It has been an eventful year for the global economy and markets that saw liquidity driven rallies on account of stimulus measures adopted by various central banks. Frederick H Waddell, Chairman and CEO of Northern Trust that had $4.8 trillion in assets under custody as on September 30, 2012 tells Puneet Wadhwa in an interview that he expects the global economy to perform less than its long-term potential capability in 2013. Though there are regulatory and other issues for people to invest in China or India, these are economies that still offer long-term growth, he points out. Edited excerpts:
The lack of compromise regarding the “fiscal cliff” and re-surfacing of problems across the euro-zone has been creating nervousness across the globe. Do you think that the both these economies will be able to avert / overcome these issues?
I think over time, yes. The US economy's ability to get going on the right path will be will be sooner than the European economy. The European issues are deeper and more entrenched around their governance restructuring that needs to take place. And that will take a long time.
But I think in the US, the fiscal cliff issue can be resolved in an appropriate manner – that is if both sides find a way to compromise – the US economy which has been going along at a rate of little less than two per cent could pick up some steam as US companies see that there is some certainty that the fiscal cliff will be removed.
Will the Obama administration be able to find a solution or will they buy more time, go back to the drawing boards and recalibrate the strategies?
Both sides have articulated they want to get it resolved sooner than later, meaning that they want it done before the year-end; that is before the fiscal cliff actually takes place. Both sides have also recognised the need for increased revenues as well as spending cuts and they are trying to resolve those.
I think the markets will require something more than, what is sometimes been referred to as a down payment / assurance, and kick the can down the road a little bit into 2013. I think that would be a sub-optimal outcome from the market’s perspective.
How do you see the global economies shaping up in 2013 and what would be your investment strategy in this backdrop?
I think the global economy is going to perform less than its long-term potential capability in 2013. Therefore, what we have been advising our client to do is to allocate their assets in areas where we do see growth.
We are overweight in the emerging markets, with our clients now. We are overweight in high yield and underweight in US high quality fixed income. We are obviously underweight in cash given the low yield in that asset class. We are overweight (slightly) compared to our strategic allocation in commodities, as we think that there should be some hedge against potential inflation down the road. We are underweight in European equities.
Would you recalibrate this strategy in the light of an accommodative Monetary Policy and corresponding bond yields across the globe next year given that 91 per cent of Northern Trust’s total securities portfolio composed of US Treasury, government sponsored agency and triple-A rated securities in Q3CY12?
Well, those are securities on our balance sheet. We take a different view of those securities verses the investment recommendations and how we manage our client assets. For those securities portfolio in high quality short duration, it will continue to be invested in very-short duration, although we may and we have modestly extended the duration given the low interest rate environment.
We are not willing to take on any credit risk in our securities portfolio. One of our strengths is the ability to earn net interest income in a very low interest rate environment – and that has been hurt. Till interest rates continue to go up, our net interest margins will continue to be under pressure.
How are you viewing India as an investment destination – versus the emerging markets (EMs) – given all the policy / regulatory issues amid a slowing down economy?
Emerging markets offer growth opportunities. And while there are regulatory and other issues for people to invest in places like China or India, these are economies that still offer long-term growth.
For example in our mutual funds index business, our clients have exposure to more than $3 billion in Indian equities. And there will be times when these equities will over-perform or under-perform. So for our investors, we expect as these economies grow, our clients’ investments in those economies will also grow.
What is the growth that you expect in these economies over the next couple of years and what are the reasons for your belief?
There will be growth, although as I said global growth will be probably be less than it could normally be; primarily because of the European situation and relatively slower growth in some of the emerging markets like China. But they will continue to grow.
All the central banks are providing lots of monetary stimulus to keep interest rate low for a long period of time. Over time, this will force people to take riskier assets and we believe that will spur growth over the near-term. It won’t be as great a growth as it would be like in a normal interest growth environment, but then these are unusual times.
Can you put a number to the expected growth?
I think the global growth number that we are using in our tax asset allocation would be about 3.5 - 4 per cent. The growth rate of the Indian economy that we expect is about 6 to 7 per cent in the near-term and 7 – 8 per cent in China.
What are the factors that will drive this?
I think it’s a combination of demographics and other global growth opportunities. Hence, we see Indian companies investing outside the country like United States and Europe. Lately, lots of companies are looking to Europe as a place to invest now because there are good opportunities to buy assets.
Within the Indian equity space, which sectors / themes are you betting on?
I am not an investment expert but I would say the emphasis on India’s technology sector, the processing and knowledge opportunities that the Indian economy and educational system provide are potential growth areas. There are opportunities in the retailing sector as more Indians consume. So, I think those are the areas I would look at sectors where Indian economy would show growth potential.
How do you see the merger and acquisition (M&A) landscape shaping up globally over the next few years given the current economic environment and the road ahead?
My answer would vary by sectors. For example in the financial services sector, there will be opportunities for some financial firms to grow through acquisitions. However, the big transformational acquisitions may not happen because of the regulatory environment.
I think the regulators in Europe and US are going to be very cautious about letting big firms get even bigger. So in the financial services arena, we are likely to see increased numbers of acquisitions but smaller acquisitions.
In manufacturing, hi-tech has potential. Software firms like Google and Groupon have made a lot of acquisitions in the hi-tech and internet-based activities. I think you will see some acquisitions potentially that would be entrepreneurial in nature.
The automobile industry continues to do well in the US and I think they have gone through a sort of consolidation in the large car manufacturers. So I don’t think you will see much there. But we could see some consolidation of automobile suppliers.
Do you think funding these acquisitions and then servicing the debt component (if any) could be an issue going ahead?
If you look at non-high yield financing, meaning typical bank acquisition financing, there is plenty of supply in US for bank loans which are good loans, well-structured and well-priced for M&A activities.
The high yield market has got quite hot recently and their ability to service that is the function of the economy. If we have a good steady growth then acquisition that are financed in the high growth market should do well but if we have a double dip recession then you will see some losses in the high yield market.
How are you viewing the political landscape in India and the so called “policy logjam” over issues like foreign direct investment (FDI) in retail?
I think what you are seeing in all markets is a growing globalisation and a realisation that a variety of industries overtime are evolving and need to have barriers broken down in order to be competitive because if governments don’t allow the free market to function properly then you risk losing a good growth opportunity in your home country. And that goes just as much for India as it does the US which can be very protectionist in its own policies.
So, what I think is that governments are grappling with the pace of globalisation and trying to balance out protecting home grown industries against allowing them to grow while maintaining their ability to grow globally and allow global companies to come in to their home markets. That is something that will need to evolve; but I think the barriers slowly but surely will be broken down.
What are the chances of a double-dip recession?
This depends on how the fiscal cliff issue gets resolved. As I said earlier, in Europe it is a matter of boarding a crisis that causes some sort of systemic disruption in their market. So far over the last two – three years, the European Regulators and central banks have been able to navigate around those kinds of crises but the prospect of crises in Europe is always there; but I think they have done a pretty good job of navigating through it.
Many global wealth management and private banking firms are realigning strategies. How do you these spaces faring over the next few years?
From our perspective increased competition. As you know in Northern Trust half of our revenues and profitability comes from dealing with high net worth individuals and families. We like that business and think that the competition will actually increase specially among the upper end of families and individuals with $15 to 20 million or more in the US. We think the competition in that space will get greater.
What went wrong for those who pruned their wealth management operations?
I think what went wrong was that they focused on generating assets in the form of mortgages that were later securitised and distributed out into the market and the lending parameters got too loose in 2003 - 06.
Too many banks were chasing too few good loans, and therefore, too many bad loans were created. That crisis brought a whole new regulatory environment which these banks have to deal with. These factors are leading lots of these firms to rethink their consumer models and are having to restructure. Coming out of that a lot of these firms are going to look at the wealth business which is an attractive place to be. And that is the place where the competition is going to get higher for firms like Northern Trust.
How do you see the KPO business segment playing out for you?
We see opportunities for that. A lot of our growth in Bangalore is around risk management, portfolio construction and analysis, creation of customised index indices, investment products, credit and equity analysis. So, we clearly see the move from what I call processing and large scale reconcilements and other kinds of processing services to more value added knowledge that can be distributed throughout northern trust’s footprints globally.