Tuesday, September 29, 2015

UAVs: Welcome to the Drone Age


THE scale and scope of the revolution in the use of small, civilian drones has caught many by surprise. In 2010 America’s Federal Aviation Authority (FAA) estimated that there would, by 2020, be perhaps 15,000 such drones in the country. More than that number are now sold there every month. And it is not just an American craze. Some analysts think the number of drones made and sold around the world this year will exceed 1m. In their view, what is now happening to drones is similar to what happened to personal computers in the 1980s, when Apple launched the Macintosh and IBM the PS/2, and such machines went from being hobbyists’ toys to business essentials.
That is probably an exaggeration. It is hard to think of a business which could not benefit from a PC, whereas many may not benefit (at least directly) from drones. But the practical use of these small, remote-controlled aircraft is expanding rapidly. After dragging its feet for several years the FAA had, by August, approved more than 1,000 commercial drone operations. These involved areas as diverse as agriculture (farmers use drones to monitor crop growth, insect infestations and areas in need of watering at a fraction of the cost of manned aerial surveys); land-surveying; film-making (some of the spectacular footage in “Avengers: Age of Ultron” was shot from a drone, which could fly lower and thus collect more dramatic pictures than a helicopter); security; and delivering things (Swiss Post has a trial drone-borne parcel service for packages weighing up to 1kg, and many others, including Amazon, UPS and Google, are looking at similar ideas).  
The drones’ club
Nor is commerce the only area in which drones are making a mark. A glance at the academic world suggests many more uses await discovery. Because drones are cheap, geographers who could never afford conventional aerial surveys are able to use them to track erosion, follow changes in rivers’ sources and inspect glaciers. Archaeologists and historians are taking advantage of software that permits drones fitted with ordinary digital cameras to produce accurate 3D models of landscapes or buildings. This lets them map ancient ruins and earthworks. Drones can also go where manned aircraft cannot, including the craters of active volcanoes and the interiors of caves. A drone operated by the Woods Hole Oceanographic Institution, in Massachusetts, has even snatched breath samples from spouting whales for DNA analysis. And drones are, as might be expected, particularly useful for studying birds. A standard shop-bought drone can, for example, be used unmodified for counting nests high in a forest’s canopy.
Public servants, too, are putting drones through their paces. In the case of nest-counting, the idea is not to disturb the wildlife in question. In Ottawa officials have taken the opposite approach, with a “goosebuster” drone that is fitted with speakers which play the calls of birds of prey. This has kept a city park on Petrie Island free from the hundreds of geese whose droppings were causing problems. Police in Michigan are considering using drones for mapping the scenes of accidents, so that roads can be reopened more quickly. And drones can save lives, as well as keeping parks clean and traffic moving. In June, for example, Frank Roma, a fireman, rescued two boys from a river in Maine with the help of a drone. The boys were stuck on a rock in the middle of a powerful current. Mr Roma employed a drone to carry a line out to them, along which he passed life jackets that they were able to put on before an inflatable boat went out to perform the tricky manoeuvre of picking them up.
Other roles for drones are more questionable. Their use to smuggle drugs and phones into prisons is growing. Instances have been reported in America, Australia, Brazil, Britain and Canada, to name but a few places. In Britain the police have also caught criminals using drones to scout houses to burgle. The crash of a drone on to the White House lawn in January highlighted the risk that they might be used for acts of terrorism. And in June a video emerged of KATSU, a pseudonymous graffito artist, using a drone equipped with an aerosol spray to deface one of New York’s most prominent billboards.
How all this activity will be regulated and policed is, as the FAA’s own flat-footed response has shown, not yet being properly addressed. There are implications for safety (being hit by an out-of-control drone weighing several kilograms would be no joke); for privacy, from both the state and nosy neighbours; and for sheer nuisance—for drones can be noisy. But the new machines are so cheap, so useful and have so much unpredictable potential that the best approach to regulation may simply be to let a thousand flyers zoom.
The trailblazers of the field—the Mac and the PS/2 of the drone world, if you like—are the AR and the Phantom. The AR, built by Parrot, a French company, became a bestseller in 2010. It is an easy-to-fly quadcopter that beams video back to a smartphone. Then, in 2013, a Chinese firm called DJI introduced the Phantom. That brought professional-quality aerial photography within the reach of general users. The Phantom’s latest incarnation, which costs less than $2,000, can shoot 20 minutes’ worth of footage before it has to land.
How long these two firms will dominate the world of drones is anybody’s guess. Andrew Amato of Dronelife.com, an American consultancy, says that the Phantom’s limited flight time makes it vulnerable. A drone that could fly for significantly longer—an hour, perhaps—would change the marketplace, as would one that was fitted with “sense-and-avoid” technology that would stop it running into obstacles by mistake. Researchers are busy in both these fields.
Up, up and away
Sense-and-avoid, needed for drones to operate safely in shared airspace without close human supervision, is hard without extra sensors, such as radar. Using a drone’s own video camera to recognise objects in real time requires tremendous computing power. Some firms are, however, attempting to do just that. One, Bio Inspired Technologies of Boise, Idaho, is tackling the problem with a hard-wired neural network, a type of device that is good at learning things. This can, the firm’s engineers believe, be trained to recognise and avoid aerial obstacles. Alternatively, a conventional, if high-end, computer can be programmed with algorithms pre-designed to recognise and evade threats, by understanding how objects visible to a drone’s camera are moving. Percepto, a firm based in Tel Aviv, uses this approach, which it dubs “intelligent vision”. Percepto’s system might also be used to frame camera shots, by taking into account such things as lighting angles.
Whichever approach—training and learning, or pre-cooked recognition software—wins, drones that are able to understand their environments to even a limited extent will be a lot more useful. They could, for example, recognise their operator and home in on him when required. They might be set loose on frost-damaged roads, to look for potholes. They could be released to cruise over forests to spot fires early, or sent off to seek errant hikers who have failed to report in when expected.
Extended flight time will make all these putative uses more plausible, and many people are working on that, too. The most common approach is to switch in mid-air from being a helicopter, which relies on power-hungry rotor blades to stay aloft, to being an aeroplane, which gets its lift, more efficiently, from fixed wings.
The SkyProwler, from Krossblade, a firm based in Tempe, Arizona, looks like an aeroplane, but has four rotor blades which flick out of its body for vertical take-offs and landings. Dan Lubrich, the company’s boss, claims it is efficient at both hovering and forward flight, and says the transformation mechanism adds only about 10% to the drone’s weight. The SkyProwler cruises at 100kph (60mph) and has a flying time of 40 minutes. It can travel up to 25km, hover to shoot video or drop off a package when it arrives, and then return. It should go on sale in December.
Engineers at VTOL Technologies, a company spun out of the University of Reading, in Britain, are working on Flying Wing, a drone with a 120cm wingspan. Four ducted fans propel it forward in level flight, but their attitudes can be adjusted to allow them to provide lift directly. The upshot is a device which can be angled into the wind, to provide yet more lift. That permits it to hover in the way that gulls and other soaring birds do, with little expenditure of energy. VTOL estimates it will be able to do so for an hour, or remain in level flight for more than two hours.
The days of the Parrot/DJI duopoly thus look numbered. Mr Amato extends the comparison to PCs to the time when IBM’s grip on its half of the personal-computer duopoly faltered and numerous competitors rushed in. This did not, of course, prevent Apple’s business surviving on the back of a loyal and particular group of consumers, but it did mean that small computers became commodity products. Like a drone in a gust of wind, the future of the this market will have many twists and turns—but all the signs suggest that the air will soon be abuzz with machines.

Greys’ elegy


THE population of the developed world is ageing. Everyone knows that it is happening but no one is sure what it will mean. A new paper from Morgan Stanley, part-written by Charles Goodhart, a former member of the Bank of England’s rate-setting committee, along with Manoj Pradhan and Pratyancha Pardeshi, suggests there may be dramatic economic impacts.
In particular, the paper suggests that the greying population may reverse three long-term trends: a decline in real (inflation-adjusted) interest rates, a squeeze on real wages and widening inequality. That is because those trends were driven by previous demographic shifts; first, the entry of the baby boomers into the workforce after 1970 and second, the more than doubling of the globally integrated workforce as China and eastern Europe joined the capitalist system. 
This rise in the labour force produced downward pressure on real wages. It also led to slower improvements in productivity, particularly in Europe. As Mr Goodhart writes, “As labour cheapens, managers spend less effort and invest less capital in order to raise productivity.”
The falling cost of labour also produced downward pressure on the prices of manufactured goods, especially as companies relocated to Asia and eastern Europe. This created deflationary pressures, allowing central banks to ease monetary policy. China’s relatively closed financial system and lack of a social safety net created a savings glut that added to the downward pressure on real interest rates. In turn, lower real rates pushed up asset prices which, along with the pressure on wages, added to inequality since financial assets tend to be owned by the better-off.
But population growth in the rich world, which was 1% a year in the 1950s, has fallen to 0.5% and should drop to zero by 2040. Some countries will see declining populations before then. Crucially, the share of the population formed by those of working age is already starting to fall. Indeed, Mr Goodhart reckons that the ageing population will create additional demand for labour, as illnesses such as dementia will require more care workers. This will start to push real wages higher, raising labour’s share of national income and reducing inequality.
Real interest rates balance the desired level of savings with the desired level of investment. The elderly save less and spend more of their income than the middle-aged, as a natural part of the life cycle. But even the middle-aged will not save enough, Mr Goodhart says, either because they underestimate the amount they will need for a comfortable retirement or because they expect to depend on the state.
If that analysis shows that savings are bound to fall, what about investment? In a slow-growing economy, there will be fewer profitable investment opportunities. But Mr Goodhart argues that investment will not fall as fast as savings and thus real rates will rise.
What is his rationale? Most investment by households is in the form of housing. The old are usually reluctant to move out of the homes they bought when middle-aged, even though their children have moved out. This will make it more difficult for families to find the space they need; that means residential investment will not fall significantly. As for investment by firms, rising wages will encourage companies to substitute capital for labour. Corporate investment could rise.
The thesis is vulnerable to other changes in the economy. The labour force could be boosted by greater participation by women and the elderly, or by immigration—although Mr Goodhart does not think these factors will be sufficient to compensate for the effect of ageing. The less educated, for example, find it harder to stay in the workforce beyond 65.
This last point also raises the question of whether inequality will fall as he predicts. Demography has not been the only factor behind widening inequality: many economists point to “skill-biased” technological change as a driving force. Low-skilled workers who can be replaced by computers or robots will be more vulnerable in a world of rising real wages; the computer-literate will still command premium salaries.
The people who would most like Mr Goodhart to be right are probably mainstream politicians. The sluggish performance of real wages in advanced economies, along with the signs of rising inequality, have caused them to lose votes to parties on their left and right. If these trends go into reverse, voters might be a bit more content. But the change might not occur fast enough to save some political careers.

Outlook for the Global Economy and Markets


The fourth quarter is a good time to start thinking about the outlook for the global economy and markets not just for rest of the year but for the following year and  for the following year as well.  The independent and well regarded research firm BCA produces a quarterly strategy update which  covers the global economy and markets (US, Europe, Japan, China, EM) as well as specific investment ideas, and given their remarkable track-record (turning cautious on global markets in June after being bullish since 2009, bearish on EM currencies  and commodities since last year, ending of the US dollar bull run earlier in March) it is advisable to pay due heed to their research. To summarise:
 
-The global economy is expected to muddle along a below trend pace  this year, but should pick-up some steam next year  driven by successful efforts by China to reflate their economy  and the resulting recovery in EM economies. However, the shortfall in aggregate demand will keep inflation subdued and will keep rates low for years to come.
 
-US growth is currently averaging 2.3% for the year, which is in line with growth over the previous five  years, and looking ahead it is unlikely to deviate much from the 2% rate. While some developing tailwinds should provide support  - like the positive  impact of lower oil prices on consumption, a normalization of the 30%  drop in energy capex spending, and a diminished fiscal drag which has subtracted 0.50% from GDP growth over the last five years (assuming no government shut down later this year). They are likely to be offset by   fading tailwinds from loosening in lending standards, improving business and consumer confidence, rapidly rising asset values, zero rates, and finally a  normalization of the recession induced pent-up demand (i.e. auto sales).
 
-The remarkable feature of the US recovery has been that a meager 2% growth rate has reduced the unemployment growth rate from 10% in late 2009 to 5.1% , which based on the pre-crisis relationship should have kept unemployment at around 10%. This is due to the exceptional  decline in labour productivity (see chart below) driven by  both structural factors (flattening out in the rate of educational  achievement, disappointing gains from the latest technologies) and cyclical factors (low levels of business investment, misallocation of labour).
 
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-An enduring feature of the sub-par recovery since the crisis has been the shortfall in demand. While the adverse  impact of  deleveraging on demand has been well  documented, what has been missing is  a new re-leveraging cycle to bring demand back to pre-crisis levels. For example, residential investment is currently  3.4% of GDP, and while it may go back to 4%, it is very unlikely to go the pre-crisis level of 6% which means that 2% of GDP has just vanished.
 
-This fall in demand is unlikely to be replaced by increased consumption (as savings are higher), increased investment (as labour force growth is falling implying less demand for building capacity), increased exports (due to a  stronger dollar) or higher government spending (political considerations).
 
-The possible way out is that rates remain low for an extended period (the above analysis assumes rates move back to pre-crisis levels) which could spur consumption, increase  investment in marginally profitable projects made possible by low rates, stronger exports due to a weaker dollar and  higher fiscal spending due to  low borrowing costs.
 
-How low should rates be? With short-term real rates averaging only 1% during the previous business cycle (see chart below) when all the above factors were major tailwinds, it is safe to assume that real rates should stay at zero or even negative for the foreseeable future.
 
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-By contrast, Europe with is poorer demographic profile and dysfunctional institutions, will need continued zero or even negative nominal rates to support the economy and the risk is that it may not be able to ease financial conditions sufficiently to prevent a Japanese style deflationary spiral.
 
-While official forecasts (IMF, European Commission) expect a rebound  in the peripheral economies to support European growth, the signs are that this may prove to be difficult. For example, the IMF expects Italian growth to pick-up driven by increased investment by the private sector to offset the increase in  government austerity (thereby reducing the debt/GDP ratio) , but this  is unlikely  given their shrinking labour force and  lack of competitiveness, forcing the government to increase spending (and therefore increase the debt/GDP ratio) or face stagnant growth.
 
-Therefore, the longer term prognosis for Europe implies a resurfacing of the debt crisis at some point, though over the next 12 months we are likely to see a surprise on the upside driven by  lower oil prices, a weaker euro, improving credit markets (see chart below which  shows the almost perfect correlation between credit growth and GDP) and pent-up demand from the recession.
 
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-Moving to Japan, while the economy faces numerous challenges like a declining working-age population, disappointing productivity growth (output per hour remains 36% below US levels), a high government debt level limiting fiscal stimulus , and a relatively higher vulnerability to  EM economies, it is important to note that  falling property prices and corporate deleveraging have largely run their course. In addition, Abenomics seems to be working with inflation expectations rising  sharply and  pushing down real rates by almost 2% (see chart below), and the prime age employment-to-population ratio has risen by 3% and is now 5% higher than in the US.
 
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-EM economies  have suffered greatly from an outflow of liquidity this year, a reversal of the massive inflows which took place until a few years ago.  A lack of structural reforms during the boom  years led to a significant fall in productivity outside of Asia (see chart below) and the credit  deleveraging cycle is still in its early stages with Turkey, South Africa and Brazil being most vulnerable.
 
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-Growth in China is slowing down driven by a slowdown in demand for its exports, the government’s anti-corruption drive which has  reduced  consumption of luxury goods, and  as it transitions from a capital intensive  export-oriented economy to more focus on consumption and services (see chart below).
 
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-However, policy makers have the tools in place to ensure that the transition does  not disrupt economic growth in a significant way. The cuts in rates and reserves seem to have caused a rebound in the housing market with both sales and prices accelerating recently (see chart below). In addition, the fiscal measures to boost infrastructure spending  announced recently should add 1% to annual  GDP growth over the next three years.  On the negative side, the recent   mini-devaluation of the yuan  was botched as the move was not meaningful enough resulting in   capital outflows  which offset some of their easing measures. Expect the yuan to depreciate by another 5-8% against the dollar.
 
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-China is likely to avoid a hard landing – firstly, their debt is mainly from state owned banks to local governments and SOEs and arguably these could be  netted out as its one part of the government lending to another. Secondly, the housing market has very low debt levels  with mortgage debt at 19% of GDP (versus 74% in the US) and loans to developers  at 10% of GDP versus 30% in pre-crisis Spain. Even if housing prices fall sharply, the correct analogy would be Hong Kong, which despite suffering precipitous price  declines during the Asian financial crisis, saw only a marginal increase in mortgage default rates compared to the US and Spain.
 
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-Claims that China overinvests are also somewhat misleading, as despite the capital-to-output ratio moving higher in recent  years it is still lower than it was in the late 70s (see chart below) . This is because the optimal  level of investment depends on the growth rate – while China has  invested heavily its economy has also grown substantially keeping the capital-to-output ratio in check and well within the range of other countries (see second chart below).
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-China is expected to maintain a relatively strong growth rate for  years to come driven by its exceptionally high educational attainment level for its stage of development (see chart below). For example, if China’s output per worker were to converge with the level of South Korea by mid-century(currently at 30%), it implies a growth still averaging 7% over the next decade.
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Investment implications:
 
-Remain tactically cautious on equities (since June 12, 2015) given the fragility in emerging markets, the  uncertainty surrounding a Fed rate hike in December and the collapse in global earnings (see chart below).
 
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-However,  remain  cyclically bullish (have been since October 2009) using the late 90s as the template, when every major sell-off proved to be a buying opportunity. While some factors differ from the late 90s – i.e. EM are a bigger part of the global economy and DM central banks have less room to cut rates, valuations are much more attractive now with global equities at a forward P/E of 16 (compared with 25 in the late 90s) and at 2 times  book (versus 4 times in the late 90s).  Europe and Japan are preferred  over the US given their more attractive valuations and favourable liquidity conditions.  So remain cautious for now and use a 10% or more pullback to increase exposure.
 
-Remain cautious on EM over the near term and use a further sell-off of 15-20% to add risk. While EM stocks have got cheaper, and trade at a low 12 P/E, this reflects depressed valuations in a few heavy weight sectors like energy, materials and financials, and they still trade at a relatively high median 19 P/E (same for price-to-book).However, the Chinese stimulus should provide a boost to global growth in 2016 which would support the cyclical sectors in EM, and in particular, China H-shares which trade at record low valuations despite earnings and dividend growth which have far exceeded the US over the past decade (see chart below). They represent  the single best current trade idea over the long haul.
 
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-US treasuries remain cheap given  10-years at a fair value of 1.5%  (with Fed funds remaining in a 1-2% range for reasons outlined earlier and other fundamental reasons), though in the near term they are vulnerable to a sell-off. Typically during past tightening cycles, long rates sell-off during the months preceding  the  first tightening, then stabilise and actually decline over the cycle.  Long treasuries also provide a  good hedge against stock market risk, as evidenced by the negative correlation in place  since the 2000s which is in sharp contrast to the previous three decades (see chart below).
 
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-The dollar  is expected to continue to be range bound against the Euro and Yen while appreciating against commodity and EM currencies for the balance of the year.
 
Fascinating insights which  I broadly  agree with. As detailed in last weeks letter, the current uncertainty surrounding the flow of liquidity warrants a cautious approach and the need to raise cash if we do get a rally into year-end, to be redeployed if we get the 10% plus correction in DM equities (and more in EM). Over the longer haul, EM  equities (in particular China and India) and currencies provide superior expected returns implying that core portfolios should continue to favour EM assets. The  continued Chinese stimulus should also provide good upside to Russian and Brazilian assets in 2016. Perhaps the single most important variable to keep a close eye on in the coming months is the monthly Chinese M2 growth number as it encapsulates the net effect of all the Chinese easing measures (besides being more reliable than other economic variables)  which have a significant impact on global  markets. As the chart below illustrates clearly, monthly M2 growth dipped to 10% in the summer, the lowest level in more than 17 years, but since then has  moved up sharply in the past three months in response to policy measures. Please also note the relationship between  falling money supply growth since its peak in 2010, and the slowdown in EM economies (with the US escaping the slowdown due to its QE policy implemented in late 2010). Chinese money supply growth is key -  equivalent to $21 trillion versus $12 trillion for the US!

Monday, September 28, 2015

Aluminum giant Alcoa is splitting itself into to two


Aluminum giant Alcoa is splitting itself into to two public companies: Upstream Company and Value-Add Company.
The names of the companies speak for themselves. Upstream Co. will be involved in getting the stuff out of the ground. Value-Add Co. will turn that stuff into a workable product for its customers.
"The globally competitive Upstream Company will comprise five strong business units that today make up Global Primary Products - Bauxite, Alumina, Aluminum, Casting and Energy," management explained. "The innovation and technology-driven Value-Add Company will include Global Rolled Products, Engineered Products and Solutions, and Transportation and Construction Solutions."
Management expects the action to be completed in the second half of 2016.
“In the last few years, we have successfully transformed Alcoa to create two strong value engines that are now ready to pursue their own distinctive strategic directions,” CEO Klaus Kleinfeld said. “After steering the Company through the deep downturn of 2008, we immediately went to work reshaping the portfolio."
"We have repositioned the upstream business; we have an enviable bauxite position and are unrivalled in Alumina, we have optimized Aluminum, flexed our energy assets, and turned our casthouses into a commercial success story," Kleinfeld continued. "The upstream business is now built to win throughout the cycle. Our multi-material value-add business is a leader in attractive growth markets. We have intensified innovation, made successful acquisitions, shed businesses without product differentiation, invested in smart organic growth, expanded our multi-materials profile and brought key technologies to market; all while significantly increasing profitability.”

Saudi Arabia withdraws overseas funds


Saudi Arabia has withdrawn tens of billions of dollars from global asset managers as the oil-rich kingdom seeks to cut its widening deficit and reduce exposure to volatile equities markets amid the sustained slump in oil prices.
The Saudi Arabian Monetary Agency’s foreign reserves have slumped by nearly $73bn since oil prices started to decline last year as the kingdom keeps spending to sustain the economy and fund its military campaign in Yemen.
This month, several managers were hit by a new wave of redemptions, which came on top of an initial round of withdrawals this year, people aware of the matter said.The central bank is also turning to domestic banks to finance a bond programme to offset the rapid decline in reserves.
“It was our Black Monday,” said one fund manager, referring to the large number of assets withdrawn by Saudi Arabia last week.
Institutions benefited from years of rising assets under management from oil-rich Gulf states, but are now feeling the pinch after oil prices collapsed last year.
Nigel Sillitoe, chief executive of financial services market intelligence company Insight Discovery, said fund managers estimate that Sama has pulled out $50bn-$70bn over the past six months.
“The big question is when will they come back, because managers have been really quite reliant on Sama for business in recent years,” he said.
Since the third quarter of 2014, Sama’s reserves held in foreign securities have declined by $71bn, accounting for almost all of the $72.8bn reduction in overall overseas assets.
Other industry executives estimate that Sama has withdrawn even more than $70bn from existing managers.
While some of this cash has been used to fund the deficit, these executives say the central bank is also seeking to reinvest into less risky, more liquid products.
“They are not comfortable with their exposure to global equities,” said another manager.
Fund managers with strong ties to Gulf sovereign wealth funds, such as BlackRock, Franklin Templeton and Legal & General, have received redemption notices, according to people aware of the matter.
Some fund managers have seen several billions of dollars of withdrawals, or the equivalent of a fifth to a quarter of their Saudi assets under management, the people aware of the matter said.
Institutions such as State Street, Northern Trust and BNY Mellon have large amount of assets under management and are therefore also likely to have been hit hard by the Gulf governments’ cash grab, the people added.
“We are not that surprised,” said another fund manager. “Sama has been on high risk for a while and we were prepared for this.”
Sama has over the years built up a broad range of institutions handling its funds, including other names such as Aberdeen Asset Management, Fidelity, Invesco and Goldman Sachs.
BlackRock, which bankers describe as the manager handling the largest amount of Gulf funds, has already reported net outflows from Europe, the Middle East and Africa.
Its second-quarter financial results reported a net outflow of $24.1bn from Emea, as opposed to an inflow of $17.7bn in the first quarter.
Market participants say the outflow is in part explained by redemptions from Saudi Arabia and other Gulf sovereign funds, such as Abu Dhabi.

Saturday, September 26, 2015

China's consumers: Doughty but not superhuman


IN THE 1950s Caoyang New Village, then on the outskirts of Shanghai, became one of China’s first model settlements for heroic socialist workers. Thousands moved into its plain, lookalike homes to man its state-owned textile mills. Today, rising from the once-modest streets is a gaudy building intended for a new kind of model citizen: consumers.
Global Harbor (pictured) ranks among the world’s biggest shopping malls, its floor space equivalent to nearly 70 football fields. It blends ersatz European architecture with a distinctly Asian selection of stores. Beneath its vaulting glass domes and mock renaissance murals are a Hello Kitty café, a half-dozen noodle restaurants, jewellery shops dripping with gold and a theatre used for karaoke contests.  
It is only a slight exaggeration to say that China’s economic hopes rest on the faux-Corinthian columns of Global Harbor. With the country’s decades-old investment boom fast dwindling, it needs consumption to kick in as a new driver of growth. This rebalancing has been talked about for years, but has become more urgent as China’s industrial downturn has deepened. The nationwide frenzy of construction is abating, factories are saddled with overcapacity and the northern rustbelt is on the brink of recession. This week a manufacturing index recorded its lowest monthly reading in six years, and the seventh successive contraction.
Amid the extreme pessimism about China’s economy in recent months, it is tempting to conclude that rebalancing has failed. Just look at the car market, usually a good shorthand for the health of consumer demand. Automobile sales fell by 3.4% in August compared with a year ago, the third monthly decline in a row. Yet other forms of consumption are accelerating. A property recovery has stoked demand for furniture, home electronics and renovation materials, with sales rising an average of 17% in August from a year earlier. From jewellery to traditional Chinese medicine, buying has picked up in recent months.
Smartphone sales are down in volume terms but soaring by value, as shoppers move upmarket. Companies hit by the anti-corruption campaign under Xi Jinping, China’s president, are learning to prosper despite the new strictures. Distillers’ profits, which fell last year, have rebounded, pulled along by affordable brands for ordinary consumers rather than the exorbitantly priced bottles previously used as bribes for officials.
Overall, China’s retail sales have increased by 10.5% in real terms this year, well ahead of economic growth (officially 7% but closer to 6% according to many analysts). There are, as ever, doubts about the reliability of China’s data, though in this case it may be that the retail figures are too low. Nicholas Lardy, an expert on Chinese statistics at the Peterson Institute for International Economics, a think-tank, notes that retail numbers do not include services, a glaring omission since surveys show that services account for as much as two-fifths of China’s consumer spending.
All this suggests that consumption is picking up at least some of the slack from the industrial downturn. The main reason for the resilience of the Chinese shopper is steady income growth. Wages for migrant workers rose by 10% in the second quarter compared with a year earlier, faster than the national average of 7%. Since low-income earners tend to spend more of their pay than the rich, that has given consumption an extra boost.
One concern is whether this income growth can continue as Chinese industry struggles. Some factories are cutting jobs. But services account for a bigger share of the economy than industry, employ more people and are still growing well.
Structural factors are also at work. With China’s working-age population now shrinking, labour is becoming scarcer and employees command higher wages. China’s household savings rate of nearly 30%, among the world’s highest, is also beginning to fall as the population ages and the elderly draw down some of their accumulated wealth. Household consumption as a share of GDP fell to 35.9% in 2010, unusually low even by Asian standards, but has since been clawing its way up.
A generational shift has helped. For older Chinese, the experience of deprivation in Mao’s day inhibits spending. At Global Harbor on a Sunday afternoon, those carrying shopping bags or queuing up at restaurants are overwhelmingly in their 20s and 30s. “Our parents are very careful but we want to have more of a balance in life,” says Lulu Yu. A legal assistant out with her boyfriend to watch a film, she is the picture of a fully grown consumer. Sporting fashionably tinted hair and contact lenses to make her eyes appear bigger, she dangles new high heels from her arm, an impulse purchase on the way to the cinema.
Does this mean that Chinese shoppers are poised to become an engine of the world economy, like their fabled American counterparts? In some ways this has already happened. The number of Chinese tourists going abroad rose by 19.5% last year to 107m. What’s more, Chinese tourists spend more than others, snapping up goods that are cheaper abroad. All this makes China the world’s biggest source of tourism dollars (see chart). In South Korea and Thailand, the increase in spending by Chinese tourists in 2011-14 made up for the fall in exports to China over the same period, according to Capital Economics, a research firm.
But even if Chinese consumption remains healthy, it will not be a cure for ailing global growth. The commodity-exporting countries whose fortunes have hinged on China over the past decade stand mainly to lose, since they produce little in the way of consumer goods that appeal to Chinese buyers. Indeed, for the outside world as a whole, China’s shift from investment to consumption will subtract from demand, since making steel involves more imports than stocking malls like Global Harbor. The imported component of Chinese consumption is 11 percentage points lower than that of its investment, according to Goldman Sachs, a bank. A rebalancing of 1 trillion yuan ($157 billion) from investment to consumption would thus cut Chinese imports by about 110 billion yuan.
This relative self-reliance is likely to increase with time. A study by Bain, a consultancy, found that out of 26 categories of cheap consumer goods, foreign brands lost market share in 18 last year, including skin cream, milk, fabric softener and toothpaste. In more sophisticated products, domestic companies are also elbowing into territory once dominated by international players. Chinese car brands have accounted for 41% of sales this year, a 3.5 percentage-point increase in market share. Growing consumption of services, whether cosmetic surgery or restaurant meals, only accentuates the home advantage, since most services are delivered locally. China’s consumer boom is real. But do not count on it to lift the global economy.

Will Alibaba’s woes rub off on Indian e-commerce?


As the stock price of China’s online retail giant Alibaba Group plunges on account of slowing growth and question marks over the company’s accounting policies and business model, investors fear a ripple effect on valuations of e-commerce companies in India.
The funding boom in India of the past 20 months was at least partly driven by the success of Alibaba’s initial public offering (IPO), which was the largest ever share sale and valued the company at more than $230 billion. It spurred hope that India, the next big online retail market after China, could also produce valuable e-commerce companies. Eager investors pumped more than $8 billion into Indian start-ups. Tech investors in the US, Europe and Asia, who either missed out on Alibaba’s IPO or were enriched by it, queued up to invest in India’s e-commerce companies.
It’s a different matter that, time and again, investors and companies attracted by comparisons of India’s consumption potential with that of China’s market reality have inevitably been disappointed.
Now that question marks have emerged over Alibaba’s perpetual motion engine, venture capital (VC) firms and other investors said they will be more cautious on late-stage deals in India, conduct stricter due diligence and demand higher transparency and disclosure from current and potential portfolio companies.
Since Alibaba went public last September, the company’s market value has plunged to less than $160 billion from a peak of more than $250 billion. In an article published earlier this month, Barron’s, a US-based financial weekly, predicted Alibaba’s stock may fall by up to 50% and criticized the company’s accounting and corporate governance and said its claims of high user numbers and spending were inflated.
Alibaba fired back and said the Barron’s article contains “factual inaccuracies and selective use of information, and the conclusions (it) draws are misleading”.
Whatever happens to the Alibaba stock, e-commerce investors are already turning cautious on emerging markets, especially India.
“Clearly, the sheen has been taken off (Alibaba’s IPO); the IPO was a major event in the funding boom of the past year or so,” said an investor in Flipkart, speaking on condition of anonymity. “In India, late-stage valuations are already showing signs of plateauing and it’s clear they will not increase with the ease they did in the past year. Now, when new investors are evaluating Indian companies, they are doing more due diligence and asking about structures and corporate governance because they’re seeing the scrutiny Alibaba is being subjected to. These kinds of questions weren’t asked with such seriousness earlier.”
Executives at five other venture capital firms confirmed that they were doing this.
There are some close connections between Alibaba and India’s e-commerce business.
SoftBank, Tiger Global and DST Global, all three of which are currently writing the largest cheques for Indian e-commerce firms, backed Alibaba. Another shareholder in Alibaba, Temasek Holdings Pte. Ltd, which is Singapore’s state-run investment firm, is an investor in Indian e-commerce as well as a limited partner (LP) in some VCs. LPs put their money into VCs, which in turn back start-ups.
Japan’s SoftBank, in particular, has taken a direct hit from the drop in Alibaba shares as it owns roughly a third of the Chinese company. Alibaba itself is an investor in Snapdeal (owned by Jasper Infotech Pvt Ltd) and its affiliate Ant Financial backs One97 Communications Ltd-owned Paytm.
These linkages pose a threat to the funding rush into Indian start-ups that is already showing signs of ebbing as profits and viable business models still elude e-commerce companies, Mint reported on 24 August . Alibaba’s declining stock price played some part in the slight but sure shift in investor perception toward Indian start-ups and any further hit to Alibaba’s image may make a funding slowdown worse, investors said.
LPs are already asking VCs to go slower on deals because of the controversy surrounding Alibaba, a prolific early stage investor said on condition of anonymity.
There will be some negative impact on valuations, particularly for late-stage companies because of the controversy surrounding Alibaba, but that is not a “bad thing”, said Amit Anand, managing partner at Singapore-based VC firm Jungle Ventures.
“Such a correction is healthy and it will eventually build confidence among investors. While some fly-by-night investors will exit or avoid India because of the Alibaba impact, people who are serious about investing in India will continue to put in money because of the massive potential,” Anand said.

Latin American slowdown hits spending power of consumers


For the best part of a decade the popularity of premium brands has been one of the most striking features of Latin America’s rapidly growing consumer economy.
But in the last couple of years, a different trend has started to emerge. With economies slowing, unemployment and debt burdens rising, many households are under financial pressure and shoppers are starting to rein in spending. 
“More and more people are worried for their jobs, and are economising,” says Luciana Hope, a 43-year-old housewife who lives in an upmarket district of Salvador in Brazil’s north-east.Families that may have freely spent on an Apple iPhone or L’Oréal face cream are looking at cheaper alternatives.
In the past few months, she has swapped her tried and tested Omo washing powder for discounted Ariel, used Ypê fabric conditioner instead of Comfort and Seda shampoo rather than the more costly TRESemmé.
When Ms Hope’s friends and neighbours go out, they are choosing cheaper trendy Skol beer rather than the more expensive spirits or cocktails they might recently have preferred.
The trend is particularly strong in Brazil’s economy which is expected to contract by about 2 per cent in 2015. However, the region as a whole is set to stagnate this year, so confidence is subdued elsewhere too. Regular surveys of 6,500 consumers in six Latin American countries conducted in recent months by FT Confidential Research, show confidence edging lower even in countries such as Colombia and Peru that are expected to grow by more than 3 per cent this year.
Across the region, the research shows a steady increase in the number of consumers who are attaching more importance to price than to quality. In June 2015, for example, 19 per cent of respondents said price was the most important consideration when buying food compared with 16.4 per cent nine months previously. Price was also a more influential factor when it came to buying clothes and personal care products, becoming the main concern for 41.5 per cent (up from 38.8 per cent) and 34.4 per cent (up from 31.1 per cent) of respondents respectively.
“We are seeing depremiumisation as Latin America passes through a moment of crisis,” says Eduardo Tomiya, managing director for South America at Millward Brown Vermeer, a marketing consultancy in São Paulo.
In the group’s latest compilation of the top 50 most valuable Latin American brands, five relatively cheaper beers, four of which are made by AB InBev, the beer giant of which Brazil’s AmBev forms a significant part, are in the top 10. Skol heads the table for the first time, taking over top position from Corona, which was the region’s most valuable brand in 2013 and 2014.
The calculations — based on the difference between an estimated market value and a brand’s tangible assets — shows economy products gaining ground in other areas too.
19%
The portion of people who think price is important when buying food
In the food sector, growing numbers of consumers are preferring to shop at cash and carry outlets or discount supermarkets. Bodega Aurrerá and Lider, respectively the Mexican and Chilean discount operations of the US supermarket group Walmart, both rank highly in the Millward table, with Bodega up six places to 14th and Lider up eight to 17th.
“Cash and carry has been expanding very aggressively,” says Mr Tomiya. The local operations of two international groups: Brazil’s Atacadão, owned by France’s Carrefour, and the Argentine and Brazilian operations of Spain’s El Día, illustrate the same tendency.
Many Brazilians still put a priority on upmarket shampoos, face creams and other personal care items and cosmetics, but recent research by FT Confidential showed that economy brands have been doing well this year.
Brands doing well in its most recent survey include Bic of France’s cheap disposable razors and Risque, a mainstream nail varnish made by Hypermarcas, a Brazilian consumer group known for its slick marketing campaigns.
This trend has also been very clear in the electronics sector, where the upmarket mobile phones, tablets and laptops of international manufacturers such as Apple and Samsung are still hugely popular, but less so than in recent years.
$8.5bn
The brand value of Skol, Brazil’s most popular beer
Latin Americans remain big fans of the smartphone and enthusiastic participants in social media but they are less likely to splash out on the most expensive equipment.
In June 2015, only 41.8 per cent of the 1,500 Brazilian respondents in the Confidential survey said they intended to buy an Apple or Samsung tablet over the next six months. When the survey was first conducted in December 2012, 59.7 per cent of respondents said they planned to do so.
The Millward Brown BrandZ survey, part of the broader group’s global survey, illustrates more general points.
First, Latin American brands are relatively small compared with the largest global brands. None of the leading Latin American brands is big enough to figure in Millward Brown’s table of the top 100 global brands. Skol’s brand value is estimated at $8.5bn in the research. By contrast, Scotiabank, the 100th largest global brand, is judged to be worth $11.04bn.
Second, some of the most successful brands in the Latin American table are only partly Latin American. Ambev is part of the giant AB InBev combine, formed first by the 2004 merger of Belgium’s Interbrew and Brazil’s Ambev into InBev and then by Inbev’s 2008 takeover of Anheuser-Busch of the US. Aguila, the Colombian beer brand judged ninth most valuable, is owned by another drinks giant, SABMiller.
Third, with the partial exception of beers, Latin American brands remain locally or regionally focused. Bradesco (number four in the Millward survey) and Itaú (number seven), Brazil’s two biggest banks, are minor players outside their home country. Retailers such as Chile’s Falabella (number five) have extended their business abroad but only into relatively small regional markets such as Colombia and Peru.
In the telecoms sector Mexico’s Telcel and Telmex are ranked third and 11th, but largely by virtue of their dominance of the highly concentrated local market. The same is true in the media sector of Televisa, the media company.
Experience suggests caution is advisable in assessing the global potential of Latin American brands. Brazil’s Petrobras, the state controlled oil company that was judged the most valuable Latin American brand in 2012, has dropped out of the regional top 50.