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The main event of 2018 was the bearmarket triggered by the cumulative 20%+decline in the equity markets.
The bursting of a financial bubble alwaysflags a reversion to the mean, whichcomes with an increase in volatility and aradical shift in market sentiment.
As long as the markets haven’t rallied pasttheir previous highs, the bear marketconfiguration will continue to rule the day,and investors will just have to take thisnew configuration on board. First of all, themacro-financial environment, in generalterms, is that economic growth has fallenbelow its potential, with late-cycleinflationary pressures emerging(particularly in wages). The marketparadigm is shifting rapidly: volatility is onthe rise; we are moving from financialleverage to a preference for liquidity;financial asset valuations are beginning aprocess of convergence towards their long-term means; investors are moving intomore liquid assets; and there is muchtactical selling into rallies, whereas, in abull market, there is much buying on thedips.
Investing in a bear market is a challenge.There is a risk of false signals, as in 1998,for example. Historically, since the SecondWorld War, the average bear-marketdecline in the S&P 500 has been 24% overa period of seven months when a recessionhas been avoided. When there has been arecession, the cumulative loss hasaveraged 37% over a period of 18 months.The underlying trend is downward, withshrinking valuations acting as an anchor.Long-only investors in a bear marketsooner or later end up being forced to sellin an environment of heightened
emotions. Bear market rallies do occuroften but are hard to capture, due to theircounter-trend profile. There are two typesof bear market rally: 1/ moderate ones atthe start of the downturn (+9% to 12%);and 2/ aggressive ones later in the cycle(+20% to 25%).
Alternative strategies will once again beattractive as market risks increase. Wehave identified three vectors in the equityuniverse: 1/ market-neutral with alphaextraction; 2/ long/short to capture qualityin company balance sheets; and 3/convergence of valuation multiples (withvalue and regional rotations).
The likely end of the bull market in equitiesopens the door to relative opportunitiesand is likely to bring disciplined, diversifiedand dynamic management processes backto the fore.
The strongest beginning of the year since1987 for the S & P500 looks very much likea bear market rally: disconnection withfundamentals and flows, technical catalystsand the role of synchronized central bankeasing. The message could be « Sell inMarch and Go Away ».
EDITORIAL
How to invest in a bear market
MARCH 2019
Focus
PAGE 7
Emmanuel FerryCIO+41 22 316 02 [email protected]
Pauline FroissartEditor-in-chief+41 22 316 02 [email protected]
NEWSLETTER
Market Performance and Agenda
PAGE 2
Convictions
PAGE 3
AssetAllocation & Ideas
PAGE 4 – 5
Expertise
PAGE 6
Water Serpents, Gustav Klimt, 1904
MARKETS PERFORMANCE
AGENDA
PAGE 2
MONTHLY LETTER| MARCH 2019
Source: Banque Pâris Bertrand Index Performances in local currency
An
nu
al Pe
rform
ances b
y Asse
t Class
March 2019 April 2019 May 2019
7
15
20
29
ECB
USA
Fed
UK
Governing Council
US-Mexico-Canada agreementFOMC
Brexit
10
12
15
17
ECB
IMF
USA
AU
Governing Council
Spring Meetings
Semi-annual FX report
OPEC Meeting
1
18
23/26
Fed
USA
EU
FOMC
Auto tariffs
Parliamentary elections
June 2019 July 2019 August 2019
6
19
ECB
Fed
Governing Council
FOMC
25
31
ECB
Fed
Governing Council
FOMC
7 ECB Governing Council
20
29
UE
Japan
European Council
G20 Summit
The market rebound initiated in January has extendedinto February. The best beginning of the year since 1987 forthe S&P500 (+11.5%) is displaying all the characteristics of abear market rally: disconnection with fundamentals and flows,technical catalysts and role of the central banks’ inflexion.
Global Equities advanced +2.7%. All regions rose again overthe month, however the hierarchy between them reversed:STOXX600 +4.2%, S&P500 +3.2%, Nikkei +2.9% and MSCI EM+0.2%. Equity volatility retreated (VIX -1.8pts, VSTOXX-1.5pts).
Credit outperformed Duration in February. US 10Y rates wentup +8.5bps at 2.72%; Treasuries fell -0.4%. The credit spreadstightening has continued: -5bps for the HY segment and -6bpson the IG segment, with indices rising +1.7% and +0.2%respectively. Overall, the Global Aggregate index endedmarginally higher (+0.1%).
In Commodities, Energy (+5.4%, including WTI +6.4%) andIndustrial Metals (+3.5%) kept rebounding, while Golddecreased (-0.6%). Listed Real Estate, one of the best assetclasses last month, paused (-0.1%).
All asset classes have reached overbought territorysimultaneously, for the first time since 2000.
2018 2019February
2017 2019YTD
MSCI ACWI24.0%
US IG6.4%
US Gvt Bds2.6%
Gold13.1%
S&P50021.8%
MSCI EM37.3%
EM Debt Local15.2%
EM Debt Hard10.5%
Real Estate11.4%
Stoxx60010.6%
Commo1.7%
Cash (USD)1.1%
US High Yield7.5%
Russell 200014.6%
MSCI ACWI10.8%
US IG2.6%
US Gvt Bds0.3%
Gold2.4%
S&P50011.5%
MSCI EM9.0%
EM Debt Local4.3%
EM Debt Hard5.9%
Real Estate10.8%
Stoxx60010.7%
Commo6.5%
Cash (USD)0.4%
US High Yield6.3%
Russell 200017.0%
SPI19.9%
SPI11.5%
MSCI Japon7.6%
MSCI Japon19.7%
Gold-1.6%
Stoxx600-10.8%
Cash (USD)1.5%
Commo-11.2%
MSCI ACWI-9.4%
US Gvt Bds0.9%
S&P500-4.4%
Russell 2000-11.0%
US IG-2.5%
Real Estate-4.7%
US High Yield-2.1%
MSCI EM-14.6%
EM Debt Hard-5.2%
EM Debt Local-6.2%
SPI-8.6%
MSCI Japon-15.1%
MSCI ACWI2.7%
US IG0.2%
US Gvt Bds-0.4%Gold-0.6%
S&P5003.2%
MSCI EM0.2%
EM Debt Local-1.1%
EM Debt Hard1.0%
Real Estate-0.1%
Stoxx6004.2%
Commo1.0%
Cash (USD)0.2%
US High Yield1.7%
Russell 20005.2%
SPI4.3%
MSCI Japon2.3%
PAGE 3
MONTHLY LETTER| MARCH 2019
Corporate Credit, global market’s weak link
CONVICTIONS
The correction of the fourth quarter of 2018 offereda preview of what the next recession will be, with a shockin the corporate credit markets quickly becoming theepicenter of the crisis.
Corporate leverage has tended to increase in worryingproportions in recent years. Inheritance of unconventionalmonetary policies, deregulation or exacerbated pro-shareholder activism, the causes are multiple but they leadto the same observation: corporate debt as a percentage ofGDP is close to or even surpasses historical highs in mostdeveloped countries.
In the United States, corporate debt currently amounts to70% of GDP. Although this figure may seem modestcompared to other countries, it is nevertheless on ahistorical high and masks an extreme dispersion of thequality of the balance sheets. In fact, only 30 out of 3000US companies share more than half of the aggregate cashflow of publicly traded companies. The extreme"oligopolization" of the US economy makes aggregatedstatistics irrelevant, and when we take the small and mid-cap segment apart, we see that their net debt representsmore than 3 years of EBITDA, a level that will inevitablylead to a flurry of defaults in the event of a slowdown inprofits or a tightening of monetary conditions.
We can be reassured on the basis of the observation thatthis debt has mainly been used to finance share buybacksand dividend payments and that there has generally beenno creation of overcapacity, which should limit the impacton the real economy. But we must not ignore the systemicrisks related to the credit market itself, largelydisintermediated, poorly regulated and whose structurehas rapidly evolved with the emergence of a new base ofinvestors attracted by the search for yield in a world ofnegative rates, fueling a boom in the most risky segments,High Yield and Leveraged Loans.
For now, the Fed has managed to contain the crisis thatbegan last autumn and credit spreads have quicklyreturned to lower levels. Given high debt levels and risks onthe outlook for profits, we recommend taking advantage ofthe recent upturn to reduce exposure to the asset class.
Non Financial Corporates Debt / GDP as of June 2018
Source : BIS, Banque Pâris Bertrand
Debt ratio: Net Debt / EBITDA
Source : Factset, Banque Pâris Bertrand
Spread on US High Yield (in bp)
Source : Banque Pâris Bertrand
Jean-Eudes Clot+41 22 316 02 18
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
US Large Caps US Small Caps
40
60
80
100
120
140
160
180
Latest Median 1st quartile 3rd quart ile
PAGE 4
Equities
Switzerland
U.S.
Europe
Japan
Emerging Markets
The strongest beginning of the year since 1987 for the S&P500 (+11%) looksvery much like a bear market rally: disconnection with fundamentals and flows,technical catalysts and the role of synchronized central bank easing. Themessage could be now « Sell in March and Go Away ». The main event of 2018was the bear market triggered by the cumulative 20%-plus decline in the equitymarkets. The market paradigm is shifting rapidly: volatility is on the rise; we aremoving from financial leverage to a preference for liquidity; financial assetvaluations are beginning a process of convergence towards their long-termmeans; investors are moving into more liquid assets; and there is much tacticalselling into rallies, whereas, in a bull market, there is much buying on the dips.
Interest rates
Switzerland
U.S.
Europe Core
Japan
EM hard
EM local
Divergences in monetary policy peaked in November 2018 (US/German 2-yearbond yield spread peaked at 355bp). The US tightening cycle is already wellalong, and the Fed has announced a stabilisation. Real interest rates in Germanyfell to -2%. The ECB is about to normalise its monetary policy. In EMs, there isroom for easing, but that will depend on a reversal in risk appetite, with the endof capital outflows, a stabilization in the dollar, and the reduction of idiosyncraticpolitical risks. The US yield curve could invert by the end of H1 2019. Goviesshort duration is a compelling trade in the US in absolute and relative terms.
Credit
IG U.S.
IG EU
HY U.S.
HY EU
EM corp.
Extreme valuations and wide dispersion in balance sheet quality. Net leverageis high, but interest cover is excellent. The credit cycle is mature. Defaults wouldnot rise unless there was an economic downturn and an increase in volatility. Inthe US, the Fed has flagged its normalization process properly, and that processhas been smoothly priced into spreads. The EM crisis (Turkey and Argentina), theSovereign crisis in Europe (Italy) and the likelihood of corporate fallen angels (GE,AT&T) are early warnings of the fragile environment inherited from themanagement of the financial crisis. Contagion into the most fragile bondsegments is a significant threat. In corporate bonds the risk is in the largeweighting of BBB-rated bonds that could tip over into HY.
Real Assets
Swiss real estate
Intl. real estate
TIPS
Commodities
Gold
The output gap in developed markets is near zero. It points to a comingacceleration in inflationary pressures, which would result in a prolongation in thebusiness cycle and monetary cycle. REITs now have more value in the US than inEurope, which is still waiting for interest rates to catch up. Exposure toCommodities is more of a contrarian tactical play after the 2018 correction.More specifically, Gold is gradually becoming attractive once again, withdiversification in equity and dollar risk, convexity vs. the inflation risk, and thereturn of the political factor. Strong preference for liquid assets at the currentstage of the cycle.
AlternativesRaise non-directional exposures (i.e. global macro, Long/Short Equity MarketNeutral and CTA).
Cash USD Cash competes with Bonds (inverted yield curve) and Equities (>DY).
ASSET ALLOCATION
Asset Class Tactical and strategic allocation View on the strategic allocation
Change - = +
MONTHLY LETTER| MARCH 2019
PAGE 5
Core
Multi asset: 3 layers of defense1/ Diversification should be at its highest level across all asset classes. 2/ Active management: Central banks liquiditywithdrawal will trigger valuations adjustements. 3/ Risk management: including the ability to disinvest according to adisciplined process.
Equities: Extract all-weather alphaIt relies upon a disciplined stock selection, combining a Fundamental Model and a Tactical Model with no Style bias.
Commodities: Optimized exposure on GoldSystematic options selling is a source of additional return for Gold. The dollar stabilization and a more stable USmonetary policy will unleash the appreciation potential of Gold.
Thematic
Risk Adjusted Income : European Equities with an Income approach
The European Equity risk is weak structurally. Consequently, investors should favor convexity and robustness in theirstock picking criteria. It is a unique opportunity to combine growth and income for investors. The income componentguarantees high convexity in case of financial stress (sovereign, banking or corporate).
EM: contrarian call
Chinese policy response is stepping up, and provides a natural offset. EM P/E multiples have derated and now appearcheap in the historical context (11.8x vs. 15x end of 2017). EM FX bottoming out should help.
Swiss Equities: Benefit from a defensive and quality bias
The right stock selection has to find a compromise between diversification, liquidity and tracking error. Such anapproach diversifies itself away from the Large Caps vs Small Caps dilemma.
Opportunist
Equity Long / Short with balance sheet quality focus: Exposure to a Credit cycle U-turn
The strategy expects the outperformance of financially less risky companies in the event of credit risk deterioration.Such a strategy would generate a significant absolute performance during prolonged credit stress periods.
Value: Exposure to macro-financial normalization
The Value theme offers a unique mix of price/profitability/growth around 3 regions: 1/ US: inflation acceleration, Techweakening; 2/ Europe: decrease of political risk premium; 3/ EM: macroeconomic-financial context stabilization.
An opportunistic approach to income: yield enhancement option selling strategies
Investors can generate returns through exposure to various asset classes, including bonds (coupon payments) andequities (dividend payments). In a more rangie market environment with more frequent market stress, carry strategies– via options selling – are one way of generating income, thanks to implied volatility spikes.
Global Risk
2018 has been marked by a structural disruption, with the start of a more defensive footing. The entry into a bearmarket radically changes the risk profile of the market: a downward force, more tactical management (sellingrebounds), a less directional approach. The US’s second-longest post-war phase of expansion has created manyimbalances in fundamentals (public and private debt and a tight labour market) and financial asset valuations. It hasresulted in markets more vulnerable to shocks (political, geopolitical, economic or financial). The market is nowexpecting a new monetary impulse.
Currencies
The lack of conviction on foreign exchange markets points towards a neutral position in FX risk. The dollar couldresume a downward trend due to a mature business cycle, a narrowing in spreads, the return of the twin deficits, and abelated fiscal stimulus. Any rally in the dollar is an opportunity to reduce exposure. The euro has been penalized byBrexit and the Italian crisis. In level, it is largely undervalued. EM currencies are benefiting from positive carry. The CHFis once again a risk-off currency. The GBP is still under pressure (Brexit and political instability). The yen is the besthedge against financial stress.
MONTHLY LETTER| MARCH 2019
IDEAS
PAGE 6
EXPERTISE
Socially Responsible Investment from the angle of diversified asset allocation
MONTHLY LETTER| MARCH 2019
9%7%
6%6% 5%
3%
Financial performance is no longer investors’ soleobjective. In response to current environmental, social andgovernance challenges, investors want to combinefinancial performance with socially responsibleperformance over the long-term. Since 2014, we havemanaged socially responsible mandates for foundationsand non-governmental organisations. We also do so for ourretail clients.
Our sustainable strategies are reflected in a tailored multi-asset class investment solution. We put our know-howinto practice through active, disciplined and dynamicstrategies. Our investment process creates value at thelevels of asset allocation, portfolio construction and riskmanagement.
Once the mandate’s framework has been worked out withthe client, its social and sustainable approach is reflected inits selection of investment vehicles. We call on managersspecialising in socially responsible investment (SRI). Toguarantee the success of our selection, it must be in openarchitecture and fully independent, with a clear insightinto the market environment.
The selected funds are based on various strategies, such asbest in class, integration, shareholder engagement andexclusion. The investment universe includes about 20 sub-asset classes, as well as various regions. This broadcoverage provides good diversification for the mandate.
There are no clearly laid out rules in SRI. However, giveninvestors’ growing interest in sustainable investment, it iscertain that bottom-up approaches will become morecommon than any particular standard or rating. As it is, SRImanagers produce extra-financial reports in addition totheir financial performance reports. We fully expect extra-financial research to become more widespread, at therequest of end investors.
SRI is now present in all asset classes without exception.Apart from the traditional and liquid asset classes that wecover in our mandates, impact investing is one alternativeapproach that is drawing increasing interest. According to asurvey by Swiss Sustainable Finance, a little more than70% of millennials believe that it is possible to achievepositive returns while investing in companies having animpact on society and the environment. In light of needsfor diversification, impact investing must also be regardedagainst a backdrop of portfolio construction and maximumsustainability.
3%
3.3%
12.1%
29.8%
19.3%
31.6%
3.9%
Source : Banque Pâris Bertrand
Emmanuel Ferry+41 22 316 02 16
Multi asset class allocation ISR
Cash
CHF Bonds
Foreign CurrencyBonds
Gold
SwissEquities
Global Equities
PAGE 7
FOCUS
MONTHLY LETTER| MARCH 2019
«. We are convinced that we are entering into a market cycle that will remain challenging for some time», says Emmanuel Ferry, CIO of Banque Pâris Bertrand, and head of Pâris Bertrand Systematic Asset Management.
Did you set up a quantitative asset management activity because of growing demand from clients?
We viewed quantitative investment strategies as essentialfrom the very moment Banque Pâris Bertrand wasfounded, in 2009. All at the same time, we had to reassureinvestors after the financial crisis, make risk managementthe hallmark of our offering, and offer an investmentapproach that was credible in terms of results, promisesand the ability to keep up with the rapid growth in assetsunder management. Our investors have responded well toour investment philosophy. Pâris Bertrand SystematicAsset Management covers three investor profiles: privatebanking clients via Banque Pâris Bertrand; institutionalclients covered by a dedicated team; and externalinvestors, such as private banks, family offices andindependent wealth managers.
How did you set up these activities?
Our investment offering has been designed for and by ourclients. Pâris Bertrand Systematic Asset Management’sresearch and management team combines experience inasset management with renowned expertise infundamental research and quantitative analysis. Ourportfolio management DNA and our market vision havebeen expressed for almost 10 years in investment funds,investment mandates, and investment advisory. We alsodesign and manage opportunistic investment solutions tocapture occasional market anomalies.
Is the cost structure more attractive for both the asset manager and client?
Our systematic investment approach offers our investorsmore added value in terms of risk-adjusted performance aswell as costs. Our research is proprietary, which is aguarantee of independence and competitiveness.Technological progress, falling transaction costs andregulatory barriers (MiFID 2) give our strategies a decisivecomparative edge over traditional approaches. Based onthese criteria, our Swiss location offers advantages such asthe ability to attract talents and proximity to the world’stop pool of financial assets – private banking andinstitutional wealth management.
What types of solutions do you offer?
We currently manage more than 15 strategies with a totalof almost CHF 1.7bn in AuM. Our expertise covers themulti-asset universe with two flagship funds: SMART, adiversified and dynamic asset allocation solution; and FAST,a defensive absolute return strategy. Meanwhile, ourequity investment programme, called WISE, combinesdynamic stock-picking with robust portfolio construction. Itassembles a broad range of fundamental, technical and riskcriteria providing a 360° view of a company’sattractiveness. Our investment philosophy aims to exploitbehavioural biases on a large scale via an active andsystematic approach. Lastly, our cross-asset culture allowsus to identify opportunities throughout all asset classes.Thanks to a disciplined process, we transform theseopportunities into high-performance strategies. This iscurrently the case of our gold yield strategy.
Generally speaking, how did these products fare in 2018?
2017 had been an exceptional year for our range of funds.The 2018 market disruption was something of a stress testfor our diversified strategies, and one which we carried offsuccessfully. Our strategies are still highly ranked in relativeterms, with FAST in the first quartile and SMART in thesecond. Our WISE Europe fund has held up well amidst thisalpha crisis and continues to be ranked in the first quartile.We are convinced that we are entering into a market cyclethat will remain challenging for some time. We thereforebroadened our Absolute Return range in launching ourWEAR strategy, a long/short European equity strategy in aUCITS format. The results have been encouraging.Systematic management also allows us to adjust ouroffering when necessary.
8 February 2019 (extract)
Interview - Quantitative Asset Management : reassuring investors
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