When asset managers talk about the long term, they often have in mind five to seven years. But, for some, like HSBC’s global head of asset allocation research Fredrik Nerbrand, the time frame is a great deal longer than that.
“If there is one thing that is linear in this world, it is ageing,” says Nerbrand.
This linearity is useful, he explains, because once you recognise that people want to do different things in different parts of their life, and allocate assets accordingly.
“You start to get an understanding of not just why markets trade the way they do or why bond yields are so low.
“You also begin to be able to predict what is likely to happen in the future,” he adds. “It begins to become rather deterministic because, outside of improving fertility rates and changing immigration and emigration patterns, both of which tend to take a long time to show up in investments, there is little countries can do to change their demographic trends.”
Natural progression
Generally, says Nerbrand, people in their twenties and thirties, if they have money, will put it into a house.
For those in their forties, investments tend to be more into cash and equities and, in their fifties and into retirement, investments are increasingly focused on getting a yield.
Such a progression has worked perfectly well for many years but, as populations get older and people live longer, so the latter parts of the curve start to dominate and result in significant changes to the types of assets that are needed.
“Right now the world is in an interesting place because, while historically you have tended to have more young people coming into the workforce than people leaving it, in countries such as Japan and Italy that is no longer the case,” he explains.
“Japan now has twice as many people leaving the workforce as coming in and Italy will be there soon.”
Nerbrand believes the massive dislocation of the demographic pyramid currently under way will ultimately flow through to investment decisions. But, he adds, because asset allocation is to a large extent driven by attitudes, people will need to buy into the fact they are going to be working and living much longer than they used to before asset allocation patterns will change.
“This is a 20 to 30-year story,” Nerbrand says, but, partly because of that, people have not really looked at the current crisis through this particular lens.
“I think people still perceive it to be cyclical rather than structural weakness, and it is that transition I am interested in. You are beginning to hear some people talk about structural stagnation but, around the financial crisis, I think many people thought of this as a cyclical issue or as a recession, rather than as a shift in trajectory.”
That is not to say one can have a 30-year view, allocate accordingly and then go and put one’s feet up in the interim, but it does definitely colour his asset allocation decisions.
“If I were to sit here and predict where gilts are going to go tomorrow, it is highly unlikely I would get it right, but I can say with a lot more certainty that, over a long period of time, economic growth equals population growth and productivity gains.
“And, for many countries, that demographic dividend is ultimately going to be in negative territory and so technological improvements will have to pick up the slack.”
A boost for bonds
Overlaid onto this is another change that has come as a direct result of the global financial crisis.
Traditional economic theory says a lower interest rate should entice households to borrow and consume more, while corporates will both borrow and invest more as a result.
However, Nerbrand points out that both savers and borrowers have become more conservative throughout the financial crisis. Savers, who tend to be both much older and wealthier relative to previous time periods, will most likely decide to spend less when their incomes drop as a result of lower rates.
Borrowers, on the other hand, who he says tend to be younger, both relative to savers and history, have not seen the benefits leverage in the way their parents did. As a result, they do not have the same appetite for new credit that has previously come to be associated with people in their twenties and thirties.
From a financial perspective, he says, the implication of these changes is that bond yields will remain much lower than people expect and the rates normalisation argument will not kick in in the same way as it has in the past.
As a result of all of this, from a structural perspective, Nerbrand is long on bonds. But, because of the length of the time period, he says it is also important to trade in line with the business cycle. He explains: “At the moment, the business cycle looks like it is turning off. We are seeing more and more evidence of that, specifically in Asia and Europe but also in the US.
“That just means that even though I am long bonds from a structural perspective, I am even longer bonds on a cyclical basis and from a trading perspective.”
Nerbrand says he has a minimal allocation to credit at present, because it has been one of the highest consensus bets anyone has made over the past couple of years. He has also brought back his exposure to emerging market risk assets.
At the beginning of the year, he says, he had a 40% aggregate allocation to emerging market assets, which is much higher than in the past. During the course of the year, he has brought that down to around 27%. He currently also has a fairly high cash position, partly in order to wait for better entry levels but also because it provides some protection against a May 2013-type event, where bond yields rise on the back of the end of quantitative easing.
“If anything gives you carry at the moment, just buy the dip. I think that has been the most successful trading strategy all year,” he says.
It pays to be nimble
But, Nerbrand adds, there is a need to moderate one’s return expectations. Yes, bond yields can drop lower, he says, but you are not going to see the same type of return as you once did, and the same can be said for equity markets.
“If bond markets are correct in terms of their expectations for lower nominal growth rates, then the equilibrium price/earnings ratio is probably not going to change much.
“Looking ahead, you are going to need to be a lot more nimble when it comes to moving in and out of assets. When you see an asset class sell off materially you can go in on a valuation or a recovery-based argument, but I don’t think that just buying in and staying long is going to work.”
But, he adds: “We shouldn’t underestimate the difficulty of doing that. It is going to be very difficult but the good news is that the world is no longer being held hostage by these systematic types of risks.
“The faltering of the US financial system or the collapse of the eurozone: these are different risks but they tend to be more idiosyncratic. It means you probably have more ability to think about this not just from a macro perspective but from a stockpicking and a more regional view, and decisions can be much more tactical as a result.”
However, he cautions: “Don’t fall in love with equities, they are a mistress at best.”
