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Asset Allocation Letter - “Good or bad Trump?”

EDITORIAL

Donald Trump’s election has unleashed radical changes in the financial landscape since November, with reflationary policy expectations pushing up long bond yields, the dollar, and the equity indices. Since Trump took office, however, investor enthusiasm has cooled, as the new US president’s first announcements have dealt with healthcare, immigration and international trade, rather than the fiscal boost hoped for through tax cuts or infrastructure spending. This has kept long bond yields and the US dollar from rising any further.

Against this backdrop, two investment strategy visions will face off in the next few months. To wit: have we embarked on a structural upturn in interest rates, the mirror image of the decline they began in the early 1980s? Or has the trend seen since 20 January been a mere correction of market excesses?

We think it’s the latter. Yes, the protectionist rhetoric that is spreading worldwide is likely to feed inflation fears, while pressures on the US labour market are undeniable at this very late stage of the economic cycle. However, we believe that deflationary pressures are still very much with us, driven mainly by the impact of new technologies and the need to absorb the massive stocks of debts piled up in recent years. Bonds, US Treasuries in particular, will therefore continue to play a useful role as tactical allocation and hedging instruments during risk-on phases.

Meanwhile, and surprisingly so in light of all the above, the equity markets remain solid, with far lower volatility than bonds. But beneath this superficial calm, powerful rotations between sectors and factors are at work, and these are offering asset managers some attractive investment opportunities.

 

 

Eric Tazé-Bernard

Chief Allocation Advisor

CONVICTIONS

Investment scenarios

  • Our central scenario, based on a limited but stabilized global growth remains valid - around 3% per year in 2016-2017 – with a 70% probability of occurrence (stable). US growth should be slightly higher than expected for 2018 (2.2% vs 1.7%) and Developed Economies globally driven by domestic demand (Europe, US, Japan). Emerging Markets should improve benefiting from the stabilization of oil prices. This environment should favor risky assets and also QE friendly assets (Euro Corporate and Equities, Peripheral Sovereign Debt).
  • Our first alternative scenario (stable at 15% probability) assumes an acceleration of US growth as well as US inflation expectations thanks to fiscal expansion leading markets to reprice rates higher and USD stronger, with the Fed eventually more aggressive than initially anticipated. It would create a widening gap between disappointing growth expectations and sustained inflation expectations.
  • Our second alternative scenario sees a global growth slowdown with 15% probability of occurrence (stable). The trigger could be a deterioration of the US economy, a disappointment from the Chinese data or the consequences of the Brexit vote.

 

Positioning under our central scenario

The intermediate risk budget is stable at 5/10.

  • On equity markets, we have a small overweight in directional but looking for a better entry point to increase it.

- Geographically, we maintain our long exposure to Eurozone, a region where we are ready to increase our position in any drawdowns, and also to Japan, partially hedged. We still have a neutral exposure to US. On Emerging Markets, we remain cautious as there are still question marks related to USD level, US interest rates hike and risk on US tariff policy. We keep the underweight on Europe ex-EMU.

- Sectors/factors: we favor the Value bias in Eurozone, including Utilities and Telecommunication and avoiding Capital Goods. We balance our exposure to US Equities between Value and Quality bias.

  • In the fixed income space, we keep an underweight exposure in nominal duration and a long exposure to Credit.

- Rates: We maintain a short duration exposure to Core Eurozone and a moderate long exposure to Peripherals. We maintain a long exposure to US duration via a position on US 2Y. We also keep a long exposure to Euro Breakeven.

- Credit: We are globally positive on the asset class. We balance our overweight exposure between Industrials and Financials and increase our position on High Yield in Eurozone. We maintain a long position on US Investment Grade.

  • Currencies: we maintain a long position on JPY to benefit from its risk-off feature and maintain a low risk budget on Emerging Markets Forex.
  • Macro Hedging: we still prefer equity volatility to other macro hedges. We are still waiting to reinforce the exposure to US treasuries. We also add a moderate exposure to Gold Miners as a protection against inflation and potential for lower US real yields coupled with a low equity correlation

 

Cross asset views and portfolio positioning

RISK LEVEL: 5 / 10

 

Asset Allocation Letter 201702_img1

 

FOCUS

Multi-Asset Absolute Return Approach: Why more today than yesterday?

Multi-Asset strategies have been a big hit in recent years. Assets under management invested in diversified open-ended funds has risen 10-fold since 2009 (1), and the trend has accelerated sharply since 2014, with a growth higher than 60% (1) during this period and a rather marked bias for absolute return strategies. Multi-Asset AuM is currently at about 1.5 trillion euros for institutional investors (2) and 165 billion for open-ended funds domiciled in Europe as of the end of September 2016 (1). And there is still a significant room for growth compared to “traditional” assets!

The success of Multi-Asset strategies, based on absolute return approaches in particular, is being driven mainly by their ability to meet various needs in the especially complex investment environment of the past few years:

1. The quest for returns within a limited risk budget at a time when performance drivers are becoming scarce and it is becoming necessary to take more risk to achieve decent returns.

2. The objective of robustness in the event of a crisis or volatility shock by considering various market risks, whether incurred from the macroeconomic environment and political risk or from the very nature of the various assets and how they interact.

3. The implementing of non-directional strategies based on a dynamic tactical allocation, in a context where weak returns are expected from traditional equity and bond assets.

 

  • Amundi’s Multi-Asset Absolute Return approach

Amundi’s Institutional Multi-Asset investment process has many things going for it:

- A multi-scenario approach: most investors define their views using a central scenario that is very close to the consensus market scenario. A given strategy stands out above all in its ability to draw up probabilized alternative scenarios that are quantified in terms of their consequences on asset prices. We generally have one central scenario plus two alternative scenarios based on what we see as the main sources of market risk and to which we assign probabilities of occurrence. The risk budget that we use for our portfolios is based in part by the estimated probabilities of these scenarios. We believe that this aspect of our process enhances our portfolios’ robustness in the event of an adverse scenario and provides us some downside protection during corrections in risky assets, thanks mainly to macro-hedges set up in response to alternative scenarios.

- A quest for diversification through various dimensions: investors know all about the benefits of diversification, but diversification must be achieved in various ways that are far beyond the traditional combination of equities and bonds. The lack of significant correlation between these two major asset classes may not last, especially if interest rates do indeed rise. In addition to the multi-scenario approach that we just mentioned, we analyze our investment universe and pool those market instruments with the same valuation features and common explanatory variables and behaviours. On this basis, we then define our proprietary factors from a cross-disciplinary approach covering the various asset classes, in order to more precisely exploit what we believe to be market valuation anomalies. We also diversify our portfolios by horizon, while combining medium-term strategies with strategies that are more tactical and have a shorter lifespan. We then implement our views through various types of investment vehicles, including securities, baskets of securities, derivatives, and active or passive funds that are selected on the basis of a trade-off between performance and replication capacity, while, of course, accounting for their costs.

- Sophisticated risk management: building a Multi-Asset portfolio is not merely a matter of juxtaposing sub-portfolios of equities and bonds, but also seeking out efficiency in risk-adjusted terms. We possess sophisticated management tools for quantifying the sources of risk in our portfolios and ensuring that they are balanced and that our risk budget allocation is calibrated properly with our investment views, for the purpose of not duplicating the same risk but, rather, choosing the best vehicle for exploiting flow dynamics or a return to fundamentals.

These special features of Amundi’s Institutional Multi-Asset strategies help us offer resilient absolute return investment strategies fitting various investor profiles. The Multi-Asset Absolute Return Low Volatility flagship strategy, for example, targets natural bond investors seeking steady returns based on a limited risk budget – an objective that dovetails with our strategy targeting an annualised, three-year return of Eonia plus 2.50%, with ex-ante annual volatility of 4%. The strategy has paid off. Since being launched more than 12 years ago, it has achieved a three-year annualised of 4.12% (3), while staying within its volatility budget. Quality of management and consistent results are why AuM in this strategy has expanded so rapidly (30% in 2016).

In order to address those investors willing to take on more risk exposure for greater expected returns, an additional investment strategy, Diversified Growth Fund Strategy, was launched in early 2016. In addition to being denominated in US dollars, this strategy is positioned as a natural substitute for equity investments in terms of long-term performance, while offering a safer risk profile and greater diversification. Its objective is an annualised return of 1-month US LIBOR plus 5% over five years, with ex-ante volatility ranging from 6% to 10%. It has gotten off to a promising start, achieving a gross return of 5.88% since its inception, with a Sharpe ratio of 1.2 (4).

 

  • The challenges of Multi-Asset investment management in 2017

An absolute return approach makes more sense than ever in the challenging environment of 2017. In the wake of Brexit and Trump’s election and in the run-up to crucial elections this year in Europe, it is clear that the political landscape will continue to contribute to market volatility. In response, managers are likely to introduce hedging strategies or macro-hedges into their portfolios, while ensuring that these strategies make sense in light of the possible scenarios while also watching over their valuations and liquidity. By way of illustration, we felt in early 2016 that Yen exposure was the proper response to the uptick in market volatility but unwound it when we felt the Yen was overbought. We then reinstated it after the yen fell by almost 15% vs. the dollar between 3 November and 15 December.

Investors will also face the challenge created by the exit from the quantitative easing policies in place since the financial crisis, and the “taper tantrum” of spring 2013 shows how much the markets are at risk from shocks unleashed by the slightest change in the conduct of monetary policies. Accordingly, we use two covariance matrices in our portfolio simulations, corresponding to risk-on or risk-off markets in order to stay within our portfolios’ risks budgets even in the event of a steep run-up of market stress.

Lastly, amidst low interest rates and narrow credit spreads, the bond markets are no longer a sufficient driver of performance for our portfolios. In response, we are using more equities in our strategies, not just on a directional basis but also via a tactical allocation in those equity factors that we feel are best suited to our market expectations. One current example of this is the value theme (1) in European equities.

1 Sources: Morningstar Direct, Open-ended funds domiciliated in Europe, Septembre 2016, en EUR Billion.
2 Source: EFAMA / BCG, december 2014.
3 Source: Amundi. Performance data, gross of fees from 01/31/2014 to 01/31/2017.
4 Source: Amundi. Performance data, gross of fees from 02/26/2016 to 01/31/2017.
5 Monthly Allocation letter of April 2016.

 

 

Yannick Quenehen

Senior Investment Manager - Absolute Return Multi-Asset Management

 

Alexandre Burgues

Global Multi-Asset Portfolio Manager

 

 

 

PERFORMANCES

Gross performances of our strategies (January 31, 2017)

Amundi, data as at end of Janauary 2017. Gross performance of “Balanced Institutional Absolute Return Low volatility “, Multimanager Multi-Asset Fund of Funds (Bonds)“ GIPS composites in euro. Their respective benchmarks are: Eonia capitalized and a composite benchmark: 50% JPM EMU Government Bond Index, 30% JPM Government Bond, 20% Exane ECI – Europe Convertible. Past performance is not a reliable indicator of future results or a guarantee of future returns.

Asset Allocation Letter 201702_img2

 

Laurent TIGNARD, Global Head of Multi-Asset, Institutional Clients
Frédéric PASCAL, Deputy Head of Multi-Asset, Institutional Clients
Eric TAZE-BERNARD, Chief Allocation Advisor
Marc-Ali BEN ABDALLAH, Senior Analyst, Investment Solutions
Florian NETO, Client Portfolio Manager
Dan LEVY, Head of Multi-Asset Investment Specialists
Bénédicte GUILLEMOT, Investment Specialist
Leslie DEBOUT, Investment Specialist
Yannick QUENEHEN, Multi Asset Absolute Return Portfolio Manager
Alexandre BURGUES, Amundi

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Asset Allocation Letter - “Good or bad Trump?”
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