The eurozone is not doomed, but large structural issues remain to be solved, making ongoing volatility an occupational hazard for wealth managers. Umberto Bacchi gathered the views of six private banks on their preference for corporate bonds and the likelihood of a unified euro treasury-issued euro bond
European governments latest measures to sail the eurozone out of the storm have been good enough to get private banks words of praise and support but not their clients money.
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All around the globe, wealth managers are still keeping a stay put and hold investment approach towards the old continent and its troubled currency, while looking for opportunities elsewhere.
PBI contacted six private banks headquartered in different geographic areas Italys UniCredit, Coutts in the UK, Sarasin in Switzerland, the US Merrill Lynch, Deutsche Bank in Germany and Bank of Singapore to compare their views on the euro crisis.
We found that, while wealth managers are confident that the European Monetary Union (EMU) will not break up, especially in the light of the decisions taken at the June European summit in Brussels, they are still restive in investing in euro and in European government bonds.
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By GlobalDataEuro to survive, say private bankers
"At the end of the day we believe the euro will stay together," said Norman Villamin, Coutts chief investment officer (CIO) for Europe and Asia.
"We strongly believe that the euro will survive," echoed Manuela DOnofrio, head of global investment strategy at UniCredit Private Banking.
"Important decisions were taken in terms of achieving a single banking supervision with the ECB playing a key role, allowing the European Stability Mechanism to recapitalise banks directly and therefore breaking the dangerous link between the banks and the sovereign debt," she said.
However, she added: "The solution to the crisis is not yet a done deal and the road will remain bumpy with a more severe recession as a likely short-term outcome."
The failure of EU politicians to give a rapid and effective response to the crisis is forcing wealth managers to keep a cautious investment stance in the euro area and to assess the viability of different investment strategies.
Kevin Lecocq, Deutsche Bank global CIO, said: "Politicians are continuously behind the markets. They do just enough to avert the latest pressure, but never enough to resolve the crisis fully.
"Consequently, we get the cycle of crisis response, relief then crisis again which of course causes the oscillation between optimism and gloom."
"I dont think that well wake up on Monday morning to witness that the governments have done something to fix it all," said Villamin. "But it does mean that portfolio managers will need to be quite agile in navigating the various shifts that will take place over the next 24 months."
The safe haven: corporate bonds
Navigate is the perfect word to describe how wealth managers are shaping their clients portfolios to preserve wealth amid the euro crisis.
The safe port wealth managers are looking for is without doubt the corporate bonds market.
Corporate bonds are replacing core government bonds in clients portfolios.
Companies credit instruments are able to grant higher returns than safe government bonds such as the US and German ones, without carrying the risks embedded in the tempting yields offered by sovereigns of troubled nations like Italy and Spain.
"We prefer European corporate bonds to European government bonds, as we currently dont see value in core government bonds, which offer negative real returns," says DOnofrio.
Villamin added: "We have a bottom-up selection process and prefer corporate credit over government bonds. Italian or Spanish bonds currently have very attractive yields but we are concerned about what may happen further down the road in the eurozone."
"Corporates from core Europe were remarkably resilient, with spreads drifting wider very slowly," said Benoît Robaux, head of credit research at Bank Sarasin.
"A look at the total returns paths shows that core investment-grade credit has been consistently enjoying the most attractive risk/reward profile since the beginning of the year, offering better returns than AAA-rated sovereign bonds and lower volatility than high yield."
The stake represented by corporate bonds in portfolio weighting has grown significantly for all the private banks.
For July 2012, Deutsche Bank recommends its clients allocate 23% of their assets in fixed-income developed markets corporate bonds, while keeping developed markets sovereign bonds down to 9%.
The second strategy adopted by wealth managers is to reshuffle their portfolios weightings with a move away from investing in Europe.
Moving away from the storm
Villamin said: "It is going to require clients to think about their investments differently than they have in the past and perhaps to consider geographical regions and asset classes which they havent previously tried."
"We have increased both the equities and the bond portfolio diversification by overweighting US and emerging markets equities, global corporate bonds and emerging market bonds in hard currency," explained DOnofrio.
On the other hand, Bank of Singapore suggests investing 23% of the portfolio in emerging market (EM) bonds, while looking for a balanced or aggressive tactical asset allocation.
The South East Asian bank is advising its clients to overweight EM corporate bonds in particular.
It is buying instruments of companies such as Russian private-owned bank Alfa Bank maturing in 2017 and bearing a fixed interest rate of 7.875% per annum, Philippines conglomerate First Pacific (6% per annum to 2019) and China real estate developer company Yanlord (9.5% per annum to 2017).
Deutsche Bank is betting on the US market as four out of its eight High Conviction Ideas, recommended to its clients in the banks July investment insight, are US-related instruments.
Currency changes under consideration
Together with Merrill Lynch, Coutts is also reviewing portfolios primary currency, challenging its clients to consider their position.
"Our first job is to preserve wealth for our clients within their risk appetite. We believe that we should think more strategically about euro exposure and to encourage asset liability matching and diversification. This applies not only to assets including bonds and real estate but also in the currency in which our clients are trying to build and conserve their wealth," said Villamin.
Bill ONeill, wealth management EMEA CIO at Merrill Lynch, explained: "Diversification away from significant euro currency exposure may be considered, with particular attention to the US dollar and sterling."
Equities and the dividends paid by companies in good health can be considered another substitute to the low or risk-affected yields granted by sovereign bonds.
"The risk premium afforded to European companies that have the ability to maintain, if not grow, dividends in a time of negative real sovereign yields in safe-haven sovereigns is particularly attractive, especially for longer-term investors," said ONeill.
Villamin added: "We think that dividends, rather than capital gains, will be an important driver for returns over the next few years."
Some wealth managers are also holding money in some assets that were not alluring in the pre-crisis period, but now represent a safe waiting solution.
"As a further risk-off move, we overweight cash which is to be invested in USD short-term bonds and gold," DOnofrio. "Given the cash real negative yield we will put the cash to work again as soon as we get more clarity on the euro debt crisis."
A call to EU politicians
Given that wealth managers are diversifying their investments waiting to see changes in Europe, it remains to assess what exactly they want to see happening to return to investing confidently in the continent.
"We all understand that some hard decisions need to be taken in terms of policy to start the ball rolling," said Villamin.
The call is for stronger political, fiscal and monetary integration, for the creation of a system able to react quickly and coherently to market pressures, not losing itself in political discussions.
"The lack of integration on fiscal, economic and political fronts has resulted in considerable consequences for the eurozone and global economies, including increased volatility and distorted risk premium in markets; primarily eurozone equities and peripheral sovereign debt," said ONeill.
Villamin added: "In order to reach fiscal and political union, both the periphery and the core are going to have to relinquish some control."
In particular, this process implies debt mutualisation, as, according to Coutts, Merrill Lynch and Sarasin, to regain investors trust the implementation of a common monetary policy in the eurozone must go hand in hand with the creation of a common treasury.
The call is for euro-bonds. "Mutualisation of debt is necessary," said ONeill. "We believe that the EMU will achieve integration on fiscal policy, including the creation of a single euro bond issued by a single eurozone treasury."
Euro bonds creation must be supported by spending cuts and other structural reforms, according to Coutts and Sarasin.
"We believe that euro bonds will form part of the solution to solving eurozone issues. But there is a joint responsibility which needs to go hand in hand with fiscal discipline," said Villamin.
Sarasins head of research and chief economist, Jan Amrit Poser, said: "Debt mutualisation is needed to keep the peripheral interest burden at a moderate level and to secure funding. In return, structural reforms need to be implemented to redress the imbalances of the past and a body of rules and regulations should be enacted to prevent such a financial crisis from ever happening again in the euro area."
The clock is ticking
Still, it is the lengthiness of the political debate that is worrying private banks.
"Concrete steps to this may take years, not quarters," said ONeill.
Bank of Singapores chief economist, Richard Jerram, said: "It is hard to see Germanys austere approach softening significantly. Economic reforms that increase the growth potential will take time to be effective and also face resistance from domestic interest groups.
"The concern is that the scale of the problems could overwhelm the resources of the policymakers perhaps due to political constraints. At the least, continued market volatility and poor economic growth seems unavoidable," he concluded.
European structural reform is needed desperately, but with political momentum continuing its sluggish pace, wealth managers need to remain on their toes to preserve their clients assets.
