Forecasts are irrelevant
In 1998, the development of the financial markets was an accurate reflection of the drastic change in the economic and monetary situation. This was true in both global and Swiss terms. A number of countries are either already in recession or will have to reckon with a not inconsiderable de-cline in economic growth in the year that has just begun. On the other hand, the stability-oriented policies being pursued by many governments and central banks will have lasting and favourable effects.The structural change is already bearing its first fruits and investment policy must be rapidly adapted to take account of this.
Nonetheless, we are by no means eu-phoric. 1999 will be adversely affected by relatively weak global economic growth and currency worries, of which the current situation in Brazil provides an example. Does this, however, mean that the liquidity-driven upside on the market has already come to an end? Probably not, however, although money moves the markets, it can also move itself pretty rapidly.
What will outperform in 1999? First we assume that, given low interest rates, the traditional performance 'hierarchy' will win the day, ie equities will beat bonds, which in turn will do better than the money market. Let us begin with equities. We prefer investments in stocks which stand to benefit from major long-term trends and which at the same time are in the vanguard of their sectors. These trends are: demographic developments (pharmaceuticals, leisure, investment behaviour ie asset management); globalisation (restructuring, consumer behaviour) and technology (telecommunications, Internet).
It is likely that whoever selects the best stocks in these growth sectors worldwide will outperform. A high level of visibility in a portfolio can only be of advantage. Clearer focal points will be fixed and those will be on Europe and the US.
At first sight it may sound paradoxical for us to maintain that these portfolios will have good diversification characteristics whilst talking of rigour or concentration at the same time as negligence as regards currencies. Swiss institutional investors have traditionally had a very low (albeit broadly distributed) equity weighting, averaging 15-20%.
In the past investors were well advised to maintain a greater than average equity weighting in their portfolios, and that in this respect two other major themes - the euro and the millennium - will not radically change the world. It also has to be understood that Swiss legislation on pension funds permits an equity weighting of at most 50%, of which a maximum of 30% may be in Swiss stocks. Additionally, 70% of the overall portfolio must be invest-ed in the base currency. We are lucky to have stocks in Switzerland such as Novartis, Roche and Nestlé, as well as a number of heavyweight financial stocks. Since Nestlé, for instance, generates just under 2% of its sales in Switzerland, one can but wonder what is so Swiss about it.
This stock is a good illustration of this mechanism.
There are currently around 25 securities worldwide which belong in this global core portfolio, while the FT World Index consists of about 1,500 titles. Some characteristics of this portfolio per se are: (figures in brackets refer to FT World Index): risk, standard deviation 18.5 (16); beta factor: 1.1 (1); tracking error: 6.4. It results in an overweighting of Europe, virtually normal weighting for the US and a clear underweighting of Japan and the Pacific Rim - all this being measured in terms of the traditional capitalisation-weighted indices.
This approach means that for a Swiss institutional investor we recommend an equity weighting of 35-40%. This appears aggressive compared to the benchmark most commonly used in Switzerland, the BVG (Swiss occupational pension funds) Index which has an equity weighting of 26%. Naturally, the longer-term horizon of a pension fund is taken into account.
We continue to recommend long durations for bonds. The 45-50% bond weighting is subdivided into 35% Swiss franc bonds and 15% paper in Euroland currencies and US dollars. Swedish and Danish paper or even Greek bonds, the latter being somewhat riskier and therefore only suitable as a diversification, can be used to give a little zest.
Compared to our competitors, our equity weighting is distinctly heavy and an additional difference is our overweighting (15%) of liquidity. This is justified by a type of barbell strategy on the risk curve and gives us ability to act when necessary.
It is important to note that the figures we are citing here are only averages. Julius Baer clients are used to a customised service. Individual benchmarks are therefore the rule and not the exception. Additionally, this article aims to give a snapshot of our view at this particular moment.
This last remark is important, as we assume that we shall be facing a high level of volatility this year. A minor incident, which may cause little effect on the real economy, could well trigger appreciable short-term turbulence. The markets will primarily be driven by sentiment. To overstate the case, forecasts for the year as a whole are irrelevant, since the timing aspect will have a considerabe impact on the result. Although timing goes against the grain for asset managers by skillful stock picking geared toward the fundamentals, we are aiming to protect ourselves from the expected turbulences. Leo Schrutt is head of institutional as-set management at Julius Baer in Zurich