Monday, April 9, 2018

Brick-and-mortar stores are forming 'symbiotic relationship' with digital retail


By Veronica V. Soriano,
Guest Columnist

Stock photo: Canva
Technology such as smartphones are impacting traditional retailing,

impacting the ways that consumers shop.
Technology is surely impacting traditional retailing, especially evident in the ways that consumers shop and how retailers deliver those goods. While technology is disrupting the sector and challenging retailers, the good news is that e-commerce and physical “brick-and-mortar” stores have formed a symbiotic relationship, creating a phy-gital (physical + digital) retail world.

E-commerce has been effective as a medium to reach more customers and address merchandising strategies and to increase product availability in both established and new markets. To succeed, major retailers need to embrace an omni-channel approach to integrate the two business segments of real estate and e-commerce. In retail jargon, physical retailers with online/digital sales business are called omni-channelers. In the same way that technology precipitated omni-channeling, it has also given rise to omni-shoppers. Today’s consumer shops from various access points—desktops, mobile devices, smartphones, telephones and/or brick-and-mortar stores.

We do not have to look far to demonstrate the rise of the omni-shopper. In 2017, Mastercard SpendingPulse reported a 4.9 percent increase in retail sales during the year-end holidays, beating forecast estimates. Traffic activity was reportedly heavy both online and in stores. Moreover, a post-holiday survey commissioned by the International Council of Shopping Centers (ICSC) showed that shoppers take advantage of all available channels when purchasing goods, and this trend extends across all generations (Millennials, Generation X, Baby Boomers). Most interesting to real estate investors, despite headlines reporting the demise of malls and other shopping center types, was that the great majority of consumers still shop at physical stores. This is certainly good news to shopping center landlords, as evidence that brick-and-mortar store remains the cornerstone of sales.

Click chart to see a larger view. 

Rather than diminishing the role of the physical store, omni-channeling and omni-shopping have made it more important than ever. The “halo effect” of a physical store refers to the location’s impact on its trade area consumers and the brand awareness that is created by its mere presence, including the store’s influence in its local market on increasing online sales and promoting click-and-collect. Specifically, the physical establishment offers the following advantages:

  • Showroom – retailers are able to showcase their products while allowing consumers to see, feel and touch the product. 
  • “See Now, Buy Now, Wear Now” – with the merchandise already available in the stores, retailers answer consumers’ demand for immediacy and consumers get instant gratification. There are also reportedly fewer returns for purchases made in the store. Purchases made online are fulfilled in stores instead of being shipped to homes (Buy Online, Pick Up in Store or "BOPUS") and returned to or exchanged in stores instead of mailing back (Buy Online, Return in Store or "BORIS"). 
  • There is higher conversion (i.e., browsing that result in a purchase) in stores than online. 
  • Whether the consumer picks up or returns merchandise to the store, that visit usually translates to an upsell or consumers buying more at the store, therefore, higher sales. 
  • Consumers recognize the convenience provided by the shopping center (as a compilation of stores) being a “one-stop shop.” Having many stores within the same location also encourages cross-shopping.


In this changing retail climate, there will be winners and losers. Ultimately, retail property owners who adapt quickly will be winners, in our view. Indeed, omni-channeling promotes and enhances the value of retail real estate as the physical store’s role in generating sales is more important than ever.

Note: Article includes excerpts from Barings’ August 2017 U.S. Research Special Report, “Decrypting E-commerce."

The views expressed do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Barings or TEXPERS.

Veronica Soriano
About the Author
Veronica Soriano is a member of Barings Alternative Investments, a global real estate, private equity and real assets platform. Soriano is a director of Real Estate Research and is responsible for analysis of the global retail sector.  Prior to joining the firm in 2014, she was portfolio research director at Cypress Equities in Dallas, Texas leading all research efforts, including macro level and regional economic analysis as well as forecasting real estate market trends. She also previously worked at the International Council of Shopping Centers in New York City where she was senior research analyst and helped build ICSC’s research platform which focused on fundamental consumer trends and market strategies of retailers and developers around the world. Soriano also worked at JC Penney, where she performed site selection, sales forecasting, and store location analytics. She also has international experience having started her research career with Ayala Land Inc., a property developer in the Philippines.

Sustainable investing themes and trends for 2018


Graphic: iStock/Gustavo Frazao
Trends in climate change, resource scarcity, population changes, 
stewardship, diversity and social changes could point to 
investment opportunity.
By Mamadou-Abou Sarr
Guest Columnist

In 2018, investors can find opportunity through understanding the most interesting themes and trends we’re seeing in sustainable investing.

Climate Change
Climate has emerged as a dominant area of focus for investors globally. The global program for action was outlined in December 2015, when 195 countries and the European Union adopted the historic Paris Agreement. Still, critical policy developments, international coordination efforts, major technological innovations, and a major shift from brown to green investments lie further ahead.

Resource Scarcity
Water scarcity has become the second-largest consideration on the investment agenda after carbon emissions. It is one of the biggest risks to food and apparel industries, as well as to urban infrastructure. Cape Town in South Africa already is facing a water crisis, but a number of other cities, particularly in India and China and also the state of California are exposed to similar risks. We have seen improvement in corporate sustainable water usage and wastewater management. Further, a few high-profile green bonds have been issued to upgrade the water and sewer infrastructure.

Population Dynamics
Generation X and millennials have different priorities than their baby-boomer generation predecessors. They want their investments to align with their personal ethos. Of all population groups, millennials lead in terms of social-impact investing interest at 80 percent, with 28 percent actually making such investments, according to a U.S. Trust 2017 survey of high net-worth investors. Going forward, integrating sustainable investing solutions will likely be one of the top issues for plan sponsors.

Stewardship and Proxy Voting
We expect that 2018 will earmark a pivotal point in corporate-investor relationships. The growing interest of retail investors and beneficiaries on financial markets to sustainability is shifting the use of shareholder voting rights towards the support of sustainability-related resolutions. Shareholder-filed proposals on sustainability-related resolutions and targets and interactions between companies and their shareholders have increased dramatically during the last year.

Factor Investing and ESG
The FTSE-Russell investment managers’ survey from May 2017 stated that in Europe, 60 percent of managers anticipate applying environmental, social and governance investing criteria (ESG) to a smart-beta strategy targeting well documented compensated factors. According to the survey, only 20 percent of respondents from North America said they would consider it. At Northern Trust Asset Management, we have seen substantial interest in the factor-based ESG strategies in the United States, too, as evidenced by the impressive growth of assets under management in the NT Quality ESG strategy.

Diversity and Gender Equality
Companies in the top quartile for gender diversity on their executive teams were 15 percent more likely to experience above-average profitability than companies in the fourth quartile, according to McKinsey & Company research based on 2014 data. In McKinsey’s expanded 2017 data, covering more than 1,000 companies from 12 countries, this number rose to 21 percent. For ethnic and cultural diversity, the 2017 finding was a 33 percent likelihood of outperformance on earnings before interest and taxes. In response to growing demand, a number of stock indices have emerged that incorporate gender equality parameters into stock selection. These include the FTSE Russell’s newly launched series of “Women on Boards Leadership” indices, which re-weight companies with a target to achieve 33 percent female representation on the boards of constituent companies by 2020.

The views expressed do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Northern Trust Asset Management or TEXPERS.

About the Author
Mamadou-Abou Sarr is director of product development and sustainable investing at Northern Trust Asset Management. He is responsible for environmental, social and governance innovation and product development across the firm's full array of asset classes and capabilities for institutional and wealth management investors. Sarr has a key role within Northern Trust to proactively develop new ideas to ensure that ESG thinking remains central to the firm's business development.


China emerges from the smoke


Graphic: Canva
China is taking an aggressive leap from an infrastructure industry to a tech mecca.

By Simon Fennell,
Guest Columnist

China is commonly characterized as a smokestack economy, focused on infrastructure investment, cheap manual labor, and polluting industries. But that is changing, as China’s 2017 equity-market return of 50 percent suggests.

The challenge: Can China justify those returns and make the aggressive leap into an innovative, digitally led economy?

Growth in the country’s population and change in its demographics are often discussed, but China is also dominating the world in internet usage, with 731 million users in 2017 versus just 434 million in the European Union, 432 million in India, and 237 million in the United States. And Tencent’s WeChat, the popular Chinese chat app, has surpassed 700 million users, quickly catching up to Facebook’s Messenger and WhatsApp.

Scaling across a user base of hundreds of millions has led to innovation in business models. Consider, for example, that online payment companies Tenpay and Alipay are now encroaching on (even surpassing) the number of online payments seen by Visa and MasterCard, as the chart below illustrates.
Click the chart to access are larger view.

The opportunity to gain exposure to these companies, which we see as both self-funding and self-growing, is important to us as investors. The story is no longer about “Made in China” but rather “Invented in China.”

The number of science, technology, engineering, and mathematics (STEM) graduates in China will likely support this transformation: 4.7 million in 2016, according to McKinsey Global Institute, versus 2.6 million for India and 568,000 for the United States.

Ample funding is available to Chinese companies that want to innovate. Although the United States still received the most venture capital in 2016 in virtual reality, autonomous driving, artificial intelligence, and robotics, China was not far behind—and it received the most venture capital funding in financial technology.

Also supporting Chinese innovation are tax credits. Certified high-technology and new-technology companies could receive a preferential income tax rate of 15 percent, 10 percentage points lower than the statutory rate of 25 percent. There is also a 150 percent tax deduction for eligible research-and-development expenditures.

Lastly, China has one of the largest, most liquid, and fastest-growing equity markets in the world. The Shanghai and Shenzhen stock exchanges list 3,500 companies with an aggregate market capitalization of $7.5 trillion, according to a July 17, 2017, Goldman Sachs report. 

That is second only to the New York Stock Exchange and Nasdaq, and multiple times larger than other major emerging markets, such as Korea and Taiwan.

Yet China is under-represented in global equity indices relative to its economic influence. China accounts for a substantial part of the world: 15 percent of global gross domestic product, 11 percent of global trade, and 11 percent of global consumption.

China composes just 3 percent of the MSCI AC World Index. When MSCI includes China A-Shares in its indices in June 2018, they will represent just 1 percent of the MSCI Emerging Markets Index and 0.1 percent of the MSCI AC World Index.

This leads us to believe that China’s weight in global benchmarks—and thus its relevance to investors—will increase materially over the next decade.

We see two major risks to the China story.

The first is that the country opens up its capital and financial markets too quickly. When financial markets are liberalized, a period of learning and massive misallocation of capital typically ensues.

Second, after the National Party Congress, President Xi Jinping moved to a more dominant political position. If he reaches the level of power of Mao Zedong, he could be perceived as a political threat–and if he loses power, that could have an impact on the innovation China has recently seen because Xi is so closely aligned with it.



The views expressed do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of William Blair International Growth or TEXPERS.

About the Author
Simon Fennell is a portfolio manager for the William Blair International Growth, International Small Cap Growth, and International Leaders strategies. He joined William Blair in 2011 as a TMT research analyst focusing on idea generation and strategy more broadly. Before joining William Blair, Fennell was a managing director in the equities division at Goldman Sachs in London and Boston, where he was responsible for institutional equity research coverage for European and international stocks. Previously, Simon was in the corporate finance group at Lehman Brothers in London and Hong Kong, working in the M&A and debt capital markets groups.

Investors may forego blind faith in Silicon Valley

SEC charges healthcare tech company and CEO with massive fraud


Photo: Canva
Once upon a time, Silicon Valley companies only had to offer 
promises of new technology to wrangle investments. A recent 
fraud case may change the blind faith investors often have in 
Silicon Valley.
By Nicole Lavallee and Victor S. Elias,
Guest Columnists

For as long as “Silicon Valley” has been part of the popular vernacular, investors have always been willing to invest in that sector based on faith and the promise of what a new technology can bring.  As the Security and Exchange Commission’s recent charges against Theranos Inc. and its former CEO, Elizabeth Holmes, show, promises can only get you so far and there is no substitute for healthy skepticism and detailed due diligence. 

In March, the SEC charged Theranos and Holmes with a “massive” fraud that raised $700 million from investors.  The SEC accused the healthcare tech company of making false statements about a finger-prick technology said to be able to run hundreds of blood tests from just a few drops of blood.  To resolve the charges, Holmes agreed to pay $500,000.  She also agreed to give up control over the company, return millions of shares, and not act as an officer of another company for ten years.  

What takes this story outside the rubric of traditional securities fraud is the story of Holmes’ and Theranos’ rise.  Holmes, a Stanford dropout, founded Theranos in 2003 when she was just 19 years old.  She rose quickly among the ranks of Silicon Valley “disruptors.”  
Projected to revolutionize the blood-testing industry, and declared by Forbes as the youngest self-made billionaire, Holmes became the subject of beaming profiles in tech magazines.  Prominent investors jumped on the bandwagon, including media mogul Rupert Murdoch and former Secretary of State Henry Kissinger.  At its height, Theranos reached a valuation of $9 billion. 

The problem is that it appears to have all been a lie.  According to the SEC, Theranos deceived investors about its blood-testing and bottom line. The product performed just 15 types of blood tests, not 240 as touted by the company.  Moreover, the company used commercial analyzers to perform those tests, and not its own technology.  And despite claims to the contrary, military medics did not use the product on battlefields in Afghanistan.
 
The real question, however, is how investors and the public bought into the company’s hype with so little to back it up.  To attract investors, the company allegedly gave out binders with media articles and financial statements made from whole cloth.  But what those materials lacked were specifics and credibility—they contained neither details about how the technology worked nor audited financial statements. 

The charges against Theranos are not the SEC’s first foray into Silicon Valley’s private sector, to be sure.  But they have to be one of its most prominent.  And while the hard lesson of this failure is a good reminder for investors that nothing takes the place of asking hard questions and performing ample due diligence, it is too soon to tell whether this experience marks a sea-change in the way investors look at the promise of new technology or rather is just a blip in the quest to find the next big thing. 

The views expressed do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Berman Tabacco or TEXPERS.

About the Authors
Nicole Lavallee is the managing partner of Berman Tabacco's San Fransico officer and Victor S. Elias is an associate in the San Francisco Office.
Victor S. Elias
Nicole Lavallee

New U.S. tariffs have lots of bark and unknown bite


Photo: Canva
By Taylor Graff,
Guest Columnist 

During the past century, trade barriers around the globe have declined substantially, coinciding with a considerable increase in global trade. Politicians will debate the winners and losers from this but multinational corporations have benefitted tremendously from free trade. However, popular sentiment for globalization has recently soured in many countries and the trend may be reversing. In many ways, President Donald Trump’s election may be viewed as a byproduct of this trend and his recent actions on trade have caused financial markets to reevaluate the future of trade policy.

For most major economies, trade with the United States as a percent of gross domestic product is small enough that U.S. tariffs alone are unlikely to derail the global economy. However, aggressive retaliation to tariffs and a broader trade war represent a risk to the global economy and an even more significant risk to multinational corporations which dominate the global equity market. Highlighting the risk of rising trade barriers, companies in the S&P 500 Index generate nearly half of their revenues outside the U.S.

What comes next? There are two historical examples that may provide context. First, in 2002 the George W. Bush administration enacted similar steel tariffs to those recently announced. In response, several nations initiated a case in the World Trade Organization and proposed severe retaliatory tariffs. After the WTO ruled against the U.S. 20 months later, the Bush administration rescinded the tariffs rather than face significant retaliatory trade action. 

Conversely, in 1930 Herbert Hoover's administration struggled in combatting the onset of the Great Depression. They enacted large and wide-ranging tariffs aimed at bolstering domestic industries. Other nations followed with their own tariffs on goods from the U.S. and other countries; these hurt U.S. exporters and led to a global trade war. The ensuing contraction in global trade deepened the economic downturn, rather than ameliorating it.

These examples demonstrate how other nations’ reactions can determine how this event ultimately impacts the economy and financial markets. We see three potential outcomes: 


1.  Retaliation Against the U.S.: International responses may be limited to targeting the United States. Corporations heavily exporting from and importing into the U.S. would feel the significant impact and the U.S. economy would feel pain. The magnitude would depend on the severity and breadth of the retaliation.
2.  Negotiating:  International trading partners may decide it is wiser to negotiate rather than retaliate in response to these actions. We have already seen South Korea renegotiate their free trade agreement with the U.S. Depending on the outcome of these negotiations, this could benefit the economy and multinational corporations.
3.  Trade War:  Nationalist political factions around the world may be emboldened to take similar actions leading to a trade war that substantially reduces global trade. The global marketplace is far more expansive than it was in 1930. Global trade is approximately 60 percent of global GDP today vs. approximately 9 percent in 1930, so the potential impact could be very significant.

Click the chart to access are larger view.
Overall, it is too early to determine the impact this may have, but it introduces significant uncertainty into global markets. 

The views expressed do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Brown Advisory or TEXPERS.

Taylor Graff
About the Author
Taylor Graff is the head of asset allocation research at Brown Advisory. He leads the asset allocation research effort within the Investment Solutions Group, a team responsible for conducting primary statistical, market and economic research as well as research on external managers. Additionally, Graff develops asset allocation strategies for balanced clients and works directly with clients as a portfolio manager. Prior to joining Brown Advisory, he was the head of research at Cavanaugh Capital Management, where he conducted investment research and developed quantitative modeling applications for asset allocation and fixed income strategies.

Downside protection is important in the emerging markets


Photo: iStock/Ildo Frazao
By Timothy Atwill, Guest Columnist

To state the obvious, emerging market equities are risky. Investors are exposed to extreme levels of unpredictability due to elevated levels of political, currency and liquidity risk. However, there is a little-known characteristic of this asset class that further reinforces this notion of risk—emerging markets routinely experience large drawdowns. And these drawdowns should have emerging market investors considering strategies that structurally offer downside protection.

In fact, in every calendar year since 2001, the MSCI Emerging Markets Index has posted a market drop exceeding 10 percent, with nearly half of these drawdowns exceeding 20 percent. Perhaps most surprising, these drawdowns can happen even during particularly bullish calendar years. For example, 2004, 2006 and 2009 all experienced calendar-year index returns exceeding 25 percent, but they also experienced maximum drawdowns exceeding 20 percent. 

If a 20 percent drop indicates a bear market and a 20 percent gain indicates a bull market, this means emerging market investors experienced a bear market on their way to booking a bull market return for each of these three years. Now that’s volatility!

Return and Maximum Drawdown for the MSCI Emerging Markets Index, by Calendar Year, 2001-2017

Source: MSCI, Parametric, as of 12/31/2017
For illustration purposes. Not a recommendation to buy or sell any security. It is not possible to invest directly in an index. Click on the image to access a larger version.

Examining the entries in the above table, one can make two further observations. First, 2017 is highly unusual for its lack of a major drawdown. In fact, the asset class had only one down month over the course of 2017. Looking at the historical record, it would be quite unusual for a significant drawdown to not occur in 2018. This is not a timing call, but simply a restatement of the fact that the emerging market asset class typically experiences a 15 to 25 percent drop in any given year. 

Given this history of frequent and material drawdowns, investors should be interested in how their emerging market investments respond to drawdowns. Because many passive strategies contain a material concentration of country-level exposures, we would note that broad diversification at the country level has historically been quite powerful in helping to provide downside protection in the emerging markets.

There are two benefits of strategies that offer downside protection. First, they allow investors to be less panicked when such drawdowns occur, which helps them stay invested. Second, and more importantly, such strategies can potentially produce strong relative returns. By helping preserve capital in drawdown periods, they allow investors to participate more fully in any ensuing rally. 

As recent days have shown, the lack of volatility seen in 2017 is unlikely to continue through 2018. Accordingly, investors should re-examine the downside characteristics of their emerging market managers because staying invested in times of sudden sharp losses will be key to success in 2018.

The views expressed do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Parametric or TEXPERS.

Timothy Atwill
About the Author
Timothy Atwill is head of the investment strategy team at Parametric. The team is responsible for articulating and evolving Parametric's current investment strategies. In addition, Atwill holds investment responsibilities for Parametric's emerging market and international equity strategies, as well as shared responsibility for the firm's commodity strategy. Prior to his role with Parametric, Atwill worked at Russell Investments in the company's manager research unit and in Russell Investments' trading group, implementing derivative strategies for institutional clients. Prior to his time at Russell, Atwill worked as a nonlife actuary and derivatives portfolio manager at Safeco Insurance Co.

Looking for impact in CEO compensation

Graphic: iStock/Natali_Mis
By Katherine Collins and Stephanie Henderson,
Guest Columnists

One powerful element to consider across all sectors is capital stewardship. While company management doesn’t directly control the performance of their stock, especially in the short term, the CEO has direct responsibility for the stewardship of a company’s capital. Additionally, analysis of incentive compensation measures reveals a lot about internal company priorities: Sometimes incentive structures amplify the company’s stated mission, and sometimes they contradict it. 

For investors concerned about corporate governance issues, the structure of management incentive compensation has become a prominent consideration. Still, we do not have a complete understanding of the linkages between pay structures and company performance. While many companies have moved to incorporate total shareholder return (TSR, or stock price appreciation plus dividends) into their incentive metrics, the use of this metric alone does not necessarily ensure alignment between management and shareholders.

First, consider the growing importance of incentives. More than 80 percent of companies in the S&P 500 used performance awards as recently as 2015, linking a part of their executives’ annual compensation to performance goals; this compares with about 50 percent of companies in 2009, according to a report from Stanford Graduate School of Business. Performance-based pay, in fact, accounts for the majority of CEO compensation for the average S&P 500 company. More than 60 percent of total compensation is from long-term incentives such as stock and option awards, the Stanford report shows.

Click the graphic to access a larger version.

TSR is the most popular metric in incentive plans.  According to the Stanford study, 57 percent of companies in the S&P 500 used it in incentive pay. However, there is little empirical evidence showing a relationship between TSR-based incentive plans and company performance.

While it’s tempting to think that stock performance and management performance are one and the same, there is often a disconnect. A recent MSCI study from October 2017 shows that there is little relationship between CEO pay and shareholder returns, even over a 10-year period. There are several possible explanations for this, involving a mix of external factors, CEO performance, and luck.

The disconnect between long-term total CEO pay and long-term shareholder return indicates that important questions remain. As compensation measures become more complicated, the assessments have turned increasingly interesting and nuanced. For example, a metric that works for an industrial company may not be tied to value creation in a technology company. 

The power of incentives becomes even more apparent over the long term. Viewing executive compensation in this light can help us to identify organizations that are best aligned with true long-term value creation for their investors and other stakeholders.

The views expressed do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Putnam Investments or TEXPERS.

Katherine Collins
About the Authors
Katherine Collins is head of sustainable investing at Putnam Investments. She is responsible for leading the firm's investment research, strategy implementation, and thought leadership on environmental, social and governance principles. Collins collaborates with portfolio managers and analysts on ESG integration, assessing the fundamental relevance of ESG issues at a security level, and the potential for alpha generation and risk mitigation at a portfolio level. In addition, she is the portfolio manager for two ESG-focused separately managed accounts, specifically managed for institutional clients. 






Stephanie Henderson
Stephanie Henderson is a portfolio manager and an analyst in Putnam Investment's Equity Research group, which specializes in sustainable investing strategies. Henderson is responsible for conducting fundamental analysis and valuation of companies, evaluating their performance across environmental, social and governance factor and identifying potential risks and opportunities related to these factors.