At BNP Paribas Fortis, the bank has seen its private equity business double and even triple in recent years. Corporate bonds have gradually replaced nominal government bonds, as have high yields. And they are investing more and more actively, which is linked to the rise of thematic investing.
This is shown in a conversation between Philippe Gijsels (photo) and Investment Officer’s sister publication in Belgium, as part of a series on asset allocation in a lower interest rate environment. Gijsels is the chief strategist of BNP Paribas Fortis.
Ranges
The tactical ranges (for a neutral portfolio towards 50 per cent in equities, with a margin of 7 per cent up and 7 per cent down) have not changed at BNP. A dynamic portfolio still invests 80 to 90 percent in equities.
However, the composition of the portfolios is becoming increasingly customised and sometimes the allocation is decided on an ad hoc basis, said Gijsels. “Flexibility is therefore more the watchword than before and the allocations are reviewed more actively and more regularly than before.” He continued by explaining “It’s not like the old days, where you drew up a contract once and for all and didn’t adjust the allocation anymore.”
In the portfolios that allow it, the strategist encouraged looking for alternatives such as corporates, high yield, dividend stocks and structured products. It’s a way to get returns without going too high on the risk curve, he explained.
“But you mustn’t overdo it. High yield is actually ‘higher yield’,” he explained. “It provides slightly more return than investment grade, but the difference is limited.” He then explained that “too much” high yield is not an option either. “Then you have the risk of a share without the upside,” he said. “I am not in favour of that.” He explained that investment grade corporate bonds are also an option.
The problem of low interest rates is especially relevant for defensive portfolios, as the addition of equities again adds risk. Clients then find themselves with more risk in their portfolios, which is not always appropriate. ”It remains advisable to be cautious about this,” said Gijsels.
Concrete
BNP calls private equity ‘concrete’ because it is an investment that is fixed for several years. At BNP, private equity falls outside the management of the portfolio.: “You do not follow this up on a daily basis,” said Gijsels. “The entrance fee is also bigger, often 250,000 euros, so it is only reserved for the wealthier clients”.
At BNP, they want to get a good spread, both in time and in terms of asset classes. “After seven years, a piece is usually released, and you can then invest it in the next project,” Gijsels explained. “In this way, you can use the released money to make an investment that builds up attractive averages.”
At BNP, private equity is a business that has grown two to three times in the wealth portfolios in recent years. Of course, this has to do with the average returns of 15 to 16 percent in recent years, which of course are offset by a higher illiquidity risk.
Not cheap
Gijsels also warned against the enormous popularity of the market, which means that private equity is currently “certainly not cheap anymore”. “There is too much cash chasing this market, which reduces returns,” he said. “Those who can go along with PE and have the capital for it, we recommend doing it.” He described “a wave” of IPOs on the stock exchange, the biggest since the 1990s. “Companies come to the stock exchange later, so the value creation happens earlier in the life cycle of the company, when the companies are still private,” he explained “Private equity can also be mezzanine debt or hybrid bonds, but mostly equity.”
The advantage of private equity, according to Gijsels, is that you do not always see the course that is being formed. Clients sometimes feel they run less of an equity risk because you don’t always have a listing. That also gives mental peace. The risk is then less ‘palpable’.
He mentions the example of Microsoft. If you had subscribed from the first listing, you would have made an enormous return, but now you see that companies only go public when an enormous amount of added value has already been created and some of the fat has already been removed from the soup.
Correlation
In addition to low interest rates, the correlation between equities and bonds has become an issue among investors. This used to be negative, but nowadays this is less the case. Currently, especially corporates and high yield are strongly correlated with equity markets.
BNP also notes this problem. “The negative correlation that used to be protected, has largely disappeared,” said Gijsels. “We also saw this during the correction in February-March 2020 and during the correction in 2009.” Then, he explained, everything fell in unison.. “That is very difficult for asset allocation specialists, because commodity markets and even gold are positively correlated with equity markets,” he continued. “Gold is also sensitive to rising interest rates.”
Active or passive
Asked about the current relationship between active and passive, Gijsels explained that BNP does not think in terms of active versus passive, or at least not initially. The bank has shifted more towards themes. ”In the last couple of years, we have again shifted more towards active management, said Gijsels, “because we look less at sectors and more at themes such as alternative energy and commodities.”
This does not solve the problem of correlation, he emphasises. On the contrary. After all, these themes are also correlated with each other. Last year, smart energy and clean energy in particular rose, but they are also strongly correlated. Many shares are found in funds around these themes.: “You used to find General Electric and Siemens everywhere, now they are mainly the FANGs, so everything is correlated, Gijsels pointed out.”
According to Gijsels, passive versus active also depends on the market in which you invest. For example, the S&P500 is a very efficient market and the chief strategist tends to buy passive products there. “At BNP, we also have open architecture next to our own in-house funds,” he said. “It happens regularly that we believe that we can play a theme better with an external manager,” he continued. “The split with us is 50/50 house funds and external funds.”
In the past, BNP used to invest more passively and we focused on the asset allocation, and only then on the interpretation.: “For the first time in years, I see a bigger switch to active management, which is also logical in this phase of the cycle,” said Gijsels. “To a large extent, it has to do with the themes in which we invest.” He explained that such themes as robotics, cyber security and the like are more likely to be actively addressed, “because a knowledgeable manager can add more value here.”