Stranded in the low-rate environment, private banks have to find a way out of the diminishing returns posed by the fixed income part of the portfolio without being exposed to unnecessary risks. Higher selectivity about where to invest and more creative approaches such as private markets or gold could solve the dilemma, investment specialists contended.
At Asian Private Banker‘s Income Week webinar series Fixed income strategies post-pandemic — more of the same or fundamental changes?, private bank CIOs and investment strategists admitted the current environment has made the search for quality income doubly difficult.
Prashant Bhayani, chief investment officer, Asia Pacific, BNP Paribas Wealth Management, said the bank has been underweight in treasury assets. “Recently, we have taken down overweight in credit to neutral in some geographies such as the US, as spreads have become relatively tight. Investors should look long and hard for yields outside of Treasury.”
However, searching for yields outside of Treasury means either moving towards longer maturity bonds, which imply duration risk, or moving down the credit scale and taking more credit risks.
“The benefit of Treasuries in private bank clients’ portfolios is really cash management and potential diversification of risks,” said Anne Zhang, head of asset class strategy, FICC, J.P. Morgan Private Bank. But the ultra-low Treasury yield these days has diminished both benefits, she added.
For cash management, Zhang said J.P. Morgan has moved into ladder investment-grade (IG) portfolios — consisting of IG bonds of varying maturities. On the other hand, asset classes such as equities, alternatives, and some structured products can provide diversification benefits in the event of underweight Treasuries.
Patrick Ho, CIO, North Asia, HSBC Private Banking, highlighted the bank’s cautious stance in selecting along the credit scale. “We are taking less risk and want to focus on quality income, especially in Asia where we focus more on IG.” He emphasised “quality spreads” in the fixed income market.
But Zhang believed investors may not have to increase the portfolio risk to hit higher yields. “Historically, the broader fixed income and high-yield (HY) indexes have definitely shifted toward the IG-HY crossover portion of triple B to double B types.” This means investors would have naturally increased their allocation to this crossover section.
“That’s not necessarily increasing the portfolio risk per se, merely structural changes in a low-yield world,” Zhang explained.
“I still think that the 10-Year Treasury rate will eventually go higher from here, on the back of potential tapering by central banks. And also, we are looking for inflation to land somewhere healthy — around the 2% level. So interest rates are rising, and you need more high yield to buffer that rising rate.”
Thinking outside the box
“We still think that we will support a well diversified portfolio with equity and fixed income, but then we need to think outside the box because when the low-rate environment materialises, we need to increase our diversification through alternatives,” said Ho.
His investment thesis is based on the stability of returns, and on top of that, he suggested embedding barbell strategies into fixed income and equity to gain alpha from certain events. Private market instruments, though often coming with some illiquidity premium, can support better risk-adjusted returns.
Bhayani was more doubtful about the room for creativity within a 60/40 portfolio to chase returns. “It is more about having alternative types of assets. You can have 10-20% allocation, depending on the risk tolerance and liquidity needs,” he said.
“From a vehicle perspective, investors with more of an absolute return orientation can think of instruments such as commercial mortgage-backed securities (CMBS), other forms of floaters to which clients traditionally don’t have direct access.”
From the point of view of portfolio diversification, Jaspar Crawley, head of distribution, APAC ex-China at the World Gold Council, highlighted the appeal of the precious metal.
“There are three things that we see that gold can bring in terms of diversifying portfolio. The first is return, the CAGR for gold is around 8 to 8.1% since 1971, which stands on a par with some of the assets that the clients hold in their portfolio.”
“The second thing is diversification. We see the correlation of gold with the S&P 500 and what we have observed is that, in a market where S&P 500 was up by two standard deviations in a week, gold actually has a positive correlation to that market, so it rides with the rising market because of the wealth effect.”
Crawley also pointed out that around US$180 billion worth of gold trades every day, making it highly liquid.
“Gold doesn’t come with credit risk and this makes it really important and different in clients’ portfolios,” he added.