1. Kempen Insight /// March 2016
I N S I G H T
KEMPEN
China
evolution,
no revolution
Keith
Ambachtsheer
‘DARing ACTION
required’
Brexit
no, thank you

2. 8 12
14 16
Kempen Insight, March 20162
Clear choices
needed
/// China’s economic
transition
A night
at the movies
/// Evert Waterlander’s
selection
Currency volatility
/// Impact
Brexit
/// No, thank you
4
Interview Keith Ambachtsheer
/// Canadian pension expert speaks out in favour of
long-term investing
Table of contents

3. Kempen Insight, March 2016 3
Credits
/// Companies take matters into their own hands 6
Welcome
/// Reception at National Gallery London 14
Time for caution
/// Which investment categories? 18
Column by Roelof Salomons
/// Changing facts 21
Urgent questions
Investing with a focus on the long term is a
topic close to our hearts at Kempen. How can
asset managers, institutional investors and the
companies in which we invest take tangible
steps in this direction? We discussed this with
renowned Canadian pension expert Keith
Ambachtsheer, the day after he was guest
speaker at the ‘Focusing Capital on the Long
Term: from talking to
walking’-dinner.
A topic on everyone’s minds in 2016 is the
slowdown in the Chinese economy, the second
largest in the world. Further on in this journal
you can read about why we do not expect the
Chinese economy to make a hard landing. Nor
do we anticipate a Brexit, the departure of the
United Kingdom from the EU. Yet the fact
remains that uncertainty surrounding the
British referendum will cause volatility over the
next few months.
This climate of low, occasionally
even negative interest rates and
low expected returns begs the
question as to whether there are
still sufficient prospects for
investors on the financial
markets. Investment strat-
egist Marius Bakker
explains why now is
the time to be
cautious.
I look forward to receiving
your comments and opin-
ions at the address below.
Lars Dijkstra
Chief Investment Officer
lars.dijkstra@kempen.nl
/// COLOPHON
March 2016
©Kempen
Address
Kempen Fiduciary Management
60 Cannon Street
London, EC4N 6NP
United Kingdom
Images
Cover: Philip Jenster
Mario Hooglander, Johannes Abeling,
Freepik
Design
Henrike Beukema
Editors
Parisa Veldman
Anja Corbijn van Willenswaard
Daniëlle Levendig
Kempen Fiduciary Management is a trading name
of the UK branch of Kempen Capital Management
N.V., which is registered in the United Kingdom
(BR017904) at 60 Cannon Street, London EC4N
6NP and which is a limited liability company
incorporated in the Netherlands, authorised by the
Dutch Authority for Financial Markets (AFM) and
subject to limited regulation by the UK Financial
ConductAuthority(FCA).Detailsabouttheextentof
our regulation by the FCA are available from us on
request. This information should not be construed
as an offer and does not provide sufficient basis for
an investment decision.

4. 4 Kempen Insight, March 2016
/// by LESA SAWAHATA photo JOHANNES ABELING
‘The horizon
is long (term)
let’s get
moving.’
Keith Ambachtsheer
Interview
Long term investing has been the
subject of much debate and discus-
sion over the past several years – and
while there’s lukewarm agreement
that it may be the best and only way
forward, action hasn’t always been
forthcoming. How to move beyond
the fear of long-termism to
successful action?
It’s the morning after the event ‘Focusing Capital on the
Long Term: from talking to walking…’ co-hosted by
McKinsey Company and Kempen, and the atmosphere
in the boardroom of Kempen’s Amsterdam headquarters is
one of palpable excitement.
“Did that really happen last night or was it just a dream?”,
asks Keith Ambachtsheer (who presented the academic
perspective on FCLT based on his paper The Case for
Long-Termism) of Paul Gerla and Lars Dijkstra, respectively
CEO and CIO of Kempen, over an early coffee. The
success of the event, attended by a large group repre-
senting the Netherlands’ most influential asset owners and
asset managers, academics and policy-makers could be
measured by the engagement level of the participants,
and an element unusual in the normally sober landscape
of Dutch investing: expressed emotion. Elation, excite-
ment, resistance, hope, confusion. And just a touch of that
most motivational of emotions, fear. “You could feel that
in the room, too,” says Gerla.
Difficult decisions
It’s no surprise – long-termism is fraught with difficult
choices. And the pressure on the industry to keep the long
horizon in view, while dealing with the short-term realities
of current pension payouts, requires a strong constitution.
“The underlying theme for some people last night is this
funding ratio,” says Dijkstra, referring to a key area of
uncertainty and therefore anxiety in the shift to long term
investing. “One of the participants talked about having to
tell pensioners that their pension was cut; no one wants to
have to do that,” he adds.

5. Kempen Insight, March 2016 5
“I noticed last night how often Canadian
examples were mentioned; why is long
term thinking so ingrained in Canada?”,
Dijkstra asks. It started, according to
Ambachtsheer, with the Ontario Teachers’
Pension Plan (OTPP). Beyond adapting the
(for then) forward-thinking long-term
model – which includes a clear mission,
good governance, integrated ESG
concerns, and a Board representative of all
stakeholders – there is an overarching
reason for the success of the OTPP: bold-
ness as well as humility.
Daring action
“Teachers in Ontario can be retired a lot
longer than they work, and they have a life
expectancy higher than that of other
professions; they needed to figure out how
to fund that, how to create wealth with
assets”, explains Ambachtsheer, “so
OTPP’s management stepped outside
normal pension investments.” OTPP
bought Canada’s largest private commer-
cial real estate firm, Cadillac Fairview,
which is now ‘Consistently Delivering
Predictable Income Over the Long Term’
according to OTPP’s website. This type of
innovative approach is proof of concept:
the shift to long-term investment is not
just possible, not just essential - but profit-
able. However, says Ambachtsheer,
making the shift requires both novel
thinking and daring action.
And then a certain iconoclasm is needed.
He offers a quote from Irish playwright
George Bernard Shaw that he finds poeti-
cally applicable to the shift to long term
investing: “The reasonable man adapts
himself to the world; the unreasonable one
persists in trying to adapt the world to
himself. Therefore, all progress depends
upon the unreasonable man.” 
A bit of anxiety may be unavoidable at this
crucial moment; but Ambachtsheer’s pre-
sentation of the night before had elevated
the mood and enlivened the discussion of
FCLT by bringing both historical context
and models of real-life success into the
room. First and foremost, the overarching
importance of long-term thinking is related
to human survival. It was only in making
the difficult, long-term decisions about
savings and investment (in the form of
seeds, implements, and shelter at the time)
that civilisation and culture could take root
and flourish. “It was this shift towards being
able to think and invest in ever longer time
frames that made possible the eventual
transformation of the subsistence societies
of long ago to today’s far wealthier, more
stable ones,” he writes in The Case for
Long-Termism.
But that’s history. Even more encouraging is
Ambachtsheer’s research into the success that
innovative long-term investing practices and
models deployed by pension funds and even
governments have achieved over the past
several decades.
One example is the Australian superannua-
tion (pension) schemes, which are now
beginning to enable pensioners to transi-
tion their retirement savings in annuities,
providing the assurance that if they live
particularly long lives, they will continue to
have a reasonably dependable income.
“That’s the global solution for the work-
place pension plan,” says Ambachtsheer.
“We need to get used to a two-part model,
and begin to separate the pieces into the
‘sure part’ for payment assurance, and the
‘longer horizon’ part for generating the
compounding returns that make pension
affordable. If people shift their thinking in
this direction, there is a smoother transition
to FCLT.”
We are proud to introduce the
social newsroom SHIFT TO Long
Term Investing, which will go live
in April at www.shiftto.org.
SHIFT TO is an independent news-
room, facilitating debate on the
topic of long-term investing
through articles, columns and
research from thought leaders
from varied backgrounds and ages.
Keith Ambachtsheer
Keith Ambachtsheer (born Rotter-
dam 1942) is Director Emeritus of
the International Centre for
Pension Management at the
Rotman School of Management,
University of Toronto (Canada)
and was Editor of the Rotman
International Journal of Pension
Management (RIJPM).
He continues to publish the
monthly Ambachtsheer Letter.
Recognised by CIO Magazine as
the world’s #1 Knowledge Broker
in Institutional Investing (2014),
he is the author of the influential
book ‘The Future of Pension
Management’ (Wiley 2016), and
a member of the Editorial Board of
SHIFT TO.

6. Kempen Insight, March 20166
We have been witnessing a quiet revolution in the
European financial system. The financial crisis has
profoundly changed the way companies fund
themselves and accelerated the trend to tap into
capital markets by issuing corporate bonds.
There are two sources companies can tap
into when they require external debt
financing. The first option is to apply for a
bank loan. This is the option European
corporations largely depend on. Alternati-
vely, they can access the capital market
by issuing debt. External financing in the
US is predominantly capital market-
based.
The new trend
One of the most important trends in corpo-
rate financing in Europe has been the shift
away from bank-based financing. This
phenomenon of disintermediation seems to
have been triggered by the financial crisis
in Europe. Increasingly, non-financial
corporations (NFCs) have turned to capital
markets for their financing needs. In the
US, disintermediation has been occurring
since the 1980s, and some say even earlier.
This was made possible by structural, long-
term factors such as the advent of direct
market financing, the development of tech-
nology, and the deregulation of banks. In
contrast, up to the financial crisis, European
capital markets were rather underdeve-
loped.
0
350,000
300,000
250,000
200,000
150,000
100,000
50,000
Dec
97
Dec
99
Dec
01
Dec
03
Dec
05
Dec
07
Dec
09
Dec
13
Dec
15
Dec
11
Credits: companies take
matters into their own hands
High yield-markt eurozone
Source: Bank of America Merrill Lynch
The left panel shows disintermedia-
tion (securities as a proportion of the
sum of bank loans and securities)
since 1999. The right panel shows
the total amounts of bank loans and
securities outstanding at the end of
each month, in millions of euro.
Development of eurozone
High Yield market based on
market value BofA Merrill
Lynch Euro High Yield index
since inception in millions
of euro.

7. Kempen Insight, March 2016 7
brokers to make markets. This increases the
likelihood that investors will be able to
enter this market in the foreseeable future
through a well-diversified fund. 
The growth has been very visible in the
Euro High Yield market comprising debt of
companies with a rating of BB and lower
(below investment grade). The total market
value has risen to more than 300 billion
euro from less than 100 billion euro in
2009. The US High Yield market also grew
strongly from less than 500 billion dollar to
over 1,100 billion dollar now while the UK
High Yield market, though smaller,
witnessed the largest relative increase, from
5 billion to 48 billion pound.
Mature
The number of issuers in the Euro High
Yield market has doubled to more than 300
since 2009. The rising share of financials is
remarkable, from 7% in 2007 to 23% now.
Also BB-rated companies are now 66% of
the benchmark versus 48% in 2007.
The Euro High Yield market is more mature
due to the experienced growth in size and
number of issuers. Also liquidity is reaso-
nable compared to the investment grade
market as wider bid-offers incentivize
The graph shows the development of disin-
termediation in the euro area with securities
comprising more than 20% of securities and
bank loans combined. In the US disinterme-
diation is a lot higher with a ratio of 52%.
Attractive
The cyclical causes that drive disintermedia-
tion can be divided in two categories. Push
factors relate to banks’ contraction of credit
and higher margins on loans, which have
made bank loans less available. Pull factors
relate to companies’ preference for diversifi-
cation of funding sources and the decreased
cost of issuing bonds, both of which have
made capital markets more attractive.
Institutional investors in particular have an
interest in bonds of at least 100 million
euro in nominal size to have some liquidity
and impact in the portfolio. For small- and
medium-sized enterprises (SMEs) disinter-
mediation therefore is not a positive trend
as they lack access to capital markets given
the size of their debt needs. They therefore
still largely rely on banks.
0
0.05
0.1
0.15
0.2
0.25
Mar
99
Aug
00
Jan
02
Jun
03
Nov
04
Apr
06
Sep
07
Feb
09
Jul
10
Dec
11
May
13
Oct
14
0
2.000
1.000
3.000
4.000
5.000
6.000
Mar
99
Jul
01
Nov
03
Mar
06
Jul
08
Mar
13
Nov
10
Jul
15
LOANS
SECURITIES
Richard Klijnstra
Senior Portfolio Manager
richard.klijnstra@kempen.nl
Development of disintermediation in eurozone
Source: Statistical Warehouse ECB

8. Kempen Insight, March 20168
Evolution
rather
than
revolution

9. Kempen Insight, March 2016 9
/// by RUTH van de belt visual PHILIP JENSTER
Investors have been concerned
about the state of China’s
economy for months. Although
China faces a number of
challenges, we do not predict a
hard landing.
Investors are very worried about the state of
China’s economy. Last year, it ‘only’ grew by 6.9%.
This is its lowest level of growth since 1990 and less
than half the rate seen in 2007. Although we do
not predict a hard landing (the government has the
resources and the will to prevent this), growth will
decline further over the next few years. This is all
bound up with the development phase the Chinese
economy is currently in. China passed the Lewis
turning point at the start of this decade. The flow
of cheap rural labourers is drying up, enabling
employees in industry to demand higher wages
without their productivity levels rising accordingly.
This causes profits to decline and/or the price of
goods for domestic consumption or export to rise.
Entrepreneurs have less money for investment and
exports are squeezed, which adversely affects
growth.
New currency regime
On the other hand, Chinese consumers have more
money to spend. A transition is taking place from
an investment-driven to a consumer-driven
economy, and this poses a challenge to Chinese
policymakers. This transition will occur in fits and
starts, occasionally triggering fears of a hard
landing.

10. Kempen Insight, March 201610
The Chinese economic transition will have
an impact on the rest of the world. China’s
demand for commodities will decrease
further and this is one of the reasons for the
lower commodity prices. There will be
growing demand for capital goods used to
manufacture high-quality products.
Demand for luxury consumer goods will
also rise thanks to the growing Chinese
middle class. A more flexible exchange rate
is important here, given that it can be used
to manage import volumes. It should there-
fore come as no surprise that, after a long
period of maintaining a more or less fixed
exchange rate, the Chinese government is
taking steps in this direction. In August
2015, the People’s Bank of China, the
Chinese central bank, devalued the
renminbi by 1.8%. At the same time,
they announced that it was to leave the
exchange rate of the domestic, onshore
renminbi more to market forces. The
offshore renminbi now plays a greater role
in setting the daily reference exchange rate,
from which the currency can deviate by up
to 2%. The direction of the change is being
left more to market forces, but not the pace
of the change. This may have been a
precondition set by the IMF for awarding
the renminbi the status of reserve
currency that China so fervently desires.
Moreover, in December 2015 China
changed its exchange rate policy from a
de facto creeping coupling to the US
dollar to a system in which a larger basket
of foreign currency is taken into account.
This coupling is likely to be merely an
interim phase and the currency will ulti-
mately be fully decoupled. Full exchange
rate flexibility will ultimately be positive
for Chinese economic stability and
growth, but the transition phase will
cause volatility.
Declining reserves
On balance, the renminbi has decreased in
value against the US dollar by about 5%
since mid-2015. This is a small decrease
compared to, for instance, the decline in
value of the euro over the past year. Yet
the depreciation worries investors, as the
currency weakness is accompanied by
substantial capital outflow. China is
dipping into its foreign currency reserves
at a fast rate in order to shore up the
currency. There are several underlying
reasons for the large capital outflow. For
instance, Chinese companies and banks
are reducing their debt listed in foreign
currency in order to diminish the
exchange rate risks, and renminbi carry
trades are currently being reversed. Capital
flight also plays a role. Unfortunately, it is
impossible to say exactly which factor is
dominant. The first two factors do not
pose an economic risk.
Convincing the Chinese
The risk of the renminbi weakening further
prompting Chinese households to convert
their assets listed in renminbi into foreign
currency is an economic risk, however. In
order to restrict this risk, it is essential that
Chinese policymakers succeed in convin-
cing the Chinese population that attractive
returns can also be earned in China. This
requires more than just stabilising
economic growth. Reforms also need to be
implemented in other areas, such as closing
loss-making (semi-)state-owned companies
and privatising others. China needs to
‘Policy makers
must think
of their
global position’

11. Kempen Insight, March 2016 11
Chinese currency reserves (x billion USD)
Source: Bloomberg Source: Thomson Reuters Datastream
RMB exchange rate per USD
move away from a centrally-led market
economy towards a true market economy.
Proceed with tact
China is undergoing an economic transition
and this poses an internal challenge to
Chinese policymakers. A sharp devaluation
of the renminbi may be an attractive option
on the basis of domestic arguments, but
policymakers also have an external respon-
sibility. The Chinese economy is the world’s
second largest and, via trade and financial
channels, has a huge impact on the ups
and downs of the global economy. A sharp
devaluation could adversely affect global
financial stability and trigger further disin-
flationary pressure. China could compro-
mise its international position if it allows a
sharp devaluation, while it wishes to be
taken seriously by the West. We believe that
Chinese policymakers will continue to aim
for their domestic targets, but in doing so
they will not ignore the rest of the world.
They will allow the renminbi to depreciate
further, but temporarily suspend the
process if it causes excessive turbulence. 
Ruth van de Belt
Investment Strategist
ruth.vandebelt@kempen.nl
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
96 98 00 02 04 06 08 10 12 14 16
6
6.5
7
7.5
8
8.5
96 98 00 02 04 06 08 10 12 14 16
Fixed coupling to USD
Fixed coupling to USD
Creeping coupling to USD
Devaluation
Creeping coupling to
basket of currencies
years years

12. Kempen Insight, March 201612
BREXIT
NO, THANK YOU
Cameron says he will campaign for EU
membership with his “heart and soul”.
we believe that uncertainty and market
volatility will remain high over the
coming months.

13. Kempen Insight, March 2016 13
/// visual freepik, HENRIKE BEUKEMA
who throughout his premiership had to
deal with the continuing arguments over
Europe within his own party.
Now, we are in a new round of this
ongoing battle. The British government is
dealing not only with divided opinions
within the cabinet, but also with the UK
Independence Party (UKIP), a party that
was founded in 1993 with the explicit aim
of achieving a British exit from the EU. The
Labour Party is not unequivocally in favour
of EU membership. The tabloid press is
largely Eurosceptic and enjoys focusing on
negative news about the EU.
Implications?
Ahead of the referendum, the ‘Leave’ camp
stresses the savings that a Brexit will bring
while the ‘Stay’ camp predicts financial
Armageddon. If a Brexit does occur, this
will cause a shock to markets. However the
scale of the impact on the UK economy will
ultimately depend on agreements with the
EU and other countries after its exit. We do
not expect a particularly advantageous deal
with the EU, as this would play into the
hands of the Eurosceptic parties in conti-
nental Europe. The City is and will remain
important. A Brexit would cause huge
uncertainty in the UK financial sector and
Britain’s large and global financial services
industry is already a politically sensitive
point with certain EU members. This further
complicates the need to reach trade agree-
ments in this area that are inherently diffi-
cult and complex.
Although a Brexit may bring some financial
The UK government itself is a proponent of
EU membership, but in an adapted form
that takes account of certain recurring
complaints of the British. In February British
demands were addressed, albeit partially.
Will this be enough to avert Brexit? Doubts
about UK membership of the EU are not
new. In the Thatcher era a large proportion
of the Conservatives were opposed to the
European idea because of a perceived
threat to Britain’s identity and sovereignty
posed by an ‘ever-closer union’. The oppo-
sition between the UK and Europe was seen
as ‘us’ against ‘them’. During Thatcher’s
tenure as Prime Minister, she negotiated
with the EU and the popular perception is
that she won important concessions. In
1993 she was succeeded by John Major,
In 2015, British Prime
Minister David Cameron
promised the UK electorate
that he would hold a
referendum on the UK’s
membership of the
European Union (EU)
if he won the general
election. What would it
mean for the UK if Brexit
becomes reality?
Michael Wray
Kempen Fiduciairy Management
(London)
michael.wray@kempen.co.uk
benefits – as there will no longer be a
contribution to the EU budget and maybe
less regulation – it is most likely that the
economic consequences will be slightly
negative on balance. Not just in the short
term but potentially also the medium and
long term.
Political consequences
The economic impact of the UK’s departure
is likely to be small on the EU as a whole;
the consequences for individual member
states could be considerable. It could also
increase the political headwinds against the
move towards closer European integration.
However, given the challenges facing the
EU and the Eurozone, such as the persisting
problems in Greece, the refugee crisis and
growing Euroscepticism, the EU will be
keen to put this issue behind them and
move on. 
OUR SCENARIO: NO BREXIT The referendum will take place on 23 June. The Cameron government has
achieved some recent victories in negotiations on its EU membership. The EU has made a number of concessions on migration, economic
policy and sovereignty. The British Prime Minister can advise his people to vote in favour of EU membership, but no level of concessions
would have been enough to please many of the British Eurosceptics. Polling evidence shows a slight preference to remain on average,
but recent polls demonstrate that there is a significant risk of a Brexit. Turnout will be important and is difficult to predict. For the time
being, our central case is that the UK will remain a member of the EU. Past experience tells us that British voters have usually voted in
favour of the status quo in referenda. In our opinion a Brexit poses a tail risk. However, uncertainty will remain high over the coming
months, as will market volatility.
Ruth van de Belt
Investment Strategist
ruth.vandebelt@kempen.nl

14. Kempen Insight, March 201614
Monty Python’s lesson
In his reflection on the 2008 financial
crisis, Dutch Professor of Risk
Management Theo Kocken explained
to Monty Python icon Terry Jones
that economics teaching glorifies our
rational desire for prosperity (boom)
and ignores the economically-disrup-
tive forces of human greed. Conse-
quently, many people believe that
crashes cannot be prevented or
avoided and that they are in fact a fixed component of the
economic cycle. The result was a joint project to spread know-
ledge of recurring economic instability. This is done using an
interesting combination of conversations with experts, light-
hearted humour, including Muppet-like animations, and
analyses by experts who include Nobel Prize winners. The film
also examines the 1929 crash and Dutch Tulip Mania.
Title: Boom Bust Boom
Director: Terry Jones
Screenplay: Terry Jones and Theo Kocken
Cast includes John Cusack, Dirk Bezemer, Zvi Bodie and Willem Buiter
When the bubble bursts
This film takes viewers through the rise
and fall of the US housing bubble,
which burst in 2008. Who were the
men who succeeded in making money
out of all that misery and how did they
do it? The inflating of the US housing
market and the financial markets as the
place where parties prefer to parrot
rather than correct each other is
portrayed using caricature. The Big
Short tells its tale at a cracking pace and contains humour and
interludes in which global stars explain Wall Street behaviour.
The film ultimately sets its audience thinking. Where are the
brakes in the financial system and is earning money in the short
term really more important than averting a foreseeable problem
with long-term consequences?
Title: The Big Short
Director: Adam McKay
Screenplay based on the book The Big Short by Michael Lewis
Cast: Christian Bale, Steve Carrell, Ryan Gosling and Brad Pitt

15. On 2 December 2015, we hosted
our first Kempen cocktail reception
at the National Gallery in London.
The evening consisted of great
food and wine, and provided the
backdrop for introducing our new
colleagues to our clients and key
contacts in the UK. To make the
evening memorable for all who
attended, we invited Ilka van Steen,
the curator of the art collection
owned by our parent company Van
Lanschot, along with the amazing
replica of one of Van Gogh’s
‘Sunflowers’ paintings. She walked
us through the history of the
painting and gave us an insight
into the artist himself.
Paul Gerla gave an inspiring speech
on our heritage; how we should
share knowledge and learn from
each other and how we intend to
build a successful Fiduciary
Management business in the UK.
15Kempen Insight, March 2016
a night at the movies
for investors
15
Evert Waterlander is
Director Client Solutions at Kempen.
evert.waterlander@kempen.nl
The man who brought down Barings
This docudrama shows how Leeson
strayed from the straight and narrow
by linking unauthorised transactions
to a fictitious client account. In the
meantime, as he becomes an incre-
asingly important ‘profit machine’,
no obstacles are put in his way.
Leeson finds himself celebrated at
Barings and takes a huge gamble in
order to recoup his covert, loss-ma-
king positions. These positions collapse after the Japanese
market plummets in the wake of the Kobe earthquake. Leeson
goes on the run and discovers that his actions have brought
Barings to its knees. We all know how this ends: Barings went
bankrupt in 1995 and Leeson went to prison.
Title: Rogue Trader
Director: James Dearden
Cast: Ewan McGregor and Anna Friel
WELCOME

16. Kempen Insight, March 201616
Currency fluctuations
are having an increasing
impact on economic and
investment results.
Standard budgetary and
monetary policy is being
pushed to the limit.
The use of currency as a tool is growing in
popularity among policymakers. Exchange
rates are primarily affected by the balance of
trade, budgetary and monetary policy,
economic growth and inflation. The interac-
tion between these factors constantly alters
the demand for and supply of a currency,
which makes the direction of that currency
unpredictable in the short term.
Real effective
exchange rates
The exchange rate is the price of two curren-
cies compared to one another. A euro-US
dollar rate of 1.20 therefore simply means
that for 1 euro you can buy 1.20 in US dollars.
You cannot conclude from this that the euro
is worth more than the US dollar, however. A
real exchange rate is required to determine
what a currency is ‘worth’, which means that
you have to correct for local price levels. For
instance, you can compare currencies objec-
tively, as the law of one price applies in the
long term (the Big Mac index). If, for instance,
a product is 20% cheaper in US dollars than
in euros, it is simply a matter of time before
traders take advantage of this (arbitrage).
Traders buy the product in US dollars, sell it
in euros and pocket a ‘risk-free’ profit. The
behaviour of arbitrageurs accidentally guar-
antees that real exchange rates tend towards
equilibrium.
As countries always trade with several other
countries, we need to combine the different
real exchange rates to reach one price. This
price is the real effective exchange rate (REER)
and reflects the fundamental value of the
currency. A REER of below 1 points to under-
valuation against the rest of the world and,
vice versa, over 1 points to overvaluation.
Not perfect, but usable
The insight that the REER provides into the
fundamental value of a currency and in turn
into a country’s competitive position has led
to many international organisations, such as
the OECD and the ECB, using it in their
economic forecasts.
Caution is due in translating REERs directly
into investment decisions: trade flows and
price growth are important components in
calculating the REER, but are not always easy
to gauge. For example, the price index
selected as an indication of the growth of the
competitive position is subjective in itself and
it is difficult to obtain a complete overview of
trade data.
For this reason, we believe it is sensible not
to draw very firm conclusions in the case of
REER values close to 1: they could point to
either a change in the REER valuation or to
white noise, i.e. measurement difficulties. In
order to ensure that we are not reacting to
white noise, we apply a margin of at least
10% of the fundamental value before we
decide whether a currency is overvalued or
undervalued. A currency that is overvalued
or undervalued may be a reason to adjust the
percentage of the currency hedge during the
annual portfolio review. The most important
currencies when taking this decision are the
euro, the UK pound and the US dollar.
Currency impact
The inclusion of expected currency fluctua-
tions in investment decisions means moni-
toring the expected difference in the return
expressed in local currency and in euros. Yet
currency fluctuations are not equally relevant
to all asset classes. A few asset classes are by
their very nature highly volatile, leading to
currency fluctuations having little effect on
the total return. In the short term this chiefly
applies to equities, in the long term also to
other real assets such as real estate and infra-
structure. However, currency fluctuations do
have a significant impact on nominal assets
such as liquid assets and bonds. Currency
volatility is high compared to the nominal
return on these assets, causing currency fluc-
tuations to affect the expected return greatly.
Within the risk-avoiding character of bonds,
we therefore prefer to hedge currencies. 
Exchange rates affect
investment results
Florian Broekhuizen
Investment Strategist
florian.broekhuizen@kempen.nl

17. à A detail from ‘De Geldwisselaar’ (The Money Changer) by follower of Marinus van Reymerswaele

18. Kempen Insight, March 201618
Are there still
sufficient prospects in
the financial markets
for long-term investors?
Investment Strategist
Marius Bakker looks
at the facts.
We are currently seeing valuations
becoming less attractive for almost all asset
classes as a result of years of upward
markets. Expected returns are low across
practically the whole market, and they
often yield too little reward for the risk
taken. Market volatility has also increased
sharply over the past few months. In this
climate, capital retention is nearly as
important as the return on capital. Govern-
ment bonds are safe investments but
currently yield very little due to the effect
of the central banks’ expansionary mone-
tary policies. Yet risk-bearing investments
such as equities also offer insufficient
reward, especially given the current market
climate.
Framework
As investors we want to be sufficiently
rewarded for the risks involved in our
investments. Our framework for deter-
mining the return we require is based on
the assumption that each asset class adds
a specific risk. For instance, government
bonds need to reward us for their long
duration and the risk of inflation eroding
the principal. In the case of credits, the
additional component is credit risk. Share-
holders have a claim on the profits that are
shared, but they are at the bottom of the
capital structure and therefore need to be
given a higher reward. In most cases, the
historical reward is a good guide. We
demand a lower return for safe investments
such as bonds than we do for equities, and
we want a greater reward for emerging
markets than for developed countries. We
use this framework to decide whether an
investment is attractively valued or not. If
the expected return on an asset class is
roughly the same as the return we require,
then it is neutrally valued in our eyes.
Above this level investments are increas-
ingly attractive, but below this level the
opposite is true.
Neutral risk attitude
The quantitative easing policies pursued by
central banks mean that interest rates
around the world are still close to their
historical lows, and in some countries they
are even negative. This also has an impact
on government bonds, which are currently
offering investors low yields. Consequently,
investors seeking return have driven up the
price of riskier investments, leading to
many asset classes becoming highly
Time for
caution

19. Kempen Insight, March 2016 19
overvalued. We expect valuations to
normalise over the next few months. This
was also the reason behind our decision to
reduce risk at the end of 2015. It is always
tricky to predict the pace at which valua-
tions revert to trend. We were (and still
are) of the opinion that the period in
which risk is substantially rewarded is
slowly coming to a close. Caution is
essential in order to restrict capital loss.
The normalisation of valuations will be
accompanied by prices decreases and
volatility. The good news is that this will
make investments more attractive in the
longer term.
Relative assessment
Although many asset classes are not
particularly attractive in an absolute sense,
investors can still exchange a number of
risks. Bonds are the most obvious choice
when we seek a lower level of risk, although
they currently offer a very unattractive
yield. This is chiefly because bond yields in
most developed regions are close to their
historical lows. However, credits do offer
sufficient additional return to compensate
for credit risk. We always find the high yield
section of the bond market attractive.
The economic climate in the medium term
is crucial to deciding where and when to
adjust portfolios. Like credits, equity
markets have already undergone a substan-
tial correction in 2016. In spite of the
decrease in prices on global equity markets
over the past few months, price/earnings
(P/E) ratios remain above the historical
average.
Outlook for growth
Equities are expected to weaken further as
soon as the economic cycle picks up. The
expansionary monetary policies that have
boosted the markets over the past few
years are now less stimulatory. At the end of
2015, the US Fed raised interest rates for
the first time in over nine years. The US
economy is the first to do so and we antici-
pate a slowdown later this year. We there-
fore anticipate fewer interest rate increases
and are cautious about US equities. Europe
still has room for growth and the ECB is
also poised to stimulate the economy via
monetary policy. As a result, thanks to
historically-low interest rates in the Euro-
zone, risk premiums on European equities
still offer sufficient reward. Yet Europe is not
an island. Given the current economic cycle
in which commodity prices are being
squeezed and the Chinese economy is
slowing down, we are more cautious about
the global outlook for growth. European
equities are more attractive than their US
counterparts, but this is a relative assess-
ment.
Balanced
As only limited yields can be earned based
on valuations and the economic cycle is
also slowly heading towards the final phase,
we believe it is now time to operate more
cautiously. After years in which price gains
were the determining factor, the economic
risks are now increasing. It is no longer ‘buy
weakness’, but time for a more balanced
approach in which capital retention is
leading and ‘selling into strength’ is also
essential. 
Marius Bakker
Investment Strategist
marius.bakker@kempen.nl
%
10
8
6
4
2
0
21 3 4 5 6 7 8 9 10 11 %
Expectedreturn
Required return
EMU BOND
EUR CREDITS
US GOVERNMENT BONDS
US EQUITY
HIGH YIELD
EU EQUITYEM GOVERNMENT BONDS ($)
EM EQUITY
Expected vs required return
Source: Kempen
The solid line shows
where the required
return is equal to the
expected return.
The dotted line shows
that the slope of the
line connecting expected
equity and bond returns
(the risk premium) is
still the same, but that
expected returns are
lower.

20. Kempen Insight, March 201620

21. Kempen Insight, March 2016 21
/// visual PHILIP JENSTER
Changing
facts
Financial markets move between hope
and fear, euphoria and panic and bull
and bear. In our investment process we
incorporate this into the third building
block: sentiment. While valuations are
crucial in the long term and the
economic cycle determines the
medium term, sentiment affects the
short term. As long ago as 1966 Nobel
Prize winner Paul Samuelson said in
‘Wall Street indexes predicted nine of the
last five recessions’ that the equity market
was often not the best forecaster. This is
still much better than the average econ-
omist. When was the last time you heard
an economist predict a recession? In
about half the cases, the panic is nothing
more than a ripple on the surface. In the
other half, however, there is good
reason to be worried.
Let us look at the facts. There was panic
on the financial markets in the summer
of 2015. Investors thought en masse that
China was heading for a hard landing
and at the same time that the US Fed was
about to raise interest rates. In retrospect,
the panic proved to have no basis in
fundamentals. It was simply the expec-
tation that these were about to change
that caused the panic and investors
subsequently overreacted. There was a
short-term opportunity to increase risk.
We are now in 2016 and this year kicked
off with another panic phase. Yet we
believe that there is more reason for
concern this time. As you can read else-
where in this edition, there are doubts
about Chinese growth, concerns about
credits and high valuations – and there-
fore low expected returns – in many asset
classes. In a climate in which economic
growth is levelling off and inflation is
declining because oil reserves just won’t
diminish, these issues are a matter for
concern.
We are of the opinion that markets got
out of control and overreacted last
year. Prices are again reacting severely
now, but as the economic situation is
fundamentally different from that in
2015 it is our belief that the markets are
in the right this time. We are currently
seeing not just a change in forecasts
but also a change in facts. It is time to
operate more cautiously. After all, lean
years always follow on from good
years. After years of capital growth the
mantra for the next few years is capital
retention. Exactly what you would
expect of an asset manager. 
Roelof Salomons is Chief Strategist
at Kempen
Professor of Investment Theory
Asset Management at the Univer-
sity of Groningen.
roelof.salomons@kempen.nl