{"id":79467,"date":"2019-04-30T01:28:00","date_gmt":"2019-04-29T23:28:00","guid":{"rendered":"http:\/\/beta.next-finance.net\/strategie\/risk-assets-dont-let-your-intuition-lead-you-astray\/"},"modified":"2019-04-30T01:28:00","modified_gmt":"2019-04-29T23:28:00","slug":"risk-assets-dont-let-your-intuition-lead-you-astray","status":"publish","type":"post","link":"http:\/\/beta.next-finance.net\/en\/strategie\/risk-assets-dont-let-your-intuition-lead-you-astray\/","title":{"rendered":"Risk Assets: Don\u2019t let your intuition lead you astray"},"content":{"rendered":"

The first quarter of 2019 certainly ended with a brighter outlook than could be seen when it began. The resolution of several uncertainties and clear signals of support for the economy coming from central banks are reviving attraction to and appetite for risk assets. Does that mean it\u2019s time to start changing portfolio allocations? If the answer is to be yes, then any increase in exposure to equities must take into the account the notion of total portfolio risk.<\/strong> <\/em><\/p>\n

For this year, we have identified five pivotal issues likely to influence financial markets.
\nFor each of these, the outlook was relatively unpromising at the end of last year and
\nbeginning of 2019, prompting a strengthening of portfolio protections. While this remains
\nrelevant, Q1 2019 marked an inflexion point, alleviating uncertainties regarding several
\nof these pivotal issues. The most notable expressions of this shift are new injections
\nof liquidity that should strengthen risk assets, and stocks in particular. Nonetheless,
\nany increase in exposure to risk assets must be approached from the perspective of
\nmanaging portfolio risks and maintaining a suitable risk level.<\/p>\n

CENTRAL BANKS: SUPPORTIVE SIGNAL FOR
\nRISK ASSETS<\/strong><\/p>\n

While just last February, the ECB held that it had
\nno plans for the long -term refinancing of banks,
\nit ultimately announced the opposite in March.
\nThis about-face has multiple repercussions.
\nThe injection of liquidity is, first and foremost,
\nintended to boost the economy, primarily
\nfinanced by banks in Europe. However, the mere
\nfact of the announcement resulted in an easing of
\nthe market.<\/p>\n

A similar phenomenon can be seen in the US, where,
\ndespite short-term setbacks, growth is supported
\nby the Fed\u2019s pronouncements. On both sides of the
\nAtlantic, inflation remains subdued. In the eurozone,
\ncore inflation hovers around 1%, whereas in the US it
\nremains checked at about 2%. These are low inflation
\nlevels that encourage domestic consumption.<\/p>\n

The accommodating policies of central banks,
\njustified by the absence of runaway inflation and
\na maintenance of long-term rates at low levels
\ntend to push up the valuation of stocks.<\/p>\n

THE OTHER PIVOT POINTS: D\u00c9TENTE AND SURVEILLANCE<\/strong><\/p>\n

Several factors identified as having significant
\nrepercussions on the value of assets have
\ndeveloped favorably over the quarter. First
\namong these is the stabilization of oil prices
\nat a price in line with our ideal scenario of 70
\ndollars a barrel. This stabilization promotes
\nconsumer spending by limiting inflationary
\npressures. In Western economies with low
\ninflation, fluctuations in the price of oil are, in
\nfact, the primary source of variance in inflation.
\nEmerging countries that are not producers also
\nstand to gain from this stabilization, as a sharp
\nrise in oil can quickly damage their external
\nbalances and trigger inflation.<\/p>\n

In Europe, political tensions have eased off.
\nThe departure of the UK from the EU has not
\nyet begun, but the capacity of Brexit to produce
\na major shock appears to be lessening. As
\nfor the European elections, these will in all
\nlikelihood bring an array of surprises, however,
\nthe end result is unlikely to threaten the current
\npolitical equilibrium.<\/p>\n

Another notable d\u00e9tente concerns the USChina trade war. While it is by no means over,
\nand the outcome is yet to be determined, the
\nstart of negotiations presents a significant step
\nforward compared to the tensions of 2018.<\/p>\n

The last of our pivotal issues rests on the
\nresistance of China\u2019s economy. Government
\nmeasures to support growth are beginning
\nto bear fruit. Credit shows signs of recovery;
\ninvestment spending is picking up, particularly
\nfor infrastructure. While China cannot play its
\nexchange rate card without annoying the US, it
\nis certainly leveraging monetary and budgetary
\npolicy to prop up growth. The country may
\nbenefit from another round of measures in the
\nsecond half of the year, with a positive impact
\non global growth.<\/p>\n

SPOTLIGHT ON STOCKS<\/strong><\/p>\n

At the beginning of the year, we opted for a
\nbalanced profile in our portfolios. The lifting
\nof certain areas of uncertainty on the world
\nscene leads us now to look at increasing our
\npositioning on higher-risk assets, particularly
\nequities. Although we are seeing a short-term
\nslowdown of activity, we are confident in our
\ncore scenario and believe we can identify risk
\nassets with a favorable risk-adjusted return over
\n6 – 12 months. <\/p>\n

We see the risk of overvaluation in the equities
\nmarkets as no longer an issue. Valuation on the
\nbasis of expected profits is currently in line with
\n10-year averages. While much higher just a year
\nago, it has been forced downward by lower stock
\nprices, even as companies\u2019 profits continued to rise.<\/p>\n

From the perspective of strict fundamentals,
\nhowever, sovereign bonds remain far too
\nexpensive. The rates on 10 – year bonds are
\ngenerally pegged in the long term to a slidingaverage GDP growth. The latter comprises real
\ngrowth, which is in Europe around 1.5 %, plus
\ninflation, also around 1.5 %. That means the
\n10 – year Bund should pay around 3 %, when
\nwhat we see is that it has sunk back into negative
\nterritory. Absent a deflationary scenario, we are
\ntherefore headed for a rise in long-term interest
\nrates, and consider bonds to be expensive
\ncurrently. From our perspective, bond holdings
\noffer relatively low levels of natural protection to
\nequity risk, within the eurozone at least.<\/p>\n

TO INCREASE THE PROPORTION OF RISK ASSETS, TRIM THE BONDS<\/strong><\/p>\n

These market forecasts, geared toward an
\nappetite for risk, should translate into portfolios.
\nHowever, a response consisting entirely of
\nfavoring stocks over bonds would be biased,
\nas it fails to take into account a key aspect: the
\noverall risk of the investment portfolio.<\/p>\n

Before undertaking any change to allocation, a
\nfirst step consists of assessing the amount of risk
\ndesired for the portfolio. This level of acceptable
\nlosses will play a part in determining the weight
\ngiven to various asset classes. Reasoning from a
\nstrict arbitrage standpoint between asset classes
\ncan have significant\u2014and sometimes poorly
\ngrasped\u2014consequences in terms of risk. <\/p>\n

To understand this, let\u2019s consider the simplified
\nhypothesis of a balanced portfolio comprising
\n50 % stocks and 50 % bonds, for which one
\nseeks to increase exposure to risk. For this
\nportfolio, assume potential losses in the
\nequities component to be 30 %, and that of
\nthe bonds segment to be 10 %, or three times
\nless. The weighted average of potential losses
\nwould thus stand at 20 %. This can be reduced
\nto 15 % thanks to the additional protective
\neffects of inverse correlation between asset
\nclasses, as stocks and bonds mutually protect
\neach other.<\/p>\n

If we stick to a strict move toward risk assets
\nand increase the stock component to 70 %,
\nversus 30 % bonds, the potential losses also
\nshift, becoming 24 % on average, or 19 %
\nif we factor in the protection afforded by
\ndecorrelation. Granted, the new allocation
\ndoes increase the proportion of risk assets held
\nin the portfolio. However, the portfolio\u2019s overall
\nrisk budget is also significantly increased.<\/p>\n

It is, however, possible to increase the portfolio\u2019s
\nsensitivity to stocks, while maintaining risk
\nlevels similar to that of a balanced portfolio,
\nif such is the asset manager\u2019s goal.<\/p>\n

In a limited risk management scenario,
\nexposure to equities should be increased
\nto 55 % only. However, bonds should be
\nreduced to 23 % and the remaining capital
\n(22 %) should be reallocated to monetary
\ninstruments. The increased exposure to
\nrisk assets thus entails just a 5 % increase
\nin the equities component. Meanwhile, the
\npercentage of bonds is halved.<\/p>\n

This demonstration is merely an example,
\nbut it nonetheless illustrates our core focus
\nwhen it comes to allocation: determining the
\ncorrect risk level assigned to a portfolio, in
\norder to preserve or, on the contrary, adjust
\nit if need be.<\/p>\n

If we choose to keep the budgeted risk level
\nconstant, then cutting the bond portion and
\nintegrating a risk free asset \u2014 cash \u2014 makes it
\npossible to ride the curve of market efficiency.
\nIn doing so, we confirm our positive view of
\nstocks, but are able to keep overall risk flat if
\nwe make that our strategy.<\/p>\n

DETERMINING ACCEPTABLE LOSSES<\/strong><\/p>\n

The art of asset management, however,
\nconsists of adjusting risk levels over the life
\nof the portfolio. Indeed, risk budgeting is the
\ncornerstone on which allocation rests. Naturally,
\nthis begs the question, which is crucial, of how
\nto determine the risk budget for a portfolio.
\nThere is no easy answer for this, but rather a
\ncombination of factors to be weighed:<\/p>\n