Visiting Dubai to meet high net worth clients in the middle of the international financial crisis in February 2009, Lars Kalbreier, global head of equity and alternatives research at Credit Suisse, advocated a return to "basics" in a diversified portfolio. He suggested his clients be overweight cash and corporate bonds and underweight equities until the downturn eased. Alternative investments — including assets such as commodities, hedge funds, private equity and real estate — were discouraged. Gold, on the other hand, had been recommended facing rising government debt in developed market as a result of the crisis.
Times change. With the financial crisis starting to slowly abate towards the middle of 2009, the bank shifted its recommendations. Now, Kalbreier is recommending overweight equities, while sticking with corporate bonds and adding alternatives to the mix.
While some confidence is back, his clients still lack faith in risky assets and equities. "We have seen [clients] reducing their cash positions somewhat, but not to pre-crisis levels. So there is still a level of caution," Kalbreier told Gulf News last week in Dubai.
Over the past two years, as global economic recovery has progressed in fits and starts, Credit Suisse has recommended within a standard balanced portfolio an overweight position on equities, high yield corporate bonds and commodities. It is underweight both cash and fixed income, especially government debt of developed markets, though it has a preference towards governments bonds in emerging markets.
In percentage terms, the bank has advised allocations for balanced portfolios of 43 per cent to equities, 32 per cent to bonds, 22 per cent to alternatives, and 3 per cent to cash.
In fact, Kalbreier said the bank went overweight in equities in June 2009 when it realised that "we were in recovery mode". It has remained that way since, on the grounds that monetary and fiscal measures taken by governments has not only helped avoid depression but also generate good growth in some pockets of the world.
However, the Zurich-based researcher, who also serves on the investment committee of the Swiss bank, said they have tactically downgraded emerging markets to neutral from overweight.
The reason for that, he explained, is that many emerging markets are expected to start using monetary policy to put the brakes on economic growth and inflation, something that is already happening in India and China.
Big opportunity
However, he was careful to point out that real interest rates — that is, adjusted for inflation — in emerging markets are still negative. Among emerging markets, he believes, the commodity exporting countries, such as Russia will continue to do well with their attractive valuations and because inflation is less of a worry there.
In terms of stock picks, he still sees a "very big" opportunity in the liquid developed markets. "I [mean] multinational companies that have exposure to emerging and frontier markets," Kalbreier said. "It's more of an indirect play, picking the big brands of the world."
As has been reported in the media, the cash positions as a percentage of the balance sheet of some of the companies in the non-financial sector in the US and Germany has reached the highest since 1959. Their profitability is at 16 to 17 years high in terms of margins, and they have very strong topline growth, especially selling outside of the Group of Three (G3) economies. The US company Nike, for instance, is selling 20 per cent more shoes than it did before the crisis. The German Volkswagen has never sold as many cars as now. And that is despite the crisis.
In terms of sector diversification, the bank recommends a shift to the more cyclical sectors from defensive ones. But such performances are true more in the US, than Europe, where "we are more cautious", said Kalbreier. He pointed to energy, information technology, automotives, and transportation and logistics — the last sector being a key beneficiary of the increase in global trade and a feature in the global recovery.
He still prefers corporate bonds, but less so than equities. Corporate bonds have already had a "fantastic rally" and so, within this asset class, the bank is now leaning more to only those offering high yields.
In its recommendations, the bank is overweight commodities, especially industrial metals, which he treats as part of the alternative asset class.
"They [commodities], which comprise 17 per cent of the alternatives, still move with the cycle," Kalbreier said. "Historically commodities continue to do well during recoveries and, since we expect global growth rate of about 4.2 per cent for 2011, this asset class we feel is going to do well."
Private equity, gold and real estate (mainly in the form of REITs) and hedge funds are some of the other assets within alternatives. REITs comprise 18 per cent and hedge funds 36 per cent of this composite asset class.
Private equity is a preferred choice, with the bank allocating 20 per cent of the total 22 per cent lodged in alternatives investments. "Private equity over the long run has been outperforming public-traded assets. Even within private equity, the first quartile portfolio has performed very well. If you have access to better performing funds, risk and return are more balanced," Kalbreier said.
With the hedge funds industry shaken up during the crisis, the survivors are in fact well positioned to perform, he said and that is why "we are overweight hedge funds in our strategic allocation as well."
As for gold he feels there is still upside potential, but more over the longer term, say two years. Many of the policies which are being implemented now are inflationary, he argues, not in the short term, but in the long term. These inflationary pressures are going to crystallize in the next 12 to 18 months.
Uncertainty
"That is supportive of gold as a diversifier. It is 9 per cent part of the alternative part of the portfolio."
Such broad asset allocation, moving away from cash into equities and a wide range of alternatives, is a mark of clients' confidence slowly returning amidst what is still an uncertain time, that continues more in some parts such as Europe, two years after his last visit to Dubai.
Frontier markets
Frontier markets (FM) are characterized by higher volatility and lower liquidity. They have outperformed the broad global markets index, but not the emerging market. At the end of the day FM is a subsector of the EM. We have to look at risk-reward ratio there and look at whether there is a value. And now we are seeing value appearing in the frontier market. It has underperformed emerging market, yet it does have a benefit on the commodity led cycle of growth that we are seeing. So this is a little bit of an anomaly at the moment. A big, big weight of the FMs comes from this region (Mena). There is definitely a lot of optimism there from the institutional side regarding what the FMs can provide. Again I think these are markets that are in their infancy in terms of investability. If you want you can still play FMs by investing indirectly—in companies that are outside the frontier markets but have a huge investment or exposure there. Second aspect is look at markets directly—value, momentum and interest are appearing, which are all quite critical. We are also seeing a recovery in the corporate profitability on the FMs.
All in all we are getting all the ticks of the box, so to say. In terms of asset allocation it's going to be a very small percentage. At Credit Suisse, we believe the FMs will be gain a lot of traction in 2011 and probably be much more mature in the coming years. But if you want an early mover advantage and again take into account the risk tolerance level the investor has, then that's an opportunity. But I think the investor has to realise the tolerance level of his to be indulging in the frontier markets in the GCC.
— Kamran Butt, Director and Head of Middle EastEquity Research, Private Banking, Credit Suisse
On the radar: Frontier markets
