It is tough to find a positive regional economic “good news” story right now and any gems resting in the rubble are most likely to be unearthed at the company level, argues Schroders Private Banking.

It
is tough to find a positive regional economic “good news” story right now and
any gems resting in the rubble are most likely to be unearthed at the company
level, argues Schroders Private Banking.

The
US economic position, while
showing some improvements, could still spring nasty surprises; China’s once
red-hot economy is looking far less perky and the eurozone’s travails just won’t
go away. So making money requires investors to drill a lot deeper to discover
value, argues Robert Farago, head of asset allocation at the firm, part of
UK-listed Schroders.

“In terms of how we approach
equities, we have not taken big regional bets; it is more stock-specific. We
are favouring high-quality companies; companies that are able to generate
dividends. The quality and dividend theme has been very successful. The concern
is that have valuations gone up too far?” Farago told this publication in a
recent interview at the firm’s offices in Wood Street, London.

“In terms of pure
sustainability [by firms], things look a bit expensive [in quality firms]. It
is still possible to get some firms for decent value, though,” Farago said.

In
such an environment where there is no “easy” macro-economic theme to play on as
in the past. The graft of searching for overlooked corporate gems becomes ever
more significant, a fact that arguably highlights the positive case for active
fund management as opposed to adopting a more purely “passive” stance.

The
argument between the “passive versus active” schools of fund management is,
probably never going to be resolved, and is arguably a falsely stark choice in
the first place. But it is certainly the case that an outfit such as Schroders
Private Banking believes it can prove its worth to clients when it is so hard
to read the economic signs, as now.

The
private banking arm of Schroders may not be the largest in terms of assets
under management (£16 billion (around $25.4 billion0 at the end of June), but Schroders is one of the
more voluble houses on economic affairs. (In total, Schroders has around £194
billion of client assets under management.) The end-June AuM figure of £16 million was unchanged from the end of December last year, suggesting that the bank has, in a difficult market environment, at least managed to hold client money at a steady level, although it will want to do better than that for client wealth to withstand inflation.

Farago,
who has been at the blue-blooded firm since 1994, is also fund manager of the
Schroder Managed Wealth Portfolio, a multi-asset unit trust. His investment
career started in the post-Big Bang financial era, joining Bankers Trust in
1987. At Schroders, Farago has worked as a senior Pacific Basin
fund manager, a member of the global equity team, and alternatives analyst for
the multi-asset team.

Not so keen on China

China
has been the investor’s darling for so long that it still almost comes as a
shock to hear a more cautious approach. Farago explains

“I
am not positive on China,
so the positive points… are simply illustrative that we will probably avoid a
hard landing, not that I am hugely bullish. For now, the economic data is
pointing down (as is the stock market),” he said.

“Data has clearly showed
that the economy has slowed and the economy, so concerns remain on the table.
You are still seeing inconsistencies in data that makes people think that
things might be worse than is suggested in the official figures,” he said.

But some of the signs point
against a sharp crunch, he said: “China is one place where we have
had some evidence that things look like they are turning and not getting worse.
M2 money supply growth is picking up. Property sales volumes have picked up as
well.”

It is easy to see why China’s markets
make some experienced investors queasy. Farago explained that China’s massive
construction boom has triggered fears about heavy mal-investments that, sooner
or later, will have to be unwound. For example, construction makes up 12 per
cent of Chinese GDP. In Japan,
just prior to its property bust of early 90s, it accounted for 10 per cent of
GDP.

Schroders’ Asia-Pacific managers are
taking a cautious approach to China
exposure, he said.

Uncle Sam 

The
recent second-quarter earning season in the US has been a mixed bag, with some
less-than-stellar results to remind investors that the world’s largest economy
has a long road to travel before regaining its old lustre.

“There
were some revenue disappointments [from companies in their Q2 results] that
were a concern to us. We think there is room for earnings disappointment there,”
said Farago.

Macro-economic
data in the US remains a
concern – and highly relevant as the US Presidential elections approach.
For example, just over a week ago, figures showed an unexpected rise in initial
jobless claims in the week that ended on 18 August, for example.

On
the corporate side, while there are still strong firms with robust earnings to
choose from, valuations are getting stretched somewhat, said Farago.  

“The
concern is that have valuations for high quality, dividend-paying companies gone
up too far? In terms of pure sustainability, things look a bit expensive.
However, it is still possible to find companies with strong balance sheets and
generating strong profits at attractive valuations.”

Gold and inflation

Along
with some other wealth management firms, such as the UK’s Kleinwort Benson, or the
private bank of HSBC, Schroders Private Banking has been a fan of gold,
although in the case of the latter firm, it has decided to retreat slightly for
the moment.  

“Gold
is something we have invested in for some time. We took some profits earlier
this year. It had become too expensive to be a reliable hedge for inflation,”
he said. (Gold traded around $1,690 per ounce today, as of the time of writing;
it is some way from its record high above $1,917 an ounce.)

Any
talk about gold raises the issue of inflation, an issue that, despite concerns
about sluggish economic growth and even a protracted recession in some
countries, is a worry for anyone protecting real wealth.

In
fact, even the debate about whether passive investing is the way forward
touches on inflation, because Farago argues that in passive investments, it is
not always clear to a manager what the relevant benchmark should be.

“For
an individual, the real benchmark is but that is not something you can buy a
passive product to replicate,” he said.

Eurozone

Farago
is concerned, like his peers, about the risks of a eurozone crack-up.

“Whereas two years ago the odds of a currency breakup
were zero, now they are quite real. That [euro collapse] would trigger a global
recession and be disastrous for European companies,” e said.

In peripheral European markets,
Schroders is cautious, taking the view that if the euro
remains, it will come at the expense of years of low-growth and austerity.
Banks, meanwhile, “look like bad bets” with their opaque balance sheets and
exposures to European bad debts. There are good quality European firms earning
revenues from around the world; compared with global peers, they look
relatively cheap, he said.  

And finally, there is
Schroders’ home turf: the UK.
Farago said there is little point discussing the national economic story when
considering investing in UK-registered firms, since the UK and its
companies were so influenced by global factors that a national perspective made
little sense.