FlexShares re-evaluates Value and warns on inflation
The Value factor might make all the difference in that hunt for yield says Mark Carlson, Senior Investment Strategist at FlexShares ETFs.
Founded in 2011, FlexShares is the ETF suite of Northern Trust Asset Management. There are 29 funds totaling USD13.3 billion. The funds are primarily sold through individual and institutional financial advisors. Carlson focuses on real assets and fixed income and explains that their aim is to create strategies in ETFs that are fully compatible with any investors’ objectives, whether direct to retail or through a registered investment advisor (RIA) or a big money management firm.
Carlson believes that Value, one of the key factors which has been out of fashion in equity investing for the last decade or more, might be coming back into focus in portfolios.
“In terms of the traditional sense in equity management, the value factor is without a doubt the underperformer because growth has been the bigger performer, especially in the technology revolution that we have seen for over a decade,” he says.
However, Carlson believes that the Value factor can be useful in terms of evaluating exposure within the high yield market place.
“High yield has long been one of our favourites but we don’t approach the asset class like a traditional sector allocation. In the traditional sense, people see it as the highest risk portion of fixed income, we see it more like the lowest risk portion of equity,” Carlson says.
He believes this is because it shares a lot of investment characteristics with equities. “You can capture a great deal of the investment capabilities that you do with equities but with a fraction of the volatility.”
At the outset of creating a high yield investment strategy, FlexShares identified securities that were trading below their intrinsic value.
“We implement a value score that identifies companies or securities that are undervalued and also those that are over-valued,” he says. “The whole concept of value is not to overpay.”
The firm looks at USD focused companies whether global or US based but issuing in US dollars and across a wide swathe of technology, financials, industrials and communications companies, across the spectrum of assets, examining the return components in their high yield offerings.
“Our research into the Bloomberg Barclays high yield index found that consistently over 100 per cent of our return comes from the income component so we think it’s a good idea to intelligently maximise that yield, not just be in pursuit of yield, chasing the highest yield bonds outstanding, because their business models might be under duress or over leveraged,” he says.
“This is where the Value factor comes in. We use a quantitative system that identifies those companies using our proprietary value factor.”
The Fed’s bond-buying programme has also had its impact, Carlson says, bringing down the yield on corporate bonds, as for the junk-rated borrowers is now hovering near 5.6 per cent, down from its 2020 high of 11.4 per cent on March 23.
And then there is the chill wind of inflation fears, Carlson says, with recent data showing that core CPI had the largest monthly increase since 1991, and worries of inflation over the long-term heightening.
Carlson believes that, for investors, that also means a green light to start inflation preparation.
“Obviously investors are concerned about inflation,” he says. “We had a short-term deflationary trend when we saw demand retraction in Covid-19 shutdowns and then a snap back in July in the CPI.
“Investors are concerned about the way the economy is potentially going to change going forward.”
Post the global financial crisis, inflation did not rear its head despite the huge amount of liquidity pumped into the global economies. This time around, it could be different, Carlson warns, with issues due to Covid-19 and its effect on the supply chain pushing inflation up.
“What happens if we get a positive health development in the global health market?” he asks.
“The global economy is able to rebound, but does that demand come back quickly? Also, we don’t know how global corporations are going to manage their ongoing relationships with China. Do companies now lessen their amount of manufacturing sourced from China and look for alternative sources of supply and will they be more costly? Part of the low inflationary environment we have had has been a function of outsourcing to lower cost production.”
Carlson believes that some of those uncertainties are in investors’ minds. “We say to investors, investing against inflation is like buying insurance for your portfolio – it’s nice to have in case things turn ugly.”
Carlson describes inflation’s effect on investor’s purchasing power as like sclerosis of the arteries that goes unnoticed.
“Don’t wait for inflation to show up in order to position your portfolio as it will be too late,” he warns. “If you have concerns as an investor then you should be taking some actions in your portfolio.”