INVESTMENT MANAGEMENT: The renaissance of risk

Pioneer Investments believes it is time for investors to allocate more to risk assets. Special report by Funds Europe in association with Pioneer Investments.

Investors’ confidence in capital markets and how they truly feel about the level of economic recovery are likely to be laid bare in the next few months should the US Federal Reserve reduce its bond purchasing programme, known as quantitative easing.

Like many investment professionals, Tanguey Le Saout, head of European fixed income at Pioneer Investments, expects the Fed to taper its bond buying – and thinks this may start sooner than many people think.

“If non-farm payroll comes through strongly, I think the Fed could start tapering by September. The market is not pricing this in so soon, but if tapering happens it will be before the change of Fed chairman.”

Incumbent Ben Bernanke’s term ends in January 2014.

The Fed will only start tapering if it thinks the economy is recovering, hence why Le Saout is watching payrolls. But should the reduction in bond purchases happen, markets would be at a crucial juncture.

It would challenge investment professionals’ convictions about the state of global finances once the support of quantitative easing is pulled back.

“The partial withdrawal of quantitative easing is good for markets in the sense that it will show how good the fundamentals are,” says Le Saout. He spoke on this topic at the company’s annual investment conference held in Dublin in June. The main message that Pioneer, which called its conference “The Renaissance of Risk”, put over was that investors should consider adding more risk to their portfolios. This means buying even European equities, which have seen a year-long rally.

But this does not suggest that Pioneer expects an imminent recovery in European economies.

Speaking at the conference, Giordano Lombardo, group chief investment officer, said: “Five years into the crisis, I believe we are living in an environment that is not more stable, but that is even more unstable.”

One of the causes of instability is an increase in public sector debt and decrease in private debt.

Also, contingent liabilities – those intergenerational liabilities such as pensions – are burdensome, particularly in the US and the UK, but also in certain European countries.

“Our generation, or the generation before us, has kind of betrayed the generation that comes next,” says Lombardo.

“How can we expect these people to pay for our pensions if they have no job?”

IM boxAnd though central banks have employed quantitative easing, or similar measures in the case of the European Central Bank (ECB), in order to support economies, Lombardo says a world “awash with liquidity” only creates further risks.

There is the risk of asset price bubbles – not just in fixed income, an asset class that has benefited both from quantitative easing and from the search for yield that investors have been engaged in, but also in dividend-paying stocks, which are also a beneficiary of the yield hunt. Lombardo stressed, however, that he did not predict this bubble in one particular corner of the stock market to be imminent, just potential.

The picture gets worse. Despite the massive efforts of central banks and government, it is the wealthy that are benefiting most from all the liquidity. Rather than flow into the real economy, the liquidity has instead boosted wealthy asset owners’ net worth (Lombardo notes Manhattan property prices have gone sky-high).

“If this is the case, then, why is it rational to be long on risk assets?” says Lombardo.

Pioneer, which has €165 billion under management, increased its allocation to European equities when its sentiment turned positive relative to a previous preference for US equities in June last year.

Notably, this was before the July announcement by Mario Draghi, president of the ECB, to do “whatever it takes” to save the eurozone from collapse. The climb in equity markets across Europe in recent months can be dated to that speech.

Lombardo notes that 75% of fiscal reform in the eurozone has happened already, while most eurozone countries are close to balancing their current accounts. The eurozone as a whole is running a trade surplus.

Meanwhile, the US is ahead in the cycle of recovery and is forecast to become a net exporter of energy.

“It’s absolutely right to consider risky assets and particularly equities. They offer better value than any other alternatives, especially bonds, and they have a better risk-reward profile in the longer run.”

Although there has been fear about European equities, there is a demand for the asset class. Lombardo said the chief investment officer at a European insurer wants to buy the asset class but could not for regulatory reasons. An Asian sovereign wealth fund also wants the assets.

Yet equity allocations by some institutional investors have been decreasing.

Looking at Mercer research, Diego Franzin, head of equity, Europe, at Pioneer Investments, notes that UK pension plans have decreased allocations from 68% in 2003 to 39% in 2013, and that it
is more or less the same trend globally.

Yet he says: “In relative terms,  equities are extremely cheap relative to cash and bonds.”

Both Lombardo and Franzin agree that the average allocation to equities by investors is too low.

©2013 funds europe



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