Global Outlook March



Ken Adams, Head of Tactical Asset Allocation (TAA) Research

During the latter half of February investors experienced an extraordinary bout of equity market volatility: while there have been bigger weekly equity market falls during the course of the last few decades (for example during the 2008 Great Financial Crisis), the speed of the US market’s decline from a historic high was by far the fastest on record. Prior to the sell-off, our behavioural equity market indicators were signalling a clear recovery in risk appetite to above average levels, with investor positioning in equities rising closely behind.

However, fast forward to today, and the opposite is apparent: many bricks have been added to the wall of worry – and understandably so. Recently certain leading indicators of economic activity had been suggesting an improvement in economic momentum over coming months, but these now seem irrelevant: a reassessment of the outlook is now clearly in order as evidence mounts of a widespread Coronavirus pandemic.

So this issue of Global Outlook begins with an article authored by Robert Gilhooly of the ASI Research Institute and Gerry Fowler of Multi Asset Solutions that presents our latest thoughts on the macro-economy and what it means for markets. Yes, it’s time to prepare for a sharp near-term decline in activity, with risks skewed towards a deeper and more prolonged adjustment. However, a policy response is also likely, as already evidenced in China, and joined more recently by a 0.5% interest rate cut by the US Federal Reserve and the Bank of England. More importantly, fiscal policy is likely, to play a bigger role, especially in economies where the efficacy of monetary policy has reached its limits. Of course, markets have rapidly begun to discount the near-term negative impact of the virus, while also making judgements about the likely policy response. Karolina Noculak’s article delves deeper into patterns of corporate profitability and the disruption caused by the virus to what was expected to be a moderate pick up in earnings. Consensus expectations are viewed as being too high and the process of downward adjustment will likely be a feature of the coming few months; it risks being dramatic if downside risks become reality. Ultimately our belief in the resumption of a moderate growth and profit trend remains in place, but downside risks have clearly grown. The path to normality is likely to be volatile as investors try to balance risk and opportunity in the face of a rapidly evolving situation.

Coronavirus is not the only disruptive force impacting financial markets; the challenges presented by climate change remain very much front of mind. Stewart Brown reports that finally, and fortunately, we seem to have reached a watershed moment. A broad range of relevant stakeholders is now engaged. Europe is leading the way, as evidenced by the Green Deal and the proposed EU Taxonomy for Sustainable Finance. This shift is mirrored in certain sectors such as utilities which now derive two thirds of earnings from networks and renewables: a competitive and maturing technology in wind power generation now presents export opportunities. There is more good news: consumer and business behaviour shows clear signs of responding, with convincing evidence of a shift towards ‘clean transport’.

Times of significant stress provide a reminder of the critical importance of diversification. Thinking beyond conventional and high level asset class allocations, Andy Lister asks is this the time to consider listed private capital? By creating a portfolio comprising a combination of investment companies and private market asset managers, it is our belief that it should be possible to deliver long-term returns similar to those generated by investing directly in private equity and debt. In a similar vein, Min-Chow Sai presents the case for a more granular idea: investing in Japanese multi-family rental real estate as a complement to a direct real estate portfolio. Robust fundamentals are expected to drive rental growth higher while a clear yield advantage also exists over equivalent overseas markets. The icing on the cake is the diversification benefit offered by low correlation with global real estate.


Ken Adams

Chart editor
Eimear McKeown


Coronavirus: a tale
of two shocks

Chapter 1


Robert Gilhooly, Senior Emerging Markets, Research Economist
Gerry Fowler, Investment Director, Absolute Return Funds

The coronavirus is poised to materially disrupt the global economy in the near-term. This shock should abate along with the virus, but is creating major disruption in the meantime.

The coronavirus has created a major shock to the Chinese economy in the near-term, and as the virus has spread East to West the size and duration of the shock on both China and the global economy has risen. Disentangling the shock between the manufacturing and services sectors helps to illustrate the impact. It also reveals the potential for sharper than normal spillovers between countries. Overall, while the near-term corona shock may be very large, we expect that it will not derail the global economy; however, risks of a worse outcome remain high, even with supportive measures by policy makers.

The size and persistence of the shock created by the coronavirus is uncertain

Activity is expected to drop sharply in the near-term

The size and persistence of the shock created by the coronavirus is uncertain. Ultimately, it will hinge on the scale (numbers and countries affected) and the duration. The longer this goes on, the greater the chance that negative effects are amplified, perhaps via supply chain disruptions.

China was the first to be affected, and we believe that official Chinese GDP growth is likely to drop to around 0.0% quarter on quarter (q/q). However, we expect our China Activity Indicator will drop much more sharply, perhaps more consistent with a quarterly growth rate of -1% q/q or lower. Overall, we believe that a contraction is plausible given the extension of holidays and what appears to be a slow return to business in February – both necessary steps to contain the spread of the virus.

Uncertainty about the duration and impact is very high and we shall be updating these views as the data develops. The shock to supply chains is one area we will pay close attention to. For now, we assume some disruption to manufacturing (particularly at company level) is inevitable. We believe that this is captured within our forecast assumptions for the hit to Chinese manufacturing and the shocks to the rest of the globe. But supply chain risk could move from the company level to the macro-level. This risk is likely to rise in a non-linear manner with the duration of the outbreak. Data on production, inventories, trade and PMI surveys - both inside and outside of China - are key metrics to watch, as are signs that a whole industry (autos or technology, for example) is grinding to a halt.

Policy should step in to help growth recover

Policy has already become more accommodative and is likely to loosen further. This should help limit the damage caused by the coronavirus and help the global economy to recovery more quickly as the virus abates.

In China, monetary policy has been easing marginally. For example, the medium-term lending facility (MLF) was recently cut by 10bp. Further steps to help maintain credit growth are likely, but we do not expect the authorities to meaningfully roll back their financial de-risking campaign.

Steps to encourage forbearance in the banking system are more significant, and should prevent the financial system from amplifying the shock to the real economy.

Gauging the combined effect of the smorgasbord of announced fiscal policies is hard. The most significant appear to be: measures to shore up small & medium sized enterprises (SMEs), such as cutting employer contributions to social security; and bringing forward local government special bond issuance, which typically supports infrastructure spending.

Chart 1: Chinese manufacturing recovery delayed as virus spreads to West

Source: Aberdeen Standard Investments (as at 12/03/2020).

For illustrative purposes only. Projections are offered as opinion and are not reflective of potential performance. Actual events or results may differ materially.

Chinese monetary policy may now ease more decisively, reflecting additional headwinds from the West which prolong the shock. Overall, the most significant shift in Chinese policy is still likely to be via fiscal policy, which we expect will move more conclusively over the course of Q2.

A tale of two shocks

Disentangling the shock as it affects manufacturing and services sectors helps to illustrate the key channels by which the virus impacts an economy and spills over to other countries. The same dynamics which we illustrate here for China are likely to affect other countries who suffer outbreaks in a similar manner.

Assuming there are signs of the virus coming under control in March, we expect that Chinese manufacturing should be able to resume production. Before the virus showed signs of taking hold in the euro zone and US we had thought that Chinese manufacturing would be able to make up lost production by the middle of the year. But the corona-shocks in the West now suggest that Chinese manufacturing will be slower to recover, perhaps not doing so until Q4.

Measures to contain the virus and ensure it does not resurface – combined with a cautious approach by households – may result in a more protracted drag on the services sector. Therefore, it may remain depressed for longer and then not catch up until next year.

The overall shock to China is skewed towards the services sector. This would normally suggest a relatively smaller spillover to other countries compared with the hit to China. But in this instance, normal modelling approaches may fall short. The disruption to global manufacturing may go through supply chains quickly, while the impact on travel and tourism is also more immediate.

Emerging markets in Asia will be heavily affected by the coronavirus shock. Not only are they deeply embedded in regional supply chains, they also benefit from large numbers of Chinese tourists. Thailand, Malaysia and Vietnam stand out as being particularly exposed on both metrics. And similar to China, even if the engines of manufacturing restart, services may be somewhat slower. With the spread of the coronavirus to the West, global travel & tourism may be even slower to return to normal.

Commodity prices have now fallen very sharply, reflecting the impact and uncertainties of the coronavirus on the global economy, plus changing dynamics in the oil market.

This means the coronavirus shock has a longer reach across developed and emerging markets. For oil importers this provides an offset which will help cushion the blow slightly, but commodity exporting economies, such as the Saudi Arabia, Russia and Brazil will see a correspondingly larger drag. The rise of shale in the US suggests that the US economy is more neutral with respect to oil: the gains to households may be offset by lower business investment, for example.

As this supply shock fades, demand should return and the tailwind from policy easing should help growth momentum to accelerate. The ‘phase one’ trade deal between the US and China had looked likely to come under pressure. But the coronavirus shock may allow China’s purchase commitments to be pushed back, moving any flash point in US-China trading relations beyond the US elections. However, the corona-shock has highlighted potential fragilities in global supply chains, which could further weigh on capital spending and in an era when globalisation was already under pressure.

Chart 2: Emerging Asia is particularly exposed to China

Source: Aberdeen Standard Investments, Refinitiv (as at 12/03/2020).

Markets have reacted violently but consensus may still be too optimistic

As China and the rest of the world escalated their responses to the spread of the virus from mid-January, a cascade of significant market impacts became evident.

Oil prices fell sharply and this has been further exacerbated by the price war announced by Russia and Saudi Arabia. Oil was already declining after US/Iran tensions receded in early January, but expectations of demand destruction and a supply increase have renewed the weakness and taken oil back to 20-yr lows. Prices are now well below where shale producers are considered to be profitable and it is likely there are energy sector defaults in the coming quarters.

Because the bulk of the immediate risk aversion and economic effect was in Asia, equity indices there fell sharply first - led by energy companies, airlines, transportation companies and industrials. As the China-led shock was processed into forecasts, it became more evident that the disruption would be amplified through tight knit global manufacturing supply chains and because the virus was not contained to China. Steadily, international companies with Chinese supply chain exposure or production facilities began to warn of the impact. As global business travel and tourism have now been curtailed aggressively, extreme weakness globally in the equities of related sectors has ensued. Many companies have withdrawn profit guidance altogether.

We and other investors are assessing the cumulative and compounding effect of multiple and simultaneous global shocks. However, these come at a time of extraordinary monetary looseness and the likelihood of additional monetary and fiscal easing albeit not as fast as the market would like. This slowdown or recession comes at a time of extra-ordinary liquidity but where the availability and price of that liquidity is highly bifurcated between companies of varying quality and business models. We are seeing this already with sector and quality dispersion very high across credit and equity markets.

Our multi-asset portfolio managers use a range of behavioural, scenario and survey tools that have helped guide decision-making. Equity markets were technically overbought before virus concerns escalated and so, at least now, we are reassured that this headwind has reversed with many metrics now signalling the market is deeply oversold. However, profit expectations in the short-term are moving sharply lower as the severity, duration and cascading consequences of the downturn are being assessed. This period is increasingly likely to include some permanent value destruction through defaults or equity capital raisings of the viable, but more indebted companies and we must judge how widespread this value destruction becomes.

If the pandemic passes in Q2 and permanent value destruction is contained to some companies or smaller sectors, great value and asymmetry is already available – we think more in credit markets than equities. With equities valued on profits and growth, the same quality bifurcation is likely but with much more volatility until virus and recession risks are clearly receding. We have a list of positive waymarks we would like to see before we become more positive on equities globally. We are not there yet.

Activity is very slowly resuming in China now and the worst of the global economic impact of the virus hopefully passes in the coming quarters. The focus now moves to Europe and the West facing its own crisis. Our baseline scenario is for a sharp slowdown but a steady recovery back to trend in the coming two years. However, we worry of the potential for a cascade of negative consequences from the growth shock (through credit and employment). With consensus still somewhat optimistic of a sharp V-shaped recovery, we think they may still end up disappointed by the severity and length of the slowdown and consequently, the potential for lower valuations and losses on capital that are not recovered quickly.


The size and persistence of the shock created by the coronavirus is uncertain

Earnings outlook:
recovery under threat
from coronavirus

Chapter 2


Karolina Noculak, Investment Director, Multi-Asset Solutions

Two themes; a recovery in earnings and the disruption caused by the coronavirus – are likely to define at least the first half of 2020 for most major listed companies.

If there’s one stock that encapsulates the corporate trends of early 2020, it’s Apple. The iPhone-maker has hit the headlines recently both for blowout results for the final quarter of 2019 and for warning of the threat posed to its 2020 earnings by the coronavirus outbreak. Revenue exceeded consensus expectations by more than $2.5 billion, with strong sales of new iPhone models. But with China’s partial shutdown having a significant effect on the company’s supply chain and Chinese stores, Apple expects to fall well short of its revenue target in the first quarter.

The outlook is best characterised by an abnormally high degree of uncertainty

Earnings bounce back

Judging by the most recent round of corporate results, the earnings recovery was well underway. In the US, fourth-quarter earnings beat analysts’ expectations by a substantial margin. With around three quarters of S&P companies delivering positive surprises, it’s clear now that fears of a 2019 slump in earnings per share (EPS) were overblown. On the whole, companies did a good job of managing expectations.

And with overall corporate profits returning to modest growth of just over 3% in the fourth quarter, it’s now clear that third-quarter year-on-year EPS marked the lowest point in the US earnings cycle as S&P 500 companies ‘worked through’ one of the most demanding quarters of the past two decades. In the fourth quarter, the biggest proportion of beats came from the technology sector, followed by consumer and healthcare. Banks have also done well, with their results heavily driven by trading, especially in fixed income.

The largest proportion of negative surprises came in the energy sector. Here, companies came under pressure from weaker commodity prices. With the price of Brent crude sliding sharply lower in March, this trend has further to run. Already, shares in energy-related companies such as Chevron, Exxon and Schlumberger have endured a horrible start to 2020.

The big questions

While profit growth returned in the latter months of 2019, for the most part, it was still weak (and even non-existent in some cases). Nor is this trend confined to the US: profit appears to be been hard to come by worldwide.

So the first big question for 2020 is whether companies will be able to kick-start earnings growth once the Coronavirus standstill comes to an end. This will depend on several factors. Revenue growth is still robust, but margins have been under some pressure – something that is not atypical at this stage of the cycle.

Against that, the comparison base for EPS growth in 2020 looks undemanding. This situation has arisen as the effects of the Trump tax ‘sugar rush’ have worn off. Accordingly, analysts have been expecting EPS to deliver growth in the mid-to-high single digits over the coming quarters. The technology sector could also be poised to start contributing to the earnings picture in 2020. Having made provisions for a tightening of data security and privacy regulations in 2019, many analysts are now increasing their earnings forecasts again.

Going viral

As Apple’s recent profit warning showed, a major new uncertainty is the impact of the disruption caused by the coronavirus. This is likely to have a particular impact on semiconductor, consumer and industrial companies, and will undoubtedly imperil the cyclical recovery that many analysts have been looking for.

The rapid evolution of the outbreak poses further crucial questions for investors. Most obviously, are analysts’ estimates fully reflecting the disruption that the coronavirus is causing to technology and consumer supply chains? The areas under greatest focus here are travel and transportation stocks, leisure sectors, and consumer goods and services. Analysts have marked down estimates where demand has already been affected by the standstill (especially among airlines and travel & leisure companies). With the global situation changing day by day, these estimates are likely to be subject to rapid revision as the year progresses.

But there is also the question of the supply side. In this era of protectionism (trade wars, Brexit) there could be merit in shortening supply chains and bringing production closer to home. Coronavirus could turn out to be a catalyst for such a shift. This could bring further effects on capital investment and longer-term profitability trends.

Costs, cashflows and consensus expectations

Low funding costs and abundant cashflows (in the absence of capital investment) had underpinned cash distribution to shareholders. Buybacks have been strong and remain EPS-accretive. The actual rate of profits growth will depend on the growth rate of economic activity. For the S&P 500 index, our proprietary models predict profit growth of 7% under a moderate growth scenario or high single digit contraction under a slowdown scenario. The reality for 2020 is probably somewhere in between. Depending on the duration of the effects of coronavirus, this could well turn into a year of two halves, with a recovery pushed into the latter months of the year.

Current consensus expectations are somewhat higher than ours, at 6% US earnings growth in 2020 – a figure that can be considered as little more than a starting point for future negative revisions and which has already been revised lower. But mild profit downgrades are not necessarily bad news for share prices. This is because investors tend to think of analysts’ inevitable 10% initial figure that as little more than an arbitrary starting point. The currently 6% figure looks optimistic to us, given the factors outlined above, but sell-side estimates do seem to be rapidly converging with our EPS forecasts.

So what does all this mean for the equity market? The equity market’s gains of January and February were driven by liquidity as the shift to accommodative policy and hopes for a cyclical improvement led to a re-rating of equity multiples. Multiples took the centre stage in the rally, but sustained equity gains require profit growth to materialise eventually. The severe declines in March have been a sobering reminder that multiple expansion can’t sustain equity returns forever as equities became vulnerable once profit outlook turned uncertain.

What investors require is a more constructive view on future profits. But the outlook is best characterised by an abnormally high degree of uncertainty. The damage that the coronavirus has already done is significant and the possibility of further severe disruption in the months ahead remains real.

Chart 1: Sector results: Q4 2019 earnings season. Strength in technology and healthcare.
Energy under pressure

Source: I/B/E/S data from Refinitiv, 2 March 2020.

Companies mentioned for illustrative purposes only and does not constitute as an investment recommendation or indication of future performance.


The outlook is best characterised by an abnormally high degree of uncertainty

A global climate change
turning point?

Chapter 3


Stuart Brown, Investment Director, Equities

When it comes to tackling climate change, we seem to have reached a watershed moment. Europe, in particular, has a number of sectors which may benefit from the increased regulatory and political support.

When it comes to tackling climate change, we seem to have reached a watershed moment. A broad range of relevant stakeholders are now properly engaged. This is due to a variety of factors, including high-profile campaigners such as Greta Thunberg, a younger generation which cares a lot about the issue, the Green Party’s growing political support and increasing evidence of the scale and pace of global warming. This increased focus will create challenges for high-emitting industries, which will need to adapt, while it will create a large opportunity for those able to facilitate the energy transition.

The proposed European Green Deal confirms that the new European Commission will prioritise climate and environment-related challenges

Europe is leading the way… and it is serious

The proposed European Green Deal confirms that the new European Commission will prioritise climate and environment-related challenges. It focuses on wide-ranging measures including more stringent targets on greenhouse gas emissions and policies related to renewables, energy grids and the circular economy, among other things. While it is currently at the proposal stage, subject to challenge and will take time to implement, it sets the direction of travel for European strategy.

The proposed EU Taxonomy for Sustainable Finance shows the EU is serious about its climate ambitions. The overarching aim is to unlock investments, combat the risk of ‘greenwashing’ and ensure accountability on the path to delivering climate ambitions. For example, the use of the taxonomy will be needed for investment products to be marketed as ‘environmentally sustainable’. To be included in the taxonomy, an activity will need to contribute to one out of six objectives and ‘do no significant harm’ on the other five, while at the same time complying with minimum social and labour conventions.

The six objectives are:

  1. Climate change mitigation
  2. Climate change adaptation
  3. Sustainable use and protection of water and marine resources
  4. Transition to a circular economy, waste prevention and recycling
  5. Pollution prevention and control
  6. Protection of healthy ecosystems.

While no firm date has yet been set for enforcement of this taxonomy, it is widely expected to start in 2021.

From zeros… to net zero

One of the beneficiaries of this trend is the European utilities sector, which has faced a decade of challenges. The main headwind was tumbling power prices driven by a combination of falling fuel prices, carbon price and oversupply. This resulted in earnings and cash flows coming under pressure against a backdrop of stretched balance sheets and resulted in a number of financial restructurings and dividend cuts. Unsurprisingly this also drove poor returns for investors.

Fast-forward to today and the picture looks very different. The earnings mix has changed materially, with networks and renewables representing close to two-thirds of sector earnings compared to one third in 2010. Earnings are being driven much less by power prices. This means that the sector’s earnings profile is less volatile and less macro-sensitive at the same time as being well positioned for higher growth as driven by decarbonisation and energy transition. This trend is already underway as a result of the improving cost competitiveness of renewable technologies and an attractive backdrop for access to capital.

Investors are increasingly focusing on this trend across the capital structure with the expansion of the green bond market and the rapid growth in environmentally focused equity products. This means that on top of the more visible earnings growth, companies can benefit from a lower cost of capital alongside an already accommodative bond yield environment.

One example of the growth opportunity is the offshore wind industry, which has until recently been focused on Europe. As the technology has become more competitive and mature, it is starting to expand into new markets such as the US. Last year the International Energy Agency estimated that the offshore wind addressable market alone could grow at a 15% CAGR to 2040, requiring over $1trn of investment. Further policy initiatives such as the EU Green Deal and an increasing focus on the ‘journey to net zero’ should further enhance visibility around this trajectory. The European Utilities sector is home to some of the leading players in the industry, such as Orsted.

Planes, trains & automobiles

A focus on lowering carbon emissions amongst a broader range of stakeholders is leading to implications beyond renewable energy and utilities. ‘Flysgskam’, or ‘flight shame’, is a term which has entered into common parlance in recent years and describes the shame we should feel about flying given its impact on the environment. One implication of this is the emerging trend of consumers to shift from air travel to rail, given rail’s lower emission profile. Recent data from Germany has shown weakening of domestic flight passenger numbers in favour of long distance rail. In November 2019, the German Airports Association (ADV) registered a 12% drop in passenger numbers year on year for German domestic flights. It is not just consumers being attracted towards rail. Only last year Germany announced VAT cuts for rail travel and recently announced an €86bn rail infrastructure plan agreed between the federal government and Deutsche Bahn. This is just one example of the favourable demand backdrop for rail industry suppliers. Clearly the ‘clean transport’ discussion extends further into the transition to electric vehicles and the electrification of the wider economy, where Schneider Electric should be well positioned.


The proposed European Green Deal confirms that the new European Commission will prioritise climate and environment-related challenges

An opportune time
to consider listed
private capital?

Chapter 4


Andrew Lister, Head of Closed End Fund Strategies

Private equity and debt markets are enjoying continued strong performance and growth. Listed Private Capital strategies are designed with the aim of providing more simple access to these trends through a liquid structure.

What is Listed Private Capital?

At ASI, we use the term Listed Private Capital (LPC) to describe the universe of stock-exchange-listed companies whose long term value is driven by the performance and growth of private markets. Private market asset classes range from private equity and debt to real estate and infrastructure. A diversified portfolio of LPC investments aims to provide provide investors with liquid exposure to these otherwise difficult to access opportunities.

The focus of Listed Private Capital strategies is primarily on opportunities in private equity and private debt

The focus of Listed Private Capital strategies is primarily on opportunities in private equity and private debt, but with flexibility also to invest in the likes of real estate and infrastructure. The core LPC investment universe extends to around 220 companies with a combined market cap in the region of US$580bn (Source: Aberdeen Standard Investments, Bloomberg, 31/12/19).

The universe comprises two broad types of company:

1) Listed investment companies

Listed vehicles that hold a portfolio of private market assets, the long term value of which will be determined by the performance of those assets. The best known example of such structures are real estate investment trusts, or REITs, but similar companies exist that invest in private equity, debt, infrastructure and other private market asset classes. A key feature of such companies is the potential for the shares to trade below the value of the assets held within the company’s portfolio – this is referred to as a discount. Discounts can present opportunities to buy at an attractive price.

2) Listed private market asset managers

Operating businesses that derive their value from the management of, and investment in, private market asset classes on behalf of third party clients and often the company’s own balance sheet.

By combining a portfolio of such investments, we believe it is possible to deliver long term returns similar to those achievable by investing directly in private equity and debt. The approach is summarised in the picture below.

Chart 1: Liquid access to private markets

Source: Aberdeen Standard Investments.


2019 into 2020

At the start of 2019 we predicted that attractive returns lay ahead in the LPC universe for investors who were willing to look past the market volatility seen at the end of 2018. This prediction proved correct, with a combination of rising asset values, narrowing discounts and dividends propelling returns. After such a positive year, it’s prudent to take stock and consider whether we can rely on the same return drivers to deliver in 2020.

What’s ahead for private equity?

Listed investment companies focused on private equity continue to offer value, in our opinion. This view is supported by generally good performance from underlying portfolio companies (the ultimate long term driver of their performance), defensive positioning and regular realisations at premiums to carrying value. Given the scarcity of ways to access private equity in a liquid fashion, and the continuing drive towards democratisation of the asset class, we believe the double digit discounts on many private equity investment companies to be excessive. Our view remains that in any year in which a benign economic and corporate backdrop exists, investors can reasonably expect to make returns from these companies in the mid to low teens.

Corporate activity in private debt investment companies to present opportunities

Private debt investment companies (predominantly listed in the US and extending loans to middle market private companies) will, we believe, remain a fertile source of opportunity in 2019. The pace of corporate activity that was a feature in 2019 is likely to continue, with more private debt companies to be listed, merged or subject to management change. Corporate activity generally presents opportunities for informed, long term investors to capture attractive yields supplemented by capital gains. Regulatory change in the US could provide a tailwind, potentially leading to greater institutional ownership and better governance. We are monitoring such developments closely.

Selective value in listed mangers

Many US-listed private market asset managers elected to convert from publicly traded partnerships to corporations in 2019, a change which provided tailwinds for their share prices by making them investable for the first time for a broad range of investors. This process is now largely complete, meaning returns in 2020 will be driven more by fundamentals. Key factors will be the ability to sustain fundraising success, the performance of underlying strategies and a brisk pace of portfolio activity (investments and realisations). We see little evidence to date that the positive trends of prior years’ are moderating. Current valuations more fully reflect such expectations than they did a year ago, but value as well as growth still can be captured in selected names. We prefer those managers with scale, breadth and strong underlying performance and believe those with significant balance sheet investments are undervalued compared to their capital-light peers.

A focus on liquidity

A discussion of the last year would not be complete without mentioning liquidity. Investors are well aware of the issues of open-ended funds that invested in illiquid underlying asset classes such as direct private equity and real estate. The risks around “gating” and pricing in times of market stress or material redemptions are real. Investors, however, should be wary of potentially ‘throwing the baby out with the bath water’ through lack of appreciation of fundamentally different ways to access illiquid or private markets.

ASI’s LPC strategy invests 100% of its assets in listed investment instruments which trade on stock exchanges around the world. We monitor the liquidity of those instruments closely to ensure we are able to meet even a punitive level of redemptions. While our underlying investments may be volatile in the event of a market selloff, but such dislocations ensure that the market finds a level at which willing buyers match motivated sellers.

A sanguine outlook for 2020

Private markets as a whole continue to enjoy strong growth, as shown in Chart 2, with private equity and debt being among the fastest growing and most substantial categories.

Chart 2: Private equity and debt amongst the largest, and fastest growing alternative asset classes

Source: Preqin, June 2019.

While concerns around private market valuations and leverage are commonplace, we remain sanguine on the outlook. Our base case is that core private market asset classes such as private equity and debt can continue to deliver excess returns over public markets. They can do so on account of the illiquidity premia that experienced managers can capture and the large and growing universe of investment opportunities from which to choose, often to less cyclical sectors than in the public markets. The year has started with a record level of private equity capital waiting to be invested (estimated at US$1.5 trillion). This, combined with the accommodative stance of central banks, will likely ensure deal-making (which totalled US$450 billion in 2019) and debt origination will remain brisk.

In summary, 2019 was a positive year for private markets in general. While rising prices have eroded the margin of safety presented by the lowly valuations of 2018, they still have not reached levels that cause us undue concern. The private market investments that underlie our holdings are performing well, and this will remain the fundamental driver of returns in 2020 and beyond. Wherever possible, we will seek to further enhance returns by taking advantage of mispricing when we encounter it.


The focus of Listed Private Capital strategies is primarily on opportunities in private equity and private debt

Japanese multi-family

Chapter 5


Min-Chow Sai, Head of Real Estate Research, Asia Pacific

Three reasons why this asset could warrant a place in a portfolio: strong fundamentals, a high yield gap and diversification benefits.


The real estate market in Japan has been a major beneficiary of ‘Abenomics’ since Prime Minister Shinzo Abe took office at the end of 2012. The perception of the Japanese yen (JPY) being a ‘safe-haven’ currency among investors has also increased the appeal of JPY-denominated assets. This includes real estate, as evidenced in the 9.1% gain of the JPY against the US dollar (USD) since the end of 2014.

On an unlevered basis and in USD terms, Japan real estate overall has generated a total return of 9.8% per annum on average since 2015.

On an unleveraged basis and in USD terms, Japan real estate overall has generated a total return of 9.8% per annum (p.a.) on average since 2015. To put things in perspective, this is a better performance compared to 1) listed equities in Asia Pacific (APAC – 8.1% p.a.), 2) investment-grade bonds in Asia (4.6%p.a.), 3) high yield bonds in Asia (6.6% p.a.), 4) direct real estate in APAC overall (8% p.a.), and 5) listed APAC REITs (9.5% p.a.) over the same period. Within the Japan real estate market, the industrial sector has performed the best since 2015 (10.7% p.a.), followed by the residential sector (9.8% p.a.).

A large part of this total return has been driven by capital value growth – about half, compared to 36% in APAC and 38% globally. Considering 1) the gap between property yields and the 10-year government bond yield is now already at a low, 2) the 10-year government bond yield itself is already below zero, and 3) slowing economic growth, the key questions on investors’ mind are therefore whether Japan real estate’s outperformance could be sustained, and which sector to focus on.

In this article, we highlight three reasons why we believe Japan multifamily rental apartments, especially those located within the Tokyo 23 Wards, remain an attractive asset class for direct real estate allocation, notwithstanding the sector’s outperformance in recent years.

Robust fundamentals to support further rental upside

At Aberdeen Standard Investments, long-term urbanisation and demographics remain two of our favorite investment themes. Specifically, we believe skilled labor will increasingly be drawn to cities that are ranked highly in terms of quality of living, infrastructure, education and healthcare. This will in turn support housing demand in these ‘winning cities’. Japan is a case in point. While the total population in Japan has been shrinking since 2010, net migration into the ‘winning cities’ of Tokyo, Osaka, Nagoya, Fukuoka and Sapporo has in fact been on the rise. In the case of Tokyo, for instance, the average net migration each year since 2016 is more than 61,000 persons, which represents a 15% increase from what the rate was in the early 2000s.

Chart 1: Average total return in USD since 2015 (% p.a.)

Source: Bloomberg, MSCI IPD, Aberdeen Standard Investments; February 2020.

As a result, the average vacancy of rental apartments in these five cities is now less than 3%, compared to an average 4% over the last 10 years. While new supply of rental apartments has increased in recent years, we expect vacancy levels to remain relatively tight, especially within the Tokyo 23 Wards. Since 2016, for example, construction starts of rental apartments within these wards have been on average c.26,300 units each year, which represents a fraction of the yearly net migration rate. Consequently, we forecast market rents in Tokyo 23 Wards to rise 3%p.a. over the next three years, more or less in line with the pace achieved over the past three years (3.2%p.a.).

Higher yield gap, faster market rental growth versus peers

The average yield gap for rental apartments in Tokyo is 413 basis points (bp) as of end-2019. While this is 40bp below the -1 standard deviation level since 2010, it appears relatively attractive compared to the average 267bps in APAC and 300-400bp on average in Americas, the UK and Europe ex-UK. This is especially the case if we were to overlay this assessment with the rental growth outlook over the next three years (see chart 2). A potential reason for the higher-than-average yield gap could be the slow transmission between market and passing rents (i.e. the average rent that tenants are currently paying in a property) as a result of high tenant renewal rates. For instance, net operating income among rental apartments in Japan has on average increased just 0.5% p.a. over the past three years, notwithstanding a gain of as much as 3.2% p.a. in market rents in Tokyo. We believe a value-add strategy (buying properties, refurbishing them and then re-leasing them back to the market) could raise passing rents faster than a core strategy and it is therefore our preferred strategy for this sector.

Chart 2: Cap rate spread (bpd) vs. 3-year forward rental growth (%p.a.)

Source: Advance Residence Trust, Bloomberg, Jones Lang LaSalle, Aberdeen Standard Investments; February 2020.

An effective diversifier for direct real estate portfolios

Data from MSCI IPD dating back to 2002 (the earliest available for Japan real estate) suggests the correlation between the total return of Japanese residential and global real estate is just 0.28. Further, the correlation between the total return of Japanese residential and office properties is -0.05 since 2013 (i.e. the beginning of ‘Abenomics’). While most investors appreciate that rental apartments are typically counter-cyclical assets, it appears this is more so the case in Japan than in other markets. For example, the correlation between the total return of residential and office properties in Europe since 2013 is 0.69. This suggests Japan residential properties could be an effective diversifier for direct real estate portfolios.

In conclusion, we believe that, even after their relative outperformance in recent years, Japan multi-family rental apartments remain an attractive asset class for direct real estate investors. This is from both a risk-reward angle (relatively high yield gap and projected market rental growth underpinned by robust fundamentals), as well as from a risk management angle (low correlation with other markets and hence an effective portfolio diversifier).



On an unlevered basis and in USD terms, Japan real estate overall has generated a total return of 9.8% per annum on average since 2015.

The views and conclusions expressed in this communication are for general interest only and should not be taken as investment advice or as an invitation to purchase or sell any specific security.

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