July-August 2012


William de VijlderDiversification is not dead, William de Vijlder, of BNP Paribas Investment Partners, tells Nick Fitzpatrick. Reaching this point of view was one of the CIO’s best decisions. Financial conundrums are best illustrated with analogies and William de Vijlder has a good one to explain the frustrating relationship that many corporate investors have with risk.
“You are very hot and sitting next to a swimming pool. You want to jump in but are worried. Eventually, you jump in the shallow end.” In his analogy, de Vijlder, who is chief investment officer (CIO), strategy & partners at BNP Paribas Investment Partners, sees the pool as the capital markets, while what is making investors hot is a fear of failing to meet objectives, such as pension scheme funding targets in the case of trustees. When they eventually take action, they risk not taking enough and only get in the water where it’s shallow. It is also a frustrating situation for those fund management firms bold enough to think they may have better answers to investors’ problems than investors themselves have – and BNP Paribas IP, with its 24 investment partners and a diversity of products and strategies, is not likely to be heard saying that it doesn’t. The suspicion is some CIOs in de Vijlder’s position would like to run down the pool side, tipping investors in the water where it’s deeper – though probably with floaty downside protection. It is plain that to de Vijlder, and probably to many other CIOs, there is the delicate task of explaining to institutional investors that their objectives will not be met fully given the levels of risk many are (un)willing to take. “If clients are risk avoiders, you have to accept that, but we have to explain there may be a gap in reaching their objectives. That’s something we have to tell them.” He says it could be for regulatory reasons that some clients have become more structurally risk averse, or because of a psychological fixation with the downside. We live in a time when a client “isn’t bothered about the equity risk premium over the last 150 years”; instead, they want to know their money is safe. Risk-on/risk-off
And the signposts used the most to guide investors through the maelstrom at present are those of “risk-on” and “risk-off”. These seem to pass by investors with even greater frequency and speed as the eurozone boils up and boils down again. Elsewhere in our conversation, de Vijlder says: “Equities are being used as the indicator of risk assets, but there needs to be a broader opportunity set.” It was while the opportunity set appeared to be shrinking that de Vijlder believes he made one of his best decisions relating to investment management during the crisis period: to be “stubbornly contrarian”. By this he means to resist tearing up the diversification thesis. “I’ve never believed diversification is dead,” he says. During the crisis, the range of investment options seemed to many people to narrow as assets correlated. Risk is now simply on the table, or off it. Criticism of the investment-diversification theory reinforced this belief. “Diversification was criticised a lot in 2008 and markets have become more about risk-on/risk-off. Diversification is measured by looking at the average correlation between asset classes, but one can still observe that dispersion of returns between and within asset classes is high, meaning the opportunity set to make good or bad calls is there. Diversification is down but dispersion is still there.” A positive influence of this has been the opportunity to explain the risk anomaly within equities to clients. It has led to an understanding that equities with lower risk levels outperform in the longer run, says de Vijlder. In other words, minimum-variance equities work. “This is about minimum-variance equities and it’s a very positive development. People are more sensitive to it now and it makes people realise there is more in life than just building cap-weighted portfolios.” So, investors have a broader opportunity set than they might think. BNP Paribas IP has seen a “significant increase” in global balanced strategies and has been advising on risk overlays for these. The firm had a total of €513 billion of assets under management at 31 March 2012.­ Safe haven trade
De Vijlder may be right about diversification, but has anything caught out the CIO in the past two years? Yes, he admits. He did not predict to what extent Germany would be seen as a safe haven. “Where we have been surprised in 2011 was how far Bund yields would go down. With the benefit of hindsight we see that we should have put more attention on how far the safe haven trade would go. “When risk aversion becomes so high, prices are bid up.” It isn’t a surprise if de Vijlder feels bruised by this. Fixed income and convertibles make up the largest slice of BNP Paribas IP’s assets under management, or 37% (money markets and balanced are joint second with 18%). Looking at that other main safe haven – the United States – de Vijlder looks aghast at yields there. “I have difficulty accepting 1.5-1.6% on medium-term government bonds as being the equilibrium of the cycle. This would imply either the economic growth rate would be zero or that investors would, on balance, expect inflation to be zero in the medium term, something which is highly unlikely.” Meanwhile, he sees emerging market debt as “structurally compelling. Ratings have improved trend-wise over the past ten years, international reserves are high, and public sector debts are lower there”. Eurozone woes
And Spanish yields are worth a quick glance, too. After all, it is the day after the Greek elections when we meet. “Spanish yields are not declining because of fears that tail risk is still there,” he says. Bond yields may prove better signposts through the market turbulence in the eurozone than risk-on/risk-off, and as de Vijlder digests the aftermath of the Greek election he considers what the signposts of Japanese and US yields are telling us – and the relevance to the indebted eurozone. Like the eurozone, Japan and the US have had high debt-to-GDP levels “for ages”, but continue to have low yields. “This illustrates that markets can manifest patience with respect to the evolution of GDP-debt ratios.” But there is an impatience with the eurozone. “Markets feel that if it drags on it will get worse and worse.” Markets want to see a political cohesion, which is what the fiscal compact agreed earlier this year was about. “It was about gaining credibility, behaving like a disciplined group of people.” Does de Vijlders, who came to BNP Paribas IP from Fortis Investments following the 2010 merger, have confidence that Europe’s leaders will pull us through the crisis despite their unconventional monetary policies that make investors too scared to jump in the pool? “I’m of the opinion that in the end they will get there, but it is taking a lot of time – and, in fact, too much time.” ©2012 funds europe 

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