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G10 Macro Rates Blog – Beta is everywhere - Pure Alpha is hard to find

Thursday, November 15, 2018

Latest G10 Macro Rates Blog
With Shayne Dunlap, Co-Portfolio Manager

One of the biggest side effects of $14 trn of QE/Balance sheet expansion by the Fed/BoE/ECB and BoJ since the GFC, has been asset price inflation. This has created immense wealth for the lucky people who were long assets in various forms, such as housing or equities. Invariably this has increased the wealth divide to extreme levels and a generation of asset winners who believe it was their investing genius that acquired this wealth, when largely it was just a by-product of public policy. Not only those lucky individuals, but a large proportion of the investment industry may have fallen for the same self-deception. The fact is the lowering of central bank rates on inflation targeting and QE programs, has allowed the UST 10Y (and many other key government bonds) to rally since 1981.

What many in the investment community forget is that asset valuations are dependent on borrowing cost (Private Equity and Venture capital) and discounting yields (Equities, Property, Credit etc.) that have been going down. By simple mathematics, the discounting of future cashflows via lower yielding rates curves has pushed up asset values. This has had a profound effect on returns across the entire investment spectrum, to the extent it is very hard for analysts to strip out the beta effect, or for that matter, for many institutions to admit how much of their investment returns were not due to internal skill. The tsunami of money poured into Passive funds over the last decade is testament to the scale of these beta returns. However, collective QE programs finally peaked in early 2018 and with it the small beginnings of a reversal, or “normalisation” of monetary policy by some central banks. I very much doubt rates will return anywhere close to past levels, as the economic sensitivity to them from extreme global debt levels will prevent this.

However, I do think that the extent that Beta has pervaded the investment market will slowly, but surely, be outed in this repricing process towards higher yields. The scale of this will surprise for sure. Pure Alpha is hard to find.

30 year rally of discount rates has pumped up all asset prices
Fed short term rates vs 10 yr US treasury

Source: Bloomberg

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IMPORTANT INFORMATION: Issued and approved by Pacific Capital Partners Limited, a limited company registered in England and Wales, authorised and regulated by the Financial Conduct Authority . The information contained herein is not approved for use by the public and is only intended for recipients who would be generally classified as investment professionals. Information or opinions contained in this article do not constitute an offer to sell or a solicitation, or offer to buy, any securities or financial instruments or investment advice or any advice or recommendation in respect of such securities or other financial instruments. Where past performance is shown it refers to the past and should not be seen as an indication of future performance.

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