Posts Tagged ‘Investment Opportunities’
Wednesday, July 25th, 2012
by Geoffrey Lutz and Jon Brorson, Mesirow Financial
Water is ubiquitous, the ultimate source for life and the most important commodity for human existence. No less importantly, water is a critical input for food. Yet only a small fraction of total global water – less than 1% – is usable for food production, due to salinity and glaciers1. As a result, water represents one of the single most important determinants of the value of today’s investment opportunities in food production and farmland.
Although water is used, it is neither created nor destroyed, meaning that the total existing amount remains constant. That total must be shared by a global population that is expected to increase from 7 billion today to more than 9 billion by 2050, according to United Nations estimates. What’s more, over the past 100 years, increases in water demand have outpaced overall population growth by a factor of two2. In 1990, 10,000 cubic meters of fresh water was available for each person; by 2010 that amount had dropped to 7,770 cubic meters3.
An equally powerful related trend is increasing urbanization, which can lead to higher pollution in fresh water supplies from the byproducts of industrialization and development.4 Half of the word’s population now lives in an urban area, and that fraction is expected to grow to over 60% in the next two decades.
By the year 2025, an estimated 1.8 billion people may face water scarcity5 as world demand for water is expected to exceed supply by approximately 40%6, By 2050, the excess demand may be as high as 140%, according to the consulting firm McKinsey.
Strong desire by populations worldwide for on-demand water has led to widespread over-allocation of existing supplies. Three of the world’s major rivers, the Nile, Colorado and Yellow, are now so heavily utilized that they often do not reach the sea7. Aquifers and other ground water sources are also being depleted – most notably in areas where water is most critically needed8. What’s more, as aquifer water levels drop, the quality of the remaining water can become compromised by natural substances – such as salt, arsenic and fluoride9 – that can harm crops.
While attempts have been made to manage water flow systems and aquifers, the knowledge to successfully counter a growing water crisis remains woefully insufficient, even in the world’s most developed regions. In Australia, for example, where water withdrawal is monitored through sophisticated accounting systems, engineers have not been able to prevent net losses in the country’s important Murray-Darling Basin10. Closer to home, the well known and heavily used Ogallala Aquifer in the Western United States faces inexorable rates of depletion11. Urban effluent and desalination may add to fresh water supplies, but these efforts are expensive and the quantities produced are insignificant relative to demand, particularly in the context of agriculture12.
Water and Food Production
Food production requires significant amounts of water, in some cases as much as 1,000 times the weight of food produced13. But that water is needed at specific points in the production cycle – too much or too little at any given time can be catastrophic. That delicate balance is often achieved through irrigation, which is vital to agriculture. China, where 70% of grain production depends on irrigation, exemplifies the emerging threat. Currently China is home to 21% of the world’s population, but only 6% of the fresh water, and its water resources are expected to drop 10% in the next 20 years14. But China isn’t alone. Almost half of all irrigated land in the world15 is located in Pakistan, India and China. As nations are beginning to become aware of the risks of restricted water supplies, aquifers and dams in rivers that cross political boundaries may represent significant sources of potential conflict16.
As water becomes an increasingly scare resource, its allocation will likely be based on the highest return from use. In most cases, the value of output per unit of water will be higher for a factory or energy producer than a food producer. As a result, agriculture’s claim on fresh water supplies will often be subordinate to that from industry, as well as from human consumption, sanitation, environmental and navigation needs. In other words, Los Angeles will get water for residents, at the expense of the farmers in the Central Valley.
As these current global trends accelerate, we expect several significant shifts in farmland values over time.
- Agricultural regions with adequate fresh water to grow food should experience greater demand for these products from consumers in water-stressed areas. Given its low value-to-weight and -volume ratios, food distribution may represent the most profitable way of transporting water (in some form) from regions with adequate supplies to those without.
- Irrigated properties with a politically secure source of water should increase in value relative to water -deficient areas that are accessible to industry and urban populations.
- Regions with adequate and reliable rainfall should experience an even greater increase in demand than irrigation-dependent regions.
Currently, water may not be fully priced into land valuations. This relative mispricing represents significant agriculture investment opportunities in areas where rainfall is frequent and predictable, and where there are no other claims on water. However, the calculus is not simple. When attempting to exploit disparities between water-constrained and water-abundant properties, it is critical to consider water from multiple perspectives – including historical sources, variability, quality and the potential for future access – as well as a variety of other variables. These factors will vary widely, not only between continents, but also within regions and even between individual properties. For example, in many locations, water rights may be determined by the political process, or subject to sharing arrangements with neighboring properties, or completely separated from the surface rights of the property.
1 U.S. Geological Survey, Where is Earth’s Water Located?
2 FAO, United Nations, Water News: water scarcity
3 Bloomberg, Peak Water: The Rise and Fall of Cheap, Clean H2O, February 6, 2012
4 United Nations, International Decade for Action “Water for Life” 2005 – 2015
5 National Geographic, Water: Our Thirsty World, April 2010
6 Financial Times, Earth Talks “in need of vision and direction”, April 24, 2012
7 Bloomberg, ibid
8 FAO, United Nations, Water Report: Climate change, water and food security
9 U.S. Geological Survey/FAO, United Nations ibid
10 FAO, United Nations, ibid
11 USDA, NRCS, 2012 Ogallala Aquifer Initiative
12 U.S. Geological Survey
13 United Nations, World Water Day 2012 and Farm Journal, January 2012
14 FAO, United Nations, ibid
15 FAO, United Nations, ibid
16 University of Nebraska, Cornhusker Economics, May 9, 2012
Mesirow Financial Agriculture Management (“MFAM”) is an investment management division of Mesirow Financial Holdings, Inc. MFAM serves as the investment advisor for limited partnerships. Partnerships, which MFAM serves as the investment manager, are only open to accredited investors. The information contained herein is intended for accredited clients and is for informational purposes only. This information has been obtained from sources believed to be reliable, but is not necessarily complete and its accuracy cannot be guaranteed. Any opinions expressed are subject to change without notice. It should not be assumed that any recommendations incorporated herein will be profitable or will equal past performance. Performance information that is provided gross of fees does not reflect the deduction of management and/or incentive fees. Client returns will be reduced by such fees and other expenses that may be incurred in the management of this account. Mesirow Financial does not render tax or legal advice. Nothing contained herein constitutes an offer to sell or a solicitation of an offer to buy an interest in any Mesirow Financial investment vehicle(s). Any offer can only be made to accredited investors and through the appropriate Offering Memorandum. The Memorandum contains important information concerning risk factors and other material aspects of the investment and should be read carefully before an investment decision is made. This communication may contain privileged and/or confidential information. It is intended solely for the use of the addressee. If this information was received in error, you are strictly prohibited from disclosing, copying, distributing or using any of this information and are requested to contact the sender immediately and destroy the material in its entirety, whether electronic or hardcopy. Comparisons to any indices referenced herein are for illustrative purposes only and are not meant to imply that a strategy’s returns or volatility will be similar to the indexes. The strategy is compared to the indices because they are widely used performance benchmarks.
Mesirow Financial refers to Mesirow Financial Holdings, Inc. and its divisions, subsidiaries and affiliates. The Mesirow Financial Name and logo are registered service marks of Mesirow Financial Holdings, Inc. C 2012, Mesirow Financial Holdings, Inc. All rights reserved.
Tags: agricultural, Aquifers, Byproducts, Critical Input, Cubic Meters, Demand Water, Excess Demand, Food Production, Global Population, Global Water, Ground Water Sources, Human Existence, Industrialization, Investment Opportunities, Jon Brorson, Mckinsey, Population Growth, Strong Desire, Water Crisis, Water Demand, Water Scarcity
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Saturday, July 14th, 2012
Emerging Markets Radar (July 16, 2012)
- China’s second quarter GDP was up 7.6 percent, in line with the market expectation of 7.7 percent. Asia markets were up after the data release. Fixed asset investment growth accelerated on stronger infrastructure, increasing 20.4 percent year-over-year for the first half of the year versus the forecast of 20 percent. Consumption was stable, rising 13.7 percent in June, slightly down from 13.8 percent in May, but better than the estimated 13.4 percent. Clearly, China is growing at a slower speed, which makes it possible for the government to stimulate with easing monetary and fiscal policies.
- China’s June new loans were RMB 919.8 billion versus the estimate of 880 billion, but short-term lending is still high at about 50 percent. Household lending was 30 percent, which explains why housing sales went up 41 percent in June.
- Korea unexpectedly cut its benchmark interest rate by 25 basis points to 3 percent.
- For the China Region Fund we find that the current market is offering plenty of investment opportunities of growth at a reasonable price (GARP) in the China region. The Fund’s portfolio currently has an average dividend yield of 3.4 percent with average revenue growth at 25 percent.
- China’s June industrial production was up 9.5 percent, lower than the estimate of 9.8 percent, but just slightly down from 9.6 percent in May. The growth of industrial production was still restrained by enterprises’ destocking and deleveraging, which has negative implication for the economic growth. As a leading indicator to China’s GDP growth, power output is in decline, flat in June, compared to 2.7 percent year-over-year growth in May.
Acceleration in Chinese Bank Lending Should Help Sustain Property Transaction Recovery
- After two interest rate cuts, China housing transactions have increased as home buyers can borrow at lower rate. In the meantime, the People’s Bank of China, the central bank, has encouraged banks to lend to first-time home buyers. The increased new loans in June are a positive sign that new loans are back on an upside trend.
- Although China’s June economic numbers are showing a steady economic growth, the trend can be on the downside, which makes the market believe the Chinese government will continue to spend to backstop growth weakness.
Tags: Asia Markets, Asset Investment, Bank Of China, Basis Points, Benchmark Interest Rate, China Region, Chinese Bank, Current Market, Dividend Yield, Emerging Markets, Fiscal Policies, Garp, GDP Growth, Housing Sales, Implication, Investment Growth, Investment Opportunities, Leading Indicator, Property Transaction, Quarter Gdp
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Tuesday, November 15th, 2011
Pimco Co-Chief Investment Officer Bill Gross and Chief Executive Officer Mohamed El-Erian talk about the European sovereign-debt crisis and its impact on the U.S. economy and Treasury yields.
Notes courtesy of Edward Harrison
PIMCO’s Mohamed El-Erian and Bill Gross spoke exclusively with Bloomberg Television’s Tom Keene today from the company’s headquarters in Newport Beach, CA about Europe’s crisis, PIMCO’s investment strategy and Treasury yields.
Gross says that Europe can turn around its crisis, but “they have to get it together.” El-Erian reiterates that it’s ultimately about Germany, which “needs to make a decision.” On investment opportunities in Europe, Gross says “we cannot clean the dirtiest shirt.”
On what they’ve learned in 2011:
Gross: “I think we’ve learned that policymakers are most important in these types of markets. We have seen that in Operation Twist, policy in terms of lack of fiscal spending and a move towards stringency, all of which has affected bond and equity markets. Follow the policymakers to the extent you can.”
El-Erian: “A couple of things. The Europeans have taken a long time to understand the depth of their issues. The other thing is that the rest of the world is standing there, puzzled as to how the U.S. and Europe can be having so many difficulties. That is important because we all live in a world where the core is the West. The rest of the countries depend on this core and they are seeing this core weak. What I learned is that people that are unsettled. They are confused, and hopefully, we are going to have some anchors restored.”
El-Erian on whether there will be a shift in IMF votes soon:
“I hope so. Part of the problem the IMF has is that it is not viewed as credible and legitimate enough. Part of that is because Europe has all the votes compared to the developing world. What we are seeing is a slow process, but hopefully it will get accelerated. But we need the IMF. We need a conductor to help organize what is increasingly very conflicting policy measures at the regional and national level.”
El-Erian on whether he’s surprised by the speed of economic changes in the last 18 months:
“We have not been surprised for several reasons. We had a sense, as a society, that we would have to pay back for all the over borrowing and over leveraging. Secondly, we are now catching up with the reality of slow growth for a long time. Part of Europe’s problem is it has not been growing enough for years. Therefore, deleveraging safely their economy is proving to be difficult.”
Gross on whether it’s a strategy of PIMCO to take advantage of Europe’s crisis to find value in equities or better quality bonds:
“We cannot clean the dirtiest shirt. The Netherlands is on the borderline, they are close. It’s not liquid. Germany obviously qualifies. France, perhaps, mom and I have mild disagreements there. But the other countries are at risk, from the standpoint of spread, investors’ perception of growth and the standpoint of the ECB and their willingness to move all in. They certainly haven’t done that. They didn’t do that today with 2 billion worth of purchases in terms of Italy.”
On whether Europe can turn around its crisis:
Gross: “They can, but they have to get together. They are dysfunctional. They are a family that does not function well. That’s obviously because the fiscal and monetary authorities are not co-joined. They cannot get together and agree on things. Germany wants to do it their way, Greece wants to do it their way. There is never a total agreement, no significant change. It’s always ad hoc and at the margin.
El-Erian: “It is about Germany. Germany needs to make a decision. It needs to decide does it want a fiscal union with greater political integration. The model I have in my mind is what West Germany decided about East Germany. The West said it will be a fiscal union with political integration. Yes, that’s a big bill, but we’re willing to pay it. Or does Germany opt for a smaller and less than perfect union of countries with similar conditions? Germany holds the key. Germany needs that to make that decision.”
Gross on tension in short-term bank paper in Europe compared to the U.S.:
“Much more tense. Spreads are much wider, which means more risk. At least perceived risk in terms of the banking system. Obviously, there is an interchangeable flow between dollars in the United States dollars in Europe and to that extent it helps, but there is much greater risk on the banking system at the moment.”
Gross on the risk investors need to focus on in the bond market:
“The risk in the bond market, certainly in the cleanest dirty shirt bond market, let’s talk about Treasuries. They are artificially suppressed. Everyone knows that. There is a twist, a two-year point of time where the Fed will stay at 25 basis points. All of that produces a 10-year treasury at 2%. That is an artificial yield. The question is how long it will be artificial. What we are suggesting is, it will probably be artificial probably for a number of years. The real risk comes at the long end, the 30-year Treasury, where investors wonder what will happen when QEs disappear.”
Gross on whether he’s been a victim of financial repression this year:
“I think we all are. To the extent that real interest rates are negative, that basically means that investors in the bond market and in the stock market cannot keep up with purchasing power. That is what financial repression does. It takes money from savers and reallocates to the government’s balance sheet. All investors, going forward, to the extent real interest rates stay negative, to the extent that that’s an example for equity markets in terms of valuation, it means that investors will only earn lower rates of return relative to inflation than they have in the past.”
El-Erian on how politicians should adapt to the reality of financial repression:
“They have to realize this is structural in nature. This is not a cyclical world. These are fundamental changes that will be with us for awhile. They have to think structurally, which they have failed to do. The second thing that we all have to realize is that we are changing the dynamics of markets. We are a market-based economy, and the dynamics of markets are changing. You see this in terms of shifts in the demand curve. Italy is starting to lose investors for a long time. They’re not going to come back. I think there’s a real concern about banking fragility. Lots of people have stepped back to see how this plays out. We also have to be concerned about how the landscape has changed. Banks in this country are being turned into utilities over time. We are going through something fundamental where the function of markets itself will change, going forward, and politicians and all of us will have to understand that.”
El-Erian on what sort of institutional solution he would like to see in Europe:
“First, you need a circuit breaker. You need to calm things down. That’s the ECB. Secondly, Germany has to step up. They both have to step up to the plate. One is short term, the ECB is a bridge, but a bridge to a stronger union, which is Germany.”
On what PIMCO looks for when hiring:
El-Erian: “First, we look for the best athlete. PIMCO has been very good at bringing somebody and then finding new positions for them on the team, and then finding that they excel. Some of the people you talk to are excelling in new positions. The second issue is putting people together in teams. PIMCO functions in teams. We need an economist, a mathematician, and somebody who has a street instinct, gut instinct on the markets. You want to make sure we have these individuals together in teams so that we can go out and earn returns for our clients.
Gross: “Common sense is a neglected ingredient, I think. It is hard to find common sense and to basically interview for it. But intelligence, to my way of thinking, is a significant overvalued quantity. We need a CQ in addition to an IQ. Put them together and you’ve got a great investor.”
Source: Bloomberg TV
Source: Bloomberg, November 14, 2011.
Tags: Anchors, Bill Gross, Bloomberg Television, Chief Executive Officer, Chief Investment Officer, Debt Crisis, Developing World, Economy, Edward Harrison, Erian, Europe Strategy, Europeans, Investment Opportunities, Investment Strategy, Mohamed, Mohamed El Erian, Move Towards, Newport Beach Ca, November 14, PIMCO, Sovereign Debt, Tom Keene, Treasuries, Treasury Yields
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Wednesday, September 21st, 2011
Neel Kashkari has written an interesting piece on active equity management, to point out some qualitative differences that exist in active management, and he also touches on the controversial subject in our education system of our teachers “Teaching to the Test” to make the point, eloquently. For those of us in Ontario, Canada, this is none other than the EQAO. Although it is a bit of a commercial for PIMCO’s new equity division, it extends a full perspective/reasoning on what is both effective and ineffective within active portfolio management, and, our education system. At the very least, we thought it was worth reading.
Teaching to the Test
by Neel Kashkari, Head of Global Equities, PIMCO
- Many managers are focused on beating benchmarks, rather than helping clients achieve their investment objectives. Clients save and invest their money for specific reasons, such as for retirement or children’s education and managers should focus on helping them meet those goals.
- Many managers are really “closet indexers” masquerading as active managers while charging premium fees for benchmark returns. Many equity managers deviate very little from their benchmark because they are terrified of potentially underperforming it.
- All of our active equity strategies are unconstrained relative to typical equity strategies. We go anywhere across the globe looking for the best investment opportunities and the best risk-adjusted returns. We are not closet benchmarkers. We invest aggressively in our best ideas.
Most people agree America’s K-12 education system needs a lot of help. Too many students drop out of school, and too many of those who do finish graduate without proficiency in math, reading and science.
An intense debate is taking place among education policy experts as to the merits of rigorous academic testing to make sure students are on track, to identify and reward schools and teachers who are succeeding, and to identify and replace those who are failing. This is related to the mantra from management guru Peter Drucker, “If you can’t measure it, you can’t manage it.”
Critics of testing argue such quantitative assessments lead to unintended consequences. For example, they believe teachers are incentivized to “teach to the test,” which results in students who are able test takers but lacking in other social, cultural and interpersonal skills that are necessary for success in life.
I will reveal my bias: If our biggest educational challenge is that all of our students graduate from high school having successfully been “taught to the test” – Hallelujah! It will mean all of our students actually can read and actually have basic math and science skills. Even if they aren’t all budding creative writers, this is far better than the current state of American education.
Teaching to the test is helping China and India produce many talented students who are performing well in our best graduate schools – and going on to become successful entrepreneurs, doctors, engineers and scientists.
However, not all of the unintended consequences of rigorous academic testing are positive. Recent revelations that some teachers cheated by changing their students’ answers on tests are deeply troubling. This is worse than Bernie Madoff, who, in the analogy of “teach a man to fish…,” stole an awful lot of fish. Teachers who cheat their students are stealing their students’ fishing poles. They should be prosecuted to the fullest extent of the law. And if teachers cheating students isn’t breaking current law, Congress should pass a new law.
So what does this have to do with equity investing, you might ask yourself? There is a parallel to “teaching to the test” – it is “managing to the benchmark,” the traditional approach stubbornly adhered to by many equity managers. Contrary to the clear evidence of benefits of teaching to the test, in equity investing such positives are hard to find.
Many academic studies, as well as highly regarded industry figures such as index fund pioneer John Bogle, have argued that equity managers often struggle to beat equity indices, such as the S&P 500. They argue that investors should stop trying to beat the market, but instead just select the cheapest fund that tracks the benchmark.
In response to these findings, the active equity mutual fund industry has fundamentally restructured itself around an almost singular mission: to try to demonstrate that active management can, in fact, beat benchmark returns in order to justify charging premium fees for active stock selection. Regular measurement of equity fund performance against index returns has become the primary tool in proving managers’ worth.
Objectively assessing whether managers are earning their fees is a good thing – but, as with all measurements and incentives, there are often a number of unintended consequences. Let’s explore specific examples:
1) Many managers are focused on beating benchmarks, rather than helping clients achieve their investment objectives.
Success has now been defined as beating a benchmark. Managers are promoted and firms are rewarded when managers outperform the equity market in a given time period. But this framework loses focus on clients and their objectives. Clients save and invest their money for specific reasons, such as for retirement or children’s education.
Did a manager who lost 34% in 2008 while the S&P 500 fell 37% do a good job of protecting his client’s assets? Did he control risk effectively?
Managing to the benchmark would say, “Yes, job well done.” Common sense would say, “No.”
2) Many managers are really “closet indexers” masquerading as active managers while charging premium fees for benchmark returns.
Many equity managers deviate very little from their benchmark because they are terrified of potentially underperforming it. The stated thesis of most active equity managers is to dig deeper, to unearth investment opportunities that the market hasn’t yet appreciated. Managers try to get to know companies, their competitors, suppliers and customers better than other investors in order to determine who will do well, and avoid those who will do poorly. But many active equity funds have 150 or more individual stock holdings; some have 200 or more stocks.
Can a manager really understand the detailed business models and changing competitive positions of all 150 or 200 stocks in her portfolio? This is highly unlikely, if not impossible.
Hence, many managers are reducing their risk of underperforming their benchmarks by buying more and more stocks, and, as a result, knowing less and less about each of them. In doing so, they usually end up just tracking the benchmark – or even worse, lagging it – while still charging premium fees.
Some managers will only consider buying a stock if it is included in their benchmark. This artificially limits their hunting ground to the sparsest part of the market where the companies are best known by the most investors.
In a 2010 review of active equity mutual fund managers, Professor Antti Petajisto of Yale found “weak performance across all actively managed funds, with the average fund losing to its benchmark by –0.41%. The performance of closet indexers is predictably poor: They largely just match their benchmark index returns before fees, so after fees they lag behind their benchmarks by approximately the amount of their fees. The only group adding value to investors has been the most active stock pickers, which have beaten their benchmarks by 1.26% after fees and expenses.”
3) Risk has been redefined in terms of managers rather than clients.
Equity managers today often define “risk” relative to their benchmark. For example, healthcare makes up 12% of the S&P 500. A manager who has a healthcare allocation of 7% or 17% of his portfolio is said to be taking more active risk than one who has a 12% allocation, who is, in theory, taking no risk.
But is this really true? Are clients really more or less likely to achieve their investment goals, or more or less likely to lose money, because of a 7% or 17% healthcare allocation just because the benchmark happens to have 12%?
Or is that benchmark-centered framework designed to minimize the career risk of the manager? Certainly the 7% or 17% healthcare allocation will increase the tracking error for the fund relative to the S&P 500. That increases the likelihood that the manager will be deemed either a hero or goat at the end of the year. But what does it have to do with the risks clients are taking in achieving their investment objectives? Nothing.
4) Managers are rewarded for launching as many funds as possible.
Another unintended byproduct of managing to benchmarks is even more pernicious: the proliferation of mutual funds and mutual fund awards. In full disclosure, PIMCO has won many of these awards. But every year, thousands of awards are made to equity managers by prestigious firms largely based on recent performance delivered relative to benchmarks. For example, in 2010 Lipper granted over 1,500 awards globally (1,500!) for the best equity mutual funds based on relative performance.
This focus on managing to the benchmark incentivizes equity mutual fund firms to launch as many funds as possible, because at least a few are bound to win a few awards. Firms can then buy advertisements in the Wall Street Journal or USA Today declaring themselves a “Mutual Fund Award Winner.” Such a designation can have a powerful effect on potential clients who don’t realize that only a few of their funds won the awards; it provides a halo to the entire firm.
Why do the raters give out so many awards? Because those advertisements that highlight the winners don’t just help the fund managers, they also convey a level of stature to the firms granting the awards. It is a virtuous cycle of back-scratching between the fund managers and the awarding firms. Everyone wins, right? Everyone except for clients. Do these backward-looking awards indicate that clients actually achieved their investment objectives? Not always.
Managing to the benchmark has transformed much of the active equity industry away from helping clients achieve their objectives and toward helping fund managers achieve theirs. While “teaching to the test” aligns incentives between teacher and student, managing to the benchmark unfortunately can lead to an unhealthy divergence of incentives.
If managing to the benchmark is flawed, how should clients choose among hundreds of equity managers? For starters, clients should focus on those firms that have the best processes to deliver the desired outcomes. This isn’t easy. It requires work and diligence. But considering how hard clients have worked for their savings or retirement nest eggs, some diligence to decide with whom to invest is prudent.
Having entered the active equity industry later than others, PIMCO has had the opportunity to do a lot of basic questioning. As a result, we have developed a series of principles that guide how we invest in equities. And we believe clients will be better off using a framework such as this to decide where, how and with whom to invest:
1) Look at a portfolio in its entirety, rather than just by asset class, and focus on outcomes. What is the goal for this portfolio?
- We are focused on delivering investment solutions that meet our clients’ needs. We are increasingly offering multi-asset solutions that combine equities, fixed income and other asset classes in one offering.
- Many clients appropriately try to diversify across asset classes, but often they don’t realize that many asset classes are correlated.
We focus on risk factors rather than asset classes to help ensure portfolios are truly diversified and risks better understood.
2) Determine in which markets passive equity management makes sense, and in which markets active equity management is potentially better. For the index exposure, you may want to buy the fund or ETF with low fees. For the active exposure, choose the manager with the best investment framework.
- We believe U.S. equity markets, especially large caps, are quite efficient and it is hard to sustainably generate an edge. In this space, the academics and John Bogle are right. It makes sense to use low-cost index products for U.S.-only equity exposure, but selecting a smart benchmark is also important. Market cap–weighted benchmarks are simple but not necessarily smart.
- However, we believe global equity markets are less efficient and there is an opportunity to add value through careful active management where managers can invest across borders, geographies and sectors looking for the best opportunities.
Hence, all of PIMCO’s active equity strategies are global.
3) For the active management segment of an equity portfolio, actually actively manage the investments. Remove artificial constraints. Don’t hug the benchmark. Go anywhere to find the best opportunities and exploit them.
- All of our active equity strategies are unconstrained relative to typical equity strategies. We go anywhere across the globe looking for the best investment opportunities and the best risk-adjusted returns. We are not closet benchmarkers.
We invest aggressively in our best ideas.
- Our active equity portfolios are fairly concentrated relative to the approach taken by many other managers – between 50 and 100 stocks in a typical portfolio. Our equity investment process starts with rigorous individual company analysis. And our investment team knows each of the names we invest in exceptionally well. If we didn’t, it wouldn’t be in our portfolios.
4) Buy companies you want to own and evaluate them in the context of the economic environment in which they operate.
- At PIMCO we have a team of world-class equity investment professionals who tap into our firm’s macro process and global economic insights when evaluating individual equity investment opportunities.
We believe it takes both rigorous individual company analysis and a global macroeconomic framework to successfully manage global equity portfolios, and that’s how we’ve structured our equity investment process.
5) Invest for the long term.
- Given quarterly financial reporting, the 24-hour news cycle, and real-time social media, attention spans seem to be getting shorter and shorter. It is easy to become lost in the constant stream of events affecting global equity markets.
- Although we clearly pay attention to near-term market movements, which could create buying opportunities, we are much more focused on how near-term events affect our long-term outlook for the companies we like.
We are buying companies we like at attractive valuations that have strong fundamentals. We are patient investors. We tend to measure our equity holding periods in years, rather than months (or even days or minutes as some do).
6) Manage downside risk.
- As the financial crisis and recent market turmoil has reminded us all, market corrections can be swift, dramatic and can erase years of gains.
- Understanding how portfolios respond to unusual circumstances is critical to understanding risk and managing potential downside scenarios.
We stress test our equity portfolios against market shocks, and often actively embed “tail risk hedging” in the strategies themselves. While tail risk hedging isn’t free, we believe it can help reduce downside risk and help our clients achieve their investment objectives in a range of market environments.
As a society, we can and should aspire for every single one of our students to receive a good education and become proficient in reading, math and science. Education is not a zero-sum game: Knowledge can be shared widely to everyone’s benefit.
Benchmark-oriented investing, or managing to beat an average, however, is a zero-sum game. Everyone cannot outperform the market; by definition, half must outperform and half must underperform. Reorienting the way we think about equity investing, away from beating a benchmark and toward achieving clients’ objectives, will take time. We look forward to continuing to explore the global equity investment landscape with you in the coming months and years.
Copyright © PIMCO
Tags: Active Management, Active Portfolio, Canadian Market, Controversial Subject, Education Policy, Education System, Equity Management, Equity Managers, Equity Strategies, Global Equities, Indexers, India, Intense Debate, Investment Objectives, Investment Opportunities, Neel Kashkari, Ontario Canada, Outlook, Policy Experts, Portfolio Management, Qualitative Differences, S Education, Worth Reading
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Thursday, July 14th, 2011
What a Multi-Speed World May Mean for Equities
by Masha Gordon and Anne Gudefin, PIMCO
- An apparent rebound in risk tolerance since the financial crisis has supported higher equity valuations.
- Emerging market economies appear to be undergoing a mid-cycle rebalancing. We view this as a welcomed cyclical adjustment rather than the end of their growth cycle; long-term fundamentals remain intact.
- We believe advanced economies should continue to see headwinds to growth, and that potentially means investors may be generally willing to pay lower multiples to earnings. But we see select opportunities, including developed-nation companies with exposure to the developing world.
Certain developed nations appear to be facing the potential for flat, or even tepid, economic growth, while some emerging nations are beginning to face inflationary pressures and other challenges resulting from their faster growth rates. Investors may find asset allocation challenging in this multispeed world.
In the fifth of a series of Q&A articles accompanying the recent release of PIMCO’s Secular Outlook, portfolio managers Maria (Masha) Gordon and Anne Gudefin discuss global growth and inflationary dynamics and what they may specifically mean for equity markets in the years ahead.
Q. PIMCO has said low real interest rates have pushed investors out the risk spectrum. Could you discuss what that means for equity valuations?
Gudefin: There definitely seems to have been a rebound in risk tolerance since the financial crisis, which in turn has supported higher equity valuations. We believe this higher appetite for risk has been encouraged by central bank activities that tend to ultimately suppress real interest rates.
But we do view some pockets of opportunities in the equity market. This can work in investors’ favor as it allows them to remain contrarian and look for good investment opportunities. And considering that PIMCO sees gradually rising inflation in the years ahead, I believe some equities may outperform fixed-rate securities over the next three to five years since certain companies appear to have the potential to translate nominal growth into higher nominal earnings.
Q. Some economic indicators suggest growth may be slowing in parts of the world. What is PIMCO’s outlook, and how are companies positioned for that outlook?
Gordon: After two years of strong growth, emerging market (EM) economies appear to be undergoing a mid-cycle rebalancing. We view this as a welcomed cyclical adjustment rather than the end of their growth cycle. Fiscal consolidation, macro prudential measures and monetary tightening are likely to have the desired effects of slowing domestic demand and curtailing asset bubbles. In some places, such as China, this process appears to be well advanced.
These countercyclical measures are likely to put modest pressure on earnings of select EM corporates, particularly EM banks in countries where growth in credit has been buoyant. However, we still see the EM corporate profit pool growing at a healthy clip of 10% to 12% in 2011.
Gudefin: As part of PIMCO’s New Normal worldview, advanced economies should see headwinds to growth including deleveraging and greater regulation, and these could persist for the next few years. This potentially means investors may be generally willing to pay lower multiples to earnings, especially if high unemployment persists and growth remains moderate in advanced economies, as we expect.
Still, many developed market companies have greatly improved their cash positions, though they seem to favor investing in developing economies and distributing their earnings through dividends or share buyback programs. Perhaps they feel it is better to distribute their earnings than increase production capacity in the developed world, given the limited growth outlook for that part of the world.
Q: Does PIMCO still view emerging markets as a compelling growth story over the long term? What about inflation risks?
Gordon: Yes. We believe that the long-term fundamentals remain intact, and they include demographics favorable to growth, unleveraged consumers and a thirst for investment that is poised to underpin further productivity gains. Over a secular horizon, we expect to see a move to a more balanced growth model across the larger EM economies, such as China, with diminishing reliance on exports and greater contribution of domestic consumption. Along with these trends we anticipate appreciation in EM currencies.
As to inflationary pressures, while they appear to have started homogeneously across emerging economies emanating from higher food prices and robust gross domestic product (GDP) growth, they are likely to become less synchronous over time. For example, Mexico seems to be experiencing little if any price pressures due to a weak labor market and less robust domestic demand. Differentiation is key as reality appears to be far more nuanced. This underscores the importance of incorporating a global macro framework to one’s bottom-up stock selection process.
Over the secular horizon, we are likely to see a rise in wages in EM countries that may lead to a somewhat higher level of trend inflation. On average, emerging market companies should be able to adjust to this environment since they tend to have pricing power due to the health of EM consumers and because corporate leverage is only about 20%. Clearly, there will be exceptions to this rule such as companies that depend on wholesale funding to finance working capital or firms that are involved in low-end manufacturing.
Q. Considering PIMCO’s outlook, what are the key metrics you look at when evaluating companies?
Gudefin: We are attracted to good business models. We have observed over the years that quality companies tend to perform well, and we look for companies with high barriers to entry and strong cash flow generation and the ability to pay down debt. And we evaluate businesses based on what kind of pricing power they might have in the face of rising inflation. We also look at management’s ability to successfully steer the ship and catalysts for value to be unlocked. This is usually in the form of a new CEO, a restructuring program or maybe plans to spin off or divest non-core assets. We look to buy these high quality companies at times when short-term issues bring valuation to what we feel are attractive levels.
Our strategy, as it relates to the global economy and its many influences, remains opportunistic. For example, companies in developed economies with significant exposure to developing ones could be a place to search for attractive opportunities. Also, part of our worldview is for the potential for heightened market volatility – as our CEO Mohamed El-Erian likes to say we are on a bumpy journey – and that can create attractive opportunities as well.
In addition to discerning security selection, we aim to mitigate downside risk through the use of appropriate risk hedging strategies. I believe the ability to hedge our portfolios is a key differentiator for us.
Gordon: We spend a lot of time thinking about the return profile of businesses, favoring those that have high cash flow return on invested capital. Another important consideration for us is an ability to self-finance growth. A number of emerging market franchises may look great from the revenue growth perspective but they often rely on continued financing from new equity issuance that may not be return accretive or sustainable.
The maturity profile of a company’s debt is also an important consideration as business cycles in emerging economies tend to be shorter and companies that rely on short-term financing may find themselves locked out of the market.
Q: Finally, are there any secular equity market considerations that haven’t received much attention but deserve to?
Gordon: We believe China should continue its move up the value chain in select industries. Over the medium term, this could result in significant margin pressure for the European and U.S. industrials that have enjoyed unchallenged dominance of the Chinese domestic market.
Separately, a potential retreat of the United States from dominating global geopolitics is likely to lead to a power vacuum giving rise to regional powers. In light of this, we think defense spending will likely grow considerably in larger EM economies.
Gudefin: In the energy sector, many have written down nuclear energy after the Fukushima tragedy. Although some reactors will be closed, we believe it is not the end of nuclear. Safety norms will tighten, but a number of developing economies will likely continue their aggressive construction plans, starting with China, India and South Korea. Saudi Arabia reaffirmed in June its commitment to build 16 reactors by 2030.
Thank you, Masha and Anne.
Masha Gordon is a portfolio manager heading the recently launched Emerging Markets Equity Strategy, an actively managed equity strategy focused on attractively priced stocks with exposure to emerging markets. Anne Gudefin and Charles Lahr are portfolio managers heading the PIMCO Pathfinder Strategy, a deep value approach to global equities.
Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio.
This material contains the opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. References to future results should not be construed as an estimate or promise of results that a client portfolio may achieve. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.
Copyright © 2011, PIMCO.
Tags: Appetite, Asset Allocation, Developed Nations, Developing World, Economic Growth, Emerging Market Economies, Financial Crisis, Global Growth, India, inflation, Inflationary Pressures, Investment Opportunities, Masha Gordon, Mid Cycle, PIMCO, Portfolio Managers, Rebound, Risk Spectrum, Risk Tolerance, Speed World, Valuations
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Monday, July 4th, 2011
“There may be greater safety in equities, especially high dividend stocks and there’s greater safety in very high quality corporate bonds worldwide,” Larry Fink, CEO of BlackRock told CNBC. “There are investment opportunities that are pretty unique today,” he added.
Source: CNBC, June 29, 2011.
Tuesday, March 22nd, 2011
Investment opportunities in the alternative energy revolution. Financial Thought Leader and energy analyst Bill Paul discusses some surprising developments and overlooked investment ideas.
Monday, January 17th, 2011
This week on Wealthtrack, Consuelo Mack continues her interview with Ed Hyman of ISI Group, Wall Street’s long-time number one ranked economist, and Dennis Stattman, BlackRock’s star Global Asset Allocation fund manager.
The discussion focuses on the economic prospects and investment opportunities internationally.
(Last week they discussed the outlook for the U.S. economy and financial markets. If you missed it, click here.)
Note: The transcript of this interview is not available yet, but will be posted here as soon as it arrives.
Source: Wealthtrack, January 14, 2011.
Tags: Asset Allocation Fund, Blackrock, Consuelo Mack, Economic Prospects, Economist, Economy, Ed Hyman, Financial Markets, Focus, Global Asset Allocation, Investment Opportunities, Isi Group, Long Time, Time Number, Wall Street, Wealthtrack
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Monday, November 29th, 2010
By Claus Born, Senior Executive Director, Templeton Emerging Markets Group
At the end of November 2010, Chile, Colombia and Peru are planning to integrate their stock exchanges, providing local investors with more investment opportunities and also allowing companies to access a broader investor base. We are likely to see increased foreign investor participation with improved liquidity. Once fully integrated, this new regional exchange should have the highest number of issuers in Latin America (before Mexico and Brazil), the region’s second-largest market capitalization (after Brazil) and its third-largest trading volume (after Brazil and Mexico).
Year to date, equity markets in Chile, Colombia and Peru returned 38.8%, 60.2% and 52.6% respectively, outperforming the larger equity markets of Brazil and Mexico, which rose by 4.7% and 18.3% respectively.
Two major events brought the small Andean country worldwide media coverage this year. The most recent was the spectacular rescue of a group of miners trapped underground for more than two months. Chile’s newly elected President Sebastian Piñera was among the first to greet the miners when they came out of the ground. And earlier this year, a devastating earthquake with a magnitude of 8.8 struck the country, the seventh-strongest earthquake ever measured worldwide. While many were rescued from the rubble and the number of survivors was high, the total damage is estimated to reach about 15% of the country’s GDP.
Mr. Piñera’s government has targeted a 6% GDP growth annually during its term and wants to create 200,000 new jobs each year. It also wants to bring the country closer to its boom years of 1986 to 1997, when the economy grew at an average rate of 7.5% annually. So far, the country seems to be on track despite the impact of the earthquake, with GDP projected to grow 5% in 2010 and 6% in 2011.
We believe Chile will continue to be a leader in Latin America, in terms of managing the economy, encouraging investment, both local and foreign, and its stable policies.
In August this year, Colombia elected a new president, Juan Manuel Santos, who will lead the government until 2014. He took over from the very popular Álvaro Uribe, who had led the country since 2002. Juan Manuel Santos is a former Minister of Defense under the Uribe government, which was very successful in limiting the threat imposed for decades by FARC guerilla forces in the country. Mr. Santos’ efforts have resulted in better security conditions, which have increased investment, and improved the world’s perception of Colombia.
The Colombian economy was relatively weak in 2009, but recovery is underway with a projected GDP growth of 4.7% in 2010 and 4.6% in 2011. A lot of investment is taking place in the energy and mining sectors, driven by a large resource base combined with favorable regulation. The expectation that Mr. Santos will continue the market-friendly policies of his predecessor reinforces the positive trend and contributes to steady growth rates.
Peru will be holding presidential elections in April 2011. The last presidential elections were overshadowed by the threat of an extreme leftist candidate taking over. This time, following very strong economic growth during the last few years, the polls indicate that the majority of Peruvians now favor a moderate candidate. Politics in Peru is as dynamic as its counterparts in the region, but the economy has been stable during the last 10 years, thus creating the foundation for sustainable growth.
There have also been strong investment opportunities in the mining sector. Peru is the world’s top producer of silver, second in zinc, third in copper and tin, fourth in lead and sixth in gold. In addition, the country has managed to develop alternative export products, especially in the agricultural sector. There also appears to be strong growth potential in retail and financial services. The country’s GDP is projected to grow 8.3% in 2010, one of the highest rates in the region. It is very possible that Peru will continue to outperform most of its neighbors in terms of economic growth over the next few years.
Mark: Our Strategy in Latin America
Within Latin America, we are currently focusing on Brazil, Mexico, Peru and Chile. Our focus on the consumer and commodities sectors gives us exposure to some of the fastest growing companies in the region. Robust consumer demand, supported by increasing per capita income, creates opportunities in areas as such automobiles, retail, and services such as finance, banking and telecommunications. In the commodity area, resource-rich countries in Latin America are benefiting from increasing global demand.
Our bottom-up, long-term approach is based on analyzing a wide range of companies’ fundamentals such as earnings quality and growth, asset values, and cash flow potential over a five-year horizon.
The Latin American region is undergoing tremendous changes both politically and economically, as highlighted in our past 3 features. We will continue to share our insights and observations as we watch the region navigate through the various challenges.
 Source: MSCI, based on total return indices, as of October 31, 2010.
 Source: MSCI, based on total return indices, as of October 31, 2010.
 Source: Europa, Press Release: Factsheet Chile Earthquake, as of April 3, 2010.
 Source: IMF Report: Chile: Strong Recovery After Devastating Earthquake, as of September 29, 2010.
 Source: IMF, WEO, as of October 2010.
 Source: U.S. Department of State, Background Notes, Peru, as of September 30, 2010.
Tags: Andean Country, Brazil, Commodities, Devastating Earthquake, Emerging Markets Group, GDP Growth, Investment Opportunities, Investor Base, Investor Participation, Issuers, Largest Market Capitalization, Latin America, liquidity, Miners, New Jobs, Regional Exchange, Rubble, Sebastian Pinera, Silver, Stock Exchanges, Strongest Earthquake, Templeton Emerging Markets, Worldwide Media Coverage
Posted in Brazil, Commodities, Gold, Markets, Silver | Comments Off
Tuesday, October 26th, 2010
The Fundamentals of Recoveries (October 2010)
Commentary on the health of equity markets today and the perils of investing while looking backwards. Will McKenna interviews Tim Armour and Jim Dunton, portfolio managers, with Capital Research and Management Company.
Tim Armour, Portfolio manager, Capital Group*
Jim Dunton, Portfolio manager, Capital Group*
*Portfolio manager with Capital Research and Management Company; does not manage Capital International portfolios.
- Recovery off to a slow start – but it’s just the start (VIDEO, 5:12)
- The perils of investing while looking backwards (VIDEO, 3:04)
- Opportunities across a wide swath of companies (VIDEO, 3:29)
- Strong corporate fundamentals an encouraging sign (VIDEO, 3:01)
- Reflections on the presidential cycle (VIDEO, 1:53)
You may watch all of the above videos by clicking HERE, or on the image below. To view all 5 chapters visit “Select Chapter.”
The fundamentals of recoveries
1. Recovery off to a slow start — but it’s just the start
Craig Strauser: Hello. I’m Craig Strauser. Welcome to this edition of Capital International Perspectives. In this program, you’ll hear the latest insights from veteran portfolio counselors Tim Armour and Jim Dunton. When my colleague Will McKenna sat down with Tim and Jim to talk about market recoveries, the topics ranged from company fundamentals and investment opportunities today to presidential cycles and the tendency of investors to gaze into the rearview mirror when calculating their next move.
To start things off, Will asked Jim and Tim to assess the current recovery.
Will McKenna: Let’s start by talking about the current investment environment. Jim, you’ve invested through a number of full market cycles in your more than 40 years in the business. How would you characterize where we are at this stage of the recovery, and where do you see us going from here?
Jim Dunton: There’s a large body of economic evidence on a worldwide basis that any kind of recession that emanated from a financial crisis [like the one] that we’ve just gone through was going to evolve into a deeper recession than any that we would typically experience; there would be a longer recession than any that you typically experience, and, what’s more, the recovery itself would be much slower than normal.
Well, that’s exactly what we’re going through. We now are one year into the [U.S.] recovery, and it’s been very slow — like 3% real GDP. But it’s also important to bear in mind that it is underway. And once recoveries get started, they typically go a long time. The last cycles were seven years, 10 years, nine years; the one before that, eight. The typical cycle is seven to 10 years long, not one year long. So, one year into the recovery — which is where we are now — is not exactly the time to get overly concerned that the recovery has ended. We, in fact, just started.
But I think if you look also at the details, you would feel comforted by the fact that [U.S.] employment is, in fact, gaining ground; it has been all year. The number of hours that are worked is increasing. The number of people employed is increasing. And, importantly, the temporary workers are probably up sixfold from what they normally are in a recovery, which means that a lot of companies are hiring temporary people until they find out what the full status of the current economic programs are, the stimulus programs, the tax programs, the health programs — as to what all that is going to cost corporations before they want to fully employ people.
We’re through, I think, the worst of the recession, and we’re in a recovery mode, which I believe, from my point of view, is going to go on for the next eight or 10 years. So, I think we are slowly gaining ground — slowly gaining ground — but gaining ground nonetheless.
And it’s important that you recognize that what the end of the cycle looks like is more inflation [and] higher interest rates; that’s the typical end of a cycle many years from now. But it does suggest that between here and there are rising corporate profits, rising inflation, rising interest rates and probably a very healthy stock market over that period.
Tim Armour: The overarching issue, I really think — as with any recovery — is that it will be an up-and-down process. There’ll be bits of information or bits of data that come out that are either positive or data that appears that we’re either slowing down again or retrenching, which looks negative. I think one really has to keep an eye on the long run and see what’s happening with corporations, what’s happening with consumers. In the U.S., there’s been a reliquification on the consumer end of things. Consumers went into this period pretty indebted. The savings rate is up a lot in short order, and consumer spending — although not strong by any definition — certainly has maintained a reasonable level.
At some point here, we need to see employment growth in the U.S. pick up and consumers return to spending at a somewhat higher rate if we’re going to really see GDP [gross domestic product] growth here in the U.S. be stronger. But my expectation is that will happen ultimately; it’s more a question of time. And looking at past cycles, you can find any experience along that spectrum of either a more rapid recovery or a slower one. Having lived through some of these in the past, I think, makes us more comfortable that, really, the way to invest in this kind of period is identify the best companies out there, with good fundamentals, and don’t worry so much about the economic backdrop.
2. The perils of investing while looking backwards
Will McKenna: Given what they’ve been through over the past couple of years, a lot of investors are nervous about putting their money in the stock market today. What perspective could you offer, given your experience, about the wisdom of investing in stocks in this environment?
Jim Dunton: Cycles generally develop as I’ve outlined, and that is that you go from paranoia and fear through the evolution of employment growing again, of business getting back together, of resources being used up. And as they’re used up, inflation appears, and the [U.S.] Fed needs to control that. The standard cycle — it’s happened that way every time. There’s no reason to expect this time to be any different.
It is true, of course, that in the last 10 years, the average investor has been hit by two terrible recessions and two very significant stock market declines. It’s enough to scare the average person, for sure. And in the current period, of course, there’s just a plethora of commentary about the difficulty of getting the economy going, of the difficulty of getting people back to work and so forth. But that happens every time. That is what the bottom of a recession — the early part of the recovery — looks like. So, it doesn’t feel any different to me, having been through a lot of them.
Stock market participants are generally always chasing the last good story. And, of course, the last good story is the [U.S.] bond market — which, in fact, has had positive returns for the last 10 years and the equity market has not. Unfortunately, people seem to invest by looking in a rearview mirror. And that’s very unfortunate, because we saw the same thing happen in the period in the late 1990s in the tech blow-off, or in the Nifty Fifty in the 1970s, in the oil run-up in the 1980s. I mean, all these things were chased by people looking backwards.
Tags: Armour, Brazil, Capital Group, Capital Research And Management Company, China, Colleague, Company Fundamentals, Counselors, Dunton, Economic Evidence, Group Portfolio, India, International Asset Management, International Group, International Perspectives, International Portfolios, Investment Environment, Investment Opportunities, Market Cycles, Mckenna, oil, Perils, Portfolio Manager, Portfolio Managers, Rearview Mirror, Silver, Video 3, Wide Swath, Worldwide Basis
Posted in Brazil, China, Energy & Natural Resources, Gold, India, Markets, Oil and Gas, Silver | Comments Off