InvestmentNews | Has central bank policy helped or hurt the global economy since the financial crisis in 2008?
Mike Avery | The actions taken by central bankers helped get the global economy out of a steeper decline than it may have been in otherwise. The questions for us as portfolio managers are, “Will the actions prove to be good enough? Will there be unintended consequences as central bankers try to reverse course in the weeks and months ahead?” The collective actions of the central banks since 2008 were designed to arrest a fall in real gross domestic product (GDP) and to prevent a deflationary spiral. Those actions resulted in interest rates going into a steeper decline and then holding at very low levels. The global economy had the benefit of real GDP not declining as rapidly as if the central banks had done nothing. We wonder if we're likely to see very slow real GDP growth for what could be a very long time.
IN | How does talk of tapering fit into what you've just described?
Avery | The taper discussion reflects the desire of the Federal Reserve to try to back out of a policy that we don't think is working, at least in the context of what it was intended to do. The intent was to stimulate real GDP and reduce the unemployment rate. The problem is that the Fed and other central bankers can make money available and keep interest rates at zero, but they can't force banks to offer that credit or make individuals use it. The U.S. economy is already about 70% domestic consumption. Can the Fed stimulate consumers by making more credit available to them at lower rates? That's one aspect of the dilemma for the Fed. A second aspect is whether central bankers have correctly diagnosed the problem. What if it's not a demand problem; what if it's too much supply?
IN | Why aren't policymakers considering the possibility?
Avery | Policy makers are reluctant to let businesses collapse because that would put people out of work and create social tension that, from their perspective, would be worse than a world with excess supply and the resulting deflation. Central bankers have a reserve policy rhetoric that suggests we just need to get demand going again. We're concerned that central bankers in general are ignoring the fact that we may have too much global supply. That means it will take a long time in a world with low real GDP growth to increase demand enough to overcome that excess supply.
IN | What is investor sentiment like at the moment? What are they not seeing about the market that they should be seeing?
Avery | A year ago, our investor base in the Ivy Asset Strategy Fund was still nervous about our exposure to equities. To give you some perspective, we had 85% of the portfolio invested in equities and 3% invested in cash. Through private investments, our only exposure to fixed income was about 4% of the fund. Today we have about 75% of the portfolio in equities and about 13% in cash. Shareholders went from saying we were foolish to have so much in equities to now telling us we're foolish not to hold more. You find people justifying why they should move out of an asset class that is beginning to offer less return and into an asset class that has done pretty well over the last five years. Many try to justify why the market might have another 25% upside from here without facing that it has gone up 175% from the lows of March 2009. It's classic investor behavior that occurs after any asset class has done well for a long period of time. People try to come up with all kinds of reasons to explain why ”this time it's different.”
IN | How is this type of behavior reflected in market correlations?
Avery | In markets such as those since 2008, when investors became fixated on a handful of macroeconomic events, valuations can quickly become tightly correlated. Securities within indices, or indices within markets, or markets across borders tend to move pretty much the same. The focus on macro issues means they don't take the time or don't care about micro issues and idiosyncratic risk. They care more about systemic risk and how to minimize it. Markets in late 2012 were fairly tightly correlated. But since the beginning of 2013, as investors became more complacent and more euphoric, convincing themselves to go overboard in equities, market correlations have moved back to the very low pre-crisis levels of 2004 to 2007.
IN | So how does your macro view and assessment of investor attitudes translate to the sectors you currently like and your investment philosophy?
Avery | We think investors are likely to continue to shift out of fixed income, and they may move out of long duration, higher risk bonds. This could create an opportunity similar to the fourth quarter of 2008. Markets had become tightly correlated and many investors threw out high-yield securities, which gave us an opportunity. So we're watching the high-yield market very closely. We're also watching equities in emerging markets, which is not an area of significant investment now. But we know we must look outside the developed markets for sectors, industries and individual securities that will serve the needs of people who are entering a domestic-consumption phase of economic development. Within the developed markets you want to pay attention to materials, energy, industrials, technology and infrastructure sectors. So far, the developed markets have gone up on the back of consumer discretionary sectors. I think investors have used that as a safe way to invest in equities, so there could be opportunities if there is a correction and investors move to cash. As for our investment philosophy, we always remember that we are managing our investors' money for a long period of time. We've managed this style for about 17 years and our focus for the last 10 years has been on the pursuit of global growth. In other words, we're analyzing where growth will come from over the next three-, five- and 10-year periods.
IN | What about valuations of equities and fixed-income securities? Are assets cheap or expensive at the moment?
Avery | We're in an odd period – neither asset class is really cheap because central bankers are manipulating the markets by forcing interest rates very low. They're using the balance sheet to buy certain securities and the outcome of that, whether intended or not, has been to drive up the price of both equities and fixed-income securities. The choice for us has been to reduce our exposure to equities by moving to cash, which is not a great choice either because the return on cash is zero. At some point, we're going to look differently at the fixed-income market as yields go higher, but it certainly isn't now. We still think equities – while perhaps less compelling than a couple years ago in this low-growth environment – are the preferred investment choice in relative value terms.
IN | Describe the “flexible portfolio” in the Ivy Asset Strategy Fund. What are its benefits?
Avery | It's different from being an equity- or fixed income-only portfolio. When it was created, the idea was to be able to have zero to 100% of the fund in global equities, in global fixed income or in cash. We can use precious metals and we also can access derivatives for income enhancement, hedging or directional exposure. It allows our investment team to look at markets globally, consider all asset classes and have the flexibility to execute a decision that we believe will benefit our investors. We've been able to take investors into a wide range of different asset classes across geographies, market cap structures, private and publicly traded – all as a way to generate long-term returns.
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