Safety first for clients wary of equity markets

Many private banks are finding themselves at an impasse with their clientele. Having lost trust in wealth managers since the 2008 global financial crisis, clients are petrified of risky investments and anything linked to stockmarkets. Most are seeking refuge, rightly or wrongly, in what they see as fixed income havens. It is up to their bankers to advise them about how to diversify the risk of these increasingly concentrated portfolios.

“After the Lehman Brothers collapse, the confidence of private clients, in terms of investing in any assets, not just equities, has simply never returned,” says Manuela D’Onofrio, head of global investment strategy at UniCredit’s private banking division.

Even having a conversation about equity investment is difficult with most clients, confesses an exasperated Ms D’Onofrio, who sees value in equities against poor yields in German Bunds, Japanese government bonds and US Treasuries. “Either you lock yourself up into negative real yields, or you buy equity, if you want a positive return,” she says.

The one common denominator across UniCredit’s private clients in Italy, Germany and Austria is fear, with many unsure about which currency they will use in the near future, should the euro break up. “The kind of fear they are gripped by today is very different from that of 2008,” says Ms D’Onofrio. “Before the crisis, their only fear was of missing upside or of the value of their portfolio fluctuating.”

The common perception amongst her clientele is that bonds are still much safer than equities, although the events in Greece, Ireland and Portugal have shown this is not always the case in reality. To accommodate her clients’ concerns, Ms D’Onofrio is shifting big chunks of these overwhelming fixed income allocations to corporate bonds.

“Since 2009, the balance sheets of many corporates are much safer than governments, so we have decided to invest a significant proportion of our bond portfolio into investment grade corporate bonds.”

A parallel shift to developing economies also mirrors her belief that these countries are better financed and provide a safer haven than the developed world. “Ours is a very diversified bond portfolio with significant exposure to corporate bonds in the US and emerging market debt, with only 25 per cent invested in Eurozone government bond markets,” explains Ms D’Onofrio.

This is a totally different proposition to her fixed income views of 2007, which saw quite the reverse, with UniCredit’s pre-crisis bond portfolios heavily biased towards European rather than Asian and Latin American debt.

“We used to tell people to do a bit in Europe first and then look at emerging markets,” she remembers. “But emerging markets bond funds have become the safe bet, as they are a non risky move. Previously, clients would have stayed with their local bias. That will probably not reverse so quickly.”

While clients in bonds are undoubtedly losing money, they are losing less than they would in a fully allocated equity-biased portfolio, believes Jane Fraser, CEO of Citi Private Bank Emea. “They will take some profits and then not commit to risky assets unless the return is worth the risk,” she confirms.

She too favours debt issued by corporates, that are “lean, mean and efficient,” offering strong but unspectacular revenue growth and strong operating profitability. “Even when the world falls in, people will still use cell phones, electricity, and need to buy consumer goods, so the companies that produce these will remain safe havens.”

In fact she favours these multinational corporates more than the emerging market debt recommended by many private banks such as UniCredit. “Emerging countries tend to be more volatile and their capital markets are not as deep,” says Ms Fraser. “Core expectations in emerging markets have come down quite a lot and will continue to do so,” with Asian investors in countries such as Indonesia and Singapore increasingly worried about contagion from the Euro crisis.

Although Citi are fans of “good, diversified emerging market portfolios, containing some great fixed income ideas from around the world,” clients that buy these portfolios tend to be from the fast-growth regions themselves, allowing them to identify more closely with the assets they are buying. “People tend to look for familiarity in times of fear,” says Ms Fraser.

Equity fund managers, witnessing these trends of reluctance to invest in stocks among clients, are also ready to unleash more fixed income firepower to their distribution partners. “We see exactly the same trends in the UK, Europe and the US market place in terms of the predominance of assets flowing into fixed income,” says Andrew Owen, head of marketing, investments and product at Wells Fargo Asset Management, the $400bn (€317bn) US group which is making increasing inroads into European distribution markets.

“People’s portfolios are not as balanced and aligned to strategic allocations as they should be. There is definitely a fear factor out there.”

Indeed the group is looking towards the imminent launch of a global bond fund. “We will be looking from a credit perspective, a corporate and sovereign perspective and a currency view to determining where everyone should be invested, and even more importantly, where they should not be. We will be providing fixed income exposure along those lines,” confirms Mr Owen.

Hedge fund inflows tilt towards fixed income

Very few European market participants have a view about the aftermath of the European monetary party which started on 31 December 1998 and lasted the best part of a decade, believes Stefan Keller, head of managed account research at Lyxor Asset Management.

This means most investors are reluctant to make strong bets, wary of anticipating future policy measures related to austerity or growth stimulation, quantitative easing, a euro break-up or further integration of economies.

Instead, we are facing a flow of assets into a dwindling number of safe havens such as US Treasury bonds and German Bunds – where yields are at record lows – as investors scramble for safety.

“Investors are no longer searching for yield; that belongs to the past,” says Mr Keller. “They are searching for a place that is perceived to be safe. But we don’t know if that perception may be proved wrong over time.”

Right across the hedge funds universe, Lyxor has seen a marked shift in investor sentiment over the last six months, with clients preferring those funds with a fixed-income bias, rather than vehicles investing in equity or commodities.

This means increased flows into relative value strategies, fixed income arbitrage – where the managers use sector allocation and techniques and choose individual bond issues in the same way as traditional equity managers – and long-short credit, with a bias to emerging economies.

“This is the first time in recent history, where we have had a global financial crisis, where emerging countries came out stronger than they were before the crisis,” says Mr Keller.

He cites managers on the Lyxor platform – such as Income Partners in Hong Kong – significantly increasing exposure to bonds of Asian financial institutions, with no exposure whatsoever to peripheral European debt.

Lyxor’s analysis of CTA funds carried on its platform shows a risk budget of just 8 per cent of total exposure allocated to equities, compared to 25 per cent in 2009, while risk exposure to bonds has surged from 25 per cent to 55 per cent over the same period. Mr Keller, however, believes this is a temporary situation, with secular investment opportunities during the next 12 to 18 months signalling a major shift back of out bonds towards equities, once valuations have been crushed, allocations have reached their lowest point and improved regulatory frameworks are in place.

Citi’s private banking CEO Jane Fraser also has a keen eye on alternative assets for her clients, recommending allocations into carefully selected CTAs.

In addition, she is putting clients on alert about forthcoming distressed debt opportunities. “We are not necessarily buying yet, as it takes a remarkably long period of time for the market to go down,” she says. “But it will happen faster than you expect and you need to be ready with dry powder, but don’t use it all at once.”