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pace-for-pace by new highs in US equity markets, whether in large ... We have talked plenty before about defaults under the current 'cov-lite' ..... data. Comparing the price levels of different futures expirations provides a good view of VIX term structure. Since volatility is a measure of systematic risk, in that sense the VIX term ...
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How to evolve in the new investment climate Eoin Murray Head of Investment

Hermes Investment Office Q4, 2017

For professional investors only

OUTCOME #10 Contributed to the development of Japan’s first corporate governance code, encouraging companies to apply best-practice governance and work in the interests of long-term investors


It is not the strongest of the species that survives, not the most intelligent that survives. It is the one that is the most adaptable to change. Charles Darwin Naturalist, 1809-1882

In markets, change is inevitable; for investors, adaptation is a choice. And this quarter we have chosen to introduce a new slice of intellectual DNA into our ever-evolving risk analysis gene pool. While our five-factor matrix – covering volatility, correlation, stretch, liquidity and even risks – has served us well in preparing clients for changing market conditions, we’re confident the addition of environmental, social and governance (ESG) analysis is a step up the evolutionary curve. Historically, we have shied away from tackling ESG risk for a number of reasons, including: „„ A wish to avoid potentially being considered as alarmist, given that

our ESG convictions are typically stronger than consensus views;

„„ A view the sheer complexity of the topic could not be captured

within the scope of this quarterly publication, given that important updates are typically released annually; and,

„„ A fear of muddying a highly important issue with ethical or political

overtones: we consider ESG for investment purposes, not political or ethical agendas.

But ESG has become such a central component of how we (and many of our clients) think about investing, that including it now seems part of a natural selection process. As Niccolo Machiavelli noted, however, taking the lead in “the introduction of a new order of things”1 is no easy task. The great Italian Renaissance strategist, though, also wrote: “The one who adapts his policy to the times prospers, and likewise that the one whose policy clashes with the demands of the times does not.2” Our times are undoubtedly moving into an ESG era with an increasing number of asset owners and investors demanding a more thoughtful and holistic approach to the business of investing money. We are heartened by the shift in investor conversations from governance issues alone to broader environmental and social concerns.

Given the many years of post-global financial crisis (GFC) deflationary psychology perhaps it was inevitable that the first signs of co-ordinated global growth would be greeted with wild enthusiasm. The globally-synchronised uptrend in bond yields has been matched pace-for-pace by new highs in US equity markets, whether in large caps (S&P500), small caps (Russell 2000) or sectorally-focused indices (Nasdaq). But we scratch our collective heads at the euphoria of asset markets. Growth is hardly spectacular. Central bank liquidity (and yes, the taps are still largely on) has, to an extent, floated equity prices higher. And as we have documented many times before, corporate buybacks have also flowed into higher stock prices, boosting EPS growth by lowering the share count rather than driving organic growth. US stock boosterism has been pumped up further by a low dollar with multinational companies getting the double-whammy from currencytranslation gains and stronger export markets. Of course, the prospect (however vague and/or unlikely) of tax cuts, too, provides another fillip to animal spirits. Whether those pressures are creating a sustainable market ‘reflation’ or merely supplying the laughing gas to a late-cycle bubble party remains to be seen. On the downside, capital markets have seen little long-term investment despite the favourable liquidity/credit environment featuring cashed-up corporates. As short-