�a�challenging�year,�as�earnings�and�dividend�growth�are�likely�to�be�quite�modest.�Discount�rates�will�rise�as�the�Federal�Reserve�increases�interest�rates,�reducing�the�nominal�value�of�future�cash�flows�and�profits.�However,�by�taking�a�considered�investment�approach,�we�believe�it�should�be�possible�to�generate�reasonable�risk-adjusted�returns.�
“�It�is�largely�fluctuations�which�throw�up�the�bargains�and�the� uncertainty�due�to�fluctuations�which�prevents�other�people� from�taking�advantage�of�them.”
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Soo Nam NG Head of Asian Equities
ASIAN EQUITY OUTLOOKWhile�much�coverage�is�devoted�to�China’s�economic�slowdown�and�to�Asian�equity�market�volatility,�investors�can�find�value�in�sectors�that�play�on�growth�in�the�region’s�fast-transitioning�economies.
Asia�continues�to�be�misunderstood�as�it�goes�through�a�process�of�economic�transition.�China�is�still�the�key�driver�for�the�region�because� of�the�size�of�its�economy�and�because�a�lot�of�markets�in�the�region�have�exposure�to�China.�India�is�an�economic�power�in�its�own�right� but�is�more�insular.
The�slowdown�of�the�Chinese�economy�(from�10.6%�growth�in�2010�to�7%�this�year)�has�been�extensively�analysed.�However,�Asian�companies�have�been�adjusting�to�this�more�modest�rate�of�expansion�for�a�number�of�years�and�corporate�strategies�and�cost�bases�have�been�recalibrated.
There�is�considerable�evidence�to�suggest�that�the�Chinese�economy�can�achieve�a�soft�landing�through�a�combination�of�fiscal�and�monetary�measures.�The�government�is�talking�about�GDP�growth�of�approximately�6.5%�over�the�next�three�years�and�the�consensus�numbers�reflect�that�expectation.�
The�IMF’s�decision�to�classify�the�renminbi�as�a�freely�usable�currency�from�1�October�2016�is�further�testament�to�the�progress�of�reform�over�recent�years.
On�the�macro�front�we�are�looking�at�a�relatively�benign�environment,�which�anchors�a�positive�case�for�investing�in�Asia�ex�Japan.�In�fast-transitioning�economies�it�is�important�to�look�beyond�averages/aggregate�figures�into�sectors�that�are�growing�faster�than�the�overall�economy.
In�Asia,�this�is�linked�to�the�rise�of�services�for�the�middle�class�–�such�as�insurance�–�and�the�growth�of�the�online�economy.�Ping�An�Insurance,�AIA�Group,�Baidu�and�Alibaba�are�examples�of�interesting�companies�in�these�sectors.�
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Another�sector�we�like�across�both�developing�and�emerging�Asian�economies�is�healthcare.�There�are�some�strong�healthcare�and�pharmaceutical�names�in�Australia�(Healthscope,�Ramsay�Health�Care,�CSL)�and�China�(China�Biologic�Products)�who�are�tapping�into�the�requirements�of�an�ageing�population�across�Asia�and�the�rising�demand�for�quality�healthcare.
Infrastructure�companies�should�benefit�if�the�Chinese�government�invests�in�major�projects�to�boost�growth�–�CRRC�(China�Railway�Rolling�Stock�Corporation)�plays�well�into�this.�
Domestic�consumption�and�investment�demand�will�therefore�drive�growth�in�Asia.�There�are�a�number�of�Asian�companies�at�the�forefront�of�technological�innovation,�for�example�selective�chip�makers�and�electronic�components�manufacturers�in�Taiwan�and�South�Korea,�who�will�continue�to�excel�on�the�export�front.
We�continue�to�be�underweight�natural�resources�because�demand�and�supply�will�remain�challenging�in�2016.�Mid-market�products�including�those�in�the�electronics�and�automotive�sectors�may�face�an�intensified�squeeze�by�competition�from�high-end�brands�and�entry�level�‘value-for-money’�products.�
The�quality�of�companies�in�Asia�is�improving�through�greater�focus�on�competitive�advantages,�sustainable�profitability�and�corporate�governance,�which�in�turn�delivers�more�resilient�earnings�and�dividend�streams.�
It�is�therefore�important�that�investors�do�not�become�fixated�with�macro�developments.�While�recent�events�such�as�the�Chinese�domestic�market�rout�and�the�mini-devaluation�of�the�renminbi�have�led�to�increased�market�volatility,�they�have�also�created�opportunities�for�investors�to�look�beyond�the�headlines�into�individual�stocks�to�find�exceptional�value,�while�Asian�equities�are�still�generally�cheap.
Quick view: What to expect from Asian equity markets in 2016
n Opportunities:�The�rise�of�the�middle�class�is�boosting�providers�of�services�such�as�healthcare�and�insurance.
n Threats:�Rapidly�transforming�consumer�behaviour�and�aggressive�competition�in�selective�sectors.�
n General outlook:�Market�participants�have�adjusted�to�the�slower�pace�of�economic�growth,�offering�a�cleaner�slate�to�assess�the�forward-looking�merits�of�Asian�equities.
n What should investors look out for?�Companies�that�are�undervalued;�higher�growth�sectors�in�China;�progress�in�policy�reforms/implementation�in�Indonesia�and�Thailand.�
n What should investors consider?�Opportunities�to�tap�into�volatility.
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Melda Mergen Director US Equities
ACTIVELY BUILDING PROFITABLE PORTFOLIOS
“�Although�higher�volatility�means�higher�risk,�it�also�provides�active�managers�with�opportunities�to�produce�higher�returns.”
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Return spreads between outperforming stocks and the overall market are still substantial
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Return spreadOutperformers Underperformers
Prior 12-month total return
Sources: Columbia Threadneedle Investments and S&P Capital IQ ClariFi, 11/15
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Return spreads between outperforming stocks and the overall market are still substantial
Prior 12-month total return.Source: ColumbiaThreadneedle and S&P Capital IQ ClariFi, November 2015.
Building�a�well-diversified�portfolio�can�be�a�daunting�task.�With�so�many�strategies�to�choose�from,�a�challenging�market�environment,�and�the�fact�that�all�portfolio�managers�are�not�expected�to�outperform�all�the�time,�it’s�not�easy�finding�the�right�mix�of�investments�to�meet�your�financial�goals.�Investors�are�no�longer�prepared�to�reward�active�managers�for�market-driven�beta�performance,*�but�expect�these�managers�to�prove�their�skill�by�producing�positive�alpha.**
As�portfolio�managers,�we�face�the�same�dilemma�every�day,�namely�finding�and�managing�the�right�combination�of�investments�to�help�our�clients�reach�their�desired�outcomes.�Did�you�know�that�only�49%�of�S&P�500�stocks�on�average�have�outperformed�the�market�since�1989?�Despite�generally�low�hit�rates,�there�is�still�significant�return�spread�between�outperforming�stocks�and�the�market.�With�the�help�of�portfolio�construction�techniques,�we�can�seek�better�risk-adjusted�returns�by�balancing�stock�characteristics�at�the�portfolio�level.�
Producing repeatable outcomesConsistency�is�very�important�when�choosing�active�strategies.� We�believe�that�a�consistently�applied�investment�philosophy� to�identify�and�exploit�mispriced�stocks�can�produce�repeatable� investment�outcomes�over�time.�Investing�in�active�managers� with�dependable�styles�can�help�you�to�build�a�portfolio�with� reliable�investment�performance.�
Diversification�remains�a�cornerstone�of�portfolio�construction.� We�believe�that�picking�active�strategies�with�lower�excess�return�correlations�is�a�better�approach�than�looking�at�each�manager’s�performance�and�volatility�separately.�
* The beta of an investment portfolio is a measure of the amount of risk inherent to its exposure to the broad market. ** Alpha is the idiosyncratic component of an investment’s return not explained by the relationship to the broad market.
Separating the winners from the losersThe�tide�will�not�raise�all�boats�in�2016.�With�diverging�monetary�policies�around�the�globe,�secular�headwinds�in�commodity�markets,�increased�geopolitical�risk�and�slowing�global�growth,�investors�will�continue�to�rely�on�active�managers�who�can�identify�the�winners�from�the�losers.�
We�expect�market�volatility�to�remain�high�in�2016.�Although�higher�volatility�means�higher�risk,�it�also�provides�active�managers�with�opportunities�to�produce�higher�returns.�Particularly,�when�secular�changes�similar�to�what�we�are�experiencing�today�push�return�spreads�wider,�the�market�indices�are�designed�to�include�both�the�winners�and�the�losers.�Active�managers�have�the�opportunity�to�invest�only�in�the�companies�that�benefit�from�these�changing�trends.
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ARE ENERGY STOCKS HEADED FOR A FIFTH YEAR OF UNDERPERFORMANCE?Four years and counting Energy�stocks�have�underperformed�the�broader�market�for�a�fourth�consecutive�year.�They�have�also�posted�the�lowest�returns�among�the�10�S&P�500�sectors�over�both�a�three-�and�five-year�time�horizon,�and�rank�second�lowest�(above�only�financials)�over�the�past�10�years.
Oil prices are only part of the problemThe�long-term�relative�performance�of�energy�stocks�versus�the�broader�market�typically�correlates�with�the�price�of�oil.�Energy�stocks�performed�very�well�during�both�the�1970s�and�2000s�when�oil�prices�rose�and�underperformed�during�most�of�the�1980s�when�oil�prices�declined.�
“�Outperformance�of�energy�stocks�in�2016�will�require�an�earlier�than�expected�oil�price�recovery.”
Jonathan Mogil Portfolio Manager and Senior Analyst
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The close correlation between energy stocks’ relative performance and oil prices
Source: Ned Davis Research, Bloomberg, 11/25/15
Annual relative performance of energy vs. the market (1973-2015)
The close correlation between energy stocks’ relative performance and oil prices
5-ye
ar c
umul
ativ
e (%
)
Annu
al re
lativ
e re
turn
(%
)
-60
-40
-20
0
20
40
60
80
100
120
0
20
40
60
80
100
120
100
150
200
250
300
-30
-20
-10
0
10
20
30
40
50
60
Annual relative performance
Rolling 5-year relative performance
Source: Bloomberg, 12/09/15Data for 2015 is year-to-date average up to December 9.
Average Brent Crude oil priceS&P energy vs. market
73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15
Tota
l ret
urn
($)
Pric
e pe
r bar
rel (
$)
1973
2015
2013
2011
2009
2007
2003
1999
1993
1995
1989
2005
2001
1997
1991
1987
1985
1983
1981
1979
1977
1975
Source: Bloomberg, December 2015 Data for 2015 is year-to-date average up to 9 December.
The�sharp�contraction�in�oil�prices�is�largely�responsible�for�energy’s�weak�recent�performance,�although�many�other�factors�are�to�blame,�some�of�which�have�been�in�place�for�several�years.
Corporate�returns�have�been�steadily�deteriorating�since�the�middle�of�the�last�decade�as�a�result�of�record�levels�of�capital�spending�and�easy�access�to�capital.�With�oil�prices�recently�below�$40�per�barrel,�the�energy�sector�is�being�forced�to�focus�on�lowering�its�cost�structure,�improving�operational�and�capital�efficiencies�and�spending�within�its�means.�
Can�the�underperformance�continue? Statistically�speaking,�a�losing�run�of�five�or�more�years�for�any�sector�is�par�for�the�course�and�has�occurred�on�numerous�occasions�over�the�past�50�years.
Reversing energy’s losing streakFor�energy�shares�to�outperform�the�broader�market,�higher�oil�prices�and�a�more�disciplined�business�model�must�emerge.�Sentiment�towards�oil�prices�remains�negative.�The�lower-for-longer�view�is�widely�accepted�throughout�the�investment�community,�and�the�prospect�for�an�oil�price�recovery�before�late�2016�or�early�2017�seems�unlikely.�Equity�investors,�however,�appear�to�be�an�optimistic�group.�Valuations�today�look�beyond�the�current�downturn�to�a�time�when�oil�prices,�earnings�and�cash�flows�will�all�be�higher.�
The�timing�of�oil’s�recovery�will�likely�dictate�how�energy�stocks�will�fare�versus�the�broader�market�in�2016:
n Early surprise:�An�oil�price�recovery�in�early�to�mid-2016�will�likely�catch�the�market�off�guard,�providing�a�positive�catalyst,�especially�if�the�higher�prices�are�perceived�to�be�sustainable.�
n A 2017 recovery:�Expectations�for�a�gradual�recovery�in�2017�will�likely�not�be�enough�of�a�catalyst�to�move�the�stocks�higher�during�2016.
n Lower for even longer:�Should�oil�market�imbalances�persist�throughout�2016,�pushing�out�the�recovery�out�beyond�2017,�energy�stocks�will�most�likely�face�another�difficult�year.
Oil�markets�will�likely�remain�oversupplied�for�most�of�2016,�although�signs�of�the�next�oil�cycle�are�already�starting�to�emerge.�Declining�US�shale�activity�(a�positive)�and�the�continued�market-share�war�within�OPEC�(a�negative)�are�only�two�parts�of�the�supply�equation.�Sharp�declines�in�capital�spending�outside�of�these�two�regions�have�been�underway�for�almost�two�years�and�should�continue�in�2016,�further�delaying�future�supplies�to�accommodate�modest�demand�growth�and�natural�decline�rates.�While�it�is�difficult�to�predict�exactly�when�the�supply/demand�imbalance�will�reverse,�a�gradual�recovery�in�2017�remains�the�most�probable�outcome�–�one�that�is�unlikely�to�provide�enough�of�a�catalyst�for�energy�stocks�to�outperform�the�broader�market�during�2016.�
Global Annual Perspectives 2016 | FIXED INCOME VIEWPOINTS
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FIXED INCOME VIEWPOINTS
FIXED INCOME VIEWPOINTS
2016 – A YEAR FOR TREADING CAREFULLYWe�face�a�year�where�interest�rates�will�rise,�where�the�US�and�European�economies�will�continue�to�grow�and�where�the�financial�world�will�need�to�contend�with�historically�low�energy�prices,�heightened�geopolitical�risks�and�a�Chinese�economy�which�is�rebalancing�from�an�industrialised�nation�to�a�more�consumption-led�economy.�Many�of�these�background�features�remain�interlinked.
Jim Cielinski Global Head of Fixed Income
Global Annual Perspectives 2016 | FIXED INCOME VIEWPOINTS
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FIXED INCOME VIEWPOINTS
We�question�(yet�again)�the�low�level�of�government�bond�yields,�ponder�the�performance�of�corporate�credit�markets�as�we�near�the�end�of�the�corporate�credit�cycle�and�ask�whether�we�are�at�a�turning�point�for�emerging�markets�economies�after�a�turbulent�four-year�period.
Against�a�background�littered�with�so�many�risks,�are�potential�returns�sufficient�to�persuade�investors�to�recycle�or�indeed�add�to�their�fixed�income�exposures,�and�if�so,�where?
The economic outlook and the policy response We�expect�to�see�reasonable�rather�than�robust�ongoing�recovery� in�developed�market�economies�as�we�head�into�2016.
Economic�performance�will�remain�supported�by�expansionary�policy�conditions�and�an�encouraging�environment�for�the�consumer�(including�much�lower�unemployment,�decent�real�wage�growth�and�the�dividend�of�lower�energy�prices).�Meanwhile,�for�US�and�UK�manufacturers,�the�currency�strength�mixed�with�a�more�depressed�external�demand�environment�provides�a�form�of�negative�offset�for�growth�as�a�whole.� The�collateral�damage�from�the�global�commodity�and�energy�shocks�includes�collapsing�investment,�job�cuts�and,�undoubtedly�for�some�companies,�bankruptcy.
The�present�very�low�headline�inflation�rate,�suppressed�in�the�near�term�by�this�global�energy�shock�and�declining�commodity�prices,�comes�at�a�time�of�non-existent�wage�pressures.�This�has,�to�an�extent,�bailed-out�central�banks�from�being�seen�as�being�‘behind�the�curve’�in�the�eyes�of�the�financial�markets.�The�lack�of�wage�pressure�is�also�perhaps�explained�(in�a�circular�sense)�by�relatively�decent�real�wage�growth,�which�will�be�undone�in�coming�months�(as�year-on-year�comparisons�become�less�favourable)�unless�fuel�and�commodity�prices�continue�to�decline�meaningfully.�It�seems�then�that�the�downside�surprises�to�inflation�are�gradually�drawing�to�a�close.
We�sit�at�a�well-signposted�crossroads�in�terms�of�monetary�policy� with�the�US�Federal�Reserve�raising�rates�for�the�first�time�since�2006,� to�be�followed�by�the�UK�in�the�second�half�of�2016�or�later.�In�Europe,�
in�the�face�of�an�inflation�rate�that�is�below�the�ECB’s�mandated�target,�the�ECB�has�enacted�the�opposite�policy�and�lowered�rates�into�deeply�negative�territory�and�extended�QE.�We�must�question�whether�‘that�is�it!’�in�terms�of�policy�stimulus.
Given�our�own�forecasts�for�growth�and�inflation,�the�threshold�for�additional�easing�from�the�ECB�or�Bank�of�Japan�is�very�high.�There�is�a�good�chance�then�that�the�developed�market�easing�cycle�is�now�behind�us.
Government bond marketsWe�started�2015�pondering�the�possibility�of�a�material�correction�in�government�bond�markets�and�so�it�is�with�a�sense�of�déjà�vu�that�2016�will�begin�with�the�same�concerns.�Can�markets�shake�off�rising�interest�rates�and�US�economic�strength�and�be�‘reassured’�by�the�dollar’s�strength�and�the�collapse�of�energy�and�metals�prices?
Perhaps�without�a�(potentially�dangerous)�belief�that�‘this�time�is�different’�it�is�hard�to�find�any�real�value�in�either�nominal�or�real�yields� in�major�markets.�This�comes�at�a�time�when�central�banks�have�become�owners�of�such�large�swathes�of�bonds�that�they�have�in�some�senses�‘robbed’�most�of�the�returns�from�investors�going�forward�–�in�a�clear� and�deliberate�strategy.�
In�a�repeat�of�where�we�were�at�the�start�of�last�year,�it�appears�that�core�government�bonds�yields�offer�a�poor�investment�prospect�in�both�nominal�and�inflation-adjusted�terms.�As�mentioned,�real�yields�have�been�suppressed�by�global�policy�action�and�as�we�turn�that�corner,�there�will�be�heightened�pressure�for�normalisation.�Hence,�we�forecast�yields�that�are�a�shade�higher�by�the�end�of�2016�but�against�a�background�of�such�low�inflation�that�the�correction�is�not�expected�to�be�the�material�one�many�keep�expecting.
Emerging market debt It�is�likely�to�be�another�year�in�which�weaker�economic�growth�will�weigh�on�emerging�market�sentiment,�though�we�expect�spreads�to�stabilise�somewhat�after�the�Fed’s�rate�rise.�
Global Annual Perspectives 2016 | FIXED INCOME VIEWPOINTS
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FIXED INCOME VIEWPOINTS
China�in�particular�will�show�more�signs�of�running�at�a�slower�growth�rate�but�we�see�a�so-called�‘hard�landing’�as�unlikely�given�the�policy�tools�available.�In�practice�we�think�a�further�currency�devaluation�of�around�10%�might�be�expected.�But�the�use�of�these�tools�will�create�further�turbulence�in�emerging�markets.
In�2016,�we�feel�that�there�will�be�opportunities�for�investment�between�individual�countries�and�in�terms�of�overall�macro�positioning.�As�at�the�start�of�2016,�we�were�invested�with�overweights�in�Argentina,�Serbia�and�Hungary,�and�underweight�positions�in�Brazil,�China�and�commodity-linked�Latin�American�countries�including�Chile�and�Peru.�We�are�not�out�of�the�woods�yet!
Corporate credit marketsPolicy�conditions�will�remain�accommodative�and�supportive�for�corporate�credit�markets�in�general�during�2016.�The�benign�environment�of�relatively�low�growth�and�low�inflation�will�help�rein�in�the�nascent�‘animal�spirits’�stalking�corporate�boardrooms�and�that�in�turn�will�ease�the�risk�of�higher�corporate�default�rates.�Defaults�will�rise,�though�we�expect�these�to�remain�relatively�isolated�to�the�US�commodity�and�energy�sectors.�This�will�not�be�such�an�issue�in�Europe�given�the�very�different�market�composition.�However,�the�corporate�credit�improvement�story,�long�a�positive�feature�of�credit�markets,�is�told�and�we�are�in�the�final�chapters�of�this�present�cycle.�
This�would�make�us�more�pessimistic�about�the�asset�class�were�it�not�for�the�fact�that�valuations�or�spreads,�expensive�in�the�spring�of�2015,�have�revalued�to�levels�that�are�attractive�compared�to�history�–�especially�in�the�US.�
Hence�we�retained�a�neutral�to�modest�overweight�in�corporate�bonds�into�2016.�For�European�high�yield,�the�heightened�M&A�activity�could�actually�prove�positive�with�a�number�of�such�companies�being�the�target�for�their�better-rated�investment-grade�cousins.�For�developed�market�banks,�the�lengthy�period�of�credit�rehabilitation�is�coming�to�a�close�at�a�time�when�spreads�are�at�similar�levels�to�corporate�issuers.�
Conclusions and expected market returnsMarket�risks�persist�without�the�realistic�prospect�of�meaningful�investment�reward.�The�risk�of�rising�corporate�defaults,�the�oil�price�shock,�heightened�geopolitical�and�economic�risks�coming�together�at� a�time�of�policy�shift�provide�plenty�to�concern�investors,�especially�in� a�time�of�questionable�market�liquidity.
Against�these�challenges,�yields�and�potential�returns�appear�low�and�bond�markets�may�not�be�able�to�provide�the�traditional�diversification�benefits�that�they�once�did.�
So�where�should�investors�look�for�income?�We�continue�to�prefer�shorter-duration�asset�classes�where�interest�rate�risk�in�limited,�including�cash-benchmarked�absolute�return�strategies�as�well�as� some�exposure�to�spread�markets,�including�investment�grade�and�European�high�yield�corporate�bonds.�Mind�your�eye!
Global Annual Perspectives 2016 | FIXED INCOME VIEWPOINTS
FIXED INCOME VIEWPOINTS
Colin Lundgren Head of US Fixed Income
DURATION, LIQUIDITY, AND DEFAULTS, OH MY! Duration-bitten�portfolio�managers�may�be�capitulating�on�US�interest�rates�at�just�the�wrong�time.�Positioning�surveys�suggest�professional�investors�are�less�afraid�of�higher�rates�than�retail�investors.�Also,�the�market�is�priced�well�below�the�US�Federal�Reserve’s�current�guidance�for�the�path� of�the�federal�funds�rate.�In�other�words,�the�interest�rate�market�is�not�well�set�up�for�a�stronger�economy,�higher�inflation�or�anything�more�than�a�few�Fed�rate�hikes.
The market is priced below the Fed’s interest rate projectionsSh
ort-t
erm
inte
rest
rate
(%
)
The market is priced below the Fed’s interest rate projections
-1
0
1
2
3
4
2015
Projected SEP median* Market expectations
Source: Bloomberg, 12/15*Median based on the Fed’s Summary of Economic Projections (SEP), 12/15
2016 2017 2018 Longer term
Source: Bloomberg, December 2015.*Median based on the Fed’s Summary of Economic Projections (SEP), December 2015.
Gene Tannuzzo Senior Portfolio Manager
22
Global Annual Perspectives 2016 | FIXED INCOME VIEWPOINTS
23
FIXED INCOME VIEWPOINTS
Dealer inventory slump threatens bond market liquidity
Dea
ler i
nven
torie
s of
cor
pora
te b
onds
Dealer inventory slump threatens bond market liquidity
Apr Jun Aug Oct Dec AprFeb Jun Aug Oct Dec AprFeb Jun Aug Oct Nov
Investment grade money market High yield money market
Source: Federal Reserve Bank of New York, 11/15
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
20,000
2013 2014 2015
Source: Federal Reserve Bank of New York, November 2015.
Bond market liquidity: From bad to worse?Liquidity�will�continue�to�nag�the�bond�market,�and�not�just�in�risk-off�environments.�Regulatory�changes�help�explain�why�dealer�inventories�are�at�or�near�all-time�lows,�and�they�are�no�longer�the�source�of�liquidity�they�once�were.�Also,�we�can’t�necessarily�take�comfort�in�size.�Mega�funds�may�be�especially�challenged�to�navigate�changing�market�conditions,�respond�to�large�flows�or�invest�in�cash�bonds.�Morningstar’s�non-traditional�and�multi-sector�fixed-income�categories�include�six�mutual�funds�with�more�than�$15�billion�in�assets,�and�two�funds�that�exceeded�$30�billion�as�of�November�30,�2015.�Unfortunately,�the�surprise�may�be�bond�market�liquidity�going�from�bad�to�worse.
Beyond the headlines Defaults�are�on�the�rise,�but�the�headline�number�masks�the�real�story.�High-yield�spreads�are�currently�compensating�investors�for�a�5%�default�rate,�well�above�the�current�rate�and�slightly�higher�than�the�long-term�average.�Our�internal�default�forecast�is�5.5%�in�2016�and�6.4%�in�2017.�But�the�increase�in�defaults�is�expected�to�be�largely�concentrated�in�
energy,�metals�and�mining.�We�expect�energy�defaults�to�exceed�20%�in�2016�and�be�close�to�that�level�in�2017.�Excluding�those�troubled�areas,�we�think�defaults�will�be�less�than�3%�in�2016�and�under�5%�in�2017.�
Therefore,�higher�defaults�should�warrant�some�caution�and�careful�security�selection,�but�a�broad�repricing�of�the�high�yield�market�may�provide�more�than�enough�yield�compensation�to�produce�attractive�risk-adjusted�returns�in�2016.�Indeed,�based�on�our�proprietary�model�of�default�rates,�current�credit�spreads�already�price�in�rising�defaults�throughout�2016�and�2017.
Default rates expected to rise in 2016–2017Default rates expected to rise in 2016–2017
Def
ault
rate
(%
)
Moody’s global speculative-grade default rate Model default rate
Sources: Moody’s, Columbia Threadneedle Investments proprietary research, 11/15
0
2
4
6
8
10
12
14
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Sources: Moody’s, Columbia Threadneedle Investments proprietary research, November 2015.
“�High�yield�may�produce�some�of�the�most�attractive�returns�in�fixed�income,�despite�higher�defaults.”
Global Annual Perspectives 2016 | FIXED INCOME VIEWPOINTS
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FIXED INCOME VIEWPOINTS
ASIAN FIXED INCOME OUTLOOKWith�limited�issuance�and�strong�demand�set�to�fuel�outperformance�in�Asian�bond�spreads,�investors�should�be�able�to�look�forward�to�favourable�returns�from�debt�markets�in�the�region�over�the�coming�months.
Given�expectations�both�on�global�interest�rate�movements�and�currency�volatility�for�2016,�our�investment�strategy�continues�to�favour�US�dollar�denominated�Asian�fixed�income�markets.
Clifford Lau Head of Fixed Income, Asia
Global Annual Perspectives 2016 | FIXED INCOME VIEWPOINTS
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FIXED INCOME VIEWPOINTS
There are several reasons for this: n With�the�US�dollar�being�an�outperforming�currency�across�different�markets�and�regions,�investing�in�US�dollar�denominated�Asian�bonds�would�be�on�the�right�side�of�the�trade.
n We�believe�Asian�economic�fundamentals�and�overall�corporate�health�indicate�that�the�region’s�economies�are�broadly�well-financed.
n GDP�growth�has�been�underwhelming�in�2015,�but�we�don’t�expect�any�individual�economy�to�experience�serious�fiscal�difficulties.
Global�growth�rates�have�impacted�the�profitability�of�many�Asian�corporates,�particularly�those�trading�internationally�or�dependent�on�export�growth.�However,�corporates�in�the�region�have�been�actively�refinancing�maturing�debts,�which�in�a�low�interest�rate�environment�has�helped�bring�down�overall�leverage�ratios.�As�a�result,�global�investors�on�the�hunt�for�yield�are�expected�to�look�east�in�2016.
Fewer�Asian�companies�tapped�bond�markets�for�money�in�2015�and�this�trend�is�set�to�continue�while�demand�is�expected�to�remain�high.�We�believe�that�management�of�Asian�companies�will�remain�cautious�about�new�issuance�until�they�see�evidence�of�growing�demand�in�their�sectors.�Similarly,�we�don’t�expect�many�major�mergers�or�acquisitions�to�take�place�in�2016.
Reduced�issuance�could�be�constructive�for�Asian�bond�markets�by�driving�the�sector�to�outperform�and�there�has�been�increasing�demand�for�reallocating�assets�to�invest�in�Asian�bonds.�We�have�been�working�with�a�number�of�clients�from�within�and�outside�the�region�who�believe�Asian�markets�are�well�placed�for�asset�allocation.
There�is�much�talk�of�interest�rate�divergence�between�the�US�and�Japan�versus�Europe,�where�the�debate�has�been�whether�to�extend�QE.� While�there�is�not�the�same�discussion�taking�place�in�Asia�on�the� merits�of�injecting�liquidity�into�markets,�interest�rates�will�head�in� different�directions.
Looking�ahead,�there�are�likely�to�be�some�interesting�developments�in�China.�The�devaluation�of�the�renminbi�caught�the�FX�market�off-guard�and�Chinese�stocks�are�experiencing�volatility,�so�we�expect�the�Chinese�government�will�use�whatever�tools�are�at�its�disposal�to�suppress� market�volatility.
Quick view: What to expect from Asian fixed income markets in 2016
n Opportunities: The�ability�to�express�an�investment�opinion�in�a�single�market�in�different�ways�(for�example,�in�Indonesia�through�the�US�dollar�denominated�Indonesian�sovereign�bond�market;�the�local�currency�government�bond�market;�or�the�FX�market).
n Threats:�Uneven�economic�growth�across�Asia�leading�to�divergence� in�interest�rate�policy;�sluggish�global�economic�growth�impacting� Asian�exporters.
n General outlook:�Expectations�are�for�strong�relative�performance�in�the�Asian�bond�market�as�an�imbalance�between�supply�and�demand�drives�the�spread�to�outperform.
n What should investors look out for?�Surprises�in�Chinese�monetary�policy�as�the�country’s�government�seeks�to�quell�market�volatility�and�sustain�economic�growth.
n What should investors consider?�Strategies�designed�to�take�advantage� of�the�long�and�short�side�of�the�market.
Global Annual Perspectives 2016 | FIXED INCOME VIEWPOINTS
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FIXED INCOME VIEWPOINTS
EMERGING MARKETS STARTING TO LOOK ATTRACTIVEAfter�the�turbulence�of�the�past�few�years,�emerging�markets�(EM)�look�poised�for�a�rebound�in�2016.�Here’s�why:
n Key commodity prices should modestly recover:�Low�expectations�for�commodity�prices,�plus�commodity-dependent�EM�countries�that�have�largely�adjusted�to�lower�prices,�mean�even�a�modest�recovery�would�become�a�terms-of-trade,�growth�and�fiscal�tailwind�for�much�of�the�sector.
n Global growth has bottomed and should finally show year-on-year improvement:�EM�growth�in�particular�should�show�its�first�acceleration�in�five�years�and�is�expected�to�improve�from�about�4%�to�4.6%.�While�the�improvement�would�be�modest,�it�is�an�inflection�point�and�is�critical�to�improving�the�narrative�for�emerging�markets.
n The Federal Reserve rate-hiking cycle is a sign of confidence in US growth and comfort with the global economy:�A�low�trajectory�hiking� cycle�should�not�derail�EM�growth�and�investment,�and�it�could�help�reduce�uncertainty�if�accompanied�by�easing�from�the�European�and� other�central�banks.
Jim Carlen Senior Portfolio Manager
Global Annual Perspectives 2016 | FIXED INCOME VIEWPOINTS
27
FIXED INCOME VIEWPOINTS
Emerging market countries show improvementOver�the�last�decade,�the�investment�thesis�for�EM�has�been�better�balance�sheets,�better�growth�and�attractive�investment�opportunities.�The�commodity�collapse�was�a�setback�to�many�EM�growth�stories�and�exposed�weak�macroeconomic�policies�in�some�countries.�However,� a�critical�mass�of�EM�countries�is�turning�the�corner�with�policy�adjustments,�better�leadership�and�some�recovery�in�growth�(and�in� some�cases�all�three).
Russia�is�set�to�restart�growth�in�2016,�Turkey’s�new�market-friendly�government�will�address�some�long-delayed�structural�issues,�and�Indonesia�has�implemented�a�number�of�modest�structural�reforms�that�should�help�boost�growth.�Argentina�has�elected�a�market-friendly�president,�and�Brazil�may�finally�start�to�take�concrete�steps�toward�fiscal�adjustment,�which�could�spur�better�confidence�and�growth.�This�sample�of�improvement�stories�makes�up�more�than�40%�of�the�EM�bond�index�(JPM�EMBI�Global).
Emerging markets are not a monolithic sectorThere�are�still�some�tough�stories�in�the�sector,�and�the�market�is�less�likely�to�simply�hope�for�the�best�–�and�buy�the�cheapest�bond�–�than�may�have�been�the�case�in�other�recovery�years.�We�expect�the�EM�tailwinds�cited�above�to�be�quite�modest,�and�the�overriding�theme�for�the�foreseeable�future�will�be�the�level,�quality�and�sustainability�of�policies�and�economic�growth.�The�end�of�some�of�the�more�populist�EM�regimes,�or�at�least�their�neutralization,�signals�that�more�countries�should�get�their�policies�on�track.
Potential opportunity in Emerging Markets Foreign Exchange (EMFX)EMFX�and�local�debt�might�be�one�of�the�better�investment�opportunities�in�the�sector�in�2016.�With�attractive�valuations�and�the�reduction�in�EM�gloom�and�doom,�EMFX�should�benefit�from�better�investment�flows�as�investors�seek�to�tap�into�better�growth�and�reform�stories.�Given�how�far�the�US�dollar�has�rallied,�it�is�also�expected�to�be�less�of�a�headwind�to�EMFX�than�in�the�past.�
“�Emerging�markets�should�become�more�attractive�as�fundamentals�improve�and�investors�seek�to�tap�into�better�growth�and�reform�stories.”
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WILL OUTCOMES IMPROVE FOR DIVERSIFIED INVESTORS IN 2016? Investment strategy is all about decisions and outcomesEven�for�investors�who�are�sceptical�of�the�efficient�market�hypothesis,�there�is�no�denying�that�investing�is�difficult.�We�make�decisions�under�tremendous�uncertainty,�not�only�about�what�real�world�events�will�transpire�but�indeed�about�how�market�prices�will�react�to�these�events.�We�investors�must�make�decisions�in�the�presence�of�this�uncertainty,�knowing�that�not�all�of�them�will�pay�off.�Sometimes�good�decisions�are�met�with�bad�outcomes,�and�sometimes�bad�decisions�are�met�with� good�outcomes.�We�can�only�control�our�decisions�and�expect�that� the�good�ones�will�pay�off,�on�average,�over�the�long�run.
Jeff Knight Global Head of Investment Solutions, Co-Head of Global Asset Allocation
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“�We�believe�diversified�portfolios�will�fare�better�in�2016�than�in�2015”
Diversification is a good decision Diversification�offers�one�of�the�best�opportunities�in�all�of�investing.� By�combining�dissimilar�investments�in�our�portfolios,�we�earn�the�weighted�average�of�the�returns�of�these�investments.�However,�we�do�not�retain�the�weighted�average�volatility�(risk)�of�these�investments.�Because�we�can�usually�expect�some�of�our�investments�to�pay�off�even�while�others�struggle,�we�generally�see�that�diversification�reduces�some�of�the�ups�and�downs�of�investing�at�the�overall�portfolio�level.�For�this�reason,�diversified�portfolios,�over�time,�can�offer�more�return�per�unit�of�risk�than�concentrated�ones.
Diversified portfolios struggled in 2015, but 2016 should be better
Portf
olio
retu
rn (
%)
Diversified portfolios struggled in 2015, but 2016 should be better
Source: Columbia Threadneedle Investments, 12/15Equal weighted average of 10 major markets, 1970–2015: U.S. stocks represented by S&P 500 Index, international stocks represented by MSCI EAFE Index, U.S. government bonds represented by Barclays U.S. Treasury Index, international government bonds represented by Citigroup World Non-U.S. Government Bond Index, high yield represented by Barclays High Yield Index, investment grade represented by Barclays U.S. Corporate Bond Index, securitized represented by Barclays U.S. Mortgage-Backed Securities Index, TIPS represented by Barclays Global Inflation-Linked Index, commodities represented by Dow Jones-UBS Commodity Index and REITs represented by FTSE/NAREIT Index. If a particular index did not have a sufficient track record back to 1970, a representative index of similar risk/return characteristics was used.
-20
-15
-10
-5
0
5
10
15
20
25
30
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2015
Source: Columbia Threadneedle Investments, December 2015.Equal weighted average of 10 major markets, 1970–2015: US stocks represented by S&P 500 Index, international stocks represented by MSCI EAFE Index, US government bonds represented by Barclays US Treasury Index, international government bonds represented by Citigroup World Non-US Government Bond Index, high yield represented by Barclays High Yield Index, investment grade represented by Barclays US Corporate Bond Index, securitized represented by Barclays US Mortgage-Backed Securities Index, TIPS represented by Barclays Global Inflation-Linked Index, commodities represented by Dow Jones-UBS Commodity Index and REITs represented by FTSE/NAREIT Index. If a particular index did not have a sufficient track record back to 1970, a representative index of similar risk/return characteristics was used.
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Spreading investment portfolios across numerous asset classes has a great track record A�simple,�diversified�portfolio�strategy�has�produced�a�positive�return�in�the�vast�majority�of�years�(see�previous�chart).�Note�that�since�1970,�a�diversified�approach�has�produced�a�positive�return�in�most�years,�and�that�these�returns�can�be�quite�meaningful�much�of�the�time.�In�fact,�the�example�portfolio�would�have�produced�an�average�return�of�9.8%�through�2014,�with�only�three�down�years�over�that�span.�
Yet 2015 delivered very bad outcomes for diversified investors Glancing�at�the�chart,�we�can�easily�see�that,�in�context,�2015�was�a�horrible�year�for�diversified�investors.�In�fact,�with�the�exception�of�the�great�financial�crisis�of�2008,�2015�delivered�the�worst�outcome�to�diversified�investors�since�1974.�This�simple�observation�was�nearly�absent�from�most�market�commentary�last�year.�But�let’s�be�clear,�2015�was�a�historically�awful�year�for�diversified�portfolios.
2016 should be better. It seems a fairly safe presumption that diversified portfolios will fare better in 2016 than in 2015 Historically,�after�each�of�the�prior�three�negative�years,�the�following�year�delivered�firmly�positive�returns.�More�to�the�point,�however,�we�note�that�many�of�the�asset�classes�reflected�in�this�chart�experienced�a�meaningful�reset�of�their�forward-looking�risk�premia�(in�other�words,�their�expected�returns).�High-yield�bonds,�for�example,�offered�yields�277�basis�points�higher�than�in�the�middle�of�2014.*�Commodities�too�must�have�a�somewhat�more�limited�downside�with�oil�at�$40�per�barrel�than�with�oil�at�$100�per�barrel.�
Diversification�almost�always�works.�For�investors�frustrated�by�performance�in�2015,�we�confidently�recommend�that�you�stay� diversified�with�a�keen�eye�on�how�your�risks�are�allocated.
* The high-yield option-adjusted spread (OAS), a measurement of the spread of a fixed-income security rate and the risk-free rate of return, had a low of 3.23 on June 23, 2014 vs. 6.00 on December 7, 2015.
Global Annual Perspectives 2016 | MULTI-ASSET/ALTERNATIVE AND OTHER VIEWPOINTS
MULTI-ASSET/ ALTERNATIVE AND OTHER VIEWPOINTS
William Landes Deputy Head of Global Investment Solutions and Head of Alternative Investments
ALTERNATIVE BETA AS TRUE DIVERSIFIERS Alternative�betas�can�play�the�role�of�a�true�diversifier�in�a�broad-based�portfolio.�They�include�various�equity�style�factors�and�can�be�found�across�asset�classes�such�as�stocks,�bonds,�credit,�currency�and�commodities.�While�alternative�betas�have�always�been�embedded�in�markets,�they�weren’t�always�identified�as�such.�In�the�early�1990s,�academics�and�investors�first�recognized�the�persistence�of�certain�equity�factors*�and�hedge�fund�managers�began�investing�based�on�momentum�bias,�value�bias�and�other�alternative�betas.�What�used�to�be�called�alpha�in�the�hedge�fund�space�was�really�rules-based,�replicable�beta.�Today�our�understanding�of�alpha�and�beta�in�the�return�stream�has�evolved.�
*Fama and French formalized equity style investing with the three-factor model (“The Cross-Section of Expected Stock Returns,” Journal of Finance (1992), with Eugene Fama) and have written extensively on various equity style premia.
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Low correlations make alternative betas powerful diversifiersBased�on�our�research,�returns�of�a�diversified�basket�of�alternative�betas�have�a�low�correlation�of�return�to�each�other�and�to�the�overall�market��–�an�average�of�0.04.�Financial�theory�tells�us�the�best�way�to�reduce�portfolio�volatility�and�protect�from�downside�risk�is�to�own�negatively�correlated�assets�that�generate�positive�return�payoffs.�
Tapping into alternative betasThe�two�ways�to�access�alternative�betas�are�through:�1)�a�counterparty�who�manufactures�an�index�seeking�to�capture�a�specific�risk�premia;�or�2)�an�asset�manager�who�can�manufacture�an�index�itself.�For�example,�a�quantitative�equity�group�such�as�ours�could�build�momentum�and�value�risk�premia�using�internal�quantitative�tools.�An�index�designed�to�capture�the�value�equity�risk�premia�would�take�a�benchmark�such�as�the�Russell�1000,�rank�the�securities�within�by�some�valuation�measure,�and�then�go�long�the�top�quintile�of�cheapest�stocks�and�short�the�bottom�quintile�of�the�most�expensive�stocks.�This�extracts�the�value�premia�and�insulates�the�investor�from�most�general�market�beta.�
Specifically�targeting�an�isolated�alternative�beta�allows�an�investor�to�directly�own�the�value�risk�premia�described�above�with�little�to�no�market�directionality.�This�technique,�applied�across�a�range�of�diverse�alternative�beta�factors,�offers�many�of�the�same�exposures�investors�would�get�from�owning�a�multi-strategy�hedge�fund,�but�with�daily� liquidity�and�much�lower�fees.�
Alpha vs. beta: Scarcity, contribution to return and pricing
Source: Columbia Threadneedle Investments
Scarcity
Pric
e
Manager skill High costand elusive
Lower costand harderto replicate
Low costand prevalent
StyleTrendValueCarryCurveVolatility
EquityCreditCommoditiesRatesCurrency
ALPHA
TRADITIONAL BETA
Illustrative pricing curve overlaid on investment strategies
SMART BETA:Multi Factor
SMART BETA:Single Factor
ALTERNATIVE BETA
Equity
Fixed Income
Source: Columbia Threadneedle Investments.
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Capturing value premia
n Buy currencies that are undervalued according to purchasing power parity
n Sell currencies that are overvalued according to purchasing power parity
Equity
Value
Fixed income
Currency
n Buy cheapest 20% of stocks ranked on price-to-bookn Sell most expensive 20% of stocks ranked on price-to-book
n Buy government bonds whose real rates are above historical averagen Sell government bonds whose real rates are below historical average
The growing appeal of alternative betasThe�opportunity�to�access�these�sources�of�return�in�a�transparent,�liquid�and�low-cost�manner�has�made�the�subject�of�alternative�betas�compelling�for�many�investors.�We�believe�this�interest�will�only�grow�as�investors�seek�ways�to�limit�the�impact�of�higher�volatility�on�their�overall�asset�allocation.�It�is�important�that�investors�recognize�that�alternative�betas,�while�not�directional�in�nature,�are�subject�to�capital�market�influences�and�require�active�management�of�positions�and�risks.�
“�More�investors�will�use�alternative�betas�to�obtain�the�same�exposures�they�would�get�from�owning�a�multi-strategy�hedge�fund,�but�with�daily�liquidity�and�much�lower�fees.”
Global Annual Perspectives 2016 | MULTI-ASSET/ALTERNATIVE AND OTHER VIEWPOINTS
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AN UNDERAPPRECIATED OPPORTUNITY FOR INCOME INVESTORS2014�was�a�big�year�for�Wall�Street’s�financial�engineering�efforts.�A�major�revival�of�master�limited�partnerships�(MLPs)�and�the�development�of�YieldCos�were�efforts�to�satisfy�the�yield�hunger�of�investors�displeased�with�historically�low�coupons�on�quality�bonds.
By�the�fall�of�2014,�the�first�YieldCo�had�done�a�secondary�offering�at�double�its�initial�public�offering�(IPO)�price,�and�the�average�MLP�IPO�was�trading�up�20%–30%�on�the�first�day.�But�two�things�happened�to�cool�the�market�for�these�securities.�First,�crude�oil�prices�unexpectedly�declined�by�60%.�Since�the�businesses�underlying�MLPs�and�YieldCos�must�be�linked�to�energy�production,�the�outlook�soured�for�some�of�these�entities.�Second,�the�broader�stock�market�became�more�volatile�and�its�trend�flattened.�This�appears�to�have�been�caused�by�the�kind�of�political�and�macroeconomic�events�that�lead�to�measured�caution�by�professionals�but�can�result�in�panic�by�individual�investors.
In�perfect�hindsight,�the�30%–70%�declines�in�price�for�most�MLPs� and�YieldCos�in�2015�may�be�understandable.�However,�large�and� rapid�changes�in�security�prices�present�the�possibility�that�the�market�has�overreacted.�
David King Senior Portfolio Manager
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Fundamentals remain soundIt�appears�impossible�for�new�MLPs�to�go�public�in�the�current�energy�glut,�and�the�consensus�view�is�that�the�YieldCo�business�model�is�broken�due�to�the�high�cost�of�capital.�These�sentiments�are�remarkably�short-sighted.�While�oil�will�be�plentiful�in�the�near�future,�production�is�starting�to�fall�while�demand�growth�responds�to�current�low�prices.�Industry�experts�believe�that�world�production�will�fall�short�of�world�demand�by�next�summer.�Prices�will�eventually�respond�positively�to� this�imbalance,�even�if�inventories�result�in�no�lack�of�current�supply.�
As�for�the�capital�cost�of�YieldCos,�the�bearish�argument�has�a�heavy�dose�of�circular�reasoning:�the�stocks�cannot�be�more�attractive�at�higher�prices�and�less�attractive�at�lower�ones.�The�weak�performance�of�YieldCo�equities�is�more�likely�a�function�of�market�volatility�and�the�short�trading�history�of�these�stocks�than�a�sudden�realization�that�their�business�models�are�becoming�dysfunctional.
A breakout year ahead?There�is�historical�precedent�for�a�significant�recovery�in�the�MLP/YieldCo�universe.�Today,�real�estate�investment�trusts�(REITs)�are�an�accepted�part�of�a�high-quality,�income-oriented�investment�strategy.�Twenty�years�ago,�the�group�was�excluded�from�major�market�indices�and�viewed�with�scepticism.�The�stocks�traded�in�a�volatile,�undisciplined�manner.�REITs�faced�the�same�questions�about�business�model�viability�and�dependence�on�one�commodity�that�now�plague�MLPs�and�YieldCos.� As�time�passed,�however,�the�functionality�of�the�REIT�structure�was�proven,�real�estate�cycles�went�up�as�well�as�down,�and�investors�in�the�leading�REITs�enjoyed�attractive�total�returns�with�a�strong�income�component�and�only�moderate�price�volatility.�Our�view�is�that�the�leading�MLPs�and�YieldCos�will�follow�a�similar�path.�If�2016�is�a�break-out�year� for�these�entities,�it�is�not�too�soon�for�investors�to�position�themselves��to�take�advantage�of�the�trend.
The benefits and risks of MLPs, YieldCos and REITs
nCombination of dividend yield and dividend growthnTax-efficient structures with no corporate level income taxnLong-term contracts provide visibility into future cash flownParticipation in the US infrastructure buildout (e.g., shale gas pipelines,
wind farms, telecom towers)
Benefits to income
investors
nRequire periodic access to capital markets due to high payout ration Sponsors have significant influence over MLPs, YieldCos and externally
managed REITsn Overhang of rising interest rates on companies that are viewed as bond
alternativesnEnergy prices may effect MLPs’ earnings and growth prospects
Potential risks
n Mostly-fee based activities in mining, refining, and transportation of oil and gasn Growth through organic development or acquisition from sponsor/third-partyn Oil & Gas MLPs: pipelines, storage terminals, refineries, propane distributionn Non-Oil & Gas MLPs: coal mines, wood pellets, nitrogen fertilizers, soda ash
MLP
n Solar and wind power plants and other assets with long-term contractsn Growth through acquisition from sponsor/third-partyn Not a tax-exempt entity under IRS; tax shelter dependent on tax credits
and depreciation
YieldCo
n Earnings through direct real estate investments or mortgage interestn Growth through organic development or acquisition from third-partyn Traditional REITs: office buildings, apartments, shopping malls, storage facilitiesn Specialty REITs: telecom towers, timber, data centres, advertising structures
REIT
Definitions
“�If�2016�is�a�break-out�year�for�MLPs�and�YieldCos,�it�is�not�too�soon�for�investors�to�position�themselves�to�take�advantage�of�the�trend.”
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CAPITALIZING ON DISRUPTIVE TECHNOLOGIES A�growing�piece�of�the�global�profit�pie�is�accruing�to�the�brains�behind�the�systems,�whether�that�is�elite�human�talent,�software�and�systems�that�enable�business�processes�or�–�most�powerfully�–�the�two�together,�where�elite�human�talent�leverages�the�strengths�of�cutting-edge�machine�systems.�This�dynamic�makes�it�different�this�time�in�terms�of�the�drivers�of�economic�success�and�business�cycles�that�many�market�participants�learned�in�school.�Countries,�companies�and�individuals�that�lack�differentiated�intellectual�property�will�struggle�to�compete.�Simple�labour�cost�arbitrage�and�capital-intensive,�low-value-added�manufacturing�will�be�increasingly�revealed�to�be�ineffective�paths�toward�sustainable�prosperity.
Robert McConnaughey Global Head of Research
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Embracing the power – and weighing the cost – of artificial intelligence2016�will�be�the�year�that�the�real-world�use�of�artificial�intelligence�tools�grows�to�a�level�that�raises�market�and�public�awareness�of�the�profound�implications�of�its�power.�This�reinforces�the�issues�raised�above.�For�example,�even�the�overseas�information�technology�(IT)�services�companies�that�have�thrived�on�labour�arbitrage�to�attract�outsourcing�business�are�rapidly�adding�machine�learning�systems�that�can�replace�human�programmers�and�analysts.�Just�as�robots�have�begun�to�replace�human�workers�in�manufacturing,�services�–�even�white�collar�services�–�will�increasingly�be�automated.�
While�these�developments�are�threatening�for�many�traditional�avenues�for�growth�in�the�emerging�markets,�it�is�not�all�bad�news.�For�example,�we�see�technology�as�a�key�enabler�of�impactful�reforms�in�countries�like�India,�where�simply�moving�paperwork�processes�online�is�having�a�huge�effect�in�reducing�corruption.�Also,�the�biometric�registration�of�that�massive�nation’s�citizens�is�allowing�for�big�leaps�forward�in�the�delivery�of�government�services�and�the�expansion�of�the�banking�system�to�the�previously�disenfranchised.
Darwinian�evolution�is�a�nasty�business�for�those�on�the�negative�side�of�the�equation.�Industries�and�companies�undergoing�disruptive�attacks�may�behave�very�differently�to�how�investors�are�accustomed�to,�as�historical�valuation�frameworks�and�cycles�may�prove�of�little�support.�Beware�the�value�trap�of�investing�in�apparently�cheap,�buggy-whip�companies.
Playing offence: The best defence in 2016The�implications�of�the�above�will�feed�a�growing�feeling�of�helplessness�among�the�many�in�the�world�rendered�uncompetitive.�This�increasing�angst�will�likely�fuel�the�continued�rise�of�political�polarization�and�populism�around�the�world.�
On�the�flip�side,�the�concentration�of�wealth�among�the�individuals,�companies�and�nations�that�can�embrace�and�lead�the�digital�revolution�will�be�extraordinary.�It�is�crucial�that�investors�maintain�meaningful�exposure�toward�innovation�to�capture�these�benefits�and�to�hedge�against�the�disruptive�downside.�This�may�be�counterintuitive�to�some�during�periods�of�volatility,�as�innovation�can�appear�to�be�expensive� and/or�risky,�but�the�best�defence�in�this�case�may�be�to�be�proactive� by�participating�in�the�success�of�leading�disruptors.�
Harnessing the speed and power of technological innovation Mobile Robot Technology Roadmap, Global, 2000 and Beyond
Source: Frost & Sullivan.
2000 2005 2010 2015 >2020
FULL AUTONOMYPARTIAL AUTONOMYHUMAN ASSISTED
Unmanned machines (e.g., automated guided vehicles [AGVs])
Controlled by warehouse-management systems
Wearable technology(e.g., exoskeletons)
Machines controlled remotely by telepresence
Semi-autonomous machines(e.g., remotely operated vehicles)
Machines that make basic decisions
Initial stages ofcognitive systems
Limited interaction between humans and machines
Autonomous machines (e.g., collaborative robots)
Intelligent machines with human emotions that can converse
fluently and adapt to their environment
Global Annual Perspectives 2016 | MULTI-ASSET/ALTERNATIVE AND OTHER VIEWPOINTS
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DC WORKPLACE PENSIONS: TARGETING GOOD FINANCIAL OUTCOMES Britons�aren’t�saving�enough�and,�when�they�are,�most�aren’t�allocating�their�capital�efficiently.�A�minority,�however,�are�taking�advantage�of�opportunities�created�by�astute�asset�allocation�and�active�fund�management�to�generate�good�financial�outcomes.�
Most�working-age�Britons�are�oblivious�to�what�lies�ahead�for�them�at� and�in�retirement.�That�much�is�clear�from�the�recent�launch�of�the�Pensions�Policy�Institute�(PPI)�report�The Future Book: Unravelling workplace pensions1,�a�longitudinal�study�of�the�UK�Defined� Contribution�(DC)�workplace�pensions�landscape.�
Commissioned�by�Columbia�Threadneedle,�this�research�points�to�a�national�rate�of�saving�into�DC�workplace�pensions�that�is�woefully�inadequate,�resulting�in�financial�outcomes�at�and�in�retirement�far�below�OECD�averages.�Indeed,�the�gross�replacement�rate�(gross�income�in�retirement�relative�to�gross�earnings�when�working)�for�a�median�earner�in�the�UK�without�retirement�savings�(around�50%�of�the�UK�working�population�don’t�have�pension�savings)�is�29.7%.�While�for�those�with�pension�savings�and�assumed�‘full�careers’,�this�rises�to�a�more�respectable�60.8%,�this�is�much�lower�than�exemplars�such�as�the�Netherlands�(90.5%)�where�nearly�90%�of�the�working�population�have�pension�savings2.�
In�fact,�based�on�current�trends,�The�Future�Book�suggests�that�the�average�Briton�retiring�in�20�years’�time�could�deplete�their�DC�pensions�pot�within�just�six�years�and�might�have�to�rely�solely�on�a�modest�state�pension3.�Given�continued�improvements�in�longevity,�unless�individuals�are�able�to�plug�this�shortfall�with�other�savings�or�income,�there�is�a�very�real�danger�of�experiencing�a�lower�standard�of�living�in�retirement�than�working�life.�Enter�auto�enrolment�(AE).�In�its�three-year�history,�AE�has�had�an�unprecedented�impact�in�shaping�the�DC�landscape�by�boosting�the�number�of�people�saving�into�a�workplace�pension�scheme�by�nearly�5.5m4.�However,�at�2%,�current�AE�contribution�levels�are�far�from�
Chris Wagstaff Head of Pensions and Investment Education
Global Annual Perspectives 2016 | MULTI-ASSET/ALTERNATIVE AND OTHER VIEWPOINTS
39
MULTI-ASSET/ ALTERNATIVE AND OTHER VIEWPOINTS
adequate�and�there�are�more�than�six�million�working�people�who�aren’t�eligible�to�participate,�by�virtue�of�their�age�and/or�income5.�
Not�that�the�median�employer�and�employee�contribution,�into�DC�workplace�pension�schemes�per�se,�for�the�average�earner�totalling�a�meagre�6%�is�much�better.�Both�point�to�a�particularly�uncomfortable�retirement.�Indeed,�as�a�rule�of�thumb,�median�earners�need�to�contribute�11%�-�14%�of�their�band�earnings�from�the�age�of�22�to�State�Retirement�Age�(SRA)�to�have�a�two-thirds�chance�of�retiring�comfortably6.�Of�course,�the�longer�people�put�off�saving,�or�set�aside�an�inadequate�proportion�of�their�income,�the�less�likely�it�is�their�pensions�pot�will�provide�for�a�sufficient�income�in�retirement.
However,�factors�other�than�a�low�rate�of�saving�conspire�to�compromise�achieving��good�financial�outcomes.�Foremost�amongst�these�is�how�pension�savings�are�invested.�
The�Future�Book�points�to�the�overwhelming�majority�of�DC�scheme�members�investing�in�predominantly�one-size-fits-all�(and�arguably� unfit-for-purpose)�default�funds,�with�a�small�minority�investing�in� assets�capable�of�generating�inflation-beating�returns�in�the�long�run7.�
However,�given�the�prospect�of�more�modest�and�more�volatile�real�returns�from�hereon,�if�good�financial�outcomes�are�to�be�achieved,�the�imperative�should�be�to�invest�in�actively�managed,�well�diversified,�multi-asset�funds.�With�astute�asset�allocation�and�good�risk�management,�such�funds�are�well�positioned�to�combine�long-run�real�returns,�robust�against�a�multitude�of�economic�scenarios,�with�low�levels�of�volatility.�
Indeed,�as�an�active�manager�with�both�strong�multi-asset�capabilities�and�DC�credentials�and�a�keen�focus�on�providing�value�for�money,�we�are�well�placed�to�not�only�help�DC�savers�and�investors�achieve�a�financially�secure�and�comfortable�retirement,�we�arguably�have�a�responsibility�to�do�so.1The Future Book: unravelling workplace pensions. Daniela Silcock, Tim Pike and Shamil Popat. Published by the Pensions Policy Institute, October 2015. ISBN: 978-1-906284-34-3.2OECD Pensions at a Glance 2015, p.141 and p.187. A ‘full career’ is defined as working from age 20 to state retirement age without a career break.3The Future Book. Ibid p.40.4The Automatic Enrolment (AE) Evaluation Report 2015. Department of Work and Pensions. November 2015.
Quick view: DC workplace pensions in 2016 n Opportunities:�Well�diversified,�actively�managed,�multi-asset�strategies�tend�to�offer�stable�and�robust�real�long-run�investment�returns.�
n Threats:�Inadequate�saving;�underestimating�longevity;�unfit-for-purpose�default�funds;�prioritising�cost�containment�over�value�for�money.
n General outlook:�More�modest�real�returns,�continued�market�volatility,�interest�rates�lower�for�longer.�
n What should investors look out for?�Be�wary�of�investing�in�apparently�low-risk�funds�unlikely�to�generate�real�returns�and�relatively�undiversified�passive�funds�that�cannot�be�positioned�to�take�advantage�of�market�conditions�or�dampen�market�volatility.
n What should investors consider?�Actively�managed,�well�diversified,�multi-asset�funds�that�employ�astute�strategic�and�tactical�asset�allocation.�
5To be automatically enrolled an employee must be aged between 22 and SRA with an income from any one employer over £9,984 per annum. Minimum total employer and employee contributions are currently 2%, rising to 5% in March 2018 and 8% in March 2019. 6Source: The Future Book. p.24. Band earnings are between £5,824 and £42,395 in 2015/16. This assumes that at SRA the state pension will still benefit from “triple lock” indexation. 7Source: The Future Book. Ibid p.23.
Global Annual Perspectives 2016 | MULTI-ASSET/ALTERNATIVE AND OTHER VIEWPOINTS
40
MULTI-ASSET/ ALTERNATIVE AND OTHER VIEWPOINTS
John Golden Senior Analyst
SUNNY DAYS AHEAD FOR CLOUD COMPUTING What is cloud computing?Cloud�computing�lets�enterprises�choose�between�owning�their�infrastructure�and�renting/subscribing�to�the�same�capabilities�from�third-party�providers.�The�two�major�types�of�cloud�computing�are�Software�as�a�Service�(SaaS)�and�Infrastructure�as�a�Service�(IaaS).�With�SaaS,�enterprises�outsource�the�development�and�hosting�of�software�to�third�parties�such�as�Salesforce.com�and�Workday.�With�IaaS,�enterprises�write�software�internally�and�host�the�application�in�third-party�data�centres�such�as�Amazon�Web�Services�(AWS)�and�Microsoft’s�Azure.
The cloud-based software market is projected to grow
SaaS On-premise SaaS as % of software Forecast
Forecast
Sources: Gartner/IDC, Columbia Threadneedle Investments, 12/15
IaaS
On-premise
CTI IaaS as % of TAM
Gartner IaaS as % of TAM
Sources: Gartner/IDC, Columbia Threadneedle Investments, 12/15
Gartner and Columbia Threadneedle Investments projected IaaS share of total addressable market (TAM).
Reve
nue
($ b
illio
ns)
SaaS
por
tion
of s
oftw
are
reve
nue
(%)
Reve
nue
($ b
illio
ns)
IaaS
por
tion
of s
oftw
are
reve
nue
(%)
The cloud-based software market is projected to grow
Significant growth expected in outsourced infrastructure
2012
2013
2014
2015
2016
2017
2018
2019
0
100
200
300
400
500
600
700
2012
2013
2014
2015
2016
2017
2018
2019
0
2
4
6
8
10
12
0
100
200
300
400
500
600
02468
101214161820
Sources: Gartner/IDC, Columbia Threadneedle Investments, December 2015.
Global Annual Perspectives 2016 | MULTI-ASSET/ALTERNATIVE AND OTHER VIEWPOINTS
41
MULTI-ASSET/ ALTERNATIVE AND OTHER VIEWPOINTS
The cloud-based software market is projected to grow
SaaS On-premise SaaS as % of software Forecast
Forecast
Sources: Gartner/IDC, Columbia Threadneedle Investments, 12/15
IaaS
On-premise
CTI IaaS as % of TAM
Gartner IaaS as % of TAM
Sources: Gartner/IDC, Columbia Threadneedle Investments, 12/15
Gartner and Columbia Threadneedle Investments projected IaaS share of total addressable market (TAM).
Reve
nue
($ b
illio
ns)
SaaS
por
tion
of s
oftw
are
reve
nue
(%)
Reve
nue
($ b
illio
ns)
IaaS
por
tion
of s
oftw
are
reve
nue
(%)
The cloud-based software market is projected to grow
Significant growth expected in outsourced infrastructure
2012
2013
2014
2015
2016
2017
2018
2019
0
100
200
300
400
500
600
700
2012
2013
2014
2015
2016
2017
2018
2019
0
2
4
6
8
10
12
0
100
200
300
400
500
600
02468
101214161820
Sources: Gartner/IDC, Columbia Threadneedle Investments, December 2015.Gartner and Columbia Threadneedle Investments projected IaaS share of total addressable market (TAM).
What is driving the growth of cloud computing?Market expansion:�Hundreds�of�thousands�of�small�businesses�and�start-ups�now�have�broader�access�to�information�technology�resources.�According�to�venture�capital�firm�Upfront�Ventures,�entry�IT�costs�for�a�start-up�or�small�business�decreased�to�$5,000�in�2011�from�approximately�$50,000�in�2009,�significantly�expanding�the�market.
Ease of use/service on demand:�While�in�the�past�a�company�might�wait�days�or�even�months�for�traditional�IT�departments�to�procure,�set�up,�monitor�and�secure�infrastructure,�today�developers�can�now�spin�up�a�server�in�minutes.�Businesses�can�buy�computing�power�and�storage�capacity�to�meet�spikes�in�demand�driven�by�seasonal�periods,�events�or�even�time�of�day.
Lower cost of ownership: Cloud�computing�is�considerably�cheaper�than�traditional�infrastructure�for�most�applications.�Large�cloud�providers�run�their�mega�data�centres�much�more�efficiently�than�traditional�providers.� For�example,�AWS�can�manage�over�1,000�servers�with�a�single�engineer,�while�traditional�enterprises�manage�approximately�50�servers�per�engineer.
Shifting buyer base from central IT:�Today,�non-traditional�IT�buyers�(such�as�line�of�business�leaders�and�marketing)�control�as�much�as�25%�of�IT�purchases.�According�to�Gartner,�this�percentage�will�grow�to�50%�by�2018.�These�buyers�have�limited�lock-in�from�incumbent�technology�vendors�and�are�free�to�choose�the�best�solution�to�meet�their�business�objectives.
Cloud computing: A minor but growing segment of today’s IT market We�believe�the�IT�market�is�in�the�very�early�stages�of�the�cloud�adoption.�Our�historical�S-curve�analysis�suggests�that�cloud�computing�could�continue�to�grow�at�a�40%�compound�annual�growth�rate�(CAGR)�for�the�next�several�years,�above�industry�forecasts�of�28%�CAGR.�In�the�most�recent�quarter,�AWS�grew�78%�year-over-year�(YoY),�reaching�an�$8�billion�run�rate,�while�Microsoft’s�Azure�grew�135%�YoY,�far�ahead�of�expectations.�SaaS�providers�continue�to�grow�rapidly�as�well.�For�example,�Salesforce.com�and�Workday�grew�24%�YoY�and�50%�YoY,�respectively.�This�performance�is�in�stark�contrast�with�legacy�client/server�infrastructure�vendors,�which�have�reported�little�revenue�growth�or�even�revenue�declines.
Legacy client/server infrastructure players reacting, but profit pools will compress IBM,�Oracle,�EMC�and�Hewlett-Packard�all�have�newer�technology�and�as-a-service�segments�growing�in�the�20%–50%�year-on-year�range.�However,�this�growth�is�masked�by�declines�in�traditional�business�lines,�and�the�cost�of�investing�in�these�growth�areas�is�weighing�on�their�overall�earnings�growth.�Microsoft�is�the�one�legacy�IT�provider�where�the�transition�appears�to�be�further�along.�The�company’s�as-a-service�businesses�are�now�at�an�$8�billion�run�rate�and�the�company’s�overall�margins�have�begun�to�expand.�Over�the�next�several�years,�we�expect�the�newer�as-a-service�offerings�to�continue�to�take�share�from�legacy�products.
Global Annual Perspectives 2016
42
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