Welcome to a RIGGED Future in a World of Financial Repression 

As a European investor—working and living in both the U.K. and Germany, and speaking to our clients around Europe regularly—I continue to be shocked and deeply saddened at both a professional and personal level by the impact of this destructive debt crisis that still rumbles on in Europe and will continue to do so.

Faced by this unprecedented crisis and the deepening rifts appearing between societies protesting against austerity, European leaders are under immense pressure to deliver a quick solution. It must be both constitutional and the most palatable (and preferably painless) way out of the ever-deepening recession—which is hitting the poorest hardest. While facing similar though different issues, the U.S., the U.K. and Japan are not far behind.

The solutions
There are two sides to these more painless "solutions" being sought, in my view. The first, quantitative easing (QE), has been firmly established since the 2008 financial crisis, and is more popular with markets as a method of pouring short-term "oil" on the debt crisis "fire" in an attempt to alleviate slowing growth and cruelly high levels of unemployment in too many Organisation for Economic Co-operation and Development (OECD) countries.

Welcome to the now familiar theme of short-term money action by central banks—which has sprung back to life recently—with further easing by China, Denmark, Brazil and Korea all lowering interest rates, the U.K. undertaking additional QE and the European Central Bank (ECB) lowering rates to a historic level. Sadly the positive effect of these actions lasted only a very short time, with the U.S. Federal Reserve’s recent minutes disappointing those hoping for yet more stimulus in the immediate future.

The second is a much less blatant, far more subtle long-term policy—already written about widely but nevertheless invisible to many in society, and hence so irresistibly attractive to Western governments under extreme pressure to come up with less painful solutions to ease the debt crisis.

Welcome to financial repression and artificially engineered negative interest rate policies (NIRP). Having long since been implemented, it's here to stay for many years (or even decades) to come—as it must if it is to solve the excessive debt burden and entitlements obligation. While far less obvious to the average citizen in the short term, it has a huge long-term impact and brings many challenges with it—which I will endeavour to explain for you below, point by point.

 

 

Welcome to a RIGGED future
	The facts   Restrictive and regulated behaviors will impact all participants in the savings industry, as banks are forced to hold more sovereign bonds, insurers are encouraged by Solvency II to remain risk-averse, and pension funds are persuaded to accept increasingly less-volatile returns.
	Inflation of real assets and costs are likely to erode nominal cash returns, thereby making savers unable to protect the purchasing power of their money. A premium may emerge for illiquid, high-quality, infrastructure-type assets.
	Government policies will tend to squeeze out private capital during this period, thereby dulling the real value-creating part of the economy and highlighting the value of growth companies globally.
	Global investment opportunities are expected to remain attractive during a time when many policies seek to de-globalize markets and correct the remaining huge imbalances that remain in Europe and around the world—a process that may take years to undo.
	Equities in the past have been able to offset much of the pain of financial repression, especially by (A) offering real inflation-adjusted dividends within high-quality large-cap stocks, but most effectively in small caps both regionally and globally; and (B) accessing the real market growth of the emerging markets.
	Disciplined investment skills can optimize the full use of risk in a client's portfolio, implemented in as unconstrained a fashion as possible.
	RIGGED it may be ... and the fight to protect the value of your savings has just begun.

The consequences of living in a world of financial repression

1. What is it?

• It is a world where monetary policy deliberately suppresses short and medium-term interest rates to encourage a greater level of risk to investors. 

 

• It is a world where governments bias the rules through regulation to allow them to finance themselves easily at these low interest rates so they can offset any deflationary deleveraging by banks, corporates and consumers. 

 

• It is a world where the risk-free rate of return becomes lost. 

2. The challenges for investors
Demographics, improved lifestyles and health care show that longevity is rising, as well as the related costs, so that the amounts saved and the returns on them are both increasingly under strain. Within financial repression, we are experiencing deliberately lower-than-might-be-expected returns, which thus do not allow the necessary growth of savings capital and forces either lower outcomes for clients or the need for greater contributions. After the global financial crisis and within financial repression, I believe that we are all reflecting on the wrong asset allocation models now that many global bond markets are influenced by political policy—or even regulated as such. Within financial repression, the investing world is subject to both political and monetary change, which has increased volatilities and hindered quantitative methodologies of asset allocation to benchmarks, risk and returns.


3. How can we fight back against financial repression?

• In equities, history tells us that dividends, small caps and growth stocks can deliver strong, inflation-beating long-term returns.

 

• In multi-assets, we believe that a global unconstrained portfolio is best-positioned to capture returns from any asset class around the world. 

 

• In bonds, we see more preference for corporates and emerging markets, where sovereign leverage is much lower. 

4. The grim outlook ahead
What will failure look like if financial repression unleashes real inflation? A 300-basis-point increase in yields would, on average, result in a 22% loss in 10-year bond prices. In 30-year bonds, the same increase in yields would lead to a loss of 40%.

10-Year	Current Yield	+50 bps	+100 bps	+150 bps	+200 bps	+300 bps
U.S.	1.606	-4.4%	-8.6%	-12.6%	-16.4%	-23.5%
U.K.	1.696	-4.0%	-7.9%	-11.5%	-15.0%	-21.5%
German	1.533	-4.5%	-8.7%	-12.7%	-16.5%	-23.6%
Japanese	0.812	-4.4%	-8.5%	-12.2%	-15.6%	-21.7%
Average		-4.3%	-8.4%	-12.3%	-15.9%	-22.6%

 

30-Year	Current Yield	+50 bps	+100 bps	+150 bps	+200 bps	+300 bps
US	2.674	-9.4%	-17.7%	-25.0%	-31.4%	-42.2%
UK	3.009	-8.6%	-16.2%	-23.0%	-28.9%	-39.0%
German	2.177	-10.4%	-19.4%	-27.3%	-34.2%	-45.5%
Japanese	1.867	-8.7%	-16.1%	-22.3%	-27.7%	-36.5%
Average		-9.3%	-17.3%	-24.4%	-30.6%	-40.8%

Source: Bloomberg. All data as of 6/30/2012.

 
Setting the scene
This special extended article is intended to set the longer-term scene for a series of perspectives from me in the months to come, and I will be returning to this theme again in the future and the tremendous impact which it will have. But be in no doubt, financial repression has arrived and is, in my view, here to stay. Time to prepare your investments to tackle it head-on.


Read Neil Dwane’s summary >>