Stimulus measures and recovering economies support investment in risk assets like equities. Pioneer Investments advocates risk, but says diversification is more urgent.
Pioneer Investments has advocated risk assets for its clients in Latin America and other regions for two years, but this year the asset manager has argued that continued uncertainty calls for a need to use sophisticated ways of diversifying portfolios.
Investing long in risk assets over 2013 was the correct choice. Last year small-caps outperformed large-caps and high yield bonds outperformed investment grade bonds, Pioneer Investments told clients at its annual investment conference earlier this year. Risk assets have held up in 2014, too.
At the event held in Boston, US, were 120 fund selectors from 20 countries, including countries in Latin America.
However, Giordano Lombardo, chief investment officer, said that though long positions on risky assets still make sense, sophisticated diversification is made necessary by record highs in stock markets, interest-rate risk, and other factors.
The projected extra return coming from risk assets is already lower compared to the recent past, said Lombardo.
“In some areas of equities, like European equities and pockets of emerging markets, there is good value, but investors need to broaden the range of asset classes by adding alternatives and illiquid asset classes, though with some caveats,” he said.
Risk assets are still affected by uncertainty stemming from central bank policy in the US and other parts of the world and it is this uncertainty that leads to a need for diversification. Only recently, in September, the European Central Bank surprised markets by introducing a stimulus programme that included the purchase of asset-backed securities – a measure similar to the Federal Reserve’s quantitative easing. Specifically, Pioneer is advocating diversification through multi-asset funds or funds such as absolute return bonds, which invest in single asset classes but are able to employ multiple strategies with lower correlation to market direction.
The theme of Pioneer’s investment conference was “evolution progress accelerated”, conveying the need to employ flexible portfolios at a time of anticipated lower returns, higher volatility and rising interest-rate risk, while still being able to chase income or capital appreciation to meet specific investment goals.
A year earlier, at its 2013 client conference, Pioneer advocated shifting to risk assets. At this year’s conference, Lombardo told the Boston audience that Pioneer’s long stance on risk had continued through 2013 and 2014 but that building more balanced and diversified portfolios would be a better strategic choice.
One delegate questioned why the emphasis given by many investment houses on risk assets since last year had not triggered a large-scale shift out of bonds and into equities. Tanguy Le Saout, head of European fixed income at Pioneer, said there were explanations, such as the challenging decision-making process many investors go through to make large bets, and their propensity to “find a good excuse” to stay in fixed income.
“It will take another leg of a bear market for people to move their money,” Le Saout said, referring to the bearish period for bonds following the Federal Reserve tapering news in 2013.
Speaking more recently, after the ECB stimulus announcement, Le Saout said the ECB measures were positive for the credit market and should lead to tighter spreads, particularly in the financial sector where banks will be incentivised to borrow. Further, the measures are “all positive for the European economy and should help underpin the recovery in economic conditions”.
ALPHA AND BETA
Pioneer, a global investment house owned by Italy’s UniCredit bank, advocates the separation of alpha and beta drivers for a sophisticated pursuit of return, at a controlled level of risk. This separation means that a beta return can be combined with non-correlated alpha sources, whether in multi-asset strategies, or single strategies. Essentially, this approach starts with the careful selection of a beta source, which might also include an alternative beta to boost the return; and then finally seeks to add sources of non-correlated alpha.
Examples of non-correlated alpha in Pioneer’s fixed income portfolio between December 31, 2008, and December 31, 2013, include the combination of interest rates in Asia with Scandinavian interest rates, which gave a return of 8%. Combining Asian rates with a relative value strategy gave a 7% return. Also, an investor could have seen a return of 28% by combining US and eurozone interest rates.
The examples are taken from the Pioneer Euro Aggregate Fixed Income portfolio.
Matteo Germano, global head of multi-asset investments, said it was important that investors do not lose sight of their investment objectives, such as funding liabilities. He acknowledged that a lot of conservative and defensive investors did not want to take on too much risk in the current climate. But for Pioneer this is why investors ideally need portfolios that can adapt to change by shifting between return sources – allowing them to be long, but be careful.
Investors’ concern about risk was reflected in an audience poll. Nearly half of the 120 fund selectors at Pioneer’s conference said they expected asset price bubbles to be the main effect of QE, rather than more positive outcomes such as a return to growth. QE, which has seen America’s Federal Reserve and the Bank of England purchase a large amount of bonds to stimulate economic growth, has kept rates low and given investors little choice but to chase higher yields in riskier assets.
Tapering of QE in the US is primarily responsible for the retreat from risk over the past months, with many large investors exiting emerging markets.
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