Is deflation the key threat to the eurozone? When are interest rates going to rise? When will the ECB launch its widely anticipated purchases of ABS? Selectors and managers have given their views.
Matthias Lücke, head of Distribution at Volksbank Ludwigsburg, has a gloomier outlook: “My expectation is, that the ECB is going to drive the bond market and the rest to new upside extremes. Euro interest rates can test new lows – until the whole project of protecting the single currency is going to explode.”
How then to prevent exess liquidity? There is broad awareness that interest rates will have to rise again eventually, despite the current threat of deflation. Rui Castro Pacheco, sub-director at Banco Best in Portugal, argues that interest rates are unlikely to increase over the next year.
This view is endorsed by Anna O’Donoghue, head of research at Architas, who says: “The recent ECB announcement again proves it will do ‘whatever it takes’ to push inflation to 2% and above. “
Meanwhile, with the US and UK being at a different stage in the cycle, it is noteworthy that BoE governor Mark Carney recently surprised the financial sector by announcing a gradual and limited increase of interest rates sooner than expected. “Overall it seems that the UK will lead the way in raising rates, followed by the Fed. Data flow would indicate that both the ECB and the BoJ (Bank of Japan) are likely to maintain their more accommodative stance towards monetary policy into the foreseeable future, and certainly until there is firm evidence of inflation and economic growth,” O’Donoghue says.
Paulo Gonçalves, asset coordinator at Banco Popular in Lisbon, agrees
with the view that the UK is likely to see its interest rates rise first, while the rates rise in the US may take longer than consensus expects. Continuing his outlook, Gonçalves suggests that as interest rates persist at lower than expected levels, particularly across the eurozone, it means the search for yield will continue for investors such as himself.
“Riskier assets will benefit from this environment. This means that periphery and emerging markets assets both equities and bonds should outperform core markets and that in asset allocation the weight of the riskier asset classes like equities, convertibles bonds and high yield bonds should stay above the average of an ‘normal’ growth environment even if assets allocators have already became worried with the valuations of some of this classes, eg, the high yield bonds.”
Emmanuel Ferry agrees that riskier assets should benefit. “From an asset allocation point of view, it confirms the O/W stance on European equities, with a bias to value at the expense of the expensive growth style. Equities at the periphery are a good candidate. The move from zero interest rate policy to negative interest rate policy is a strong incentive for chasing the carry in the fixed income space, ie, further compression of peripheral
spreads. To sum up, the ECB meeting is a green light for shifting the asset allocation more aggressively from the US to Europe.”
Michalis Kavantzas, Third Party Funds Division at EUROBANK Asset Management M.F.M., says that while Draghi’s speech is good news for European equities, there are particular benefits awaiting peripheral markets.
For example, the action on asset backed securities is a benefit to Italy and Spain, both of which have relatively large ABS markets. Greece should benefit from the LTRO measures, because it had limited access to LTROs 1 & 2 in 2012, “Consequently, concerning asset allocation, the following assets are the main beneficiaries of ECB policies: European banks, peripheral bonds, peripheral equities and Greece; and European equities that should outperform other developed market equities.”
As for fund selection, he will be looking for funds with short duration strategies, and flexible funds that can implement multiple alpha enhancing strategies. Michele De Michelis, CIO Frame Asset Management, says that stable or slightly decreasing interest rates in the EU at a time when 10-year US treasury interest rates may increase points to long-short credit absolute
Castro Pacheco suggests that the asset allocation approach has not changed much. However, in mind of the danger that conservative portfolios start to offer less return for the same risk, the search is on for funds and managers with alternative or total return strategies to access alpha and maintain return “without compromising the risk”.
Lücke adds a different view: “It is more about timing and hedging than asset allocation, because the search for earnings is driving all the asset classes in the same direction. There is no insurance by allocation anymore.”