How has your asset allocation changed recently?
We are consistently long risk assets, both equity and credit. We’ve been positive on European equities for two years and underweight government bonds. But in early 2014 we began to scale down the level of risk.
We are still long risk but we are buying hedges on equities we think are too expensive. That’s especially true for the US market.
Are you bearish on US equity valuations?
I’m not negative but the expected returns on US equities will be in the mid-single digits, say 5%-6%
In late 2012 we shifted to an underweight position in emerging markets, both for fixed-income and equity. Now we believe emerging markets are the only places in equities with pockets of value. We are scaling up risk in select countries.
The long-predicted end to the bull market in bonds remains yet to be fulfilled. Are you still reaching for yield?
We are long credit but high yield is now fully valued. We prefer to take the carry on lower risk assets, particularly in high-grade bonds. There are also interesting opportunities in US municipal bonds and Europe’s financial sector. It’s very bottom-up.
Netting your stance on risk, then, it seems you are more cautious?
We have a more balanced portfolio today. We continue to tilt toward risk assets, but less than before. We are spending our risk budget on buying protection against volatility, which right now is inexpensive. We are adding protection against potential declines in the US equity market and a significant part of developed markets overall.
What are your biggest long positions?
We’re still long European equities but now we are looking more closely at those valuations; and select emerging markets.
We have a long position on [the] China H shares [market], which is among the cheapest equity markets in the world. There may be reasons for why it’s cheap. But in pure valuation terms, it’s interesting.
And we have recently added to India. We’re more concerned about markets such as Brazil and Russia. But for the next six to 12 months, it’s emerging markets that will have undervalued assets.
US interest rates look set to remain low. Do you agree?
There’s a debate about this, and this debate is driving asset allocation. Why are Treasury yields still so low? This is controversial because nearly everyone in the market was short duration going into 2014. The US economy is improving from a cyclical point of view. Growth will accelerate and that will probably lead to some pick-up in yields on Treasury bonds. This trend will last for several years.
The key question is will the [Federal Reserve] keep rates relatively low; in other words, it’s about the pace, not the direction. We think the Fed will keep rates quite low in order to prevent the economy from falling back into recession.
The potential [annual economic] growth of the US has declined: it’s not 3% anymore but more like 2% for the next decade. Therefore the long-term real rate for the US will also decline. The historical norm of 2.5% inflation-adjusted rates on the 10-year Treasury will probably now be 1% to 1.5%. So, yes, there will be pressure on yields to increase but they will not return to the historical norm. I’d say 3% to 3.5% in nominal terms for 10-year rates is more likely.
How do US equities compare, given your outlook for interest rates?
The current return of 5% to 6% for equities makes them still a better bet than Treasuries. But it’s not a fantastic trade-off. So portfolios will be more balanced. Recently, equity portfolios have over-weighted growth stories like biotech and social media. Now they are shifting to sectors that benefit from cyclical improvements, such as consumer stocks and industrials. One bright spot is company capital expenditures, which will accelerate. That will help traditional makers of hardware and software, as companies need to restore their IT capital stock.
Pioneer Investments, a storied US fund house with roots that go back to 1928, was acquired in 2000 by Italian lender UniCredit. In 2001 Giordano Lombardo, a long-serving UniCredit portfolio manager, became group chief investment officer. Since then Pioneer’s assets under management have grown from around $100 billion to $249 billion today. Lombardo runs the team from Milan.
