CITYWIRE SELECTOR | JULY / AUGUST 20184

COMMUNITY • BUYERS’ MARKET

at more-than-reasonable valuations, regardless of the magnificent perspectives the industry has. However, we are not comfortable making one-shot changes in our portfolios. It is impossible to predict when we have reached the market’s peak, but when confidence and euphoria are rising we feel more comfortable stepping out of these trends.

Within the fixed income spectrum, we are looking at European sovereigns with the worst risk return profile. These could start to behave like Europe’s investment grade bonds, where credit spreads are at minimum levels and starting to rise. The high yield sector needs to be watched closely and we have been selling assets here in recent months. We are expecting a significant market correction in the following 12 months once early signs of an economic slowdown are detected, and will stay on the side-lines in the meantime.

cheap sectors and stocks and takes short positions in companies with high valuations. It has suffered recently because the value style and contrarian investments have been out of favour. However, in the past, it has been able to perform in bear markets or during sector rotations.

Another approach is to consider investing in global macro funds which focus on macro trends and sometimes invest only in FX and fixed income markets. The GAM Star Global Rates fund has a good track record and should be able to perform in a volatile environment.

FÉLIX LÓPEZ atl CapitalSpain

Short-term large inflows, excessive valuations and specific marketing campaigns, such as TV

ads, are all indicators of an overheating asset class. In equities for example, specific industries within

the technology sector have recently had an impressive performance and therefore warrant close attention.

Areas such as robotics and ecommerce are trading

Which asset class, regions or sectors are at risk of overheating at present? Are you cutting exposure from these hot-spots or waiting to see if you can capitalise on any meltdown? Which managers perform well when prices are high and who would you back to withstand a sudden shock?

PIERRE MOLINEROOFI Asset ManagementFrance

Several years of bull markets fuelled by quantitative easing have left investors with few places

to hide. On an historical basis, almost all asset classes are expensive today. In the European fixed income space, yields are so low that even a small widening of spreads can wipe out several years of performance, so we are steering clear. Equities are also expensive on a P/E basis. Moreover, margins in some sectors are massively higher than historical averages and the same sectors show signs of overcrowding. That is especially the case in the US consumer space. If wages continue to rise and rates go up, earnings will be at risk.

If you aim to benefit from a meltdown, you need a long/short strategy to capitalise on sectors or stocks you think are overvalued. Bottom-up stock pickers focus on corporate fundamentals but markets tend to be less fundamentally driven during a sell-off, so you should consider a strategy with a macro insight. The Majedie Tortoise fund is a good mix of macroeconomic views and stock selection. The strategy tries to identify

BUYERS’ VERDICTS

TOO TO HANDLE?

High yield is lifting hopes but the bond bear has its paws around the market’s neck. Equities are accelerating but trade war fears could cut it off at the knees. Emerging markets are on the up but face a wide array of geopolitical roadblocks. It seems wherever you look, positivity in markets is under-cut by negatives. But are markets really getting ahead of themselves and how are asset allocators responding?

Our investor panel offered a variety of insights into which parts of the market are under pressure and how to capitalise on or defend against such a scenario. The consensus was that equities are, in some cases, rising beyond sustainable levels in the long-term and the best option for many buyers we spoke to is to look at long/short opportunities to capitalise on any downside.

This idea of keeping a foot in both camps was also evidenced on the fixed income side, with Massimiliano Conterno of CGM Italia SIM saying convertible bond funds are the best way to retain fixed income exposure but in a more flexible format.

Elsewhere, there was a belief among many that a seasoned manager can rise to the challenge on any scale, whether that’s an overheating asset class, sector or wider region. Paul Higgins of Kleinwort Hambros – another sat firmly within the long/short camp – singled out fund selector favourite Eric Bendahan and his absolute return-focused fund as a proactive and pragmatic choice at a time when equities are increasingly expensive.

Surprisingly, there was continued support for emerging market debt, which has be-come something of a whipping boy when investors are asked to name poor risk/return markets. Instead, say the likes of Matthias Schiestl, it is best to take a more nuanced approach. In his response, the Dusseldorf-based fund selector summed up many of the comments quite neatly – nothing is true for all sectors, so stick to the managers you know when times get tough.

Do you agree or have you another way of tackling markets which look set to become problematic? Read on to find out how you compare with your peers.

CITYWIRE VERDICTCHRIS SLOLEYEDITOR, CITYWIRE SELECTOR

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BUYERS’ MARKET • COMMUNITY

MASSIMILIANO CONTERNOCGM Italia Italy

Lazard Convertible Global is a good example of a fund that responds positively to today’s

market volatility and to the global increase in interest rates. In 2017 the fund returned 6.99%, outperforming its benchmark by 1066 bps. In addition, in the first quarter of this year the fund gained 1.8%, exceeding its benchmark by 2.2%. It outperformed in January this year when equity markets continued the bullish trend that characterised 2017, but it stayed ahead even throughout February, when the equity markets fell.

However, our bond pick, the Emerald Euro Investment Grade Bond fund, underperformed the market by 0.07%. It lost 0.26% in April, a symptom that bond assets are suffering from current economic conditions. Also, the Emerald Euro Inflation Linked-Bond fund is going through an uncertain period and lost 10% in April.

FABRIZIO BERGNABanca ConsuliaItaly

In recent weeks, the US dollar has strongly appreciated against all currencies. This

movement has caused a sharp devaluation in many emerging currencies, particularly in countries heavily dependent on the flow of foreign funding, such as Turkey and Argentina.

A strong dollar could be a threat for emerging markets but we expect relative strength from the Asian region supported by ambitious Chinese plans for the development of local financial markets.

In light of these risks, we are wary of local EMD exposure and prefer the hard currency. We are looking at specialised funds such as Investec GSF Emerging Markets, Investec GSF Emerging Markets Hard Currency Debt and Vontobel Fund Emerging Markets Debt, which have lower volatility than their competitors.

On a sector basis, we have a positive view on oil, healthcare and financials.

PAUL HIGGINSKleinwort HambrosChannel Islands, Guernsey

Equities are increasingly expensive, but are still much cheaper than bonds. In nominal

terms, expected returns over the next five to 10 years still favour equities, at about 4% versus 0% from bonds. Add inflation and a rising rate regime to the equation, and bond returns may well be negative in real terms. Our hesitation with current equity valuations is tempered by blistering momentum and a strong global economic picture, which is translating into corporate earnings.

That said, if momentum turns, the economic scenario falters or valuations become unreasonable, we will cut equities and hold increasing levels of fixed income assets. While the latter have poor long-term expected returns at present, they tend to hold nominal value in the short term – a wonderful attribute when stocks are selling off. With this in mind we currently recommend the Eleva Absolute Return Europe fund, a bottom-up, style-agnostic long-short European equity strategy managed by Eric Bendahan, formerly of Oyster, where he built a formidable track record. The market is ripe for this type of strategy and the reduced net exposure will provide a high degree of capital protection in more challenging conditions.

KAROL CIUKPekao TFIPoland

A dovish interpretation of the last ECB meeting by investors and Italian political risk create

an opportunity for absolute return and relative value strategies within the European bond market. The spread between 10-year US treasuries and German bunds (266 bps at the time of writing ), represents a new cyclical high and bunds are very expensive relative to US treasuries. This situation may be unsustainable in the longer term. The ECB’s ‘normalisation’ has been postponed until next year, but at the same time we are closer to the bank’s inflation forecasts. The target for 2019 is 1.9% versus 1.8% in the previous forecast. Under these conditions, negative interest rates policy pushed yields too low. At the same time, the spread of Italian bonds versus bunds evaporated due to the risk of fiscal expansion, accompanied by the unsustainably high debt. This increased spreads for other peripheral markets, which are in better political shape than Italy, generating a primary budget surplus. Taper risk in Europe in the next year and Italian political problems create further investment opportunities for long/short strategies, which are hard to implement in long-only products. Such an approach could catch additional alpha by investing in higher yielding bonds and can limit drawdown. It’s also a good way to increase the Sharpe ratio of the portfolio and take advantage of a meltdown.

MATTHIAS SCHIESTLApo Asset ManagementGermany

Our discussions about the situation in the EMD space have been very intense recently.

Besides our own market research, we have consulted a diverse set of portfolio managers from different sub-asset classes and have decided to continue avoiding dedicated EM corporate debt funds. We are

also sceptical on hard currency funds. Many of them take meaningful exposure in frontier markets and other credit risks, which bear high liquidity risk, especially in times of monetary tightening and a potentially loose fiscal policy in the US. We feel barely rewarded for these risks, even after the recent spread widening. We are more positive on local currency debt. Massive currency devaluations, immediate actions by central banks and much better economic situations in comparison to the past indicate potential value. This is obviously not true for all countries, which is why we invest in active managers we know very well. This includes long-only benchmark-oriented managers, as well as flexible allocators, who also have a focus on capital preservation.

EMMANUEL FERRY Banque Pâris Bertrand Sturdza

SwitzerlandThere are elevated valuations across many asset classes, which reduces

the potential for returns and diversification. Asset prices are consistent with a structural peak. The favourable macro backdrop has boosted returns across the board, driving a ‘bull market in everything’. Equities, bonds and credit have not been so expensive at the same time since the roaring 20s, which ended in the Great Depression. It is time to rethink the traditional 60/40 model portfolio because this construction is challenged on two grounds. First, equities and bonds are now both expensive, so a static balanced portfolio is no longer diversified. Secondly, higher correlation, lower expected returns and greater risks mean this approach is no longer able to protect capital when inflation returns. Therefore, it is time to look for alternatives. The medium-term outlook for returns across assets is increasingly clouded by high valuations. However, valuations are not a clear indicator for near-term returns and can stay elevated as long as recession risk remains low.

We have two investment approaches. One is skill-based, the other is process-driven.

First, there is an opportunity to expand the portfolio into the non-traditional and alternative space. At the moment, we favour market neutral long/short equity strategies.

Secondly, regarding traditional asset classes, we are convinced that multi-asset investing must be underpinned by a solid process combining a high level of diversification with a global reach and a systematic, repeatable process.

BUYERS’ VERDICTS

CITYWIRE SELECTOR | JULY / AUGUST 20186

COMMUNITY • BUYERS’ MARKET

BUYERS’ VERDICTS

JÜRGEN JANNWalser PrivatbankAustria

In an environment with positive growth in most regions around the world, we still have faith in

equities to earn money. We stay close to neutral in areas like Europe and keep a regional focus on the US due to its fast-growing economy. Based on the current stage of the economic cycle and less central bank support ahead, we like to express a positive view on equities with a defensive bottom-up approach. Dividend strategies can generate additional capital gains in our portfolios. Positions in the iShares STOXX Europe Select Dividend 30 ETF are a cost-efficient and liquid way to gain exposure to higher dividend-paying European stocks. One of our key picks in multi-asset portfolios remains the DB Platinum IV – CROCI Euro fund. This strategy selects eurozone companies in a rule-based process on the basis of an economic valuation methodology. We use low volatility as a single-factor strategy to reduce some risk in our portfolios. The Walser Portfolio Aktien Europa fund is an effective way to express this specific portfolio strategy.

Ongoing tightening signals from the US Fed will weigh not only on US rates. Interest rates will continue to rise in the eurozone as well, but the dynamic will be different. Earning money in such an environment is challenging. Taking some credit risk is an option, as long as economic growth remains healthy and default rates stay low. Investing part of our fixed income portfolio in corporate issuers in the crossover segment (BBB to BB) was one of our conviction trades over past years to generate positive returns, but current allocations are some way off last year’s highs. Nevertheless, we keep some important holdings in the Janus Henderson Horizon Euro High Yield Bond fund, which offers a broadly-diversified, actively-managed portfolio.

FRANCISCO AMORINMillennium BCPPortugal

After the correction in Q1, there are still some headwinds for financial markets. Global

economies continue to expand although there are uncertainties about the outcome of trade negotiations between the US and China. Politics in Italy and Brexit remain the major risk for Europe. In terms of asset classes, government bond yields face upside pressure from the recovery in growth and inflation and a low-returns environment looks set to persist. Corporate bonds should benefit from economic growth, but low spreads and low yields are likely to result in meagre returns. High yield assets in Europe should benefit from ongoing growth and supportive policies from the ECB. Meanwhile, the high yield space in the US

SPOTLIGHT ON SELECTORS’ PICKS

The Majedie Tortoise fund, selected by Pierre Molinero, is a popular alternative equity investment strategy. Molinero praised the UK boutique’s flagship long/short fund for its ability to short over-valued stocks and unearth longer-term value bets. The fund, run by Matthew Smith (pictured) and Tom Morris, now boasts $2.1 billion (€1.8 billion) in assets across its Dublin- and UK-domiciled versions. Lead manager Smith has 24 years’

investment experience and runs three funds at the group, while Morris has been in the industry for almost a decade. In their most recent update, the duo focused on how US protectionist policy could backfire for the country’s leading tech players with semiconductor production likely to be at the centre of the tug-of-war between the US and China.

SELECTORS’ FAVOURED FUNDSFUND MANAGER CITYWIRE RATING

DB Platinum IV – CROCI Euro n/a n/a

Eleva Absolute Return Europe Eric Bendahan

Emerald Euro Inflation Linked Bond Marco Nicoletti n/a

Emerald Euro Investment Grade Bond Marco Nicoletti n/a

GAM Star Global Rates Adrian Owens n/a

Investec GSF Emerging Markets Archie Hart n/a

Investec GSF Emerging Markets Hard Currency Debt n/a n/a

iShares STOXX Europe Select Dividend 30 ETF n/a n/a

Janus Henderson Horizon Euro High Yield Bond Thomas Hanson, Tom Ross n/a

Lazard Convertible Global Arnaud Brillois

Majedie Tortoise Matthew Smith, Tom Morris n/a

Vontobel Fund Emerging Markets Debt Luc D’Hooge

Walser Portfolio Aktien Europa Florain Zelder n/a

should benefit from higher growth and a recovery in energy prices. Equities have been supported by ongoing economic and earnings growth and investors’ search for returns could continue to support demand for the asset class. However, higher PERs than the past 10-year average limit upside and volatility may occur.

In terms of allocation, we remain underweight government bonds, both in the US and Europe, and have been cutting exposure to corporates and high yield. On the equity side, we favour Europe over the US. Elsewhere, we like emerging markets, but there are still structural imbalances in economies like China, and political challenges in countries such as Brazil, Turkey and Russia.

In this scenario alternative strategies are an important source of diversification and other unconstrained or total return strategies could add value to portfolios.