How do you see the outlook for 2015?
As an investor, I focus on managing risk as well as return. Going forward, simply beating the index will no longer be enough, and that is why they will have to focus on risk-management in portfolio construction. At the same time, I believe it is important to look at the long-term cycle, as there is value added in identifying long-term risks and trends.
My firm conviction is that we are entering a deflationary period, which could last more than a decade. We are at the back end of the long-term debt cycle. A long deleveraging phase, which will involve the entire banking system, is about to start in Europe. There will be some important differences from previous deflationary phases. First, deflation is no longer linked to globalisation – it is due to lack of credit creation. Second, the monetary policy tools that were used in the past to address this, such as capital controls, cannot be used to the same extent as they have been before.
Investors need to take into account this deflationary environment, which essentially means that yields will be low for longer than expected.
Countries or regions that manage that deleveraging correctly will fare better. In this sense, the US is much better positioned than the euro-zone, where governments are being forced to borrow to keep the banking system alive.
The deflationary environment is not necessarily bad for investors. It provides opportunities for companies that can take advantage of it, by learning how to create value and cut costs. The knowledge economy, particularly high-tech companies, is an example of a sector that could potentially benefit from this environment.
That said, because conventional monetary policy tools will be much less powerful, we can expect a lot more volatility. That is why I foresee a revolution, which I would call ‘Portfolio Management 3.0’, which consists of risk-driven strategies that are able to produce better risk-adjusted returns, but without the level of fees that investors have been asked to pay until today.
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I do not see yields going up any time soon; even the US may have some problems doing it. There is a recipe to fix the European economy, but it involves recognising that a large part of the banking system is effectively bankrupt, allowing the deleveraging to take place in an orderly manner, and financing that with eurobonds. But it would not solve the productivity problems that some European countries have. That is a different story.