Read the Autumn 2017 edition of IMR online
Previously a separate publication for Chartered members and Fellows, the Investment Management Review (IMR) is now available in a condensed form in eight pages of The Review print edition, and available in full online.
Written and edited by Dr Arjuna Sittampalam, Chartered MCSI, the extracts feature critical analysis of a selection of interesting outputs relevant to the asset management sector. Articles are selected for their long-term significance, covering structural changes in the sector, investment practices and fierce controversies.
This analysis was rated as one of the highest valued sections of IMR in our readership survey conducted in June 2017.
Featured below is the first extract. We hope you enjoy the new section and please do get in touch with any feedback.
Deglobalisation dangers for asset managers
Fund managers have thrived on the globalisation of the past three decades. If this powerful force is reversed, as is more than possible, it may not be good news for the financial services sector. But there is reason to be sanguine for now.
Increased protectionism and other forces
President Trump’s announcements have brought into sharp relief that populations and governments in an increasing number of countries have become protectionist and anti-global. But the threat to free trade did not start with Trump; it was already well established.
According to the World Trade Organisation (WTO), from the middle of October 2015 to the middle of May 2016, the G20 economies introduced protectionist trade measures at the fastest rate of five a week since the financial crisis. The US’s withdrawal from the Trans Pacific Partnership and the renegotiating of the North American Free Trade Agreement is the manifestation of not just Trump’s policies, but also reflects anti-global politicians becoming more popular worldwide.
Global cross-border capital flows
The prospect of restrictions on free trade is not the only globalisation story. What happens to capital flows is even more important for asset managers, and the recent evidence of the global picture is not reassuring.
Since the 2007 financial crisis, global cross-border capital flows have fallen by nearly two-thirds in absolute terms and by up to four times relative to world GDP.
Half of the decline has been in cross-border bank lending, with foreign loans down by $7.3tn since 2007, representing a 45% fall. A large part of this has been intra-eurozone lending. Interbank borrowing showed the largest decline. Swiss, UK, and some US banks exhibited a decline in foreign activity.
Several reasons account for the retreat of global banks from lending abroad. There has been a new appreciation of country risk and foreign business has been less profitable than domestic.
Many banks, having overextended themselves internationally, learnt the hard way about the risks of going abroad without adequate investigation. The sub-prime crisis, Spanish real estate problems, and Turkey, were among the areas where international banks were hit. Partly because of this, and also with the growth of a new nationalism among politicians, policies in various countries tended to encourage domestic lending rather than sending money abroad. Politicians being naturally more concerned about economic sluggishness at home was a compelling influence.
It is not, however, bad news on all fronts. Though many global banks have backed off from the rest of the world, there are exceptions. Chinese, Canadian, and Japanese banks as well as some in developing countries have been increasing their operations abroad. Canadian banks suffering from a mature limited market at home have now put half of their assets elsewhere, particularly in the US. Their Japanese counterparts have also stepped up international lending, particularly in the US and South East Asia.
But the most dramatic transformation comes from China. Its top four banks have quadrupled the share of assets invested in foreign countries since 2007. But the total still is only $1tn, just 9% of the asset base compared with the average 20% of advanced economies held in foreign investments. If Chinese move to this ratio there is still plenty of growth ahead.
Despite the massive fall in cross-border capital flows, McKinsey Global Institute remains sanguine by concluding that financial globalisation is not dead, but still alive and kicking and in fact, could emerge in better shape with greater stability and more inclusiveness worldwide. Globally, foreign investment relative to GDP has not changed much since 2007, though the rapid growth prior to the financial crisis has come to a halt. The proportion of global equities owned by foreigners has increased to 27% as of 2015, compared with just 17% in 2000. It is the same picture in global bonds, with corresponding figures of 31% in 2015 versus 18% in 2000. Only lending and other investment has fallen.
Foreign direct investment (FDI) and equity flows have risen to 69% of cross-border flows, having increased from 36% in 2007. FDI being of a strategic long-term nature is much less volatile than bank lending and adds stability to financial globalisation.
Furthermore, more countries are now contributing to financial globalisation. According to McKinsey’s new Financial Connectedness Ranking, while the advanced economies and the international financial centres are the most integrated in the world’s financial system, China and various developing countries have become more connected. China’s connectedness in particular has been on a sharp upward trajectory. Its outward stock of bank lending and foreign direct investment has trebled in the past ten years.
Though the biggest global banks have drawn in their horns, financial markets are still strongly interconnected. As of now, it is the advanced economies who are the most integrated in the global financial system. According to McKinsey’s ranking, the US, Luxembourg, the UK, Netherlands and Germany are in the top in this order of interconnection, reflecting partly that they have deeper financial markets.
Financial markets are still strongly interconnected
However, China’s role is expanding fast, with its ranking jumping from eighth position in 2015, from sixteenth in 2005. It is now a significant investor worldwide, including the emerging areas of Africa and Latin America. Its much-publicised determination to advance the international use of its currency also indicates that it is set to further increase its international role.
International financial centres play a critical role in the interconnectedness of the financial system. McKinsey defines such centres as those with assets and liabilities exceeding 10% of their GDP, and it has identified ten of these centres, including newcomers such as Bahrain and Mauritius. These have the advantages generally of low tax rates, favourable regulation, and well-developed banking sectors. A characteristic they all share is that they are hubs for attracting foreign capital and then allocating this abroad. Since 2007, they have produced a third of the total global growth in foreign investment.
Another source of foreign capital represents remittances from immigrants to developing countries. This has remained stable at nearly $500bn in 2016, representing more than 50% of private capital flows to these countries. A manifestation of globalisation spreading wider is that in 2005 the US received about 67% of capital invested abroad, and this figure fell by half by 2016.
So, overall, McKinsey concludes that financial globalisation is in good shape and will actually be more stable. But there are risks. Cross-border lending remains volatile and can lead to large fluctuations in currency rates and economic growth, possibly adding to political problems.
It is argued that banks need to adapt to digital and fintech developments, and review their global strategies. And regulators should find new tools to deal with volatility and to keep pace with rapid technological change. In the future, digital platforms, blockchain, and machine learning, hold promise as new channels for cross-border capital and to further widen participation among countries.
McKinsey is right in saying that if things stand as they are, financial globalisation is in decent shape. But it partly depends on how far the reverses in free trade go. If the latter becomes so bad that it threatens economies as it well could, then capital flows also could acquire whipping boy status. Then, fund managers have to sit up and worry.
Furthermore, banks’ prosperity and fund managers’ futures are interconnected in several ways. In many parts of the world, banks control distribution. The franchises possessed by banks are an easy route to asset management.
Having said all this, already there are signs that it is not just global banks, but global fund managers and private banks that are finding it harder in many parts of the world to establish a local presence. It’s not politics here. Everywhere, localisation is gaining as companies closer to the customer find it easier to keep up with fast-moving changes in local preferences.
Another relevant development is the onshoring phenomenon in the West, partly due to advances in robotics reducing the benefits of cheap labour elsewhere. Transport costs and increasing wages in developing countries are also encouraging manufacturers to make things closer to home.
As of now, there is no need for fund management houses to worry too much but they need to be watchful of how far populists will go in reversing globalisation.
This article was published in the Q4 2017 print edition of The Review. The print edition is available to all members who opt in to receive it, except student members. All eligible members who would like to receive future editions in the post should log in to MyCISI, click on My Account/Communications and set their preference to 'Yes'.