Reviewing asset and risk allocation: how to cope with disruptive events?
Pascal BLANQUÉ – Group CIO at Amundi
Vincent MORTIER – Deputy CIO at Amundi
Matteo GERMANO – Global Head of Multi-Asset Investments at Amundi
Moderated by Adrian DEARNELL – Founding Partner, EuroBusiness Media
The investment framework is subject to further disruption and continued uncertainty, and new macro trends are underway. What does this imply for asset allocation? What should our investment convictions be, and how can we deliver added value? Three Amundi experts shared their views on how to make the most of the evolving environment.
HOW MUCH HAS REALLY CHANGED?
Pascal Blanqué opened the roundtable by outlining what is going right in Europe, calling it “the early stages of a new story,” with a cyclical upswing of growth, still-accommodative monetary policy, and less political risk. However, the challenge of a slowdown in the US in two or three years looms, as well as how the economy can absorb higher interest rates. Other risks also remain, with some rewarded and some not.
Overall, however, Mr. Blanqué does not see a great deal of change. Debt is still a global problem, with deleveraging not really taking place, supporting the secular stagnation theory. Capital market structure has also not changed in relation to liquidity risks. “We are living with excess macro- and micro-liquidity problems potentially down the road. Banks are less risky, but those risks have just been shifted elsewhere in the system.” On the political front, he believes that Brexit risks are underestimated and have not been priced in. Concerning Trump, he feels that only the changes that make sense will ultimately happen, including infrastructure upgrades and fiscal measures.
Turning to the question to reflation, Matteo Germano stated that it is just beginning, although at least deflationary fears have disappeared. From Amundi’s perspective, he expects higher inflation for the next three to five years, in line with central bank targets.
INVESTORS NEED A DYNAMIC ALLOCATION STRATEGY
Concerning allocation of assets, Vincent Mortier emphasized that Amundi will continue to favour European equities, in particular value stocks and financials. In the credit space, it prefers higheralpha, while it remains cautious on other investments, especially foreign exchange. Mr. Germano added that equity exposure is particularly advisable in a reflationary phase. Aside from European equities, Japan is also a good bet, especially if commodity prices remain under control.
Mr. Mortier urged investors to use a dynamic, wellthought out micro-hedging strategy. Amundi, for example, plays with equity volatility directly or through funds, as well as with treasuries, which are a good micro-hedge. In fact, micro-hedging is a pillar of its investment strategy, he underlined.
INTEREST RATES ARE KEY
On interest rates, Mr. Blanqué said “the mother of all calls for asset allocation is the idea that interest rates are at equilibrium”. That does not mean that they are immobile, but Amundi has “sympathy” for parts of the secular stagnation thesis, believing that QE will continue or will be revived at any sign of recession. This does not mean that there cannot be a sharp rise of rates in the long term, not driven by fundamentals, but that this could prove self-defeating and would rapidly be reversed. However, the implications are that the search for yield will continue and include real assets such as infrastructure, real estate, and private debt.
If interest rates stay low and stable, most asset allocations are still sub-optimal, remaining biased toward government bonds, which cover just a limited amount of risk, asserted Mr. Blanqué. This may be less prudent than an allocation including more risky assets, “given the shift in the relative efficiency frontiers between governmental bonds and the rest”. Asked about Amundi’s expected returns on a fiveyear horizon for various assets, he cited economist Jeremy Siegel’s long-term stock performance prediction of a 7% nominal return.
« To an extent, markets behave as if all the unknowns are known, so part of the problem moving forward is the unknowns that are unknown. »
EMERGING MARKETS OR EUROPE?
For Mr. Mortier emerging markets remain a good investment for the long term, in both debt and equity. Their economic outlook and sovereign risk profile have improved, as have budget deficits and reserves. However, to be prepared for regime or regulatory changes, it is important to pick countries carefully and use all available investment instruments, including options.
Factor investing, and multi-faceted risk analysis can also help, he added.
Turning back to Europe, Mr. Germano agreed with Mr. Blanqué on the good outlook, based on political stability and higher growth, but called for other factors to be included. Growth has been cyclical and dependent on low oil prices and government support. Only recently have data started to show more structural growth in competitiveness, labour markets, and investment spending. This is coming “from the bottom up” and looks more sustainable. Some of the growth, however, will depend on strengthening the European Union through completing a banking union and supporting the European Stability Mechanism.
Moving to trade, Mr. Blanqué said that the drop in international trade means investors must switch to products not correlated with trade, such as services in China or infrastructure in the Philippines. This could also help diversification, since it is easier to identify idiosyncratic or domestic features of investments without “pollution” from international trade data. »
FACTOR INVESTING AS A SOLUTION
On managing risk, Mr. Blanqué praised factor investingfor allowing investors to pick the factors they want to have exposure to. It also helps you think beyond the classical distinction between liquids and illiquids. However, it can be imperfect and difficult to manage. For example, cycles are different in different countries, as are definitions of concepts such as value. Building appropriate data bases and execution are further challenges, and there is a tradeoff between factor investing and liquidity and cost transactions.
« The big shift from deflation to reflation has surely taken central stage… and the market has probably discounted much more than what has really happened on the economic level. »
MANY RISKS, SOME ALREADY REWARDED, OTHERS NOT
Concerning how to position risk strategies in an investment program, Mr. Blanqué noted that we are moving to a tri-polar world. “We have got, on the one hand, small beta leading the charge on capweighted indexing and, on the other hand, factor investing leading the charge against traditional definitions of alpha. This translates into portfolios with a three-bucket approach: an alpha component based on idiosyncratic alpha and a demanding selection of external fund managers; a big packet of factor exposure, static or dynamic, defining the rewarded factors you want to be exposed to; and cap-weighted replication, ETFs, indexing and the like, to get exposure in some efficient markets or to tactically monitor your allocation.
ESG, can also be a risk factor, or a pool of poorly-remunerated risk factors, asymmetrically distributed across corporates, continued Mr. Blanqué. For some of them the probability that the risks materialise is high enough to merit action in the portfolio. This is one of the big challenges: what to do for not-yet rewarded risks. “When you want to avoid risks that are not rewarded, you go for low volatility, mean variance, risk variety, and maximum diversification”, he suggested.
Mr. Germano added that Amundi recommends strategic diversification across risk factors. “If we look at the two factors that have been better-performing in the last two years, they are quality and low-volume. They have also been relatively resilient, apart from under-performance after the US election.”
REAL ASSETS AS A SOLUTION
Turning to the benefits and risks of real assets, Mr. Mortier stressed that better returns come with lower liquidity. Real assets are more difficult to source and structure, and have associated costs and longer due diligence. However, they have more security, with covenants for private debt, or a physical building for real estate.
They also help diversify the portfolio. For stable and predictable returns, private debt works well, while for higher returns and a link to the global economy, private equity is the solution. Real estate represents a combination of the two. However, there is much more demand than supply for worthwhile real assets, he lamented.
LONG TERM INVESTING-LIQUIDITY, RISK AND RETURNS
To conclude the discussion, panellists were asked for final insights on long-term investing.
Mr. Blanqué focused on portfolio management, specifically how to deal with “not-yet rewarded risks” and investment returns. As not-yet rewarded risks he counts some disruptive business models such as new markets or changes to old markets, with the basic feature being that it is permanent and not cyclical change. Amundi tries to reduce the exposure to sector players that will be on the losing side of the disruption, and vice versa. Concerning returns, there is no such thing as an “average annual return”. What matters for a long-term investor should be wealth creation and the trend of returns.
In general, long-term investors must consider valuations. “Today, there are some areas that are highly priced, so it is not necessarily good to deploy 100% now,” said Mr. Blanqué. “The same goes for the illiquid space, where you have to sequence. Returns have a different meaning depending on whether you are in a phase of accumulation or de-cumulation. You must have stronger returns at the end of the period, while the opposite is true for the accumulation phase.”
Concerning long term investment, Mr. Germano focused on portfolio construction, counselling to be well positioned for a possible drawdown, and having fixed debts. “Long-term investment means having very fixed debt. Un-rewarded risk would probably take some time to be recognised by the market, especially if you are early. So it is becoming critical to maintain a focus on the investment case and not to be tempted to close early, when the market is not closing in your direction. So there is a behavioural component.”
Vincent Mortier added that the long-term investor must be clear about liquidity, and remember that “in case of stress, liquidity that you think exists can vanish, so it is very important to ask yourself which portion of the asset should be liquid on a given time horizon,” he cautioned. “You must also be clear about over-crowded trades, for which investors just forget the risks, which is wrong. If you are long-term investor, you should go back to the basic risk-reward relationship. In which markets are you paid for risks and in which you are not paid?”
In closing, Mr. Blanqué called for humility, remembering wrong predictions about the US election and a forthcoming slowdown in Europe. He reminded the audience that we are in a “sweet spot” right now, with Europe growing, Japan out of deflation, and emerging markets progressing. However, “unless you assume that there is no correlation anymore between the US and the rest of the world, the big thing is the nature of the timing, the format, and the amplitude of the US slowdown.”
« We cannot say anymore that globalisation equals global trade. To a large extent global growth is retreating back home. »