Malik Haddouk : « In fixed income we are focusing in the short term on exposure to long maturities »

How would you describe 2014?

2014 turned out to be a high-quality vintage for most risky assets. The MSCI World gained more than 19% on the year, and fixed-income assets on the whole achieved strong performances, particularly on maturities greater than 10 years. To cite one example, an investment in the EuroMTS 15+ years (i.e., the euro zone yield on maturities greater than 15 years) in 2014 would have achieved a return of more than 33%, or six times the performance of the MSCI EMU equity index. 2014 was an unusual year, dominated by the quest for returns with heightened risk-taking. However, it was no walk in the park. The markets performed well early in the year, despite concerns over the solidity of growth in the US (hit by poor weather) as well as the impact of the Japanese VAT rate hike, which once again drove the country into recession despite the implementation of the famous three arrows.

Risk aversion returned in the second half with severe corrections (-10%) on the equity markets three times in six months amidst doubts on economic recovery in the euro zone and exacerbated geopolitical tensions in Ukraine, the Middle East and the China Sea. All these factors ended up undermining global economic growth, forecasts of which were steadily revised downward.

All these factors ended up undermining global economic growth, forecasts of which were steadily revised downward. Emerging markets, meanwhile, suffered in a context of dropping commodity prices and geopolitical uncertainty. A distinction should be made here between the different regions. While the Brazilian market ended in negative territory, China and India achieved a remarkable year. Even so, the acceleration in US growth late in the year, with the job market strong once again, reassured investors on the robustness of the economic recovery, at least in the US. Without a doubt, central bank communication and actions remained the most decisive factors in the ongoing market rally.

Alongside the spectacular pullback in sovereign yields, 2014 was also a year of monetary innovation by the ECB, which used almost all its tools to support the recovery of a euro zone bogged down in the risk of deflation. These included a low refi rate, a negative deposit rate, targeted long-term refinancing operations (TLTRO), and purchases of covered bonds and ABS).

Even so, investors are still eagerly waiting a true quantitative easing programme via sovereign bond purchases. And don’t forget that the BoJ expanded its quantitative easing program to more than 80.000 billion yen, leading to a further marked decline in the yen, which hit 120 to the USD at yearend, a level it had not seen since 2007.

What were the most noteworthty bets in cpr invest reactive?

Management of CPR Invest Reactive was once again highlighted by quick responsiveness throughout the year. To cite one example, the equity exposure of CPR Invest Reactive ranged from 37% to 80%, while the portfolio’s sensibility ranged from 0.6 to 4 during the period under review. Our big achievement this year was to have very skillfully weathered a tumultuous summer period during which our funds as a whole achieved gains despite a significant market correction.

We then diversified the portfolios, for example by taking aggressive positions on the Chinese A equity market (local shares). After being completely neglected by investors since the 2007-2008 crisis, this market had been steeply undervalued compared to developed and emerging markets on the whole, despite several support factors such as ongoing structural reforms or the opening of the local equity market to investors through the implementation of shareholding quotas. Meanwhile, we raised our portfolios’ sensitivity considerably, lengthening our positions to overweight 15 year + positions.

This strategy was implemented in both US and European sovereign bonds in a global economic environment that is still marked by weakness, sluggish wage growth, and the growing risk of deflation. In October, we shared with our strategists the strong conviction that the BoJ would announce a second wave of quantitative easing, thus pursuing the dual objective of raising inflation expectations and supporting economic growth undermined by the April VAT rate hike. Remember that the rate hike had precipitated the Japanese economy back into recession.

We then raised our Japanese equity exposure aggressively (while hedging it for currency risk) two days before the BoJ’s announcement, a strategy that paid off for the fund.

Another major investment theme came in June, when we began to set up dollar positions, to get the jump on the announcement of the end of quantitative easing and the return to near-potential growth in the US.

We also steadily increased our exposure in light of insistent rumors that the ECB would set up a quantitative program in the euro zone.

What’s in store for 2015?

In 2015 we should see a slight acceleration in global economic growth, driven mainly by falling oil prices, which should boost domestic consumption more or less everywhere. Even so, the pace of growth will remain below its mediumand long-term average worldwide, due to the trend decline in growth prospects in the major emerging markets (BRIC) and the weak outlook in the euro zone. We expect 2015 to be far more volatile than 2014, as there will be more challenges to meet.

Without going through the entire list, we can cite the hoped-for return in euro zone confidence with, as a corollary, further structural reforms aiming to enhance the competitiveness of the region’s economies, the smooth normalization of the Fed’s monetary policy, the success of new stimulus plans in Japan, and the stabilization of Chinese growth, which is essential for avoiding social tensions. In the shorter term, concerns early this year are focusing on weak inflation and wages, despite the expansionist monetary policies conducted since 2008. Without going through the entire list, we can cite the hoped-for return in euro zone confidence with, as a corollary, further structural reforms aiming to enhance the competitiveness of the region’s economies, the smooth normalization of the Fed’s monetary policy, the success of new stimulus plans in Japan, and the stabilization of Chinese growth, which is essential for avoiding social tensions. In the shorter term, concerns early this year are focusing on weak inflation and wages, despite the expansionist monetary policies conducted since 2008.

Against this backdrop, what allocation strategy is best for 2015?

Investors must be able to negotiate key turning points from the very start of the year, whereas there are high hopes that a European quantitative easing program will soon be announced.

After several warning shots in European equities since last summer, there could be a notable spurt in volatility if the ECB were to disappoint investors just as the Greek political situation is stirring up old fears.

The year’s other big turning point will be the Fed’s rate hike in response to the strength of the US economy and, above all, to what degree this will be priced in by the markets. The cyclical lag between the euro zone and the US should, in fact, prolong the USD’s appreciation vs. the euro. While monetary authorities will continue to watch their words carefully to prevent a spike in yields, a spring 2013-like shock cannot be ruled out. Such a scenario would have a serious impact on emerging markets, which are already being hit by the collapse in commodity prices and weak European growth. All eyes will also be on Japan. As the government’s highly aggressive policy will probably be more pro-earnings than pro-GDP, it is likely to continue driving equity performance. However, as in Europe, the shock will be commensurate with hopes if earnings let down investors. And, lastly, liquidity on fixed-income markets will obviously remain a key factor in the US as in Europe, where yields are very low. Against this backdrop we are now overweighting equities vs. bonds, in light of current valuations and the trend towards higher interest rates likely to begin in the US.

We are retaining a large portion of our equity exposure in the US, which is more robust and now riding the stronger dollar, and Japan, which, in our view, is the best investment opportunity. Policies in the euro zone are nonetheless likely to bear fruit and would encourage us to reallocate to the euro zone – gradually, in order to avoid “false rallies”.

In fixed income we are focusing in the short term on exposure to long maturities (> 10 years), which are likely to get a boost from quantitative easing and weak inflation. During the year corrections will be more drawn out, with an ultimate gain of about 5% to 8%. Once again, the allocation’s responsiveness will be decisive in weathering bouts of market volatility, such as occurred in late 2014.