Pictet goes on defensive over European debt crisis

Private investors should adopt a barbell approach to asset allocation, as they find themselves entering a summer dominated by the European sovereign debt crisis and the risk of Greece defaulting, against a backdrop of significant global economic slowdown, according to Yves Bonzon, chief investment officer at Pictet & Cie.

“That the current era should be defined as a bull market in politics is increasingly true as time goes by,” he says. Today, markets are under the influence of policy making decisions, it is all about politics rather than economics, and asset allocation becomes “extremely frustrating” being very hard to understand and forecast the consequences.

It is a struggle to diversify the portfolio as correlation between assets increases, but two groups of assets have clearly emerged. On one hand, “risk off”, safe haven assets include the US dollar, US treasuries and German Bunds. At the other end of the spectrum, “risk on” assets comprise equities, both emerging and developed, and commodities.

Pictet’s current asset allocation is well balanced between equities, fixed income and alternatives, but, within fixed income, at the end of May government bonds’ exposure was pushed up remarkably to 26.5 per cent from 6-8 per cent, while cash was slashed to zero from 12 per cent.

“Risk has increased tremendously and the only way to protect portfolios is to increase German Bunds (in euro portfolios) and US Treasuries (in all other reference currency portfolios) rather than holding cash,” he says. Long duration instruments are favoured in both.

Pictet’s tactical move, which has a six to 12 month time horizon, corresponds to the growing risk of a policy mistake in the handling of the European crisis, deteriorating momentum in the world economy and the US economy, in particular, says Mr Bonzon.

At the time PWM goes to press, although Greece’s embattled prime minister just won a make or break vote of confidence, clearing the first obstacle to receiving a new €120bn bail-out loan, the Greek government still needs to pass legislation for the austerity measures.

“If you want to protect yourself against the worst scenario, where the Greeks give up on the austerity measures and are out of the euro, then you want to be long Bunds and short the core stock markets of Europe,” he says. The German and French banks, in particular, which have big exposure to Greece, would suffer hugely.

On the other hand, the best way to play a more positive scenario, where some reasonable solution to the crisis is achieved, would be to concentrate government allocation in safe assets, such as German, Dutch and even French bonds, to some extent, and buy a small amount of banking stocks, which trade below tangible book value.

The other recent defensive tactical move in Pictet’s portfolios was to reduce credit to 10 per cent. Spreads and yields have compressed tremendously and high yield levels are the lowest ever, explains Mr Bonzon. Moreover, high yield bonds are not useful for tactical asset allocation as they turn illiquid very quickly, he believes, although the high yield allocation is diversifying from a company point of view.

As to emerging equities, they are “the ultimate beta play within the equity universe”, as the asset class is very sensitive to improvements or deterioration in world growth prospects. “With high level of correlation prevailing in global markets, the one country that is still a reasonable diversifier is China, as long as its capital account remains closed, insulating it from the ups and downs of other markets” says Mr Bonzon. In fact, China is where the modest emerging markets equity exposure – 5 per cent of the portfolio – is concentrated.

Playing safe

• At the end of May, Pictet pushed up government bonds exposure to 26.5 per cent in its balanced portfolio.
• Cash allocations, which were 12 per cent, have been slashed to zero.
• Credit has been reduced to 10 per cent.

Yves Bonzon, Pictet