Pictet AM eyes opportunities in corporate credit

Equity markets are cheap but are unlikely to rally significantly until corporate credit yields begin to move down, says chief strategist John-Paul Smith.
John-Paul Smith is the London-based chief strategist in the balanced and quantitative investment team of Pictet Asset Management. He is also the chairman of the fund houseÆs strategy unit. He is responsible for the strategic guidance of all equity teams, including both developed and emerging markets. He joined Pictet Asset Management in 2001 as head of global emerging markets.

Pictet Asset Management is the institutional division of Pictet & Cie, one of the largest private banks in Switzerland and a leading independent asset manager in Europe. The fund house includes all the operating subsidies and divisions of the group that carry out institutional asset management. The fund house manages around $109 billion globally, including $2.4 billion invested in Asian equity portfolios.

Smith shares with AsianInvestor his overall market outlook for the coming year.

How has the financial turmoil affected the way you manage your portfolios?

Smith: At Pictet Asset Management, our investment processes are based on valuation disciplines, which have made managing money in an environment driven by flow of funds, extremely challenging. We have been using our risk management tools to try to preserve as much value as possible for clients whilst maintaining a reasonable degree of exposure to what are by any rational criteria, extremely undervalued markets.

What is the biggest lesson you have learned from the US credit crisis?

The biggest lesson is something, which we also learned in the Asian crisis in the 1990s, namely to model extreme outcomes into our company spreadsheets. Still, we need to be careful not to draw the wrong conclusions from the events of 2008. We still believe that over time, valuation metrics will tend to mean-revert.

Have you adjusted your asset allocation in light of the crisis?

We began the year with a very overweight position in US equities relative to Europe and the emerging markets. Given the significant outperformance of the US, there may be some scope for Asia and the emerging markets to outperform in any rally. Over 2009 as a whole, however, we would still favour the US and Japan, which is now the cheapest major market in the world on most valuation criteria.

Where do you see the biggest opportunities in the coming year?

The most obvious opportunities are in corporate credit where yields are now discounting a worse economic scenario than the 1930s. While there is no obvious catalyst for a rerating as the deleveraging process continues, we are gradually increasing positions in high yield ex-GM and the financials. Equity markets are cheap on all valuation criteria but are unlikely to rally significantly until corporate credit yields begin to move down on a sustainable basis. Nevertheless we would anticipate some fairly spectacular returns from equities across all regions over the course of 2009.

What are your global and Asian weightings?

We are currently underweight in Asia in relative terms within our global portfolios. Within an Asia ex-Japan portfolio, we are relatively overweight in Hong Kong, Taiwan, China, Thailand and Vietnam.

What are your favoured markets in Asia?

Country weights in our Asian mandates are primarily driven by the results from our fundamental and valuation stock selection process. We currently have an overweight position in Hong Kong (utilities in particular), Taiwan (favouring consumer staples and telecoms at the expense of IT) and have recently been exploiting the valuation opportunities originating from China - moving from an underweight strategy to a small overweight. In China we prefer telecom, utility and internet companies over stocks in the industrial and financial sectors.

What markets are you bearish over?

Valuations and exposure to global cyclical themes keep us more cautious in stocks from Korea, Malaysia and the Philippines. Valuations in India still look relatively expensive whilst fiscal and current account deficits leave less room for domestic policy response to support economic activity.

Which sectors do you expect to outperform in the coming year?

We would expect to see the commodity related sectors outperform in any rally as the global trade system begins to function properly again. Nevertheless after a sharp initial upward move we would be negative on commodities over 2009 as a whole and would be overweight those sectors which have either been very oversold such as financials or have scope for margin improvement as input costs fall, such as consumer staples and industrials.

Which sectors do you expect to underperform?

We would be underweight the commodity related sectors for 2009 as we are pessimistic about the longer term pricing environment, most notably for oil. Nevertheless energy and materials are likely to outperform in any short-term relief rally as the global trading system recovers.

What are the main challenges that you expect to face in the coming 12 months?

The main challenge is to maintain some absolute value for clients whilst adhering to our valuation based investment disciplines in an almost wholly irrational investment environment. We must ensure that investors have adequate exposure to equity markets as the recovery from this bear market is likely to be dramatic in both its speed and extent.

What are the main risks of investing at the moment?

The main risk to investing anywhere at present is clearly the massive ongoing deleveraging, which has overwhelmed any rational analysis at the macro and stock level. We are managing these risks by very careful analysis at the stock level, modelling a range of extreme outcomes and maintaining sufficient liquidity within portfolios to deal with the likely level of redemptions. We are however retaining the bulk of our equity exposure since there is a real risk that many investors will be too bearish when the recovery from this bear market begins.
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