Legal & General: China Will Have a Financial Crisis

Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Justin Onuekwusi, Manager of the Legal & General Multi Index Range, to talk about ETFs.

Hi, Justin.

Justin Onuekwusi: Hi, Emma.

Wall: So, you do favor passive funds ETFs within this multi-index range which you run. And multi-asset obviously can be quite an expensive way to invest, especially multi-manager funds because you get that double layer of fees. But by concentrating on passives presumably costs are reduced for you?

Onuekwusi: Yeah, I think, we've seen a huge growth index fund. I do think multi-asset investor index fund is really the next step for multi-asset investing and this is why you've seen a growth of multi-asset funds which invest in index building blocks more recently. And clearly, cost is a key. A key reason I joined L&G in 2013 is because we manufacture our own index funds and we do so with scale.

We manager over GBP300 billion of index fund money and it means that relative to our peers we're always able to create cost effective solutions. Importantly, we're active in terms of asset allocation; however, there is no guarantee we're going to get that right every single time. The only guarantee you've got from management is that costs will detract year after year after year from returns. So, it's so important. Fund of index funds, fund of active funds you have to manage those costs down.

Secondly, it's also quite important – it's quite difficult to pick good managers and we know the average manager tends to (indiscernible) fees versus the index over time. So whilst it's not impossible, when you can't pick good managers, advisors are simply switched towards the key driver of risk and therefore return, getting the asset allocation right over manager selection. And I think that's really been driven by RDR and the increased visibility of costs.

Wall: And as well as costs risk has been the another thing that you've been vocal about recently. And a lot of multi-asset funds are ranked in terms of risk, one being the most aggressive or the most cautious through to five. But these structures can mean that people become too obsessed with the kind of risks that they are taking on. And that can end up governing all of the decisions that you're making as an asset allocator?

Onuekwusi: I think that you're completely right. Volatility, which a number of these risk targeted funds are built on, is only one measure of risk. There are key other risks, a liquidity risk, active manager risk, inflation risk, interest rate risk which simply cannot necessarily be captured by a simple measure of volatility. So, it's so important that investors really look under the bonnet of these funds and really try and understand what particularly they are doing.

But there is three key market risks that we see at the moment. The Fed increasing rates quicker than the market expects. We saw volatility that caused at the end of 2015 but also in 2013 with the taper tantrum. The Chinese hard landing; we now believe for the first time since the inception of the multi-index funds that China will have a financial crisis, maybe not next year, maybe not even two years, maybe not even three years, but unless they solve their debt situation we believe they will see a financial crisis.

And last but not least, you've got European malaise which captures Brexit risk. Now, if you look over the next 18 to 24 months, we see a number of political signposts coming up, whether it's the Italian referendum of political reform, three key general elections, the Dutch general election, the German general election and the French general election and these are going to be key to defining Europe and the future of the EU.

Wall: So, with all those risks out there where are you seeing opportunities for investors?

Onuekwusi: No, it's a good point. It's not all doom and gloom. It's not all pessimism. So, overall, we are cautious on risk assets. So it means we are taking less risk than average, actually the least risk we'd taken since the launch of the multi-index funds. But there are key areas where we're more positive. One of these areas is global real estate securities.

So, we invest in a global real estate security index fund. Why, because we think overall given all these uncertainties the Fed really has to err on the side of caution in terms of raising rates and that should be a tailwind for U.S. property. 65% of that fund is made up of U.S. property, predominantly commercial property.

Secondly, emerging market hard currency debts. We do not believe emerging markets will default on their dollar debts. It's quite important. So, you get north of 5% yield which is pretty attractive in this low risk world, but because emerging markets have built up their FX reserves over time it means they are unlikely to default on the dollar debts and separate from the lower currency debt which is quite important. And last but not least, we've become more positive on energy.

We feel that oil market is moving into balance, this was before the OPEC announcement a few weeks ago or last week, but we think the oil market is going to come into balance and therefore, we think you're going to see stability in the oil price and that should be a tailwind for both European equity stocks but also U.S. equity stocks.

Wall: Justin, thank you very much.

Onuekwusi: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.