Chinese insurer emulates ‘Buffett model’ with Waldorf purchase

The previously obscure Chinese insurance company whose global shopping spree has raised eyebrows in the investment world is pursuing a Warren Buffett-like strategy in which investment returns drive growth and insurance plays only a minor role.

This month alone, Beijing-based Anbang Insurance Group announced the purchase of Manhattan’s Waldorf Astoria hotel for $1.95bn and Belgian insurer Fidea for an undisclosed price. South Korean media have also reported that Anbang is considering acquiring a controlling stake in state-run Woori Bank.

Such ambitious investment may seem strange for a company that ranks eighth among Chinese life assurers with only a 3.6 per cent market share, far below leaders China Life and Ping An, which control 25 and 14 per cent, respectively. 

Yet a look at Anbang’s business model suggests the company is more like a private equity fund with a side business in insurance. Rather than profiting from the excess of premiums over claims, analysts say Anbang aims to generate earnings through investment returns.

Chinese entrepreneurs have expressed admiration for the “Warren Buffett model” in which insurance premiums provide cheap funding for far-flung equity investments.

Fosun founder Guo Guangchang has frequently cited the example of Mr Buffett in outlining intentions to transform his industrial conglomerate into a strategic investment group.

In China, however, the strategy of using insurance as a platform for unrelated investments is riskier, since the core insurance business is less profitable than in the west.

Roughly 70 per cent of “life assurance” products in China are more akin to certificates of deposit. The customer pays a premium only once, and the insurer guarantees the return of principal plus interest after five to 15 years.

Insurers earn razor-thin margins on such products, which are sold mainly through banks and must compete for funds with lenders’ own high-yielding wealth management products.

Protection-type products, which only pay out in the event of an accident, illness or untimely death, deliver higher margins because the insurer doesn’t pay out on every policy, but still comprise only a small fraction of China’s overall insurance market.

Privately held Anbang collected Rmb33bn ($5.4bn) in life assurance premiums in the first eight months of 2014 versus only Rmb3.4bn in property and casualty fees, government data show.
Its profitability has been further compromised by its rapid growth strategy. Premiums have grown from Rmb1bn in 2005, the year after Anbang’s founding, to Rmb36bn so far this year. That has required big spending on hiring sales agents and paying commissions to banks that champion their policies.

“I can’t see how they’re making a profit, with all the reserves they have to put away and all the acquisition costs. I would be stunned,” says Sam Radwan, co-founder of Enhance, a management consultancy that advises China’s insurance industry.

Premiums at Anbang’s life assurance unit amounted to only 8 per cent of assets by end the of 2013, compared to 16 per cent at China Life. That suggests Anbang is using equity capital, rather than premiums, to finance its purchases.

China Life and Ping An have both ventured into foreign real estate over the past year, following regulations enacted in 2012 permitting such investments by insurers. But their core businesses are more diverse and profitable than Anbang, meaning investment returns are icing on the insurance cake.

Still, in other respects Anbang seems well-suited to the Buffett model given the proven ability of founder and chairman Wu Xiaohui, son-in-law of late paramount leader Deng Xiaoping, to raise funds from China’s elite state-owned companies. 

Anbang raised its registered capital to Rmb30bn in April this year, up from Rmb12bn in 2011 and more than the Rmb28bn in registered capital at rival China Life.

A complete shareholder list is not publicly available, but the company has wooed investors including state-owned oil refiner Sinopec and SAIC Motor, China’s largest carmaker, according to state media. Anbang could not be reached for comment.

If it succeeds in efforts to emulate Mr Buffett, the danger is that Anbang ends up resigning itself to unprofitability in its core business and basing its strategy solely on high-risk investments.

“If you’re playing the asset game and pushing your yield, you can get yourself into a lot of trouble,” says Mr Radwan.

Source: http://www.ft.com/intl/cms/s/0/9b6f1036-5424-11e4-80db-00144feab7de.html

Ecommerce model proves difficult to drive

“Well, in those days, one had to telephone a room inside a building and hope that, at the very same moment, the person with whom one wished to converse might be found therein.”

As British comedian Eddie Izzard once observed — if not in those exact words — the concept of landline telephony must sound ridiculous to the youth of today.

But, as many households will have discovered over the holiday season, the 21st century concept of ecommerce is barely any more intelligent. While it may be increasingly app driven on mobile devices, it still involves goods being driven in delivery vans — in the vague hope that, in an unknowable number of days, they will arrive at a building at the very moment when one may be found therein.

Even some of the solutions to these challenges appear daft. Earlier this year, Volvo, the carmaker, announced an initiative to avoid the “first-time delivery failures” that cost companies “an estimated €1bn”: it will arrange for an operative to drive to where one’s Volvo is parked and place purchased goods therein. Anywhere. Even a shopping centre car park.

However, with a global value of €172bn — according to the dubiously named Transport Intelligence — ecommerce delivery is not a business that investors can ignore.

It offers revenue growth: analysts at Transport Intelligence forecast a rate of 9.8 per cent a year until 2017. It offers cash flows: Ofcom estimates that Britons pump £1,968 per person through ecommerce channels every year, followed by US consumers who spend £1,171 each. It offers more predictability: research group ComScore says online sales growth on Cyber Monday, after Thanksgiving, has slowed because consumers now spread out their purchases.

Delivery companies, though, seem stuck at the wrong end of the value chain. In the UK, private equity-owned delivery business City Link went into administration on Christmas Eve, claiming it was unable to handle any more parcels because of the “continued substantial losses it would incur”. Earlier this year, the privatised Royal Mail reported a 21 per cent drop in first-half operating profits, from £353m to £279m, in the face of greater competition. In the same period, UK Mail’s margins were such that it made just £4.9m of pre-tax profit on revenues of £241.4m. 

In the US, FedEx and UPS have at times found the ecommerce model more costly than lucrative. UPS warned on profit in early 2014 after a failure to deliver thousands of parcels cut quarterly earnings by 14 per cent.

Far from proving the telecoms-like income plays that their activities suggest, all these companies’ shares look low yield and expensive. FedEx offers a dividend yield of 0.5 per cent, and trades on 19.7 2015 earnings — well ahead of the S&P 500. UPS shares yield 2.39 per cent but trade on 19.9 times forward earnings. Not exactly a utility.

Royal Mail currently yields more than 4 per cent but also trades on an earnings multiple closer to higher margin FTSE 100 companies.

Where, then, is the value? Ironically, some of the most attractive yields in ecommerce now come from bricks and mortar. According to IPD, the European warehouses from whence all those vans set off yielded 8 per cent in the 12 months to end September. As one fund manager told the Financial Times last week: “It’s a very defensive asset class to invest in.” He believes ecommerce property is not just for Christmas — rather like those missing parcels you might receive in coming days.

Source: http://www.ft.com/intl/cms/s/0/9718e448-8b7a-11e4-be89-00144feabdc0.html 

The 2014 M&A Report

If one had to choose a single word to describe the M&A market in 2013, it would be disappointing, and indeed many market participants have used this very term. But the exasperated dealmakers have had little time to cry in their beer—they’ve been too busy. The M&A market took off like a rocket in 2014, fueled by the return of the megadeal (transactions with a value of more than $10 billion), which has been in hibernation for the last several years. The momentum of the first quarter carried into the second, setting up 2014 as a potential bellwether for the market’s longer-term evolution.

Megadeals capture the headlines, adding confidence to the market. At the same time, there is another, less publicized but no less significant, trend developing—one that should attract even greater interest in the boardroom. As we first noted two years ago, our research shows a continuing rise in divestitures as a powerful strategy for both unlocking value in today’s markets and improving performance by focusing on core operations. (See Plant and Prune: How M&A Can Grow Portfolio Value (https://www.bcgperspectives.com/content/articles/mergers_acquisitions_divestitures_plant_and_prune_m_and_a_2012/), BCG report, September 2012.) In 2013, divestitures represented almost half the total M&A market. Not all divestitures are created equal or produce equivalent results, however. The companion to this year’s M&A report—the tenth in our series highlighting major trends and their implications for companies—examines in depth the role of an active divestiture strategy in companies’ ongoing search for value.

2013: Hopes Unrealized; 2014: Hopes Heightened 

 

Is the long post-2008 M&A hangover finally coming to an end? Positive signs abound, for a change, starting with strong market activity. The Boston Consulting Group’s tenth annual assessment of crucial M&A trends, based on BCG’s global M&A database of almost 40,000 transactions since 1990, shows that following an anemic 2011 and a slow 2012, the M&A market stabilized in 2013, albeit at disappointing levels. It entered 2014 with a strong tailwind, including the announcement of roughly as many megadeals in the first six months as in the two previous years combined.

Multiple factors are fueling the resurgence. Continued low interest rates, the ample availability of capital, a less uncertain economic outlook, and high levels of M&A interest and financial capability on the part of both corporations and private-equity firms all bode well for the future. In addition, continuing a trend begun a few years ago, corporate divestitures are taking a growing share of the overall M&A market. (See Creating Shareholder Value with Divestitures (https://www.bcgperspectives.com/content/articles/mergers_acquisitions_divestitures_creating_shareholder_value_divestitures/), BCG article, September 2014.)

After furrowing a deep trough in the years following 2008, the M&A market has at last recovered to the levels of 2005 and 2006. That said, most market participants saw 2013 as a disappointment. Overall deal volume declined by 6 percent and total deal value fell by 10 percent from 2012—despite credit remaining cheap, corporate profits continuing to rise, and generally strong performance by global equity markets. (See Exhibit 1.)

Multiple culprits can be identified. Most significantly, the much-awaited economic recovery failed to materialize, and neither employment levels nor consumer confidence improved as expected. GDP growth disappointed just about everywhere, especially in Europe, and many companies also held back from pursuing big or aggressive transactions owing to the continuing economic uncertainty. Deal volume and value fell in the financial-services and metals-and-mining sectors after heightened activity in the preceding years. Activity in Japan and a number of emerging markets, especially Brazil, Russia, and India, also declined. As is the case every year, several hundred transactions were announced but failed to reach consummation. The number of uncompleted deals was roughly equal in 2013 and 2012, but the total value of the withdrawn deals in 2013 was bigger as several large transactions were canceled, including the acquisition of 70 percent of Koninklijke KPN by América Móvil for $10 billion and the sale of BlackBerry to Fairfax Financial Holdings for $5 billion.
How quickly sentiments—and outlook—can change, however. The total value of first-half 2014 transactions jumped 62 percent over the value of transactions in the first six months of 2013. Megadeals accounted for more than 35 percent of total first-half 2014 deal value, including five deals worth more than $43 billion each—a level of activity not witnessed since before the financial crisis. These types of transactions not only boost the statistics, they also transform the confidence level of the market. Dealmakers who have been sitting on the sidelines, uncertain about financing, investor reaction, regulatory approvals, or other factors, see industry-altering transactions in the works and start to believe their deals can get done. Indeed, the hot pace continued into the second quarter, with AT&T’s acquisition of Directv, Apple’s acquisition of Beats Electronics, the $50 billion merger of cement makers Lafarge and Holcim, and the heated competition to acquire Alstom’s energy-equipment assets, which General Electric appears poised to win.

The overall economic outlook is the most positive in years, with U.S. GDP growth projected to approach 3 percent as we move into 2015, and growth expected to return to Europe, albeit slowly. Equity markets are holding up thus far, through the end of the second quarter. As always, there are risks that political or international events—in the Middle East and Ukraine, for example—could have a negative impact on the economy and thus on deal activity.

North America Leads the Comeback—Fueled by High Tech

 

The global M&A market is led by North America, whose share has been on the rise and reached 52 percent in the first half of 2014—up from 45 percent in 2010. While M&A activity stagnated or even decreased in most regions of the world, total deal value in the U.S. and Canada rose more than 5 percent per year over this period. The roaring tech sector has been a driving force, since the most prominent players in high-tech M&A are based in the U.S. (See Exhibit 2.)

Rather than following an overarching industry trend, many tech deals are rooted in individual company needs—Apple’s acquisition of Beats to rejuvenate its music business, for example. With the acquisitions of Oculus VR and Nest Labs, respectively, Facebook and Google are looking to stay at the cutting edge of technological advances with strong consumer applications, as innovations such as augmented reality and machine-to-machine communications begin to gain market traction. Priceline.com’s purchase of online restaurant-reservation service OpenTable (for $2.7 billion) promises the potential of cross-marketing to different digital consumer segments.

The rapid rise of mobile as the world’s dominant communications technology is spurring M&A activity in several spheres. Facebook’s acquisition of WhatsApp and Verizon’s $130 billion acquisition of Vodafone’s interest in Verizon Wireless show companies expanding, or consolidating control of, their share of mobile users. Microsoft is gaining control over mobile technology with its acquisition of Nokia’s device-and-service business.

Not all the tech activity is in North America. Dozens of deals have been announced involving European countries in late 2013 and the first half of 2014. However, since many of them represent smaller transactions, their overall impact on M&A markets has been less visible.
Outside the tech sector, so-called inversion deals are becoming an increasingly significant factor, particularly in the health care industry. U.S. companies are seeking acquisitions in Europe that make strategic sense and enable the acquirer to move its corporate domicile to Europe, where the company will benefit from more favorable tax treatment. In July, the Wall Street Journal estimated that almost a dozen such deals were pending, with a total value exceeding $100 billion.

Despite a rising number of transactions, capital markets continue to have difficulty deciphering the new business models of innovative tech companies and coming to grips with the seemingly outsize valuations that acquirers place on their targets, which often have limited track records and little or no earnings history. Memories of the bursting dot-com bubble in 2000 are still fairly fresh.

The February 2014 announcement of Facebook’s plan to acquire WhatsApp, a five-year-old cross-platform instant-messaging service with 55 employees, for $19 billion in cash and stock is a case in point—especially since WhatsApp had only recently completed a round of venture-capital funding that valued the company at $1.5 billion. Immediately after Facebook announced the acquisition, its share price dropped 5 percent because of skepticism over the deal and the company’s rationale. It took several days—and a concerted investor-outreach effort—for investors to understand the basis for the deal, both strategic and financial. The market ultimately awarded Facebook a cumulative abnormal return (CAR) of 1.1 percent. (CAR assesses a deal’s impact by measuring the total abnormal change in market value over a seven-day window centered on the transaction announcement date.) The market came to recognize that with WhatsApp’s more than 450 million mobile users and rapid user growth, Facebook was acquiring a potentially formidable competitor and strengthening its own mobile position at the same time. Perhaps most significantly, the price it was paying for WhatsApp was equal to $42 per mobile user—several times less than the value the market was placing on each mobile user of Facebook itself ($141) or its fellow social network, Twitter ($124). (See Exhibit 3.)

 
Will the Pace Pick Up?
 
Multiple factors—principal among them large cash reserves, bullish investors, and buoyant debt markets—point to a continued resurgence in deal activity.

Corporate cash reserves have been increasing since the financial crisis. Countless companies have used the downturn to strengthen their balance sheets and improve their performance, giving them a much-enhanced means of financing acquisitions. Corporate cash levels are at an all-time high—three times their level in 2000. Shareholders become restless with so much money sitting idly on the sidelines, and they will eventually demand that companies either put the money to work or distribute it to their owners through share buybacks or dividends, especially as the uncertainty in capital markets recedes. As economic conditions improve, investors are becoming far more receptive to companies making acquisitions so long as the deals are consistent with their strategy and, of course, the price is seen as reasonable. In BCG’s 2014 investor survey, the percentage of respondents favoring a more aggressive approach to M&A by companies almost tripled, from 23 percent to 60 percent, between 2012 and 2014. (See Exhibit 4.)

While activity among private-equity players has increased only slightly so far—the number of transactions rose 22 percent between 2012 and 2013, but the total value actually declined 3 percent—we do not see these firms remaining quiet for long. At a total of $431 billion, private-equity cash reserves are approaching their levels in 2008 and 2009, and these firms have their own investors to answer to. Moreover, debt financing is more readily available now than at any time in recent years. Leverage levels have returned to those of 2007 and 2008. (See Exhibit 5.) The average deal in 2013 included only 35 percent equity. “Covenant lite” loan activity in 2013 also smashed all records. The incidence of these loans, which generally do not involve any maintenance covenants, indicates growing investor appetite in the leveraged-loan market, making borrowing even more attractive for private-equity deals. We expect private-equity firms to become much more active in all kinds of transactions, with the exception of the largest megadeals, which are simply beyond their reach, if not their comfort zone.

Last but hardly far from least, current transaction valuations are still within long-term historical parameters. Valuation levels (as measured by the ratio of median acquisition enterprise value to EBITDA—EV/EBITDA) have been generally (if unevenly) rising since 2008, and they surpassed the historical average of 11.9 in the first half of 2014. Deal premiums (the amount by which the offer price exceeds the target company’s closing stock price one week before the original announcement date) approximated their historical average of 35.4 percent in 2013. One could thus argue that targets are not yet overvalued from a historical perspective—one more reason why deal activity among both corporate and private-equity players should continue to increase.

That said, it should also be noted that some industries are distinctly more active than others. Our analysis of deal volume (measured by transaction value) shows clear sector differences when long-term historical activity (from 1990 through 2010) is compared with deals done since 2011.
Energy, for example, saw a 4-percentage-point uptick in the current period, owing primarily to portfolio restructurings and consolidation, as well as to an increased focus on renewable energies following the Fukushima accident. Higher levels of activity in the health care sector (up 3 percentage points) are substantially the result of pharmaceutical companies acquiring new research pipelines as their own R&D programs produce fewer blockbusters and the patents covering older top-selling drugs expire. Changes in health care regulations in the U.S. and a difficult environment in Europe are also fueling consolidation in the sector. Companies in the industrial sector have been optimizing their portfolios as economies stabilize and return to growth. And, of course, high tech is highly active.
There is a clear impact of M&A intensity in “hot” industries: target companies are able to demand higher premiums from potential buyers. (See Exhibit 6.) Companies acquired in high tech and health care, for example, received average premiums of 36.5 percent and 37.3 percent, respectively, compared with premiums of only 29.9 percent in consumer and retail and 33.0 percent in financial services and real estate.

Timing is not everything in M&A, but it almost always is a critical factor and certainly an important consideration for both buyers and sellers during upswings in their industries.

Source: https://www.bcgperspectives.com/content/articles/mergers_acquisitions_divestitures_2014_m_a_report/

Don’t fight the US Treasury bond rally

The consensus among market watchers last September was that, with US interest rates so low and the US Federal Reserve about to withdraw stimulus, interest rates would trend higher. I took a different view, writing in a commentary that “10-year rates may be heading back to 2.25 per cent or lower”.

When 10-year Treasury yields ended 2013 at 3.02 per cent, some may have thought I had taken the wrong end of the bet. But in early August, 10-year Treasury yields went as low as 2.35 per cent and I believe the path of least resistance on interest rates is still lower.

A number of factors have helped push Treasury yields lower. With yields on German 10-year bonds at historic lows of about 1 per cent and Japanese government bonds yielding around 50 basis points, Treasuries look comparatively attractive. Add to that the perception that both the yen and euro are a one-way bet towards depreciation and it is reasonable to expect that international capital will continue flowing towards the US, pressuring Treasury yields down as quantitative easing draws to an end.

Tensions from Ukraine to Iraq have added to a flight-to-quality trade, boosting demand for Treasuries. With the size of incremental US government borrowing also expected to decline because of shrinking federal budget deficits, Treasury yields could move lower.

Reduce rate risk

My original forecast of 2.0-2.25 per cent still seems reasonable. Nevertheless, markets do not move in straight lines, so yields could retrace to 2.5 per cent in the near term. Ultimately, as rates head back towards 2 per cent portfolio managers should use the rally to reduce interest rate risk.

As anyone experienced in investing in the US mortgage market knows there is a phenomenon that traders call the “refi bid”. When interest rates fall, a larger percentage of mortgages becomes economically attractive to refinance at a lower interest rate.

Whenever a threshold is breached where a large amount of mortgages make attractive refinancing candidates, prepayments spike up dramatically and portfolios that own mortgages have a sudden surge in cash. This causes portfolio duration to shorten and leads to a need to buy longer duration assets in order to maintain the target portfolio duration. This demand surge can result in a sudden and dramatic decline in rates.

Currently, I estimate that the next “refi level” will hit when the 10-year Treasury yield drops to about 2.25 per cent.

An unusual feature of this potential wave of mortgage refinancing is that the vast majority of US mortgages are on the cusp of being candidates for refinancing, given the relative stability of mortgage rates over the past year or so.

Additionally, there is one dominant holder of these mortgage securities that has vowed to reinvest in new mortgages as prepayments come in – the Fed.

Traditionally, in a refinancing rally, spreads on mortgage-backed securities widen due to increased prepayment risk and expected increases in supply. Spreads will not widen on this occasion to the same extent as during previous refi rallies for a number of technical reasons.

Among those reasons is that the Fed, the biggest mortgage investor on the block, has made clear it will reinvest principal repayments dollar for dollar. Normally, the widening in mortgage spreads mutes the impact of the rate decline on mortgage rates, slowing the pace of refinancing.

This time, advertised mortgage rates are likely to fall more rapidly than in prior refi experiences.

Selling opportunity

Given the likely rapidity of the interest rate decline, the potential for shortening in the duration of fixed income investment portfolios could further intensify the current rally and lead to a more extreme decline in rates than would normally be anticipated.

Declining mortgage rates will also give a lift to housing affordability, which could help clear unsold inventories of homes and support new construction activity. This would further support the US economy.

Ultimately, this expected run-up in bond prices and the associated decline in interest rates should prove unsustainable once the refinancing bid is past. For the near term, risks favour lower interest rates – perhaps sharply lower. In the medium term, as the economy strengthens further, this rally will reverse itself and will have proven to be a selling opportunity.

It is premature to sell now, but as 10-year Treasury yields approach 2 per cent it should provide an opportunity to rebalance portfolios. In other words, don’t chase the rally, but don’t fight it either. The opportunity to sell bonds is coming – but not just yet.

Source: http://www.ft.com/intl/cms/s/0/ece5bb60-22e0-11e4-9dc4-00144feabdc0.html#axzz3AkAuS7S0

QE and ultra-low interest rates: Distributional effects and risks

There is widespread consensus that the conventional and unconventional monetary policies that world’s major central banks implemented in response to the global financial crisis prevented a deeper recession and higher unemployment than there otherwise would have been. These measures, along with a lack of demand for credit as a result of the recession, contributed to a decline in real and nominal interest rates to ultra-low levels that have been sustained over the past five years.

 

MGI’s Richard Dobbs and Susan Lund discuss the economic impact of QE and ultra-low interest rates and the problems that may arise, depending on future conditions.

A new report from the McKinsey Global Institute examines the distributional effects of these ultra-low rates. It finds that there have been significant effects on different sectors in the economy in terms of income interest and expense. From 2007 to 2012, governments in the eurozone, the United Kingdom, and the United States collectively benefited by $1.6 trillion both through reduced debt-service costs and increased profits remitted from central banks (exhibit). Nonfinancial corporations—large borrowers such as governments—benefited by $710 billion as the interest rates on debt fell. Although ultra-low interest rates boosted corporate profits in the United Kingdom and the United States by 5 percent in 2012, this has not translated into higher investment, possibly as a result of uncertainty about the strength of the economic recovery, as well as tighter lending standards. Meanwhile, households in these countries together lost $630 billion in net interest income, although the impact varies across groups. Younger households that are net borrowers have benefited, while older households with significant interest-bearing assets have lost income.

 

Ultra-low interest rates have had distributional effects on interest income and expenses.

 

The impact that ultra-low interest rates have had on banks has been mixed. They have eroded the profitability of eurozone banks, resulting in a cumulative loss of net interest income of $230 billion between 2007 and 2012. But banks in the United States experienced an increase in effective net interest margins and a cumulative increase in net interest income of $150 billion. The experience of UK banks falls between these two extremes.

Life-insurance companies, particularly in several European countries, are being squeezed by ultra-low interest rates, so much so that if this environment were to continue many of these insurers would find their survival threatened.

Theoretically, ultra-low interest rates may have resulted in higher asset prices, and this effect may have offset lost interest income for households and other investors. But we find a mixed picture.
Rising bond prices are the flip side of declining yields, and the value of sovereign and corporate bonds in the eurozone, the United Kingdom, and the United States increased by $16 trillion between 2007 and 2012. Investors that mark the value of their assets to market have therefore seen a significant gain on their fixed income investments, at least on paper.

Ultra-low interest rates are likely to have bolstered housing prices by lowering the cost of mortgage credit. This effect is most clearly seen in the United Kingdom, where the majority of mortgages have variable interest rates that have automatically adjusted downward. The impact is less clear in the United States, where the recovery in housing prices has been dampened by an oversupply of housing, high levels of foreclosures, a predominance of fixed-rate mortgages, tightened credit standards, and the prevalence of homes with negative equity whose mortgages cannot be refinanced.

We found little evidence that ultra-low interest rates have boosted equity markets. We cannot discern a large-scale shift into equities as part of a search for yield by investors, and price-earnings ratios and price-book ratios in stock markets are no higher than long-term averages. Although stock prices do react to announcements by central banks, these are transitory effects that do not persist.

If one accepts that housing prices and bond prices are higher today than they otherwise would have been as a result of ultra-low interest rates, then the increase in household wealth and the possible additional consumption it has enabled would far outweigh the income lost to households. But we are skeptical about whether increases in wealth have translated into higher consumption in today’s environment, given that housing prices in the United States remain far below their peak. Moreover, it is more difficult for today’s households to borrow against any increase in wealth because of tighter credit standards.

Ultra-low interest rates do appear to have prompted additional capital flows to emerging markets, particularly into their bond markets. Purchases of emerging-market bonds by foreign investors totaled just $92 billion in 2007 but had jumped to $264 billion in 2012. Emerging markets that have a high share of foreign ownership of their bonds and large current account deficits will be most vulnerable to capital outflows if and when central banks begin tapering current policies.

There are likely to be risks ahead whether asset purchases are tapered and interest rates rise or, alternatively, if current monetary policies continue and interest rates remain low. In the first scenario, the benefits gained or losses incurred could be reversed. Government interest payments on debt, for instance, could rise up to 20 percent. Amid anecdotal evidence that some investors have increased their leverage to amplify returns in some markets, rising interest rates could lead to a collapse in leveraged trades and could pose a threat to some financial institutions. Capital flows to emerging markets could reverse. Investors in bond markets forced by accounting rules to mark to market could face large write-downs. Eurozone countries could be caught in a crosswind if rates increase in the United States before they do in Europe, leading to a shift in foreign capital from Europe to the United States. In the second scenario, life insurers and banks in Europe would experience continued erosion in their profitability. A continuation in ultra-low interest rates could also prompt higher leverage and the return of asset-price bubbles in some sectors, especially real estate.

Source: http://www.mckinsey.com/insights/economic_studies/qe_and_ultra_low_interest_rates_distributional_effects_and_risks