Page 28 | CC&L Financial Group Ltd.

Crestpoint Real Estate Investments Ltd., one of Canada’s leading commercial real estate equity and debt managers, is pleased to announce the launch and initial funding of the Crestpoint Opportunistic Real Estate Strategy (the “Fund”), its first closed-end product.

The Fund, with a twelve-month capital raising period and an eight-year total term, aims to invest in a range of opportunistic Canadian real estate investments and has a gross annualized return target of 15% to 18%. Returns achieved, will be primarily through capital appreciation delivered through a combination of selective, strategic acquisitions and Crestpoint’s active, hands-on approach to asset management.

Coinciding with the launch and initial closing, Crestpoint is also pleased to announce that the Fund has completed its first investment, 1318 Thurlow Street, a 0.4 acre development site located on the southwest corner of the intersection of Thurlow and Burnaby streets in the popular West End neighbourhood of downtown Vancouver, B.C. When completed, this 32-storey, concrete, purpose-built multi-family rental building, comprised of 300 units including a mix of studio, 1-, 2- and 3-bedroom suites, with a range of indoor and outdoor amenity space, will offer tenants impressive views. With a Walk Score® of 96, the property is strategically located in a transit-oriented community in close proximity to restaurants, shopping, Sunset Beach, the downtown business district, hospitals and universities. Partnering with Anthem Properties Group Ltd., Crestpoint, on behalf of the Fund, has acquired a 77% interest in the property with Anthem Properties owning the remaining 23% interest.

“Since Crestpoint’s inception in 2010, some of our best investments have been in periods characterized by the market volatility and dislocation we see today,” said Kevin Leon, CEO of Crestpoint. “We believe it’s a compelling investment environment. We expect to use multiple strategies to create and capture value, including repositioning undermanaged assets, recapitalizing properties with weak balance sheets and renovating existing buildings to higher standards.”

The Fund, focusing on capital appreciation, is designed for institutional clients seeking access to a higher potential return portfolio than available in core real estate, providing them with additional choice and an opportunity for diversification. This strategy complements Crestpoint’s existing flagship, $5.3 billion open-end Core Plus Real Estate Strategy, which has been one of the top-performing core/core plus funds in Canada since its inception in 2011. In 2022, Crestpoint launched the Crestpoint Real Estate Debt Strategy, an open-ended mortgage fund that has outperformed its benchmark since inception.

Max Rosenfeld, EVP and Head of Asset Management at Crestpoint, added, “This new strategy leverages our management expertise and deep relationships within Canada’s real estate investment community, strengths that have enabled us to successfully complete over $3 billion in value-add and opportunistic investments over the last 13 years.”

Following the success of this initial capital raise, the Fund will hold subsequent closings to allow additional investors to participate, with the next close expected to be in Q4 2024.

Learn more about this exciting new offering in a video with Crestpoint’s CEO, where he highlights the details and opportunities ahead. Watch the video here.

About Crestpoint

Crestpoint Real Estate Investments Ltd. is a commercial real estate investment manager dedicated to providing investors with direct access to a diversified portfolio of commercial real estate equity and debt investments. With over $10 billion under management, Crestpoint is an affiliate of the Connor, Clark & Lunn Financial Group, one of Canada’s largest private, independently held multi-boutique asset management firms with offices throughout the country and in the US, the UK and India. CC&L Financial Group and its affiliates collectively manage over C$133 billion in assets across a broad range of traditional and alternative investment products and solutions for institutional, high-net-worth and retail clients. For more information, please visit crestpoint.com.

Contact

Elizabeth Steele
Director, Client Relations
Crestpoint Real Estate Investments Ltd.
(416) 304-8743
[email protected]

Chinese money trends are puzzling but ominous, suggesting – at a minimum – that the economy will remain weak through H2.

Q2 real GDP growth came in below expectations but there was better news on the nominal side: two-quarter nominal GDP expansion rose for a second quarter as the GDP deflator stabilised – see chart 1.

Chart 1

This improvement tallies with a recovery in six-month rates of change of narrow money and broad credit around end-2023. Money and credit momentum, however, has since slumped, reaching a new record low in June – chart 2.

Chart 2

A post a month ago noted that money – and to a lesser extent credit – numbers have been distorted by a regulatory clampdown on the practice of banks paying supplementary interest. This has resulted in non-financial enterprises (NFEs) moving money out of demand deposits into time deposits and non-monetary instruments such as wealth management products (WMPs), as well as repaying some debt.

The post suggested discounting narrow money weakness and focusing on an expanded broad money aggregate including WMPs. The six-month rate of change of this measure had slowed significantly but was still within – just – the historical range of six-month broad money growth.

That is no longer the case. CICC numbers on WMPs show an outflow in June. Six-month growth of the expanded measure has converged down towards that of conventional broad money – chart 3.

Chart 3

F/x intervention to support the yuan has contributed to monetary weakness but the effect has been minor. Net f/x settlement by banks – which captures spot intervention using the balance sheets of state banks and other institutions – amounted to CNY590 bn ($83 bn) or 0.2% of broad money in the six months to May (a June number is due this week).

Household money growth, it should be emphasised, is stable and respectable: broad money weakness is entirely attributable to a loss of NFE deposits – chart 4. The puzzle is the destination of the “missing” NFE money. Only a small portion is likely to have been used to repay debt: banks’ short-term corporate lending fell in April / May but rebounded to a new high in June.

Chart 4

The focus of monetary weakness on NFEs suggests downside risk to investment and hiring, with negative feedback from the latter to consumer spending.

The underperformance of emerging markets equities relative to the US has tested the patience of even its most diehard advocates of the asset class over the past few years. While EM equities posted a respectable 9.9% return in USD terms in 2023, this looks anaemic next to a roaring 26.3% for the S&P 500.

The disparity between the US and EM over the past decade tempts investors into the behavioural trap of building conviction for future returns based on what has performed well in the recent past. It is easy to forget that the annualised returns from 2000 to end-2023 for EM were 7.6% versus 7.8% for the US, both outpacing 6.2% for MSCI World. The risk here is that a pro-cyclical mindset can lead to perverse thinking where conviction strengthens for a popular asset class as the likelihood of a good result decreases, and vice versa.

US equities outperformed on a decade of stronger economic growth out of the GFC, fed by a new credit cycle and strong fiscal deficits fuelling stronger corporate earnings and a dollar bull market, along with multiple expansion. On the flipside, EM moved through a painful deleveraging compounded by foreign reserve managers chasing US exceptionalism and buying dollars which choked EM further.

Several contrarian market commentators have recently pointed out that the fundamental picture in EM in many ways looks more compelling than in the US – lower valuations, trough earnings, cheap currencies, lower inflation, as well as greater fiscal and monetary discipline.

So what explains the continued underperformance, and is there anything that can break this cycle?

Vicious and virtuous circles in EM equities

George Soros’s theory of Reflexivity provides an explanation for how biases and preconceptions interacting with economic reality can distort market pricing and create extended periods of disequilibrium. For EM, the combination of weaker fundamentals coupled with a perception of US exceptionalism has led to the formation of a self-reinforcing feedback loop which has been a major headwind for the asset class. Below is a rough schematic for how this loop has played out.

Source: NS Partners.

Our view is that this cycle is coming to an end. Indeed, we believe that there is potential for a shift into a “virtuous circle” for EM, outlined below.

Source: NS Partners.

This outlook is based on a set of signals which we have used to advise clients invested in our DM and EM strategies looking to tweak the balance of exposure between the two. For context, our checklist is based on the idea that EM equities are a cyclical asset class and so tend to outperform when the global economy is strengthening (industrial cycle, commodity prices) and there is liquidity to chase the EM story (excess money, falling USD). They should also do better when economic prospects and earnings momentum are stronger than in DM (real money growth gap, revisions gap) and valuations are attractive.

Our latest update to the checklist (as of June 30, 2024) is below.

EM versus DM checklist
Source: NS Partners.

The balance of factors we monitor now favours emerging market equities for the first time in years.

Our two cents – don’t wait around until everything goes green, as you will have missed the sharpest part of the rally.

Two checklist factors deserve special attention, given their historical usefulness in signalling an improving environment for EM equities.

Liquidity

The E7 / G7 real money growth gap has been in favour of EM for some time, underpinned by better monetary policy making since 2020. This was reflected in better relative inflation performance for EM over DM, which has meant less need to tighten aggressively through the inflationary upswing, and potentially plenty of room to cut as the Fed eases.

Positive E7-G7 real money growth gap
Source: NS Partners and LSEG Datastream.

Additionally, the global excess money backdrop – proxied by the gap between real money and industrial output growth – may now be entering positive territory because of inflation peaking and industrial momentum weakening. The surplus liquidity can find its way into unloved financial assets, including EM equities. Prospective central bank pauses / reversals will sustain the trend.

Global “excess” money turning positive?
Source: NS Partners and LSEG Datastream.

This is what we call a “double positive” liquidity environment, and could signal improving prospects for EM equities. In periods where these two monetary indicators have lined up this way, EM equities have outperformed MSCI World by an average of 10.5% per annum. Periods of EM outperformance are indicated in the shaded areas of the chart below. They line up nicely with the double positive.

EM relative performance & monetary indicators
Source: NS Partners and LSEG Datastream.

King Dollar

The vicious and virtuous cycle diagrams above hint at just how important the dollar is as a driver of price and fundamental momentum in emerging markets.

The chart below illustrates just how large a tailwind or headwind the dollar can be for the asset class.

EM outperformance during secular USD declines
Source: NS Partners and LSEG Datastream.

The relative performance drawdown for EM versus global equities during the last dollar bull market is in line with previous dollar bull markets, but the period over which this has occurred is roughly twice as long. The risk for investors fatigued from such an extended period of relative underperformance is capitulation right as the asset class is primed to outperform.

The real trade-weighted dollar is far above its long-run average and may have reached another secular peak in October 2022 – recent strength has failed to take out this high.

October 2022 USD peak?
Source: NS Partners and LSEG Datastream.

The combination of monetary easing as inflation falls coupled with a weaker US dollar would provide a favourable backdrop for the outperformance of EM equities. Likely easing by the US Federal Reserve later this year will provide further scope for emerging market central banks to cut rates, allowing the credit cycle to move from stabilisation/recovery into expansion, providing support to economic and corporate earnings growth.

Such a pick up would encourage allocators oversaturated with US exposure to send marginal flows to emerging markets. With positioning at such extreme relative lows, even a small shift would be significant and another potential catalyst for entry into a virtuous cycle.

An analysis of the Fed’s historical behaviour suggests that the conditions for policy easing are in place.

Chart 1 shows the fitted values and current prediction of a logit probability model for classifying months according to whether the Fed is in policy-tightening or policy-easing mode.

Chart 1

The model’s determination for a particular month depends on values of annual core PCE inflation, the unemployment rate and the ISM manufacturing delivery delays index known at the end of the first week of the month (i.e. after the release of the employment report for the prior month).

The model can be thought of as an approximation of the Fed’s “average” reaction function over the last 60+ years. It correctly classifies 87% of months over this period, i.e. the estimated probability of being in policy-tightening mode was above 0.5 in tightening months and below 0.5 in easing months.

There is no memory effect – the model ignores whether the Fed was in tightening / easing mode in the previous month, only considering the above data series (with no dummy variables for “shocks”).

The dependent variable takes the value 1 from the month of the first rate increase in a tightening phase until the month before the first cut in a subsequent easing phase, and 0 otherwise. So a rate plateau before an easing is still classified as part of a tightening phase (and a rate floor before the first hike part of an easing phase).

The tightening / easing phases were identified judgementally and are shown by the shaded / unshaded areas in the chart. The Wu-Xia shadow rate informs the dating of phases during zero-rate periods since the GFC.

The model estimates the probability of the Fed being in tightening mode this month (July 2024) at 0.23, the lowest value since September 2021. Equivalently, the probability of a start of an easing phase is 0.77.

A fall in the tightening probability from 0.62 in March reflects a 0.2 pp rise in the unemployment rate over the last four months (from 3.9% to 4.1%) and a 0.3 pp fall in annual core PCE inflation (from 2.9% to 2.6%).

The Fed is unlikely to announce a rate cut at the conclusion of its next meeting on 31 July, as this would be at odds with recent communications (although the probability may be higher than the 0.05 implied by market pricing on 11 July, according to CME FedWatch).

The model’s shift, however, suggests a strong chance of a dovish statement teeing up a September move.

Five longstanding ESG themes that predate responsible investing.

Environmental, Social and Governance (ESG) factors can be seen as idealistic in investing and at odds with business performance and measurable results. However, this view overlooks their financial implications for businesses and investors, with global small caps being no exception. ESG considerations, from board independence to community relations and environmental risks, can be useful to help assess financial stability, risk management and competitive advantage.

This week’s commentary will explore five themes that show how ESG factors can be important to sustainable financial success.

1. Board member independence

Good governance has long been an investor focus. Board independence helps ensure strategic guidance free from internal influences, reducing conflicts of interests. Independent directors provide unbiased oversight on risk management, which can help to avert crises and challenge management assumptions, leading to a more thorough analysis of strategic options and their implications. Independent boards often see higher profitability and navigate risks better, reflected in their market valuation and investor confidence.

An example is our holding Kurita Water Industries, which has 50% board independence, above the average in Japan. Its independent directors bring diverse perspectives, valuable in global expansion, and help Kurita maintain a solid financial position and sustainable growth in a competitive environment.

2. Product quality and safety

High product quality and safety standards fulfill regulatory requirements and boost consumer trust and brand reputation. They can reduce the risk of costly recalls and legal issues, directly impacting sales volume and the bottom line.

For instance, our holding Menicon, Japan’s first and largest contact lens manufacturer, has international quality standard certifications for medical devices, including ISO 13485/EN ISO 13485. Each of its subsidiaries maintains its own quality management system, with general managers in development, pharmaceutics and sales overseeing safety management. There have been no regulatory recalls of Menicon’s products in recent years.

3. Community relations

Strong community relations are vital for a company to obtain a license to operate, potentially increasing project approvals. Community ties can also provide supportive networks during crises and facilitate local cooperation. Conversely, community opposition can lead to project delays, increased costs and even cessation, affecting expected returns.

An example of a company holding that benefits from its community investment is Advantage Energy, from Western Canada. Although community issues are common in the natural gas sector, the company strives to be an active community member, attending monthly meetings to facilitate communication and cooperation regarding energy developments. It has faced no project opposition or delays and operates smoothly.

4. Physical risks of climate events on company assets

Climate change heightens extreme weather events and natural disasters, increasing the risk of damaging company assets, disrupting supply chains and increasing operational costs. These risks can also affect insurance premiums and lead to regulatory penalties, straining financial resources. Companies that mitigate these risks can protect assets and maintain profitability.

For example, our Arena REIT holding in Australia, with 272 social infrastructure properties, faces bushfire and extreme weather risks, leading to potential property damage, operational disruptions and higher insurance costs for tenants. Arena REIT maintains a geographically diversified portfolio and conducts thorough due diligence on bushfire zones and flood overlays during acquisitions. It also ensures adequate disaster insurance for repairs and reinstatement across its properties.

5. Employee relations

High employee morale and fair labour practices create a positive work environment, enhanced job satisfaction and reduced turnover. This boosts productivity and innovation, benefitting a company’s financial health. Conversely, poor employee relations can result in high turnover rates, lost productivity, strikes and reputational damage, negatively impacting financial health.

Our Vital Farms holding exemplifies good employee relations. The company produces and sells eggs, butter and ghee from pasture-raised hens. Certified as a B Corp, one of the highest standards of good corporate practices, Vital Farms has best-in-class initiatives for workers’ wellbeing, such as the ReVITAlize remote crew retreat, inclusive farmer open houses, comprehensive onboarding and an annual employee engagement survey.

The financial imperatives of ESG

These examples highlight how ESG integration can be used in financial decisions. As global small-cap managers, our commitment to incorporating ESG considerations into our investment decisions is one of the inputs for achieving sustainable financial success and aligning with our fiduciary duty to act in our clients’ best interests.

Disclaimer: ESG integration at Global Alpha is driven by taking into account material sustainability and/or ESG risks that could impact investment returns, rather than being driven by specific ethical principles or norms. The investment professionals may still invest in securities that present sustainability and/or ESG risks, including where the portfolio managers believe the potential compensation outweighs the risks identified.

Monetary analysis suggests that the global economy will weaken into early 2025, while inflation will continue to decline. A cyclical forecasting framework, on the other hand, points to the possibility of strong economic growth in H2 2025 and 2026.

Are the two perspectives inconsistent? A reconciliation could involve downside economic and inflation surprises in H2 2024 triggering a dramatic escalation of monetary policy easing. A subsequent pick-up in money growth would lay the foundation for a H2 2025 / 2026 economic boom.

How would equities perform in this scenario? Bulls would argue that any near-term weakness due to negative economic news would be swiftly reversed as policies eased and markets shifted focus to the sunlit uplands of H2 2025 / 2026.

More likely, a significant fall in risk asset prices would be necessary to generate easing of the required speed and scale, and a subsequent recovery might take time to gather pace.

Global six-month real narrow money momentum has recovered from a major low in September 2023 but remains weak by historical standards and fell back in May – see chart 1. The assessment here is that the decline into the 2023 low will be reflected in a weakening of global economic momentum in H2 2024.

Chart 1

A counter-argument is that a typical lead-time between lows in real money and economic momentum historically has been six to 12 months. On this basis, negative fall-out from the September 2023 real money momentum low should be reaching a maximum now, with the subsequent recovery to be reflected in economic acceleration in late 2024.

The latter interpretation is consistent with the consensus view that a sustainable economic upswing is under way and will gather pace as inflation progress allows gradual monetary policy easing.

The pessimistic view here reflects three main considerations. First, economic acceleration now would imply an absence of any negative counterpart to the September 2023 real money momentum low – historically very unusual.

Secondly, the lag between money and the economy has recently been at the top end of the historical range, suggesting that a significant portion of 2023 monetary weakness has yet to feed through.

Highs in real money momentum in August 2016 and July 2020 preceded highs in global manufacturing PMI new orders by 16 and 10 months respectively, while a low in May 2018 occurred a year before a corresponding PMI trough – chart 2.

Chart 2

So a PMI low associated with the September 2023 real money momentum trough could occur as late as January 2025.

Thirdly, stock as well as flow considerations have been important for analysing the impact of money on the economy in recent years, and a current shortfall of real narrow money from its pre-pandemic trend may counteract a positive influence from the (tepid) recovery in momentum since September 2023 – chart 3.

Chart 3

The decline in real money momentum into the September 2023 low began from a minor peak in December 2022, suggesting that the PMI – even allowing for a longer-than-normal lag – should have peaked by early 2024. Global manufacturing PMI new orders rose into March and made a marginal new high in May. However, two indicators displaying a significant contemporaneous correlation with PMI new orders historically – PMI future output and US ISM new orders – peaked in January. The future output series fell sharply in June, consistent with the view that another PMI downturn is starting – chart 4.

Chart 4

Signs of weakness are also apparent under the hood of the services PMI survey. Overall new business has been boosted by financial sector strength, reflecting buoyant markets, but the consumer services component fell to a six-month low in June – chart 5.

Chart 5

Could a weakening of economic momentum in H2 2024 snowball into a deep / prolonged recession? The cycles element of the forecasting process used here suggests not.

Severe / sustained recessions occur when the three investment cycles – stockbuilding, business capex and housing – move into lows simultaneously. The most recent troughs in the three cycles are judged to have occurred in Q1 2023, 2020 and 2009 respectively. Allowing for their usual lengths (3-5, 7-11 and 15-25 years), the next feasible window for simultaneous lows is 2027-28 – chart 6. Cycle influences should be positive until then.

Chart 6

Major busts associated with triple-cycle lows, indeed, are usually preceded by economic booms. Such booms often involve policy shifts that super-charge positive cyclical forces. The 1987 stock market crash, for example, triggered rate cuts by the Fed and other central banks that magnified a late 1980s housing cycle peak.

Could significant policy easing in H2 2024 / H1 2025 similarly catalyse a H2 2025 / 2026 boom? Such a policy shift, on the view here, is plausible because negative economic news into early 2025 is likely to be accompanied a melting of inflation concerns.

The latter suggestion is based on the monetarist rule-of-thumb that inflation follows money trends with a roughly two-year lag. G7 broad money growth of about 4.5% pa is consistent with 2% inflation. Annual growth returned to this level in mid-2022, reflected in a forecast here that inflation rates would move back to target in H2 2024 – chart 7.

Chart 7

The forecast is within reach. Annual US PCE and Eurozone CPI inflation rates were 2.5% in May and June respectively, with a fall to 2% in prospect by end-Q3 on reasonable assumptions for monthly index changes. UK CPI inflation has already dropped to 2.0%.

G7 annual broad money growth continued to decline into 2023, reaching a low of 0.6% in April 2023 and recovering gradually to 2.7% in May 2024. The suggestion from the monetarist rule, therefore, is that inflation rates will move below target in H1 2025 and remain low into 2026.

Central banks have been focusing on stickier services inflation, neglecting historical evidence that services prices lag both food / energy costs and core goods prices. Those relationships, and easing wage pressures, suggest that services resilience is about to crumble, a possibility supported by a sharp drop in the global consumer services PMI output price index in June to below its pre-pandemic average – chart 8.

Chart 8

The approach here uses two flow measures of global “excess” money to assess the monetary backdrop for equity markets: the gap between global six-month real narrow money and industrial output momentum, and the deviation of annual real money growth from a long-term moving average.

The two measures turned negative around end-2021, ahead of 2022 market weakness, but remained sub-zero as global indices rallied to new highs in H1 2024. The latter “miss” may be attributable to a money stock overshoot shown in chart 3 – the flow measures of excess money may have failed to capture the deployment of existing precautionary money holdings.

Still, the MSCI World index in US dollars outperformed dollar deposits by only 3.9% between end-2021 and end-June 2024, with the gain dependent on a small number of US mega-caps: the equal-weighted version of the index underperformed deposits by 8.4% over the same period.

What now? The money stock overshoot has reversed. The first excess money measure has recovered to zero but the second remains significantly negative. Mixed readings have been associated with equities underperforming deposits on average historically, with some examples of significant losses. Caution still appears warranted.

An obvious suggestion based on the economic scenario described above is to overweight defensive sectors. Non-tech cyclical sectors gave back some of their outperformance in Q2 but are still relatively expensive by historical standards, apparently discounting PMI strength – chart 9.

Chart 9

Accelerated monetary policy easing could be favourable for EM equities, especially if associated with a weaker US dollar. Monetary indicators are promising. EM equities have outperformed historically when real narrow money growth has been higher in the E7 than the G7 and the first global excess money measure has been positive – chart 10. The former condition remains in place and the second is borderline.

Chart 10

Our inaugural Responsible Investment report reflects our commitment to sustainable infrastructure investments and reports on the initiatives we’ve taken across our portfolio.

Report highlights:

Long-term investors: Our business is employee-owned and our team invests in our funds directly alongside our clients; we are motivated to prioritize the long-term success of the portfolio by sustainably managing our investments.
Sustainable practices: We integrate Responsible Investment considerations at every step of our investment process, from initial assessment to ongoing management.
Impactful projects: Our investments provide essential services, with a diverse asset base consisting of critical transportation, social, and renewable energy infrastructure, including over 1.8 GW of operating capacity across a range of clean energy sources.
Community engagement: We actively engage and partner with local communities to ensure long-term alignment with our stakeholders.

Access the full report

Eurozone money trends remain too weak to support an economic recovery. A relapse in the latest business surveys could mark the start of a “double dip”.

Three-month rates of change of narrow and broad money – as measured by non-financial M1 and M3 – were zero and 3.3% annualised respectively in May. Current readings are well up on a year ago but significantly short of pre-pandemic averages – see chart 1.

Chart 1

May month-on-month changes were soft, with narrow money contracting by 0.1% and growth of the broad measure slowing to 0.1%.

Six-month real narrow money momentum – the “best” monetary leading indicator of economic direction – moved sideways in May, remaining significantly negative and lower than in other major economies. (The latest UK reading is for April.)

Chart 2

June declines in Eurozone PMIs and German Ifo expectations may represent a realignment with negative monetary trends following a temporary overshoot – chart 3. A recent correction in cyclical equity market sectors could extend if Ifo expectations stall at the current level – chart 4.

Chart 3

Chart 4

Growth of bank deposits is similar in France, Germany and Spain but lagging in Italy – chart 5. The country numbers warrant heightened scrutiny, given a risk that French political turmoil triggers deposit flight to Germany.

Chart 5

Some of our recent commentaries (December 7, 2023 and February 8, 2024) cover the 2024 election landscape. One of the biggest surprises so far was the decision of UK Prime Minister Rishi Sunak to call a general election for July 4. In this commentary, we look at the UK economy and markets as we approach this election.

Sunak’s decision caught everyone off guard and, on the face of it, the timing seems strange. A summer election during peak holiday season usually entails poor turn outs. The general thinking behind the decision is that momentum would be strongest after a stronger-than-expected GDP print in Q1 and inflation almost back to normal. A slowdown in growth is expected, and while the drop in inflation was welcomed, it was due to a decline in home energy bills and the base effect. Consensus estimates expected a larger fall, and as such, expectations for the first interest rate cut from the Bank of England have been pushed back to September from June, keeping mortgage costs higher for longer.

Labour’s lead and Conservative struggles

At the time of writing, the Labour Party has a 21-point lead, and the incumbent Conservatives are falling into a battle with Reform UK to be the official opposition party. The election campaign is well under way and Labour seem set for an overwhelming majority. This means they should be able to implement their policies, so let’s look at their manifesto and see what is likely to impact the economy and capital markets.

Labour’s strategic plans: No EU return, but stronger ties

First and foremost, there is no return to the EU on the cards, but Labour will continue to work on EU trade and investment relationships. The main points concern economic stability, defence, housing, infrastructure and clean energy. With geopolitical tensions continuing to run high, Labour will kick off their first year in government with a Strategic Defense Review, setting out a plan to increase defence spending to 2.5% of GDP.

Push for affordable housing

As expected, housing is at the forefront. Labour would like to build 1.5 million new homes over their term with an emphasis on increasing social and affordable housing. Brownfield development is the priority and approval of sites will be fast-tracked. New developments will be obligated to ensure more affordable homes.

No tax increases, but closing loopholes

For personal taxes, Labour has pledged to freeze National Insurance, the basic, higher, or additional rates of Income Tax, and VAT. There are some changes around the fringes that will be a source of income – ending the use of offshore trusts and closing some other loopholes to tackle tax avoidance. Corporate tax will also be unchanged for the term, keeping it at 25%, which is the lowest rate of the G7, and a promise to act if tax changes elsewhere hinder UK competitiveness.

Building for the future

Infrastructure investment has been low, so public investment will be used to support and attract additional private investment, whether domestic or foreign. An overhaul of the planning system would help here. In parallel to the usual spending on roads, railways and other important national infrastructure, investments will go into upgrading ports and improving the supply chain, new gigafactories to help the automotive industry, rebuilding the steel industry, accelerating the deployment of carbon capture and supporting green hydrogen manufacturing.

Wind, solar and job creation

The UK has some natural advantages that should help the transition to clean energy – a long coastline, high winds, shallow waters and access to a skilled workforce with extensive offshore and engineering capabilities. The Green Prosperity Plan aims to double onshore wind, triple solar power and quadruple offshore wind by 2030 while creating jobs. Labour does not intend to issue new licenses to explore new oil and gas fields in the North Sea. The same applies to new coal licenses and fracking will also be banned. Labour remains committed to the EV transition by restoring the phase-out date of 2030 for new cars with internal combustion engines and will accelerate the roll out of charge points.

Financial services as a boost for innovation and investment

There was some positive language around financial services, an undoubted strength of the UK economy. Labour wants to support innovation and growth in the sector, talking about a pro-innovation regulatory framework. Also concerning financial services is the ambition to increase investment from pension funds in UK markets. Domestic pension funds are mature and have reduced equity allocations in general and even more so UK equity allocations. The UK Office for National Statistics shows that domestic pension funds own 1.6% of the UK equity market from over 30% in the 1990s, low compared to similar developed markets. Theoretically this number could go lower, but with some new incentives, arguably risk is skewed to the upside, especially if a minimum level of UK equity exposure within pension portfolios is mandated. Increased demand could see a re-rating for UK equities.

UK equities poised for growth

The party in charge is ultimately not the most important factor. The last Labour government coincided with the Great Financial Crisis in 2008, and the Labour government before that (Tony Blair) was impacted by the dot-com bubble bursting and the subsequent recovery. What has been consistent over the past 60 years has been an average 10% gain for the FTSE All-Share index in the first year of an election when a change of power occurs.

The UK market looks attractive. Valuations are depressed and the discount is broad, having seen a pickup in bids from overseas competitors and private equity acquirers opportunistically seeking assets and market positions. Losing listed companies to M&A, a slow environment for IPOs and UK-based companies choosing a primary listing overseas means UK equities are in short supply. Finding solutions for the structural challenges facing the UK economy is essential to kickstarting growth and attracting investors. If execution is successful, UK equities could gain favour the way Japanese stocks have lately.

Institutional investors often grapple with the decision to hedge against currency fluctuations for non-domestic investments. A common concern is that currency exposure will increase the volatility of non-domestic equity returns.

This article explores when hedging is beneficial and when Canadian investors can gain from being unhedged.

Are domestic or global equities more volatile?

There is an assumption that investing outside of Canada, with exposure to various currencies and markets, can result in more volatile returns for global equities compared to Canadian equities. However, over shorter timeframes (rolling three-year returns), global equities have generally been less volatile than Canadian equities, although there have been exceptions.

Figure 1: Canadian vs. global equity relative volatility

Source: Bloomberg and MSCI.

Figure 1 illustrates the relative volatility of returns for Canadian equities (S&P/TSX Composite Index) compared to global equities (MSCI World Index unhedged). When the orange line is above 0%, Canadian equities were more volatile; below 0%, global equities were more volatile. The chart highlights that, over short-term periods, Canadian equities have often been more volatile.

Over longer periods (10-year rolling returns) and since the late 1990s especially, global equities have almost consistently been less volatile than Canadian equities (Figure 2), benefitting from a larger and more diversified universe of investment opportunities.

Figure 2: Canadian vs. global equity absolute return volatility

Source: Bloomberg and MSCI.

Does hedging reduce global equity volatility?

Contrary to the belief that hedging is necessary to reduce volatility, historical data indicates that this is not always true.

Figure 3 shows the relative volatility of hedged and unhedged global equity returns over rolling three-year periods. When the orange line is above 0%, hedged returns were less volatile; below 0%, unhedged returns were less volatile. Unhedged global equity returns have generally been less volatile, particularly since the mid-1990s, as currency movements tend to counterbalance equity returns for lower overall return volatility.

Figure 3: Hedged vs. unhedged global equities

Source: Bloomberg and MSCI.

What is the optimal currency hedge ratio?

The hedge ratio, the value of the hedge position relative to the total position value, varies by investor. If a portfolio holds $10 million in global equities and $3 million of the currency exposure is hedged, then the hedge ratio is 30%. While research often points to a 50% hedge ratio as optimal, individual decisions depend on specific currency exposure and risk perspectives. Figure 4 shows two investors with different hedging ratios, but the same net currency exposure.

Figure 4: Same net currency exposure, different hedge ratios

	Currency exposure (a)	Hedge ratio (b)	Net currency exposure (a-b)
Investor 1	60%	50%	30%
Investor 2	30%	0%	30%

Source: Bloomberg and MSCI.

From a risk management perspective, a 50% hedge ratio is sometimes used to manage “regret risk,” the potential disappointment of adopting an unhedged or fully hedged approach that later proves suboptimal.

Figure 5 compares the rolling three-year performance differences between unhedged and fully hedged US equity returns (orange line) to those of unhedged and 50% hedged US equity returns (green line). When the lines are above 0%, the unhedged strategy outperformed, while the fully hedged and 50% hedge strategies outperformed when the lines fall below 0%.

Figure 5: US equity rolling 3-year relative performance

Source: Bloomberg and MSCI.

By design, the return difference for the 50% “regret risk” hedging approach (green line) was less volatile over the period. For some investors, experiencing smaller differences due to currency fluctuations may be preferred.

How should currency be managed in private markets?

There continues to be significant growth in allocations to global private markets, such as direct real estate and infrastructure assets in open-end funds. These less-liquid assets still require careful consideration of currency exposure that can affect their short-term value. Private market investors generally expect income and diversification through absolute returns, which can be materially impacts by currency fluctuation.

Hedging can manage these risks, but an assessment of each investment’s specific factors is necessary. This includes understanding the asset’s underlying revenues and expenses, potential natural hedges, hedging costs and the duration of the hedge. Matching the currency of net exposure with associated financing is also important.

For Canadian investors, relying on the private market investment manager to handle currency hedging is generally the simplest and most efficient way to manage currency risk.