Quintet Private Bank is shifting its strategic asset allocation to a global asset allocation framework. “Focusing your bond portfolio on Europe has a lot of jeopardy in it,” says CIO Bill Street in an interview with Investment Officer.
“We are moving all our clients to a strategic asset allocation that’s truly global in nature,” says Street, who joined Luxemburg-headquartered Quintet as Chief Investment Officer in 2019. The shift not only concerns the equity portfolio but also fixed income.
According to Street, wealth managers and banks that continue to invest the low-risk part of their portfolio predominantly in European assets are effectively fooling themselves. “Focusing your bond portfolio on Europe has a lot of jeopardy in it, and this is not only because a large proportion of the European bond market is negative yielding. That’s not the conversation you want to have with your clients anyway,” he says.
Increasing correlation
The guarantee of low returns is not the only issue with investing in European bonds, Street adds. “The challenge in the European market is that bonds and equities increasingly move in concert. There is an increasing correlation between equities and bonds, and part of this has to do with negative yields.”
Because bond yields are already so low, European bonds currently cannot compensate for losses on equity portfolios during risk-off events. This was demonstrated during the coronavirus outbreak when European investment-grade bond and equity indices fell in tandem.
Diversification benefits
It’s therefore recommended to diversify your bond portfolio away from Europe and into assets that may look like higher-risk investments at first sight, such as US high yield and emerging market debt. “Higher volatility in the short term may generate diversification benefits over time,” says Street. “Because of their lower correlation and higher return characteristics, you end up with a much better diversification of risk than if you’re heavily Europe-focused in your bond portfolio.”
Until recently, high currency hedging costs held back many European investors from investing in bonds denominated in a currency than the euro. But this argument is no longer valid as the interest rate differential between the US and Europe has all but disappeared since the outbreak of the coronavirus pandemic, Street notes.
It’s quite possible, however, that US interest rates will at some point rise again. This could leave US bond portfolios exposed to losses, not least since US bonds tend to be of higher duration than those in Europe. “We have already seen a pick-up in yields in the US, but that hasn’t damaged portfolios as credit and equities were performing better and compensated for losses on Treasuries. That’s the benefit of a globally diversified portfolio,” argues Street.
Street is not too worried about the current rise in inflation, which he thinks will be transitory. “It will take years to get up to a pain trade as there still are many things the Fed can do, such as tapering their bond-buying, before they will start hiking rates,” he says. Street is therefore comfortable maintaining a bias for US Treasuries over European government bonds.
Ageing
Moreover, the recent news that the US population is ageing much more rapidly than previously thought because of declining immigration numbers and birth rates means bond yields will probably remain depressed for longer. “Ageing societies are good for bonds as this means there’s much greater demand for duration,” notes Street, who immediately draws the comparison with Japan, adding: “When I first started in the markets in the early 1990s, I was tasked with trading Japanese government bonds, on what we called graveyard shifts. At the time, Japanese 10-year bonds were trading at 48 bps.”
As we all know, Japanese bond yields have edged gradually lower in the subsequent decades, while Japanese government debt ballooned. US government bond yields could well follow a similar trajectory, Street believes. There is, however, one major difference between Japan and the US: Japan is able to finance all its debt domestically while the US is running both a record-high current account deficit and is currently racking up debt at an unprecedented pace.
This need not lead to a spike in US bond yields, however, according to Street. “The US can tolerate this [twin deficit] as it is the world’s reserve currency and reserve bond market. So it can afford to expand its debt-to-GDP ratio.”
Alternatives
The other big change in asset allocation that Quintet has been implementing in recent years relates to the low-interest rate environment. The private bank has followed in the footsteps of many institutional investors by paying more attention to non-listed assets, which according to Street “have an incredibly important part to play going forward, providing increased yield and return, as well as correlation and diversification benefits”.
Street, however, declines to be drawn into the question of exactly what percentage of total investments should be allocated to alternatives. “It all depends on the client. If they have a high risk tolerance and no liquidity needs, illiquids are for them. But we’d never go to a client saying they must invest x% in alternatives without first having an individual discussion with them.”
Bill Street
Bill Street was appointed Group Chief Investment Officer at Quintet Private Bank in September 2019 and is based in London. He previously served as Chief Investment Officer, EMEA, at State Street Global Advisors, where he worked for over a decade. Previously, he served as Head of Fixed Income at UniCredit. He earlier served at Bankgesellschaft Berlin, Commerzbank, Banque Indosuez and J.P. Morgan.