At ABN Amro, clients have shifted to a higher-risk investment profile. Whereas previously the most popular profile invested mainly in bonds, this has now changed to a profile investing 55 per cent in shares, explained Richard de Groot of the bank an interview with Fondsnieuws as part of its series on asset allocation amid the current low interest rate climate.
Low interest rates affect the bank’s asset allocation in two ways, says De Groot, who heads the Global Investment Centre. Expected returns are lower and the cohesion of portfolios is changing.
“In many conversations with clients these days, you have to tell them that a target is harder to achieve because returns are getting lower,” he says about the first issue. “Many clients invest with the aim of preserving their assets, adjusted for inflation. In the past, with the defensive profile 2, one achieved sufficient return for that objective. But now one has to move up to profile 4 for capital preservation. Then more than half of the portfolio in equities.”
Protection lost
With the changed consistency, the second consequence of the low interest rate for asset allocation, he refers to the characteristics of bonds within a portfolio. “Bonds were the safe part of the portfolio, giving protection when equity markets went down,” he explained. “But with interest rates so low - certainly in Europe - you lose that protection.”
For the bank, there are therefore two questions: where do we get returns from and what choices can we make to protect the portfolio or actively take account of the changed correlation?
In the tactical asset allocation, ABN has therefore added risk to the high quality side within the fixed-income part, by favouring the periphery over safe countries like Germany and the Netherlands and increasing the allocation to corporate bonds. Within the high return part, meanwhile, the bank opts more for high yield and emerging markets to get a bit more return. At a more detailed level, ABN Amro is tactically underweight in high quality, particularly in safe government bonds. It’s also overweight in high return.
Watch out
As for whether the bank is considering changes to its strategic asset allocation because of low interest rates, De Groot says you have to be careful with that. “If we were to change the strategic equity exposure of our six investment profiles ourselves, we would change the risk profile,” he said.
A client will therefore have to change his risk profile himself if he wants a higher expected return. And that does happen, the bank notes. Profile 1 and 2, the most defensive profiles, are hardly chosen because they yield so little. The most popular is profile 4, which has a 55% share in equities. This is followed by profile 3 (55% bonds, 35% equities) and then profile 5 (75% in equities, 15% in bonds). “’That’s a shift compared to five to ten years ago, when profile 3 was number one,” De Groot said.
However, the bank does have the option of moving towards greater equity exposure within a profile. Profile 4, for instance, has a 55% strategic exposure to equities, but that can be increased to 75%. “So we don’t feel restricted in that respect,” he said. “But here too, the rule is: if you were to structurally increase your exposure to equities, you would be changing your risk characteristics.”. He added: “We can’t just do that unilaterally.”
Higher risk
The bank always tests a change of risk profile: can and will a client accept a higher risk? If not, there may be an opportunity to invest a larger amount in order to still achieve the target, or: there is nothing to do but to establish that a target is not realistic given the current risk-return characteristics.
Does this shift from the client’s point of view require the addition of extra risky profiles? De Groot does not see much room for this, as profile 6 already invests 90% in equities. “The reality is that expected returns are lower due to low interest rates,” he said. “Even with higher risk profiles, it remains limited to 4 to 5 per cent. De Groot says the bank expects that the interest rate in Europe will remain low for the time being, and that those expected returns will also remain low in the coming years. “Of course, you can invest in bonds in other currencies, but then you add currency risk,” he added.
Private markets
When asked to what extent private markets can play a role in the strategic asset allocation, De Groot replied that the bank was indeed looking into this. “In the higher risk profiles, you could add up to 30 per cent in alternative,” he explained. “That could be hedge funds, but also private markets.” The bank certainly advises investing in them, but only if it suits a client. “It is only for clients with a longer investment horizon, who also understand this kind of complex investment,” he said.
The bank advises clients who want to invest in private equit, to do so for at least ten years. “Of course, you don’t lose all your assets for ten years, as we spread them over managers and maturities and there is a continuous cash flow, but in principle you want to go the whole way,” he said.
At present, the bank offers private equity for investable assets of EUR 5 million and above, but it is considering lowering this entry threshold to EUR 3 million.
Embedding sustainability
Apart from the low interest rate, another subject that also concerns the bank in the area of asset allocation is how to incorporate the theme of sustainability. “At the moment, we distinguish between sustainable concepts and traditional concepts,” he said. “In gold and commodities, for example, we do not invest within the sustainable concepts, but we do invest within the traditional concepts.” He continued, explaining that the bottom line is shifting. “The question arises whether you still want to allocate to commodities,” he explained. “Yes, we are wrestling with that.”
Richard de Groot is global head of the investment office of ABN Amro, in which capacity he is responsible for portfolio management and research activities within ABN Amro Private Banking. Previously, he was director of asset management and head of asset management at ABN Amro MeesPierson. De Groot has worked for the major bank since 2001.
This article is part of a three-part series on asset allocation in the current low interest rate environment, made by Fondsnieuws and sister platforms Investment Officer Belgium and Luxembourg. The two other interviews were with Bill Street of Quintet Private Bank and with Philippe Gijsels of BNP Paribas Fortis.