Investment Strategies

Wealth Managers Set Out Their Predictions, Asset Allocation Calls For 2015

Tom Burroughes Group Editor 18 December 2014

Wealth Managers Set Out Their Predictions, Asset Allocation Calls For 2015

Here is another roundup of economic and investment predictions by major wealth management houses for 2015.

Here is another roundup of predictions, hopes, fears and expectations for the coming 12 months from the global private banking industry. (To see a previous collection of views about what 2015 might hold in store, click here.)

UBS
Global chief investment officer Mark Haefele in the firm’s wealth management division argues that the Swiss firm still sees the US as the “main event” as it is the country coming out ahead in a world of diverging policies and outcomes.

“With the Fed voicing concerns about the labour market and remaining data dependent, we don’t think it will stand in the way of real GDP accelerating toward 3 per cent in 2015. The consumer is benefiting from lower gasoline prices and contained mortgage rates; relatively easy bank lending conditions are stimulating investment; and government fiscal policy is no longer a drag. We continue to overweight US equities, US high yield credit and the US dollar. Of course, we will continue to monitor the impact of lower energy prices on the high yield credit market, but for now we believe default risks are contained,” Haefele said in a note.

“Meanwhile in the eurozone, European Central Bank chief Mario Draghi’s party has never really got off the ground. He’s been serving up some modest libations every time people threaten to leave, but nobody’s really dancing or carrying on. He knows he probably needs to offer something stronger, but some of his co-hosts are not so keen on this, as they are more worried about tomorrow’s clean-up than boosting current momentum. We expect to see a modest acceleration in eurozone growth, to 1.2 per cent from 0.8 per cent, thanks to the recent weakness in the euro, looser bank lending standards, and the recent improvement in money supply growth. There is also a strong possibility that Draghi’s co-hosts finally admit the party isn’t as fun as it should be, and let him dole out some stronger measures. But growth isn’t going to be spectacular,” he continued.

Over a six-month horizon, UBS is neutral on eurozone equities, while underweighting both the euro and the Swiss franc. However, the recent moves in oil have prompted the bank to upgrade Swiss equities to overweight, given the country’s lower weighting of energy stocks, relative to an increased underweight in the UK, whose main equity index has a 15 per cent energy weighting.

“We are neutral on the European energy sector as a whole since the oil price is below the sector’s average free cash flow breakeven for capital expenditure and dividends,” he added.

Lombard Odier
The Swiss bank says its 10 investment ideas for 2015 are:
-- Prefer US to euro sovereign bonds in a low-interest rate environment;
-- Favour equities over fixed income on valuation grounds;
-- Hold some alternative assets to withstand higher equity-bond correlations if markets correct;
-- Stay cautious on commodities;
-- Be overweight Asia relative to Latin America and emerging European countries;
-- Gain exposure to the US consumer story and be selective holders of US high-yield debt;
-- Keep exposure to select Asian emerging credit and local currency debt;
-- As the Fed tightens interest rates, be long of the US dollar and expect further flattening of the US bond market yield curve;
-- Prefer European to US credit and be overweight European equities, especially high-quality cyclical stocks and financials, and
-- Diversify internationally in equities through US dollar-based portfolios to hedge currency risks.

Pictet Wealth Management
Christophe Donay, head of asset allocation and macro research expects the US dollar to strengthen in 2015. He also reckons that US equities represent a stronger bet than their eurozone counterparts next year. Japanese equities are attractive, he says, although investors should hedge exposure to the yen.

Donay says emerging market equities are too risky for the likely returns they can generate. “The risk/return characteristics of emerging market equities remain unfavourable. We are protecting client portfolios from potential shocks with 10-year US Treasuries. Some carefully selected European periphery sovereign bonds look attractive through a diversified approach. Some high-yield corporate bonds (US in particular) remain appealing.”
 
“Nevertheless, corporate bonds come with increased interest rate and duration risks. Meanwhile, gold is still facing significant challenges. Hedge funds and private equity enable investors to better diversify risk and increase return sources,” Donay continued.
 
“A regime shift is shaping the global economy going into 2015, with the United States leading the way: a business cycle regime is taking over the reins from a monetary regime. Nevertheless, the global economic backdrop continues to be characterised by the ‘three GDs’: the Great De-monetisation in the United States, the Great Divergence in the euro area and the Great Dynamics in emerging markets,” he said.
 


Crédit Agricole Suisse Private Banking
Dr Marie Owens Thomsen, chief economist, coined the expression “Transflation”, defined as a state where a positive supply shock in an environment of constant aggregate demand causes prices and/or inflation to fall and GDP to expand.

The world is experiencing transflation as there are positive supply shocks in oil, leading to the recent sharp decline in oil prices, and also in agriculture. Since wages have stopped falling in developed countries, the deflation caused by the positive supply shocks will allow real wages to expand and lead to a boost in disposable income and therefore GDP, she says.

The recent sharp fall in the price of oil is positive for growth consumption and corporate earnings, although the scale of the price drop is a negative development. A fear of deflation and problems for Russia are likely to weigh on markets, she said.

Owens Thomsen said it is an auspicious time to prepare a shopping list of stocks/countries that have been indiscriminately dumped by investors during some market selloffs, since they could benefit from lower oil price. Japan may be top of this shopping list, she says.

Fidelity Solutions
Trevor Greetham, Director of Asset Allocation at Fidelity Solutions, highlights the parallels with the 1990s: the dollar is strong, US stocks are fresh from all-time highs while commodities and emerging markets are weak. As we enter 2015, he is mindful of how quickly 1998’s deflationary bust moved into 1999’s inflationary boom. A low oil price and ECB QE could at some point trigger a synchronised global recovery with higher commodity prices and higher interest rates.

The Association of Investment Companies
The AIC’s annual poll of member investment company fund managers finds sentiment positive for next year - although there are some causes for concern. Some 91 per cent of managers said they expect markets in general to rise in 2015, with Europe by far the most favoured region (39 per cent), followed by the US (22 per cent) and Asia Pacific excluding Japan (17 per cent). Responses came from investment company fund managers representing over a quarter of the industry (27 per cent), with £3 3 billion in assets under management.

Managers did highlight potential risks to equities for next year: 41 per cent of managers think the weakening of developed economies is the greatest threat to equities for next year, whilst deflation was another concern for 18 per cent of managers, followed, equally, by UK election worries, recession and Russia/Ukraine difficulties (all 9 per cent).

Robert Horrocks, chief investment officer, Matthews Asia
The US-based wealth manager says the slowdown in headline growth in China is simply due to the hangover from the economic problems of the U.S. and Europe. It said in a note that investors in China may be the short-term beneficiary of US growth due to the fact market valuations have not been imbued with any lofty expectations.

Japan remains a better prospect for demand growth than Europe in the short run and it argued that Bank of Japan head Haruhiko Kuroda will continue to push inflation expectations up to 2 per cent and keep them there – a weaker yen is the symptom of the policy, not the policy itself. In India, momentum has been based on the hope, rather than reality, of reforms, and there is a risk of disappointment in markets next year.

“All in all, I think we will go into 2015 optimistic about the future. We will continue to invest in the part of the world that is most focused on reforms. It is the part of the world that, according to the International Monetary Fund, will account for two-thirds of the world’s middle class in 2050 and we position our portfolios accordingly. That puts us a little at odds with the conventional wisdom; at least as it is expressed in the markets, which tends to have a shorter-term investment horizon and a clear preference for high yield bonds and US equities. Short-term earnings growth will likely be supported by improving margins and returns on equity. That makes me modestly optimistic—and my long-term view is more optimistic still,” Horrocks added.


GAM and Swiss & Global Asset Management
The firms comment on alternative fixed income strategies that they say can deliver real returns in a rising interest rate environment.

Mortgage-backed securities
“Some investors still mistrust the MBS asset class. This is a mistake – not only has the MBS market changed but these instruments provide a great opportunity to counter disappointing yields across traditional bonds. The US MBS market is vast; at $7 trillion it constitutes 30 per cent of the US bond market and 15 per cent of the global bond market, second only to US Treasuries. It is now much more robust and has considerably less systematic risk, thanks to improved lending standards and a new approach to ratings. The current low supply and rising demand for non-agency MBS bonds makes for attractive capital gains and we expect the non-agency market to recover strongly as investors return.”
Tom Mansley, fund manager, GAM Star MBS Total Return fund

Catastrophe bonds
“We expect catastrophe bond issuance to increase by 25 per cent in 2015 as the catastrophe insurance market continues to transition from a self-retained model toward a capital markets finance model. Driven in part by volatile climate trends, rapidly growing catastrophe risks have created significant shortfalls in insurance coverage versus the economic value at risk (“Disaster Gaps”). Disaster Gaps now stand at between $300 billion and $500 billion globally and, in conjunction with increasingly stringent capital adequacy rules for insurers (such as the impending Solvency II), are leading insurers to partner with external sources of capital to help shoulder the burden of rapidly growing catastrophe losses. Catastrophe bonds and other insurance-linked securities (ILS) today cover just under 10–12 per cent of capital needs. This sizable deficit is driving impressive growth in the asset class.”
John SEO, fund manager, GAM Star Cat Bond fund

Asset-Backed Securities
“The commencement of the ECB’s ABS purchasing programme has already seen spreads tightening as a result of the rise in market liquidity and growing investor demand. As liquidity and spreads continue to improve, we expect the impact to be felt most strongly in the more risky sectors and in peripheral Europe. While European ABS are becoming more attractive, regulatory change is essential to address the un-level playing field and ensure long term revival in the market. ABS offers attractive risk premiums and valuations compared to covered and corporate bonds. Vintage tranches (from the pre-crisis era) offer good quality securities with limited credit risk, often trading below par. In peripheral Europe our focus is on senior tranches as mezzanine debt suffers from a lack of liquidity. CLOs also offer a healthy premium over several other sectors.”
Laurence Kubli and Matthias Wildhaber, fund managers, JB ABS Fund

Convertible bonds
“With 80 per cent of the world’s bonds yielding less than 2 per cent, traditional buy and hold strategies will assuredly deliver uninspiring long-term returns for fixed income investors. Along with certain local emerging bond markets, convertible debt remains one of our preferred fixed income sectors. Unlike traditional fixed income securities, convertible bonds have unlimited potential upside and have significantly outperformed high yield bonds during previous rate hiking cycles. Whilst many debt markets are facing an upper bound for prices, equity markets may move ahead in 2015 despite lofty valuations and heady levels of investor optimism which could engender more market swings. This heightened volatility would suit our protection strategies that sit alongside convertible securities, so aiding capital preservation.”
Tim Haywood, fund manager, JB Absolute Return Bond Fund

Junior bank debt
“The importance of the ECB’s role as the supervisor of the de facto 'European banking sector’ should not be underestimated both as a stick and a carrot to improve the creditworthiness of bank debt, reduce systemic risk and hence act as a positive influence on the prices of banks’ junior bonds. Basel III came into force on 1 January 2014 and until all the new provisions are phased-in between 2014 and 2019, banks will be adding layer after layer of buffers on top of their equity capital to withstand future crises and downturns. With banks becoming safer, their junior debt will also become safer, which is positive for subordinated bonds and should support a further increase in capital gains.”
Anthony Smouha, fund manager, GAM Star Credit Opportunities

Emerging market Bonds
“Differentiation is the name of the game for bond investors. While a lot of emerging market focus has been on BRIC countries, there is a large heterogeneous group of more than 60 countries from which to pick the best opportunities, with different markets and unsynchronised economic cycles. A positive rebalancing story is developing in Central Europe, where most countries have already rebalanced and reduced credit and are now growing faster than in other regions. We are also finding attractive opportunities in a number of small frontier markets, which are currently under researched by the investment community. Sri Lanka and the Dominican Republic are two examples. Although a potentially strong dollar might be a headwind for EM FX in general, opportunities can be found among reforming countries like Poland, Mexico and India. For local bonds, we like to be long in curves where central banks have acted and valuations already offer adjusted yields, as is the case in Colombia.”
Enzo Puntillo, fund manager, JB Emerging Markets Opportunities Bond Fund

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