Didier Duret, global chief investment officer for ABN AMRO Private Banking, discusses his outlook for investment opportunities in 2012, and looks at what to expect against a backdrop of subdued returns expectations as a result of last year’s volatility.

Date: Jan 20, 2012

Tags: Asset allocation, Portfolio construction, Fixed income, Equities, Cash

The general starting point for high net worth (HNW) clients is to start from a low-risk perspective.

We have inherited from 2011 a systemic dimension into investments that has worldwide repercussions. However, this doesn’t mean we will replicate this throughout the year.

In general, investors in a balanced portfolio should be looking to move from a relatively conservative approach – with an even split in their allocations between equities, bonds and cash – towards buying equities until there is more widespread confidence that volatility has not only initially decreased, but then also maintained a sufficiently low level so that investors don’t continue to feel so uncertain about their mark-to-market positions.

While it has already come down to some extent from where it was in November and December 2011, the key is for volatility to be sustained at this low level.

What factors will contribute to, or otherwise impact, this stability?

Such stability depends to a large extent on getting reassurance from the macro-economic side, which will need to come from the US.

For example, the index of economic surprise has a direct impact on equities. So while positive surprises push up the price of equities, negative surprises drive them lower.

In terms of China, which is another key factor in stability, I do not expect to see a hard landing. One of benefits for China is that commodities have stopped being so speculative.

As a result, I am underweight inflation, with an expectation that China will relax monetary policy and be more targeted in its actions. In general, China will continue to be a strong engine for world growth.

Europe, on the other hand, is like bad boy at the school, as it is starting from a point of recession.

However, I expect to see in the coming months a growth story taking precedent over the current debt story. This will lead to an increase in equity positions.

As a second step, in the second quarter of the year, I expect there to be sufficient dividends to create a condition where countries like Italy can move into more positive positions and remove the existing schizophrenia around funding.

In the meantime, where should HNW clients put their money?

In terms of bonds, I am overweight credits versus government paper.

Essentially, where investors can capture alpha at the moment is via conservative and balanced portfolios, holding corporate names in Asia, Europe and the US.

In Europe in particular, it is also interesting to also look at corporate names in the less developed countries, because these offer good real yields (above inflation rates) and very different risk profiles at a government level.

In equities, my preference is for consumer staples, healthcare, and stocks at the border of consumption and healthcare – the wellness sector, which is a US$330 billion global market. And from a mega-trend perspective, I like the pharmaceutical sector.

From a geographical point of view, my preference in equities is for the US and Asia ex-Japan.

In particular, I like the strong domestic profiles in Indonesia and Malaysia, and China offers opportunities given that we have already seen a significant correction.

In the US, where I expect to see an economic turnaround, the residential sector looks attractive, which should lead to more construction.

What was the impact of 2011 on how investors adjusted their return expectations and now look at their portfolios?

In 2011 there were still a lot of pre-conceptions about diversification – for example, the notion of safe havens, and the notion of stable correlations and the ability to achieve diversification because assets are non-correlated. This changed the behaviour of clients.

At the same time, I think that investors have adjusted their return expectations too far to the downside. For example, I am surprised to see the average level of comfort with cash at 25%-plus in typical portfolios, in in some cases up to 40% or more.

While this huge preference for cash is a result of what happened in 2011, the return expectations are a function of past performance and nothing more, and this can change dramatically.

I think expectations will increase given my view that there is more upside than downside potential this year.

More specifically, the lower expectations have not impacted investors in Asia as much as they have investors in Europe, where some clients are happy to get bonds yielding 3%. In Asia, that would be an extremely low bar.

Will this change?

The situation will remain similar until normal patterns return. And for that to happen, we need to see stabilisation in government bonds and in interest rates.

I think 2012 will be a turning point.

This will be helped be China becoming a bigger engine for global growth, and shifting from providing quantity to quality as it moves up the scale in terms of quality and builds its R&D capacity. This will mean the country competing globally not only in basic goods and services but also at the high-end.

Another key trend we will see is the emergence of China, Brazil and Russia having more say on the international financial stage. This will lead to a re-positioning of what we have got used to calling “emerging markets” into truly fast-growing countries.