The likelihood of inflation hitting developed markets means wealthy investors should reduce positions in G3 sovereign bonds, says Mark Haefele, managing director and head of investment at UBS.
Based in Zurich, he spoke with AsianInvestor during a one-day trip to Hong Kong earlier this week. Haefele’s role is to develop house views for UBS Wealth Management, drawing on discussions with clients and with teams from the group's asset-management, trading and investment-banking arms.
The firm manages around $1.6 trillion of private client money and relies on that information flow to generate investment ideas that are meant to outperform.
However, his key message will not be new to AsianInvestor readers: as governments and central banks try to reflate their economies in the face of massive deleveraging, monetary policy and political mistakes have eliminated the concept of a risk-free asset. (See our cover stories from the magazine's September and October editions last year, for example.)
Even ‘safe havens’ supposedly unrelated to the Federal Reserve, Bank of Japan or Bank of England have lost this status, with the Swiss franc now pegged to the euro, to ward off overwhelming capital inflows; and with gold, once seen as the ultimate antidote to currency debasement, now trading in line with equities or other risk assets.
Haefele says gold is still a valid hedge against a bond-market crash or an even more pronounced debasement of fiat currencies, and UBS continues to recommend wealthy people have some holdings. “People like gold because if you keep a kilogram in a Swiss bank account, you can always write a cheque against it,” he says.
He recommends investors maintain a core/satellite approach: core meaning a long-term, strategic asset allocation, just to be in the market (notably via yield products such as high-yield or emerging-market debt) with some protection against inflation; satellite meaning equities and other risk assets that are traded opportunistically.
This is not a novel concept, but the composition of ‘core’ or ‘satellite’ has changed. For example, AsianInvestor suggested that for wealthy individuals, free of the legal constraints that pension funds or insurance companies face on asset allocation, G3 sovereign bonds should not be included in the core bucket.
Haefele agrees in principle, but says many investors continue to allocate there. “It’s been the best performer, and people like to do what works,” he notes. "And because sometimes things seem so uncertain, developed-country sovereign bonds have looked safe.”
But he argues that wealthy clients should move away from developed-market government debt: “That cake is baked."
Over time, sovereign bonds from the US, Europe and Japan lose money against inflation. “And inflation is going to become your enemy,” says Haefele, noting that it is a necessary ingredient for indebted governments to reduce their loads, along with better tax collection and economic growth.
The pace of that change, however, depends on how governments in the West, particularly the eurozone, manage that shift. Haefele’s probable scenario for Europe is a muddle-through. The headlines have been dreadful, but that’s partly because the International Monetary Fund and the Germans need to use bond-market crises to spur structural reforms in Spain, Italy and elsewhere – a strategy that is gradually having an effect, despite the headaches it creates for global investors.
Separately, the US is slowly recovering, but will face deleveraging and high unemployment for several more years. That means yield products are the best bet for another year or so, at least, while investors keen to dip a toe into equities should stick with companies that pay sustainable dividends, particularly in the US and emerging markets.
UBS also recommends that wealthy investors in the US and Europe take a page from the Asian playbook and become more active allocators to currency. Haefele particularly likes the Canadian dollar: it's a US dollar proxy without the problems of quantitative easing, and Canada may be the only developed nation that could raise interest rates this year. He’s negative on the Australian dollar because of that country’s overexposure to Chinese commodity consumption.