More exposure to low-volatility European equities, high quality bonds in the U.S. and a bit in liquid hedge funds, and less to high quality European corporate debt, lower quality corporate bonds and gold. These are the portfolio shifts Luxembourg-headquartered Quintet Private Bank advises to its clients in its latest midyear investment outlook.
“We have a slowing economy. We have slower inflation, much more visible in the US than in Europe, which is actually very supportive for these asset classes,” Daniele Antonucci (photo), Quintet Chief Economist told Investment Officer. “Slowing growth and slowing inflation is supportive of high quality markets in general. That’s why you can see that kind of contrast for example.”
Peak inflation is the theme that drives the global economic outlook during the second half of this year, Quintet said, especially in the US, where the Federal Reserve now is expected to pause hiking rates. While eurozone and UK inflation remain elevated by comparison, that trend is expected to moderate over the coming months, argues Quintet’s Antonucci, who expects the European Central Bank and the Bank of England will pause their hiking cycles at some point later in the year, eventually following in the Fed’s footsteps.
Against that backdrop, high-quality bond markets look attractive as history has shown they tend to outperform equities in such conditions. “At a time when six-month Treasury bills are yielding as much as the S&P 500, the near-term risk-reward for equities appears unfavourable relative to high-quality bonds,” said Nicolas Sopel, Quintet’s senior macro strategist.
Healthcare, consumer staples
This perspective has led to a tweak in portfolio recommendations. “We have lowered our exposure to US equities to somewhat below normal, to less than before. Like with bonds, we have an increased exposure there, while we are more cautious on equities, and we have a slightly reduced exposure there,” said Antonucci.
Among corporate bonds, Quintet’s exposure is largely to large capitalization corporates. “Typically, the sectors where we are exposed at this stage are what we will call the more defensive sectors, like healthcare, consumer staples. We like low volatility assets, low volatility equities - bonds are less volatile than equities anyway,” Antonucci said.
Asked about alternative investments, Antonucci said that for sturdy portfolios it may make sense to add exposures to for example liquid hedge funds while reducing exposures to gold. “It depends on the time horizon of the client, the risk appetite. What type of diversified portfolio you want to have. We thought it makes sense, in our flagship funds and also in teh portfolios that we build, to have alternatives - liquid hedge funds as an example - across several strategies.”
Four strategies
Quintet operates with four strategies, Antonucci said. The first is directional, which is determined by the macroeconomic outlook. It’s basically “trend following”, he said, referring to investments in interest rates, foreign exchange, equity indices. “You invest with a conviction on the direction of the market.”
Secondly there is “equity long-short”, which bets on the projected rise and fall of individual stocks. Third comes “relative value‘, an approach with a focus on discrepancies in terms of valuations between securities. The final strategy is called “event driven,” focused on specific corporate events such as mergers and acquisitions, or corporate restructuring.
”The goal is to have diversification play a bigger role in more defensive portfolios,” Antonucci said. “If a portfolio was majority equities you wouldn’t need that. If you look at a cautious portfolio with 7.5 percent in liquid alternatives, it gets reduced the more the share of ties in the portfolio increases.”
Sopel noted that the potential upside for equity performance is limited during the second half of the year. “We therefore do not believe it is time to re-risk portfolios yet,” he said.
Eurozone equities are regarded as fairly valued. “Shares that blend the eurozone with defensive markets such as the UK and Switzerland – and simultaneously give a higher weight to defensive sectors like healthcare and consumer staples – could outperform the market if we see a spike in volatility or a downturn.”