Bonds, exchange-traded products and ESG

23 October 2012

Bill O’Neill, CIO, Merrill Lynch Wealth Management EMEA. Summarises reports from the firm’s recent Financial Adviser Investment Seminar, and looks at recent investment trends in bonds, exchange-traded products and ESG strategies:

Bonds: With low developed market interest rates and ageing populations, the hunt for income remains and will persist as a key theme for client portfolios. However, some fixed income assets are more risky than is generally thought – high yield bond price volatility may be sustainably higher than in the pre-crisis period. Careful selection of high yield bond managers who can pick fairly priced bonds with solid fundamentals is key to avoiding material portfolio losses.

Exchange-traded products (ETPs): ETPs (of which exchange-traded funds, or ETFs, are the most common) offer a quick way to enter and exit investments in this “risk-on”, “risk-off” environment. This may allow nimbler and smarter asset allocation. However, with the emergence of active ETPs and more sophisticated fixed income ETP benchmarks, ETPs should be viewed as an implementation tool, not as a synonym for passive investing. European listed ETPs have seen strong inflows recently ($69 billion in the third quarter) on the back of increased risk appetite, with inflows into global equity, commodity and particularly fixed income ETPs. September saw asset growth and cash flow activity reach new peaks in Europe. As we head towards the end of the year, confidence in improving economic momentum and reduced policy tail risks could see further inflows into equity ETPs. Likewise, the continuation of central bank monetary easing may continue to drive inflows into physically-backed gold ETPs.

ESG – Investors have become more mindful of the impact that unethical or inefficient business practices can have on asset prices. European assets managed in accordance with socially responsible principles rose from next to nothing in 2005 to around $8 trillion by 2010.  ESG investing selects companies with positive attributes (such as efficient use of water and energy) rather than negatively screening out unethical stocks: we believe it is a pragmatic way to select efficient firms that may benefit broader society. It is not, as some believe, synonymous with underperformance. A 2003 study showed that by buying the top 10 per cent of US companies (ranked according to the strength of corporate governance) and selling the bottom 10 per cent in each year between 1990 and 1999, investors could have beaten the index by 8.5 per cent a year. Recent studies support this trend.

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