CLOSE

We permit the publication of our auditors’ report, provided the report is published in full only and is accompanied by the full financial statements to which our auditors’ report relates, and is only published on an access-controlled page on your website https://www.hermes-investment.com, to enable users to verify that an auditors’ report by independent accountants has been commissioned by the directors and issued. Such permission to publish is given by us without accepting or assuming any responsibility or liability to any third party users save where we have agreed terms with them in writing.

Our consent is given on condition that before any third party accesses our auditors’ report via the webpage they first document their agreement to the following terms of access to our report via a click-through webpage with an 'I accept' button. The terms to be included on your website are as follows:

I accept and agree for and on behalf of myself and the Trust I represent (each a "recipient") that:

  1. PricewaterhouseCoopers LLP (“PwC”) accepts no liability (including liability for negligence) to each recipient in relation to PwC’s report. The report is provided to each recipient for information purposes only. If a recipient relies on PwC’s report, it does so entirely at its own risk;
  2. No recipient will bring a claim against PwC which relates to the access to the report by a recipient;
  3. Neither PwC’s report, nor information obtained from it, may be made available to anyone else without PwC’s prior written consent, except where required by law or regulation; and
  4. PwC’s report was prepared with Hermes Property Unit Trust's interests in mind. It was not prepared with any recipient's interests in mind or for its use. PwC’s report is not a substitute for any enquiries that a recipient should make. The financial statements are as at 25 March 2016, and thus PwC’s auditors’ report is based on historical information. Any projection of such information or PwC’s opinion thereon to future periods is subject to the risk that changes may occur after the reports are issued and the description of controls may no longer accurately portray the system of internal control. For these reasons, such projection of information to future periods would be inappropriate.
  5. PwC will be entitled to the benefit of and to enforce these terms.
I accept
CLOSE

1. Select your country

  • United Kingdom
  • Austria
  • Australia
  • Belgium
  • Denmark
  • Finland
  • France
  • Germany
  • Iceland
  • Ireland
  • Italy
  • Luxembourg
  • Netherlands
  • Norway
  • Singapore
  • Spain
  • Sweden
  • Switzerland
  • USA
  • Other

2. Select your investor type

  • Financial Advisor
  • Discretionary Investment Manager
  • Wealth Manager
  • Family Office
  • Institutional Investor
  • Investment Consultant
  • Charity, Foundation & Endowment Investor
  • Retail Investor
  • Press
  • None of the above

3. Accept our terms and conditions

Proceed

The Hermes Investment Management website uses cookies to remember your preferences and help us improve the site.
By proceeding, you agree to cookies being placed on your computer.
Read our privacy and cookie policy.

Assessing the unintended consequences of central bank policy

Home / Press centre / Assessing the unintended consequences of central bank policy

Andrew Parry, Head of Equities
11 October 2016
EquitiesPress

Quantitative easing and ultra-low rates have provided stimulus to the global economy and markets, but they are also creating distortions in the financial world. In his latest investment note, Andrew Parry, Head of Equities at Hermes Investment Management, assesses the unintended consequences of unprecedented central bank monetary policy.

Plunging gilt yields and low expected returns from real assets are threatening the long-term viability of many pension funds. Cash savers have lost most of the return from their cash savings and may soon have to pay banks just to hold their deposits, as witnessed in Germany and Japan. Meanwhile, investors are being forced up the risk scale as central banks hoover up traditionally lower risk assets.  

We are seeing the unintended consequences of the greatest financial experiment in history take hold. As investors, we must carefully consider the price distortions across asset classes and factor monetary policy risk into investment decision-making.

This is not to suggest QE has been without merit. One needs only to cast the mind back to 2009, when the US economy looked as if it was about to descend into an abyss. Since then, the economy has recovered, employment is at a new high, and while inflation has not picked up, the US is safe from deflation. Yet despite its effectiveness, concerns remain over whether this is merely a palliative cure hiding deep structural problems. Its efficacy elsewhere – Japan and the Eurozone – has yet to be proven.

AP1

Normalisation will be the true litmus test

Ultra-loose monetary policy is also driving increasingly short-term behaviour by corporates. Share buybacks have long been a feature of the US markets, fuelled by a low borrowing cost which has led to net debt growing far more rapidly than EBITDA since 2014. Now a mini-M&A boom is underway globally.  Such beneficial borrowing costs can be a fillip for financial returns and makes most acquisitions earnings accretive. However, there is a grave danger it makes companies transactional in nature at the expense of long-term fixed capital formation, which is only compounded by the drag from rising pension deficits.

For investors, coercive monetary policy creates a false sense of low risk and a dangerous herding mentality in the hunt for growth. A return to “normality” will be the true litmus test for QE and loose monetary policy – and deem it a success or failure. Unfortunately, as the monetary stakes are raised higher for longer, the greater the possibility of a binary outcome.

The dangerous denominator problem

Lower rates can certainly be a positive.  As discount rates globally plunged towards zero, so the valuation on risk assets rose. But such low levels of interest rates give rise to a dangerous denominator problem: small changes in the discount rate can lead to dramatic swings in asset valuations. This leads not only to bouts of intense volatility, but also reflexive policy moves by central banks, fearful that asset markets cannot live without their monetary largesse; as demonstrated by the inaction of the FOMC.  Even small changes in perception of policy can have amplified effects on asset prices. 

Yet while this great experiment hangs over asset prices, the market has sailed on serenely after a cataclysmic January when markets decided central banks were impotent and the US was heading for recession, led by China. Since then accommodative central bankers have become efficient distillers of market bromide to soothe anxious investors. As a result, a complacency is creeping in that could be blown apart by a re-setting of risk perception. The catalyst is likely to be ‘a great and sudden’ change from policy makers who decide it is time to remove the palliative.

What happens when the tide goes out?

AP2

Another concern is the omnipotence of central banks in the asset purchases. They have become whales in markets where the tide is rapidly receding. For example, Japan owns 45% of its government bonds in issuance. It isn’t just the size of the investments that are a problem; it is what happens when the rate of asset purchases inevitably diminishes. The positions are reminiscent of foreboding episodes, such as when Bunker Hunt tried to corner the silver market in 1980 and the London Whale’s derivative trades spectacularly backfired.

One day bond markets will rediscover their mojo. The First Law of Thermodynamics states that energy cannot be created or destroyed, just transformed into other forms. Similarly risk cannot just disappear – it has been transferred from banks to other parts of the financial system, and waits for the inevitable catalyst to reassert itself.

Coercive action by central banks that forces investors, and increasingly savers, to adopt more risk than they would naturally be comfortable with – is a strategy that inevitably leads to sudden eruptions of fear, triggered by the smallest thing. In a wider context, it has potentially exacerbated inequality creating social and political tensions that generate instability.

For truly long-term investors, it is not wise to set investment strategy based on the outcome of central bank policy meetings. This is a time when fundamental analysis and long-term, bottom-up stock pickers can help navigate investors through the stormy seas that lie ahead.

Share this post:
Andrew Parry Head of Equities Andrew Parry is Head of Equities and a member of the Hermes Strategy Group. He joined the firm in 2009, initially as Chief Executive and Co-Head of Investment for Hermes Sourcecap, now Hermes European Equities, becoming Head of Equities in 2014. In 2006, Andrew jointly founded Sourcecap with the aim of building a best-in-class investment boutique focused on excellence in European equity management. Prior to this, Andrew established Pembroke Capital Management in 2003 and successfully launched the Magenta Fund, a global equity non-directional fund. Before that, Andrew worked at Northern Trust Global Investments (Europe) Ltd as Chief Investment Officer of International Equities and was responsible for the management of global, international and regional portfolios. He has also held a variety of senior investment roles, including Head of International Equities at Julius Baer Investments, Chief Investment Officer at Lazard Brothers Asset Management, and Head of UK Equities at Baring Asset Management. Andrew holds an MA in Mathematics from the University of St Andrews. Andrew is a member of the Investment Committee of the Trafalgar House Pension Trust and a non-equity director of Aerion Fund Managers. He was formerly an independent investment advisor to the Investment Sub-Committee of the Mineworkers’ Pension Scheme.
Read all articles by Andrew Parry

Press contacts