Aaron Gurwitz is managing director and head of the investment and product office at Barclays Wealth in New York.
AsianInvestor: How are you advising your private-wealth clients to approach investments in 2010?
Aaron Gurwitz: There are four broad themes for early 2010. The post-crisis recovery has happened. It was explosive. But it's not necessarily leading to the next bubble or to another downturn. We have moved to the middle of the cycle. What strategies do well in mid-cycle recoveries? Equities, in general, and within equities, performance is moving from early-cycle winners to the more stable "steady Eddies". The exception is US small-cap equity, which didn't rally as much as it has in previous recoveries, so we recommend clients retain this exposure.
That assumes we won't face a second crash, as happened in 1937.
That second dip in the 1930s doesn't need to be repeated this time, because policymakers have learned not to tighten monetary and fiscal policies prematurely. There's no natural course of events that says this should lead to a double-dip recession.
Of course, it's still early innings. Sure, there is a risk of a double-dip, given that monetary policy is played out at zero interest rates and unemployment is high. Economic growth so far has come from fiscal stimulus, which raises the question of whether we need another dose to keep the economy on track -- and whether politics would allow it, especially in the US and the UK. If we do need another fiscal stimulus but don't get one, it could lead to a Japan-like scenario. But we're not predicting this, and both leading and lagging indicators -- purchasing manager surveys, the housing market -- seem to suggest that things are either improving or have stopped getting worse.
All right, so the first theme is equities. What's the next?
Our second theme is that this is an environment in which active managers can outperform an index net of fees and taxes. There may be some exceptions if you're just a momentum player. But mid-cycle, volatility is lower and returns and risks are normalising. That's especially true of investments in Asia, where the markets are no longer cheap. Barclays Wealth continues to look for good portfolio managers for Asia, both long-only and long/short. So are a lot of family offices in the United States - they are keen to find good Asia managers.
What's the challenge in finding good Asia fund managers?
Few of them have a sufficient track record or meet our operational due diligence. Investment firms in Europe and America tend to have a long track record in something. We'd want a minimum of three years' experience for a new firm before we put it on our approved manager list, but I'd prefer 50. Neuberger Berman has 50 years' investing experience.
Do your US clients have adequate exposure to Asian markets?
Our US clients are insufficiently exposed to international and emerging markets. What exposures they have are usually through mutual funds and exchange-traded funds. We need more good active managers in these areas.
What's your third theme?
That all investors should create their own personal public/private partnership. The financial crisis has changed the political spectrum, and governments are now going to play a bigger role in the economy and markets. What are governments trying to do? In the West, they need to increase revenues, which implies tax efficiency will become more important to investors. It implies other things as well. If large financial institutions are more tightly regulated and face higher capital ratios, it will tilt the competitive field in favour of hedge funds. Increased government intervention raises other possibilities for investors, such as whether carbon trading becomes an important asset class.
My fourth theme is to be exposed to economic growth in Asia: this is where risks are to be incurred. So the question is, what are the risk-effective ways to take such risks? One way is through local equity markets. Another is to invest in multinational corporations that derive a growing share of revenues and profits from Asia -- but international blue chips don't give investors a systematic exposure to foreign currencies. On the margin, currency bets are a more effective way to be exposed to Asian economic growth.
Is the name of the game to obtain exposure to the renminbi?
The FX market has priced in a 3% annual appreciation of the renminbi. If it does appreciate, the renminbi will have a knock-on effect on other currencies, which represent a better carry.
This advice doesn't just apply to clients in the US. Asian investors should hedge back to other Asian currencies. They should want to hold US assets, but not the US dollar. There are no major mis-evaluations among major currencies, except perhaps the yen and the renminbi. So Asian investors should own units such as the Korean won, Singapore dollar, Indonesian rupiah, and Brazilian real which is also leveraged to Asian growth.
We also recommend investors obtain a diversified exposure to commodities and natural resources via exchange-traded funds, equity futures and other instruments.
Is inflation a risk?
You know, we're no longer getting questions from clients about inflation or disinflation. Either clients assume there will eventually be inflation, or they realise that in both the short and the long run, deflation is actually the bigger risk. Interest rates are below core inflation and unemployment is likely to rise; we don't have a tight labour market, which is what you would need to get inflation.
What kind of questions are clients asking, then?
Clients want assurance that we're not headed into the next crisis, that things are returning to business as usual. This is reassuring to me, the fact that we're not getting the same questions any more. Clients are voicing individual concerns, which is a good sign.
I'd like to return to your first theme, about equities. For the past decade, equity markets have lost out to bond markets. You can glibly assume that the next decade will see equities outperform bonds, but what's the logic behind this?
Equities will outperform because the economy is growing, interest rates are low (and will one day rise) and corporate earnings are growing. All of this helps equity prices. In the world of fixed income, clients should remain invested in credit, but because yields are high, not because spreads may tighten. Yield spreads are not expected to widen, but they're stable, and this will protect you if interest rates rise.
To answer your question, investors need to mark their return expectations to market. Gone are the days of 6% bond yields. Today, long-term government bonds yield closer to, let's say 4%, for argument's sake, with 1% inflation. Now that's a lot better than an environment in which bonds yield 6% but inflation's at 4%. You have to look at real value.
Before the crash, the risk-free rate was 4% and equities had a 4% risk premium, which gave you a total return of 8% on equities, which wasn't bad. Now equities are returning 8% in an environment in which the risk-free rate is zero. Which is better for equity investors? People need to get their minds around this.
Does this mid-cycle period remind you of any others in modern history?
This period has no comparable experience since the 1930s, except perhaps Japan in the 1990s, but I wasn't there to experience it. The deflationary environment in Japan is a warning sign, however, because it's lingered so long after that country's bubble burst.
Are we likely to enter a new era of boom and bust, now that the post-war 'Great Moderation' seems to have come to an end?
There is a historical analogy: the 21st century could be more like the 19th century, which saw an explosion of productivity because of railroads and the decline of transportation costs. From 1815 to the 1890s, prices in the US fell. This could have been inflationary, but adherence to the gold standard mitigated this.
Today we have the entry of China and India into the global economy, which is raising productivity. We're not on the gold standard, but the size of the bond market is much bigger than it was in the 19th century. Today the US bond market is 400% of the size of US GDP. That means governments can't inflate their way out of trouble because mortgage rates would jump.
Does that suggest a return to 19th-century style panics?
Economic downturns in the 19th century tended to be long. It would usually take five years or so to recover from a panic, because the gold standard didn't let you cut interest rates. If the US were to be as restrained as that again, we could have a problem. But we're not going to remain at zero interest rates forever; things aren't that bad. Central banks can get inflation rates up to 2-3% without having the bond market go crazy and damage the currency.