Before looking ahead, it’s good to ensure that any decision taken is based on fundamental investment principles.
My first investment principle is to take into consideration the less likely, nevertheless, not impossible. The Swiss National Bank’s surprise move in January — it unexpectedly scrapped its three-year policy of capping the Swiss franc against the euro, and reduced the interest rate on sight deposits — would qualify as such a “black swan event”. I can’t be sure, but I do know life can work out very differently from what we expect. That’s why, as much as I’m bullish on equities, I need to hold bonds, because I know that if, for example, Russia were to attack a NATO country, the most sought-after asset class in the world would be Treasuries and Swiss government bonds. The unlikely is not impossible.
My second investment principle is to play defensively. The biggest and most widespread error made by members of the investor community is to sell winners too early and to hold on to losers for too long. We all know that, in theory, one should sell losers early, yet nobody does. That’s why I say play defensively. If you’ve got winners, take care of them, monitor them and don’t worry too much if they fluctuate. And sell losers systematically.
My third principle is that the only free lunch that exists in markets is diversification. Investors ignoring this principle do so at their own peril. Diversification doesn’t mean holding Swiss, German and French stocks alone; it means holding stocks, bonds, commodities, and cash – holding different asset classes, rather than just diversifying a little in the same asset class.
With this in mind, how should we approach the latter half of 2015?
One forecast I feel very confident about is that policymakers around the world will remain extremely nervous. That might sound obvious, but it’s important because it means they will continue to favour the most accommodative policies. While the consensus argues for tapering and phasing out quantitative easing, I don’t think an end is in sight. As a consequence, financial repression will remain with us for another painful year. This makes it all the more important for savers to be aware that cash is losing value.
On the other hand, the world is in better shape than a lot of people think. For example, the rise of the new middle class across emerging markets is still one of the biggest themes of our time. The most immediately obvious impact is its increased desire to consume lifestyle products and services. The second-order effect is, of course, the ecological footprint of the attendant urbanisation and rising mobility. We need to radically rethink how we can manage the situation sustainably — and time is running out.
The US economy will, for a variety of reasons, hum along nicely. In Europe there will be slimmer pickings after the current run-up. There may well be political crises, and these may well create an increase in risk premiums. I nevertheless hold the firm belief that the eurozone will remain intact beyond the next decade.
Translating this into an investment plan for the latter half of 2015, in terms of asset allocation, I think a balanced portfolio should hold roughly 50 percent in global equities, focusing on quality and international diversification. The second biggest chunk should be in fixed income, looking across the world for contrarian or less obvious opportunities, such as emerging market bonds or inflation-hedged assets. The latter have become so cheap that it doesn’t take a lot for them to recover a bit. Once the stress has run its course, it would make sense to pick up some better quality high-yield bonds.
At some point over the course of this year, I would reconsider commodities as an investment category. And, of course, one should always keep some cash for special opportunities. Moreover, our time is characterised by factors such as uncertainty about the future, ageing populations, new technology and financial repression. Financial repression is a great monetary and fiscal experiment. We don’t know how it’s going to play out, because we’ve never experienced anything like this before. Our time is also characterised by geopolitical uncertainty. This climate of uncertainty entices investors to hold on to cash because they think it is an anchor. My argument is that it might be a poorer anchor than most think, that risky assets might be a safer bet than many think.
Dr Burkhard Varnholt is Chief Investment Officer and Head of Investment Solutions Group at Julius Baer; juliusbaer.com