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Pioneer Funds Annual Report 2012
Annual Commentary on the Financial Markets (continued)
The Economy (continued)
India: An elusive trade-off between inflation and growth (continued)
Investors expected the Indian government to implement the structural changes, aimed at making the economy more efficient and push inflation
down, and the reform measures which the government announced in September. If these prove effective, the RBI may be more willing to let
interest rates decline. However, the main reform, the liberalisation of the retail sector, has been pursued only very gradually. Recent laws
letting foreign-owned chains open business in India were shelved and then only partially restored after intense lobbying.
Another disadvantage to business is the Indian government’s excess borrowing, which made it hard for them to raise money from private
investors and therefore left the corporate bond market undersized. So far, India has been an exception to the pattern of debt-light emerging
markets and there is little evidence of a change in this trend.
In 2012, the Indian stockmarket has benefited from the return of risk aversion and has quickly recouped all of its previous losses, both in
absolute terms and against the area’s benchmark.
Brazil: The central bank focuses on preserving growth, just like in developed countries
In 2012, Brazil’s economy slowed down markedly and struggled to recover despite policy makers’ repeated efforts to stimulate it. Hence, GDP
grew by only 0.6% in the third quarter. As a net commodity exporter, Brazil’s prospects are heavily reliant on China’s demand for resources.
Exports of iron ore to China may pick up again, but are unlikely to grow at the same frantic rate as before. In addition, on the domestic side,
Brazilian consumers also bought fewer durable goods and started a debt-reduction process. As in India’s case, structural reforms are called for,
mainly because companies are burdened by heavy taxes and excess regulation. The government has recognised the need to make Brazil more
business-friendly and improve competitiveness. In 2012, its main tool was letting the currency weaken on the back of repeated interest rate
cuts. The inflation target rate was still above the current rate, but the spread was rapidly dwindling. On present trends, it may disappear
altogether in 2013, if the Brazilian central bank continues to focus on growth targets.
Russia: Making the economy less commodity-driven
The Energy sector remains a key source of growth for the Russian economy, accounting for about three-quarters of its exports. The Energy
sector includes oil as well as several other mineral resources for which Chinese demand from has weakened in 2012, to the detriment of
overall growth. If China’s economy were to undergo a structural change and households’ demand for consumer goods replaced industrial
demand for resources, Russian exports would suffer on a long-term basis. Admittedly, private consumption’s contribution has improved a lot,
as people’s purchasing power increased and unemployment declined. Recent patterns, however, were less reassuring as real wages and
disposable incomes fell amid rising inflation. On the investments’ side, the challenge for the next few years is to attract foreign direct
investments. In that respect, recent progress in corporate governance looks encouraging, as Russia rose sharply in the World Bank’s latest
survey based on the ease of doing business.
The Markets
Bonds
Central banks have kept policy rates at rock-bottom levels since the financial crisis, in an effort to stimulate economic growth. This stance led
investors to search for additional yields in credit markets and to buy up large amounts of newly-issued bonds. US companies raised more than
$3 trillion in 2012, which is near the record set before the recession.
One could argue that there is more room for spread tightening in high-yield credit markets, as yields started from much higher levels. In fact,
companies exploited low borrowing costs by flooding the market with new issues and these have been welcomed by yield-hungry investors,
who also turned to much riskier assets such as leveraged loans. Investors have been paying less and less attention to companies’ fundamentals
in the search for yields.
While we held an overweight in credit markets throughout the euro debt crisis (despite its implications on risk aversion), we picked our
securities by blending risk and returns. There was little evidence of this selective approach in the market, as yields offered by low-rated issuers
(such as single B and C) also fell to record lows.
Central bank action has inspired confidence, notably in European Monetary Union government bond markets. The ECB’s pledge to do
whatever it takes to save the euro left borrowing costs at two-year lows for governments’ hard-hit by the debt crisis. Even Italy was able to sell
new bonds despite the impending elections. However, we acknowledge that the efforts for austerity and reforms pursued by these countries are
worth lower yields and spreads. That is why we are retaining a medium-term constructive view on the EMU periphery. Our thoughts on the
EMU periphery tend to apply to bank bonds, which account for a large share of European corporate credit markets. Spreads have fallen
alongside the sovereign market, although the ECB provided no further emergency lending since the Long Term Refinancing Operations. Their
decline appeared to be driven by an increasing risk appetite among bond investors and should therefore be viewed with some caution. On a
more fundamental note, bank credit spreads may stay low if international regulators refrained from relaxing capital adequacy standards and
revive bank lending. Profit estimates may be capped by high capital ratios, whereas bondholders are likely to feel more secure about the
banking sector’s overall solvency.
Going forward, emerging markets may provide the best combination between risk and reward. Admittedly, spreads have come down sharply
too, but they reflect the actual improvements in government policies, particularly on the fiscal side. Reasonable alternatives may be found
among emerging-market corporate issuers, though a selective approach should also apply to them, as demand from yield-hungry investors
extended into this market and set a record-high for new issues in 2012.
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