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The Art of Investment During Uncertain Times

The Art of Investment During Uncertain Times

Michael Bolliger, who heads the emerging markets asset allocation team at the UBS Chief Investment Office in Zurich, was in Cyprus earlier this month. During his stay he spoke exclusively to GOLD.

By John Vickers


The April issue of UBS Global Wealth Management report notes that investors are worried about “the next recession”, which suggests that it is inevitable. Is this what you believe? If so, why?

Michael Bolliger: If history is any guide – and we've had nine or ten recessions since World War Two – something is going to happen eventually. That said, we don't think it's just around the corner. There's a decent chance that the world will continue to grow for the next 12 to 18 months but we need to be mindful about our ability to project things into the future, especially given the trade war between the US and China, Brexit and an uncertain monetary policy outlook. At this point, though, we still see the US economy growing reasonably well. It’s a $21 trillion economy. China is very big as well so all else being equal that should help. The Federal Reserve has the leeway to ease if it has to and although the ECB can't do much more, the People's Bank of China can provide some stimulus. In these uncertain times, there are safety nets in place that should keep the global economy going. So at this point, recession is a risk case and the likelihood of that risk has clearly increased but not for some time. 


GOLD: Do you think that the EU itself is in danger or will any problems be limited to the eurozone?

M.B.: As researchers and investors, we obviously look at both obviously but the eurozone is a lot more important because of the ECB, the euro and the exchange rate, which is itself important for the way we think about European assets. So there's a greater emphasis on the eurozone than on the European Union but the two are closely interlinked. 


GOLD: Can the single currency survive and, indeed, thrive?

M.B.: Yes, I think so. It's pretty safe. The crisis in Greece in 2011 was a big test and there have been others and so talk about the euro is probably not something that's going to stop any time soon. Whenever there is stress in the system, people point to the fact that the EU has a common monetary policy but separate fiscal policies, which is seen by some as a flaw in the system. One lesson learned from the Greek crisis is that it’s very costly for a country to leave and it's very costly for those who stay as well. There was a time when almost every other EU member state was saying “We should leave the EU” but that has really died down. The populists are still complaining about all sorts of things but very few of them are proposing to leave. Brexit has proven to be a great showcase for the fact that leaving the EU can turn into a real disaster. And don’t forget that the UK still has sterling and not the euro, which makes things a lot easier.


GOLD: There is still a great deal of uncertainty surrounding Brexit and whether or not a deal will be struck, if we assume that by the end of October the UK will no longer be a member of the EU, how do you expect this to affect the country and what will be the impact on the remaining 27 nations?

M.B.: For the UK, leaving will initially create stress in the system and in the economy, and we can see some of that happening already. If you’re a British entrepreneur, you're not going to invest in new offices right now because there is so much uncertainty surrounding everything: you can't be sure about what kind of access you’ll have to the European markets or to the all the markets with which the European Union has great deals, such as the US and Japan. After the initial shock, I'm sure that in the medium and long term, the UK is going to find ways to deal with the new situation. From the European point of view, it’s not in anyone’s interest for a country to leave and it's probably not in the EU’s interest to see a member leaving and making a success of it. There will be an impact on the remaining countries but they will definitely manage the situation.


GOLD: The same UBS Global Wealth Management report mentioned earlier also noted that, due to (last month’s) EU elections and the fact that there will be a new President of the ECB, “additional risk factors and uncertainties need to be taken into account when investing in Europe.” Don’t the EU Institutions tend to ‘carry on as normal’ rather than change course when a new individual takes over a particular post?

M.B.: I think you're absolutely right in the assumption that 'the show must go on' and we fully subscribe to that. But take the ECB, for example. The next President might be like Mario Draghi but he could equally be like Jean-Claude Trichet, so whatever happens, the markets will use the information in an attempt to second-guess what monetary policy could look like under this new President, which creates a new source of uncertainty. But the idea that the EU institutions are there and will continue to function in much the same way as now is one that we wouldn't challenge. 


GOLD: The recent elections have not changed the broader makeup of the European Parliament but there is clear evidence of increased support for the smaller anti-EU parties across the Union. Do you think that this will bring any substantial change to the overall working of the EU?

M.B.: Not really. We clearly saw that the extremists on both the left and the right made gains while the centrist parties sustained losses but the result was not particularly dramatic – it could have been worse – and it's extremely unlikely that the left and the right will ever be fully aligned so as to systematically block everything. We need to distinguish between those who are driving policies and those who are influencing them. The influencers may have increased in number but the drivers are still the same. 


GOLD: There is never any shortage of uncertainty in most parts of the world and today’s markets can react dramatically and almost instantly to a crisis, so if Europe appears to be problematic for investors, what markets does UBS feel more confident and positive about for 2019-2020?

M.B.: We always start with our strategic asset allocation, which is a diversified portfolio that includes European, US and Emerging Market assets – stocks, bonds, alternatives – and we build it with a view to doing well over a five- to seven-year horizon. That's always the starting point and that's a portfolio we build to make sure that our clients can stay invested throughout the cycle. It's expected to deliver a reasonable return during times of both expansion and contraction, which is why we sometimes hold positions that may look counter-intuitive. Then we will make tactical adjustments of one or two percentage points more here, one or two percentage points less there and, clearly, at this point in time, we are broadly risk-neutral. We're still holding overweight positions in global stocks with no specific preference for a given region, but we also combine that with an underweight position indirectly through put options that we have as protection. At this point of the cycle, things have become quite fragmented so we try to have a lot of diversified positions and no directional exposure.


GOLD: You are responsible for asset allocation in emerging markets. First of all, what is USB’s definition of an emerging market? Do you mean just the BRICS (Brazil, Russia, China, India, South Africa) or others? 

M.B.: No. There are various definitions of an emerging market or emerging economy. The World Bank and the IMF have theirs, as do some of the index providers. Some bonds fulfil the standards of the developed markets and others don't, for example. We are pretty much organized within our teams internally according to these benchmarks We look first and foremost at asset classes.


GOLD: At this moment, is there a single country that, for whatever reason, ticks all the right boxes for major investors?

M.B.: No. As I said before, investors should start with a diversified exposure and many of them haven't understood that some of these markets – first and foremost China –have become really big. China is now the second biggest economy globally, it has a huge market and despite the difficulties it still has a tremendous potential. There are all sorts of opportunities that you can find once you start to open the box and look inside but there isn’t a particular geographical location or a single asset class that has all the answers. Diversification is what it’s about.


GOLD: Has market volatility changed investment strategies and even investor expectations in recent years? If so, how much harder is your job than it would have been, say, 10 or 20 years ago?

M.B.: People became quite concerned after 2008-2009 and some of them didn't invest for a long time. When they finally started to invest, they were still concerned but for another reason: the market was too expensive and some clients were actually squeezed out of the market. In that sense, the volatility caused by political uncertainty became quite painful in terms of opportunity cost for some for some investors. So that's the first thing that has changed. One of the reasons why this happened is that all the world’s central banks – some quicker than others – started to implement a completely unorthodox monetary policy. As a result, the US labour market is at full employment and yet interest rates are nowhere near what they were in the past. It’s the same in the eurozone where the ECB still has to take a step in the direction of rate hikes. This obviously has implications for investors and their expected returns. If interest rates start to rise, that will eat into their bond returns, so they may need to take more risks again and think about Emerging Markets or alternative asset classes. There will always be opportunities but where I could once invest in a B-rated country to get to double-digit returns, I now have to go to a CCC-rated place or I have to buy in the midst of a crisis. Not surprisingly, some clients will question such practices!


GOLD: Do you expect the low interest environment to continue for much longer? The Federal Reserve has begun a gradual raising of interest rates. When do you think the ECB will follow?

M.B.: As I said at the beginning, a recession has become more likely but it's not our base case and we expect things to stabilize in the 4th quarter of this year. There is a question mark about who will be the next President of the ECB, as we have also mentioned, but the incentive to raise interest rates in Europe is, of course, still there. Initially, we had March 2020 as the most likely date but we've since put it back to September 2020. That's still more than a year from now but it's going to happen eventually.


GOLD: How would you describe an economy like that of Cyprus? Is it simply too small for UBS to consider it useful?

M.B.: Well, given that it’s about 1,000 times smaller than the US economy, it certainly wouldn’t top our list! The economy may be very reliant on tourism – which

can be very good at times and not so good at others but at this point it's doing well – but what I find remarkable is that it seems to be quite a vibrant Innovative place. Every now and then, Cyprus comes up with a great new way of attracting financial service providers or investors, such as the visa scheme. In many ways it's similar to what Switzerland is doing quite successfully as well. Cyprus has been very successful and one only has to compare it with its neighbours to see that, in similar conditions, it has achieved a lot more. Being small and innovative definitely has its advantages.


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