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VanEck expresses smart beta ETF concerns


Jan van Eck, CEO of VanEck writes that the biggest investment opportunity for 2018 remains in emerging markets equities.

“As we entered 2017, US equities had done well for five years, meaning investors were underweight international and emerging markets. Emerging markets have however outperformed dramatically this year and we think it is still early innings for this asset class, which should be some comfort to investors who are worried they have missed the bull run. We however anticipate the rally has a long way to go and this view is easily justified when looking at long-term trends.”

Van Eck points out that emerging market equities are unrecognisable as an asset class compared to half a decade ago. Now almost 70 per cent of many emerging markets indices are targeted towards Asia, almost creating an ‘Asia regional fund’ due to the weighting of China, India, Korea, and Taiwan in these products.

“Another reason we think it is a great opportunity is that cash flow for Asian stocks in 2018 is expected to grow 50 per cent and we think this will be reflected in stock prices. These factors, combined with an expanding population and growing economy activity bode well for the asset class in 2018.

“For us, the beginning of 2017 was all about the concept of ‘Old China’. We had seen tremendous growth in capacity for steel and all other sorts of basic industries in this region, and this was causing a great deal of trade tension with Europe and the U.S, especially following the election of Donald Trump. Xi Jinping has now been confirmed for another term in office and has been applying the brakes to Old China, essentially confirming it is aligned with Western interests in reducing Old China’s capacity through what they call supply side reforms. We believe this is excellent news as it means that China’s traditional supply chain will begin to compete on a fairer economic basis with other countries.

“The upside change in China has been the emergence of so-called ‘New China.’ Growth has been higher than anticipated, but more importantly the stock market in China has turned completely upside down: technology is now the largest sector comprising over 30 per cent of the equity market, and dominated by global giants such as Alibaba, whilst energy and financials, for example, have become less important.  The change people anticipated for a decade finally happened in 2017; New China is now emergent over Old China. This shift will be a key theme for the coming year.”

Another concern for van Eck is the low level of volatility which has maintained over 2017. However, he writes that there is a lot of money trading volatility. Estimates, for example from Artemis Capital, the hedge fund, are that there is up to USD2 trillion of trading triggered by volatility.

“This is a significant move. If you are short volatility, or you are writing put options, it is just another way of enhancing yield. Since interest rates are so low globally, people have been searching for yield in all these different kinds of spots. The question is, if volatility suddenly spikes, what will happen to that USD2 trillion? It is a great deal of money. Will it go from being a calming effect on the markets – as the theory goes–  or become an accelerant of more volatility as market participants start taking money out of those trades?”

Van Eck also comments on smart beta, or factor investing, commenting that it is also a concern, but that digital assets cannot be ignored.

“There is a great deal of money chasing ‘smart beta’, or factor investing. This was not commonplace perhaps five years ago but now, there are billions of dollars in single factor ETFs. One worries when investors start behaving or allocating in ways they used not to, is that it either backfires or disappoints them.

“Digital assets however cannot be ignored but such trends as this follow a pattern. Any good investor will look for opportunities and risks in the financial markets which others have not yet seen. It is how Van Eck made the decision to go into gold back in the 1970s: we saw the inflationary trend that was not visible to many. The same logic should be true of digital assets, especially given their potential as a revolutionary technology; ‘peer-to-peer databases’, distributed ledgers could really revolutionise the industry and those who identify the right companies will see strong returns.

“If the technology can be proven then there is of course a significant investment upside, but we also need to be aware of the implications. Digital assets are not a mainstream asset class at this and our advice to investors would be to only take a small position in digital assets on higher risk portfolios. The key area of focus should be on governance. For example, can a crowd-governed database work, as opposed to one run by a private company like Microsoft, or Salesforce Linux is an example of a crowd-sourced software solution that has been very successful.”

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