“Given the exceptionally high level of macroeconomic uncertainty, investors need to consider the full range of public and private market opportunities,” Mr De Souter said. He outlined where the bank believes clients with at least €1m to invest should position themselves in relation to the public equity and bond markets and private equity.
Given the exceptionally high level of macroeconomic uncertainty, investors need to consider the full range of public and private market opportunities
The bank’s stance on public fixed income had been prudent to negative when bonds were yielding zero or even negative returns. “The post-COVID spending by governments brought demand forward and this led to inflation, while at the same time the supply production cycle was somewhat disturbed by the aftershocks of COVID,” Mr De Souter said. To this was added the energy crisis.
“Central banks woke up a little bit late. Now they are catching up by fighting this inflation which has been stickier than expected, addressing it by raising interest rates in an aggressive fashion,” he said. Hence the bank believes we have yet to see a peak in inflation numbers, due to the lag between the increase of interest rates and when consumers start to feel the difference and react.
“We are recommending to our clients something that we haven’t seen over the last 10 years: select a portfolio of high quality investment grade bonds,” he said. The advice is to avoid so-called “junk” or high yield debt. “In Europe, you can construct a high-quality portfolio that delivers a yield of 3.5% to 4%, while in the US it’s more like 5% to 6%,” he said. Hence the bank’s advice is to investigate such quality fixed income investments both sides of the Atlantic, with a low duration profile with low credit risk. Depending on the mix of Euro and USD exposure, Mr De Souter says a portfolio with a yield profile of between 4% to 5% would be likely.
With inflation likely to moderate over the medium term, as growth also is reduced, this would put such returns into a different perspective. “This is a portfolio with two or three years of duration,” he said. He added that second order effects can cause inflation to become more sustained, and plans need to take this possibility into account. “If interest rates go higher than expected we can redeploy the cash at higher levels,” he said.
As regards to public stock markets “for the moment we are still quite prudent,” Mr De Souter said, pointing to the “damage” of markets being down 20–25% on average globally. So, while stocks might appear cheap, he noted that there is still uncertainty with regards to earnings as companies adjust to rising labour costs & production costs accompanying rising inflation.
“We still believe that equity is the asset class that in the long run offers the best protection against inflation. Companies have pricing power, to a greater or lesser extent, and this will enable them to hike their prices,” he said. The current focus of the bank is on companies with high earnings visibility, strong franchises, and strong visible cashflow; thus a somewhat defensive stance. “But once the signs come clear that inflation is starting to plateau, to come down, that might be a trigger for central banks to have a communication which is less negative,” he said. That could be the sign for investors in public equity to be less nervous.
“This is why we’re not aggressively pushing our clients into equities, but we are probably 5–10% underweight where we would be normally,” he said. This is because the bank believes general expectations for profit increases are probably too optimistic this year and next.
We still believe that equity is the asset class that in the long run offers the best protection against inflation.
Depending on the risk appetite of the investor, Mr De Souter said that private equity remains a strong option. “We remain very committed and constructive on private equity, even if in the short run the volume of mergers and acquisitions has dropped significantly,” he said. He noted that this was a natural reaction to the current nervousness, with investors taking longer to examine deals.
“Our core message is that if you want to be successful with private equity investments, it’s about committing on a recurrent basis for several years,” he said. He noted that crisis years are very good periods in which to taken exposure because valuations have moderated and there is less competition for deals. The bank also recommends a combination of secondary private equity and with the more classic buyout and growth capital models. They are also prudent on the venture capital space as young companies depending on next rounds of funding could see their business models shaken. “Investing in secondaries is typically the strategy that has benefited the most from market turmoil,” he added.
This being said, we remind potential investors that before investing, they should always make sure to reflect well on their asset allocation and define their investment and risk profile.