Don’t write-off world equities as yet amid volatility

The volatility index shot up to more than 50 in early February, a level not seen in the past 10 years, on expectations that higher inflation

Siddesh Suresh Mayenkar, Senior Reporter
14:03 March 10, 2018
Markets went into a tizzy and the Dow Jones

Dubai: Fund managers are not writing-off equities as yet even though their strategy has changed to what it was last year due to volatility.

The volatility index shot up to more than 50 in early February, a level not seen in the past 10 years, on expectations that higher inflation would result in faster than expected rise in interest rates. Markets went into a tizzy and the Dow Jones Industrial Average corrected 10 per cent from its top, before witnessing a recovery.

The Dow Jones index has been on a straight line upwards in the past decade or so, registering gains of 226 per cent since 2009.

BUS_180310 Stéphane Monier.JPG.JPG“The reason for that volatility during normal periods compared to what we had experienced is that before the volatility event we had not had the usual market correction. In a normal market we had 3-5 per cent of correction once a quarter. But since markets have not corrected in the past few years, we feel that this volatility will be more frequent in the next 12-18 months,” Stéphane Monier, Chief Investment Officer (Private Bank) at Banque Lombard Odier told Gulf News while on his field visit.

“It come in at a critical time in the economic cycle because we are transitioning from a goldilocks scenario, which is a situation where we have good growth and low inflation to the first stage of over-heating of the economic cycle,” Monier said.

But despite the volatility, Lombard Odier is still not writing off equity markets.

“We see more volatility coming, but we still are reasonably positive on risky assets,” Monier said, adding, “the 30 per cent returns looking at the growth potential of the economy is certainly not repeatable. We are not yet negative on equity markets. The Fed will gradually hike rates, so by that we don’t think we are closer to a recession.”

Historical comparison of S&P 500 drawdownsShifts

Lombard Odier, which manages nearly $200 billion (Dh734 billion) of clients’ money, has made tactical and strategic shifts in their client portfolio.

The private bank increased its allocation to convertible bonds, which allows investors to participate in the upside of equity markets, and also protect its downside.

“We are striving to be nimble, and agile, and very adaptable in these markets. We can take advantage of those volatility events, but you need to reactive to add value for our clients,” Monier said.

Lombard Odier also increased the client’s exposure to Japanese yen by 3 per cent.

“The idea was not only to benefit from appreciation of Japanese yen in expectations of change of tone of the BOJ. The Japanese investors repatriate some of their foreign investors to Japan, and that contributed positively to the performance of our client portfolio,” Monier said.

Lombard Odier also favours emerging markets along with real assets. They also like emerging debt on expectations of an appreciation in local currencies.

Lombard Odier has 15 per cent allocation in emerging markets compared to 8 per cent by competitors. The allocation has been small compared to the size of emerging market economies. Emerging markets contribute to 60 per cent of the world economy and 80 per cent of the world population.

“The trend is we will look to increase our allocation to emerging markets. If I want to add more risk to our portfolio we would add equities and debt in local currencies. The other trend is to get into real assets like real estate, infrastructure and private equity. We will increase our allocation over the time period of 5-10 years,” Monier said.

Due to the liquidity provided by central banks, Lombard Odier said it is reasonable to assume that other assets were overvalued compared to real assets.

Lombard Odier also chose to sell some puts on European holdings, allowing them to monetise directly their expectations of a recovery, while still giving a cushion against any further dramatic falls. In currencies, the euro/US dollar has moved towards their long-term target of 1.25, reaching its long-run fair value.

Lombard Odier expects 2-3 per cent appreciation in the pound going forward.