Investment Perspectives 2021 | Mid Year review & Outlook

Executive Summary

The economy is largely recovering as expected

Eighteen months after the onset of the Covid-19 pandemic, the global economy is experiencing its most robust post-recession recovery since World War II. The rebound is, however, very uneven across countries, as major economies are faring much better than many developing ones. Some countries have nearly lifted all their restrictions while others remain constrained by a resurgence of Covid-19, or by the fast spreading of the Covid-19 Delta variant. According to the World Bank, global growth is expected to accelerate to 5.6% this year, in large part thanks to the strength of the US and China. The level of global GDP in 2021 is still expected to be around 3.2% below pre-pandemic projections, despite this year’s recovery. For the remainder of the year, the outlook looks favourable for the US and for Europe but more complicated for the Asian region.

Fiscal stimulus continues to be supportive

Monetary support has reached its peak, but it is still massive, however fiscal support will continue to significantly impact economies in the years ahead. As in the case of vaccine rollouts, fiscal support has been very uneven across the different regions and the recovery is set to be unequal between countries, with developing economies forecasted to take longer to regain their pre-pandemic activity levels. Advanced economies have already benefited from much larger fiscal packages and they will continue to do so in the future. In Europe, the recovery plan is significant in size, while the different US relief bills have already amounted to more than a quarter of US GDP. An additional $1.2 trillion US infrastructure bipartisan plan is on the brink of being approved, while a separate bill designed to fund key Democrat priorities could also be pushed through the reconciliation process. All this to say that fiscal stimulus is far from being exhausted.

The second half likely to be more challenging for financial markets

Financial markets have been rewarding so far this year, mainly thanks to the contributions of equities, emerging market debt and high-yield bonds. Volatility has also been trending lower in a context of strong appetite for risk assets. The quarters ahead, however, are likely to produce more modest returns for the portfolios and the risks of higher volatility are rising. In view of elevated inflation risks and our expectations of higher bond yields, our fixed-income exposure has an overall low duration risk and a very underweight allocation to investmentgrade bonds. We still believe that it is too early to go into an overly defensive mode, hence our significant exposure to risk assets. The markets’ focus will continue to be on inflation risks and on the Federal Reserve’s communication as to how and when they will start to withdraw some of their support to the markets. Were high levels of inflation to persist, the pressure on the Fed will only keep increasing and markets could lose some of their serenity.

We maintain a dynamic positioning of the portfolios

Our portfolio positioning remains dynamic with an overweight towards equities, a low level of cash and a fixed-income allocation which is focused on emerging market debt, high yield credit and convertible bonds. Our equity allocation is well diversified across investment styles, regions, and market capitalisations. Our assessment is that European and UK equities still offer significant catch-up potential, and we are also confident about the capacity of our Japanese equity exposures to bring worthwhile contributions to the portfolios in the quarters ahead. The main driver of credit performance will be carry as further spread compression will be limited, and we expect convertible bonds to perform better, in relative terms, than during the first semester. In the next section of the document, we will evaluate the macro environment and the prevailing financial conditions by highlighting several key indicators that we observe. Following a brief overview of the first half returns of the different asset classes, we will outline our current market outlook and asset allocation.

 

Table of contents

  • EXECUTIVE SUMMARY
  • THE MACRO ENVIRONMENT
  • FINANCIAL CONDITIONS
  • FINANCIAL MARKETS 
  • MARKETS' OUTLOOK
  • ASSET ALLOCATION 2nd HALF 2021

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Investment Perspectives 2021

Executive Summary

2020 was one of the most dramatic years for financial markets

The past year has been a rollercoaster ride for investors as the fastest equity market correction in history was followed by a swift and relentless rally. Equity markets have proven to be very resilient and very forwardlooking as they quickly priced in a strong rebound of earnings for 2021. This has been reflected by a significant re-rating of valuations which leave little room for any disappointments related to the publication of profits in the year ahead.

The Federal Reserve intervened decisively to address the severe dislocations observed in the bond markets, a key element to re-establish confidence. In addition to purchasing Treasuries and investment-grade corporate bonds, the Fed also committed to buy high-yield bonds for the first time ever. Once markets had stabilised, another strong trend was for the US dollar to depreciate against most currencies. The market broadly expects this behaviour to be extended into 2021.

Policy makers did their job in 2020

Central bankers and governments reacted promptly and decisively to support the economy and to limit the damage caused by the pandemic on businesses and households. Record-breaking aid packages and unprecedented support for financial markets were announced. The Federal Reserve slashed its benchmark interest rate to zero and committed to an unlimited expansion of its bond purchasing programs. The ECB also ramped up its asset purchase program and has recently announced an additional increase of €500 billion to a total of €1.85 trillion until March 2022.

The overall size of fiscal action globally has also been unprecedented, at about $12 trillion, close to 12% of global GDP, according to the International Monetary Fund. With economic activity being restricted by governments, their main objective was to prevent massive unemployment and to help businesses to survive the pandemic-induced shutdowns.

A successful rollout of COVID-19 vaccines is key for a strong economic rebound in 2021

The outlook for 2021 is for a strong rebound of GDP growth, + 5.2% according to the IMF, following a year when global GDP is estimated to have dropped by around 5%, the worst peacetime recession. Unprecedented fiscal actions and the rollout of vaccines are expected to significantly boost economic activity, even if some sectors are unlikely to be able to return to pre-COVID-19 levels of activity. Governments will also need to provide the framework for a successful and strong immunization programme by regaining public trust, which has been dented by the management of the crisis.

Current market conditions are supportive for risky assets despite rich valuations

We believe that the positive trends currently prevailing in financial markets should extend into 2021. Despite high valuations, we expect equities to benefit from a strong rebound of earnings in the coming quarters and the portfolios are positioned accordingly. High yield credit and emerging market debt are our favourite bond segments whereas our dollar exposure remains underweight. We are wary of a broad market consensus on the various asset classes as history has shown that the markets’ base case scenario is often derailed by unforeseen events.

 

Table of contents

  • EXECUTIVE SUMMARY
  • 2020: REVIEW OF OUR INVESTMENT THEMES
  • 2020: ECONOMIC & POLITICAL DEVELOPMENTS
  • 2020: THE FINANCIAL MARKETS 
  • 2021: ECONOMIC OUTLOOK
  • 2021: FINANCIAL MARKETS' OUTLOOK
  • 2021: ASSET ALLOCATION

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Investment Perspectives 2020 | Mid-Year Review & Outlook

Executive Summary

The economy has been hit by a “black swan” event

The first half of 2020 has been a most extraordinary period as the global economy was temporarily brought to a standstill. Governments took unprecedented lockdown measures to limit the spreading of the Covid-19 coronavirus and this pandemic represents a “black swan”, defined as an unpredictable event with potentially devastating consequences. The global economy is currently going through a recession, which should prove to be extremely severe but also extremely short. Global GDP is expected to contract by around 5% in 2020 compared to projections of 3% growth before the Covid-19 shock, with a strong rebound expected from a 2020 Q2 trough into 2021.

A war-like effort from monetary and fiscal authorities to fight the Covid-19 pandemic

The responses of the central banks and governments to limit the economic damage from the pandemic were extremely quick and on a scale never observed previously. The main central banks deployed the full range of their crisis tools within weeks. The US Fed funds rate was slashed to zero, massive quantitative easing was reintroduced and a broad range of additional measures were taken; these significant interventions contributed to improve the functioning of markets which had been under acute stress in March. Governments also acted promptly and decisively. Between early February and early April, G20 governments announced nearly 8 percent of 2019 G20 GDP in fiscal support, with this percentage now exceeding 10% following the addition of new plans. Global fiscal packages are estimated to be worth around $9 trillion, with the G20 economies accounting for the bulk of this amount: $8 trillion .

Equity markets have moved in both directions at record speeds

Financial markets went into a tailspin in February after having ignored the Covid-19 risks for some time. Equity markets plunged by over 30% in a matter of weeks as investors came to terms with the devastating impact of the pandemic on the world economy. The market correction was amplifed by the unwinding of a high level of leverage and all asset classes were caught up in the turmoil during a brief period in March. Equity markets then rebounded at a pace never seen before during equity recoveries following a bear market; this rally has been driven by the drastic measures taken by central banks and governments. Financial conditions are now very supportive for capital markets but question marks over the sustainability of the rally of equities remain. There is also a distinct risk that markets have become far too reliant on all these supports, in view of weaker economic fundamentals.

We maintain portfolio hedging in view of elevated uncertainty

Thanks to our quick hedging we did not have to sell positions. We were thus able to hold onto our long term convictions and our option protection strategy greatly reduced the volatility of portfolios. We recognize that markets are being driven by a huge wave of monetary and fiscal support, but we believe that they are not taking account of a number of risks which could ultimately have a significant impact. That explains why we hold a neutral equity exposure combined with a put spread to limit the potential downside risk; in an environment fraught with uncertainty and in view of expensive valuations, we consider the management of portfolio risk as paramount. In the next section of the document, we will evaluate the macro environment and the prevailing financial conditions by highlighting several key indicators that we observe. Following a brief overview of the first half returns of the different asset classes, we will outline our current market outlook and asset allocation.

 

Table 0f contents

  • EXECUTIVE SUMMARY
  • THE MACRO ENVIRONMENT
  • FINANCIAL CONDITIONS
  • FINANCIAL MARKETS
  • MARKETS' OUTLOOK
  • ASSET ALLOCATION 2nd HALF 2020

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Investment Perspectives 2019 | Mid-Year Review & Outlook

Executive Summary

In this mid-year publication, we review our January expectations and analyse some current key economic indicators before outlining the asset allocation that we recommend for the second half of the year.

Our equity exposure has been reduced since the beginning of the year

Our assumption that markets were overpricing risks of a recession during the December correction led us to start the year being overweight equities, as we had not cut our equity allocation despite the high level of market stress. This proved to be rewarding as the strong rebound observed in the first four months of 2019 contributed to the strong performance of the portfolios, especially with bond markets also rallying.

We took advantage of the strong rise of equity markets to reduce our equity allocation significantly from overweight to underweight, reflecting our cautious outlook in view of the rising level of uncertainty. Whilst we had not expected government bond yields to climb much, the year-to-date collapse of yields has been a big surprise and a major contributor to the strong returns of fixed- income exposures

U.S. policies are a source of increasing uncertainty for markets

The high level of market stress observed at the end of 2018 was quickly replaced by a four-month period of declining volatility where markets proved to be relatively immune to negative headlines. This changed significantly in May when the optimism over a trade deal between the U.S. and China gave way to concerns over a major breakdown of trade talks following a series of “tweets” by Donald Trump. This was compounded by restrictions placed on business between U.S. companies and the Chinese tech giant Huawei and tariff threats on imports from Mexico. This list of destabilising market factors is far from exhaustive but their common point is that they all originate from the White House which has been flexing its muscles to achieve some of its objectives. With the launch of the U.S. presidential election campaign, this is likely to continue to represent a source of uncertainty and of volatility for the markets.

Markets have been boosted by the end of monetary policy normalisation

The 180-degree turn of the Federal Reserve, in announcing a pause of its cycle of rate hikes and the
end of its balance sheet reduction, has been one of the key drivers of the bond and equity markets this year. Under the end-2018 pressure from the markets, the Fed abandoned its pre-set path of one rate hike per quarter and announced that the shrinking of its balance sheet would formally end in September, much earlier than planned. At its June 18-19 meeting, the Fed turned even more dovish and opened the door for a rate cut as early as July. The European Central Bank President Mario Draghi has also been trying to reassure market participants about the bank’s ability to act amid growing doubts on the real effect of monetary policy in case of a recession. Another key driver of the markets’ rally has been the huge provision of liquidity by the People’s Bank of China (PBOC), equivalent to 60% of the creation of credit over a 12-month rolling period.

We have a cautious positioning ahead of the second half

At the onset of the second half we have modest underweight allocations towards debt instruments and equities and an overweight cash position. We feel that markets are on a sugar high as a result of increasingly dovish central banks. They also appear to be consciously ignoring a number of risks including, but not limited to, disappointing corporate outlooks, weaker economic trends, delayed central banks’ actions and a deterioration of the relationship between the U.S. and the rest of the world. At the risk of missing some short term upside we prefer to focus on the management of risk, especially when considering the appreciable year-to-date portfolio returns.

In the next section of the document, we will evaluate the macro environment and the prevailing financial conditions by highlighting several key indicators that we observe. Following a brief overview of the first half returns of the different asset classes, we will outline our current market outlook and asset allocation.

Table 0f contents

  • EXECUTIVE SUMMARY
  • THE MACRO ENVIRONMENT
  • FINANCIAL CONDITIONS
  • FINANCIAL MARKETS
  • MARKETS’ OUTLOOK
  • ASSET ALLOCATION 2nd HALF 2019

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Investment Perspectives 2019

Executive Summary

Global financial markets were affected badly by the geopolitical landscape

In the wake of the unusually smooth financial markets observed in 2017, the past year has been a quite dramatic wake-up call for investors. Early-year euphoria in equity markets gave way to rising anxiety, due not only to economic and political issues, but also to extreme market behaviour.

If the U.S. economy was by far the brightest spot, reflected by outstanding corporate profits, a deceleration of growth was observed across other regions, in China and Europe in particular. This weaker economic trend was compounded by the escalating impact of the trade war led by Donald Trump on the rest of the world, with China being his main target. Financial markets were also affected by a number of political uncertainties which proved to be more detrimental than was the case during the previous years; the resolution of some of these issues are among the key factors for an improvement of the fragile sentiment currently prevailing in the markets.

Model-driven trading brings chaos to the equity markets

The behaviour of equity markets towards the end of
the year has been very extreme and difficult to justify; the overwhelming proportion of computerized trading, which has grown over time to around 85% of trading volume, goes a long way to explain the violent intra- day swings and daily returns, especially in a context of lower liquidity. Machine trading didn’t cause problems during the bull market, but models have triggered indiscriminate selling more recently on the back of weaker economic signals and market momentum. While it is impossible to predict when markets will have regained their composure, economic fundamentals and corporate profitability should drive market performance over the long term and not these short-term trading models.

Negative returns have been observed across most asset classes

The drop of global equity markets was the main culprit for the disappointing performance in 2018, but this headwind was compounded by the overwhelming number of asset classes with negative yearly returns. Even truly diversified portfolios failed to offer the usual levels of protection that could have been expected in such market conditions.

According to research produced by Deutsche Bank at the end of October, 89% of assets were in negative territory, in dollar terms. That was the highest percentage on record based on data going back to 1901. Even if this number decreased somewhat during the last months, it still reflects a situation where the vast majority of global assets’ valuations were supported by extreme monetary policies.

Equities still offer the best value

We do not share the current pessimism observed in financial markets and our allocation into equities remains slightly overweight. We do not dispute the fact that economic growth has peaked, but global growth should remain solid and we do not anticipate a recession in the coming year. Valuations of equities appear low considering the outlook for earnings, bearish sentiment is excessive and the turmoil within equity markets should prove to be temporary. Economic fundamentals and corporate earnings drive equity performance over time and there now appears to be a dichotomy between what the markets are anticipating and what economic data and corporate earnings are indicating.

Table 0f contents

  • EXECUTIVE SUMMARY
  • 2018: REVIEW OF OUR INVESTMENT THEMES
  • 2018: ECONOMIC & POLITICAL DEVELOPMENT
  • 2018: THE FINANCIAL MARKETS
  • 2019 : ECONOMIC OUTLOOK
  • 2019: FINANCIAL MARKETS’ OUTLOOK
  • 2019: ASSET ALLOCATION

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Investment Perspectives 2018 | Mid-Year Review & Outlook

Executive Summary

In this mid-year publication, we review our January expectations and analyse some current key economic indicators before outlining the asset allocation that we recommend for the second half of the year.

 

Our early-year portfolio positioning was cautious

Our portfolio positioning at the beginning of 2018 was somewhat cautious, with an above-average level of cash and a modest overweight exposure to the equity asset class. We contended that 2018 would be a more challenging year for equities and this has greatly proven to be the case. Our expectation that bond yields would gradually rise has been vindicated in the case of U.S. Treasuries, but not for core European bonds.

We refrained from deploying any cash towards equities during the spectacular January rally as we felt that markets had become overbought and investors too bullish. With traditional assets struggling to produce positive returns in the current unstable market conditions, the role of alternative strategies has taken on more importance, as a source of uncorrelated performance and to strengthen the resilience of portfolios.

 

Global growth has levelled off, in Europe in particular

Global growth has eased during the first half but still remains solid. The widely expected extension of the broad and strong global economic trends observed throughout 2017 has not quite materialized as manufacturing and trade growth have shown some signs of moderation. A slowdown of economic growth has taken place in Europe, in Japan and even in the United States. The combination of financial market stress, escalating trade tensions and political issues has dented elevated levels of optimism and clouded the economic outlook. Compared to 2017, the radical agenda of Donald Trump is proving to be increasingly disruptive. Looking ahead, the U.S. economy is picking up steam thanks to a strong job market, robust consumer spending and the help of tax reform. In contrast, the Eurozone will be hoping for an improvement on its first half performance; a weaker euro should provide some help for exports, especially if the global trade dispute were to be resolved quickly in a positive manner.

The ECB remains cautious

The confidence of the Federal Reserve in outlining its monetary policy contrasts with the ever cautious communication of the European Central Bank. The Fed has already raised its benchmark interest rate twice this year and has indicated it should hike rates again during both of the remaining quarters. The central bank has also started to shrink the size of its balance sheet by some $ 150 billion to around $ 4.3 trillion. As expected, the European Central Bank announced that it will be ending its asset purchase programme completely at the end of the year. However, the news that interest rates would stay unchanged at least through next summer came as a shock and weakened the euro significantly. In a context of softer economic activity in Europe and the threat of a global trade war, the ECB clearly appears to be talking down the euro as a mean of offering support to the region’s economy.

We have a modest overweight allocation in equities

The current environment of sustainable growth and the positive outlook for earnings remain supportive for equities despite the headwinds represented by higher bond yields and concerns over tariffs on goods. We continue to hold
an overweight exposure in equities with a well-diversified regional exposure. We also believe that the portfolios need to have diversification due to the challenging and ever-changing market conditions. The time when all assets were lifted by the provision of abundant liquidity and ultra-low interest rates is behind us and markets have become more discerning. That is why we have added exposures to alternative strategies in order to further spread portfolio risk and to be able to rely on a wider range of performance sources.

In the next section of the document, we will evaluate the macro environment and the prevailing financial conditions by highlighting several key indicators that we observe. Following a brief overview of the first half returns of the different asset classes, we will outline our current market outlook and asset allocation.

 

Table 0f contents

  • EXECUTIVE SUMMARY
  • THE MACRO ENVIRONMENT
  • FINANCIAL CONDITIONS
  • FINANCIAL MARKETS
  • MARKETS’ OUTLOOK
  • ASSET ALLOCATION 2nd HALF 2018

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Investment Perspectives 2018

Executive Summary

2017 was a good year for the global economy and an outstanding one for equity markets

The global economy enjoyed its strongest rate of growth since 2011 with the most noteworthy aspect being that growth was broad-based and expectations were upgraded during the year. Geopolitical tensions,
at times quite threatening, failed to dampen high levels of business and consumer confidence and had only a short-lived impact on capital markets. Concerns about European political events did not materialize as populist parties failed to create an upset in several general elections. Also, Emmanuel Macron’s spectacular rise to power in France was considered to be a major boost for the future stability of the European Union.

Equity markets had an unusually smooth ride throughout 2017 with strong and widespread corporate profitability and ample liquidity underpinning higher equity prices; volatility was consistently close to record lows and no major shocks were observed. Bond markets could be described as having been a little choppier but remained within relatively tight ranges. Surprisingly, the euro turned out to be the strongest major currency, on the back of a much more stable political landscape than expected in Europe.

 

Equity markets were the drivers of portfolio performance

The main reason for our good performance was our decision to hold an overweight equity allocation throughout 2017. Even though fixed income exposures also contributed positively to last year’s returns, equities significantly outperformed, with above-average performances recorded across all regional areas. In contrast to 2016, alternative investments performed in a more satisfactory manner. Finally, an underweight dollar exposure for non-USD portfolios limited the negative impact of its depreciation.

The foundations of the global economy are solid

The global economy is in a good shape due to solid and sustainable growth being quite evenly spread across all the main economic areas. The positive global activity momentum and low inflation should extend well into 2018 and, at this stage, the probability of a recession appears very low. Political risks have subsided, in Europe in particular, while the world is getting used to Donald Trump’s very unorthodox way of leading the United States. Liquidity conditions are still very accommodative, even if 2018 will be a key year of transition, from the quantitative easing era to more mainstream post-QE monetary policies.

Equities remain our preferred asset class

For the beginning of 2018, we maintain our favorable outlook on equities and remain underweight towards fixed-income. Overall equity valuations do not appear excessive as earnings growth should continue, even

if at a slower pace. We do not have a strong regional preference for our equity allocation. The fixed-income exposure is tilted more towards unconstrained strategies and convertible bonds. We do not plan on taking a high degree of currency risk and expect our hedge funds allocation to remain towards the high end of the strategic asset allocation range.

Table 0f contents

  • EXECUTIVE SUMMARY
  • 2017: REVIEW OF OUR INVESTMENT THEMES
  • 2017: ECONOMIC & POLITICAL DEVELOPMENT
  • 2017: THE FINANCIAL MARKETS
  • 2018 : ECONOMIC OUTLOOK
  • 2018: FINANCIAL MARKETS’ OUTLOOK
  • 2018: ASSET ALLOCATION

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Investment Perspectives 2017 | Mid-Year Review & Outlook

Executive Summary

In this mid-year publication, we review our January expectations and analyse some current key economic indicators before outlining the asset allocation that we recommend for the second half of the year.

We had increased our equity allocation at the beginning of the year

On the back of our positive macro-economic and equity outlook for 2017, we positioned the portfolios dynamically by increasing the allocation towards the equity asset class. We had also expressed our confidence that equity prices should be supported by an acceleration of global earnings’ growth and, so far, this has effectively proven to be the case. We had reaffirmed our strong conviction on emerging markets and our early-year global equity exposure was well diversified into the different regions. We have since increased our allocations towards European and also emerging markets equities. Hedge funds were an area of concern following a disappointing 2016 performance, but the different funds to which we are exposed have performed much better so far this year and contributed to the strong performance of portfolios.

Global growth has not been derailed by the many political and geopolitical events

Global economic growth is broad based and, for once, has matched expectations. Contrarily to the previous years, growth forecasts have been upgraded generally as confidence is high and investment and trade are picking up from low levels. Europe was facing a series of elections that could have had negative consequences for the European project, but populist candidates failed to beat those in favour of more European integration. The election of Emmanuel Macron as French president has boosted the chances for serious reforms in France and for stronger unity in Europe, especially at a time when economic growth in the Eurozone has surprised on the upside. Donald Trump’s administration continues to make many headlines but is struggling to introduce a new health bill and much promised pro-growth reforms. US equity markets have so far proven to be resilient to such disappointments.

The main central banks are still hoping for higher inflation

For various reasons, the monetary policies of the Federal Reserve and the European Central Bank have diverged markedly over the last years. While the ECB remains extremely accommodative, the Fed has turned more hawkish through the acceleration of the pace of interest rates’ hikes and the announcement of a plan to start shrinking its balance sheet. On one issue however, both banks are in perfect agreement: the lack of persistent inflation, which is one of the last indicators to really pick up momentum in recent years. At this stage, the Fed appears more confident that inflation will move closer eventually to its target as wage pressures finally push prices higher, hence its confidence in its ability to pursue policy normalization. On its side, the ECB continues to tread cautiously, despite a significant reduction of political risks and strong economic trends. Inflation numbers will continue to be observed closely during the second half of the year to help to determine the likely path of future monetary policies.

We remain in risk-on mode for the time being

The supportive global macro environment and the prospect of strong corporate earnings lead us to remain in risk-on mode, with an overweight allocation into equities being the main driver of portfolio performance. Despite ongoing concerns about the stretched valuations of most asset classes, in the wake of unprecedented monetary policies, we believe it is still too early to turn cautious. Equity prices are being supported finally by an acceleration of earnings’ growth and no longer just by the provision of massive liquidity and the anticipation of stronger growth. Finally, markets are not yet showing any signs of euphoria which typically characterize the end of a bull market, hence our overweight equity exposure.

In the next section of the document, we will evaluate the macro environment and the prevailing financial conditions by highlighting several key indicators that we observe. Following a brief overview of the first half returns of the different asset classes, we will outline our current market outlook and asset allocation.

 

Table 0f contents

  • EXECUTIVE SUMMARY
  • THE MACRO ENVIRONMENT
  • FINANCIAL CONDITIONS
  • FINANCIAL MARKETS
  • MARKETS’ OUTLOOK
  • ASSET ALLOCATION 2nd HALF 2017

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Investment Perspectives 2017

Executive Summary

Political upsets and a major reversal of bond yields took place in 2016

The markets had a very poor start in 2016 due to concerns about China’s economy and weak commodity prices, before moving slightly higher until early summer. The June 23rd UK referendum, resulting in Brexit, was an unexpected shock which triggered another correction of equities and a collapse of Sterling. However, equity markets erased their losses within weeks before entering into a period of stability. Surprisingly the unexpected victory of Donald Trump triggered only a very short- lived bid for safe-haven assets, as risk assets recovered almost instantly and ended the year on a bullish note.

2016 will most likely also be remembered as the year when a 35-year bond rally finally came to an end.

 

2016 was about avoiding significant losses vs chasing binary performances

During 2016, we were positioned very defensively for three extended periods as we protected portfolios against a Chinese hard landing scenario and the threats of two unpredictable but major political events. We also took profits on gold and increased our exposure to emerging markets at opportune moments. Our long exposure to the US dollar proved rewarding while our exposures to long/short equity and global macro strategies failed to match return expectations.

 

An improving economic outlook for 2017

The economic outlook for 2017 appears more promising as global growth will be more balanced and concerns about China and emerging markets have receded. The main risks for 2017 are of a political nature, with important elections taking place in key European countries and the ability of Donald Trump to introduce new policies, as expectations are rather elevated. The main central banks remain accommodative, even if they have started to imply that their interventions have limits and cannot go on forever.

 

We have a clear preference for equities over fixed- income

For 2017, we have a positive outlook on equities and remain cautious on high-grade bonds. Our equity exposure will be balanced across the different regions and we maintain our confidence in emerging market equities. European equities should benefit from reasonable valuations and the continued support of the European Central Bank’s policies. Our search for yield will continue to focus on European loans and high-yield and we will be looking for a good entry point to gain exposure to emerging market debt. The US dollar should initially remain well supported but we do not expect this trend to last all through the year ahead. Gold is facing significant headwinds, but its role as a safe-haven asset could benefit if the high expectations related to Trump’s policies were not matched.

All of the above are likely to be affected severely by any major geopolitical event – something we will be monitoring closely.

 

Table 0f contents

  • EXECUTIVE SUMMARY
  • 2016: REVIEW OF OUR INVESTMENT THEMES
  • 2016: ECONOMIC & POLITICAL DEVELOPMENT
  • 2016: THE FINANCIAL MARKETS
  • 2017 : ECONOMIC OUTLOOK
  • 2017: FINANCIAL MARKETS’ OUTLOOK
  • 2017: ASSET ALLOCATION

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Investment Perspectives 2016 | Mid-Year Review & Outlook

Executive Summary

In this mid-year publication, we review our January expectations and analyse some current key economic indicators before outlining the asset allocation that we recommend for the second half of the year.

We had maintained a preference towards equities over high-grade bonds

Despite our long-term view that equities continue to offer better relative value to high-grade bonds, we took assertive measures in early January by significantly reducing our equity exposure, and raising cash to a high level, which contributed to limit part of the impact of severe market stress on the portfolios.

We had also indicated our increasing interest for emerging market equities, which became effective in March when we decided to increase our allocation to the asset class. Another key conviction was the need for additional portfolio diversification by investing into alternative strategies with low volatility and limited correlation to traditional assets.

Global economic growth has disappointed during Q1... and is not expected to pick up during the 2nd half

Once again, global economic growth has turned out to be inferior to forecasts, with the US economy only growing modestly during the first quarter and no other major economy being able to compensate for this disappointment. Growth forecasts for the whole of 2016 have recently been cut by the World Bank, the IMF and the OECD. These revisions were published before the unexpected decision of the British voters to leave the European Union, meaning that, if anything, uncertainties have only increased. One of the main reasons for this weakening outlook is the feeling that central banks are left with very few tools that can make a difference to the real economy and that governments are reluctant to introduce any kind of fiscal stimulus.

We are more defensively positioned and will look to increase risk only when attractive opportunities arise

In the light of deteriorating fundamentals, uninspiring prospects for companies to grow their profits and higher political risks, we have adopted a more defensive stance for the portfolios by reducing further our equity exposure and by maintaining the cash allocation above 10%. Our exposure to the US dollar was tactically increased during the first half and we took advantage of its appreciation after the UK referendum to take profits on half the position so, there again, we are now exposed to a lower level of risk. We have also consistently been adding to the alternative space in order to reduce portfolio volatility and to be less dependent on the direction of the markets.

Risk management has led us to hedge the exposure to European equities

The UK public opinion during the weeks preceding the referendum on whether to remain in or leave the European Union gave us very little conviction on the outcome of
the vote. We also evaluated that the downside of equity markets in the case of a “Leave” vote would be much bigger than the potential upside if the “Remain” vote were to win. We decided to hedge our exposures to UK and European equities in the light of such an asymmetrical profile tied to a binary event. Following the result, the hedge on UK equities was quickly lifted. We will maintain the temporary protection unless the prospects for European equities significantly improve.

In the next section of the document, we will evaluate the macro environment and the prevailing financial conditions by highlighting several key indicators that we observe. Following a brief overview of the first half returns of the different asset classes, we will outline our current market outlook and asset allocation.

 

Table 0f contents

  • EXECUTIVE SUMMARY
  • THE MACRO ENVIRONMENT
  • FINANCIAL CONDITIONS
  • FINANCIAL MARKETS
  • MARKETS’ OUTLOOK
  • ASSET ALLOCATION 2nd HALF 2016

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