Monday 28 April 2014 

Brussels 

In a client meeting on our asset allocation philosophy and process I emphasise the importance of risk analysis and monitoring from the perspectives of risk factor exposure and stress environments. The former is important because diversification can just be an illusion: equities and high-yield bonds are highly correlated in economic and financial terms and credit default swap (CDS) prices on emerging debt correlate strongly with US equities, high-yield bonds and the Chicago Board Options Exchange Volatility Index. Stress testing is very relevant when realised risk is low; it can be a wake-up call to the intrinsic riskiness of a portfolio. 

Tuesday 29 April 2014 

Brussels 

In my monthly call with our CIO for India in Mumbai, he sounds more upbeat on the country’s economic fundamentals, including the growth outlook. In the short term, politics remain the key driver. The outcome of the elections, which stretch over several weeks, will be announced on 16 May. The market has priced in a victory for Mr. Modi so if he loses, there would clearly be quite a knee-jerk reaction. Later, I have a discussion with a colleague in our Multi Asset Solutions team on the long-term Sharpe ratios of different asset classes, the Sharpe ratio being defined as the excess return over cash divided by the volatility of the asset class. The results are particularly compelling for corporate bonds, including high-yield, which very often deliver higher Sharpe ratios than equities. 

Wednesday 30 April 2014 

Paris 

I have an interesting discussion with members of our credit research teams on contingent convertibles (CoCos), a form of hybrid debt for banks designed by the regulators after the 2008 crisis. Banks are required to hold more equity capital (CET1), plus a buffer of hybrid debt that would automatically convert into equity in the case of a large loss affecting the bank’s solvency. These instruments serve a very clear purpose (leading to good issuance); they meet a high demand but they are complex. For investors, they require a selective approach based on detailed research. 

Thursday 1 May 2014 

Labour Day (used for gardening). 

Friday 2 May 2014 

Brussels 

In an interview with Kanaal Z, a Belgian financial TV station, I discuss the increase in M&A activity. Citi research shows that on a year-to-date basis the volume is double that of last year at around the same time. While this may seem ‘hot’, it is not overheated because the same research shows that as a percentage of market capitalisation, M&A transactions represent 1.6 % compared to a previous peak of 2.5%. The drivers seem rather straightforward:

  1. Improving environment in the developed economies boosts corporate confidence
  2. Rise in share prices makes equity an interesting acquisition currency
  3. Funding via debt markets is very easy in view of the voracious investor appetite for yield
  4. Buying a company seems a safer bet than increasing capex
  5. US companies have accumulated huge earnings abroad so rather than repatriating them and paying taxes, there is an incentive to acquire foreign companies.

Investors will like all of this because it gives upside potential for stock pickers, at least for the target companies. Interestingly, Citi shows that the bidders are not penalised, so investors are not (yet) concerned about overpaying. In the medium term this may all change as premiums rise, as the greater use of debt will make bond-holders nervous. There is also the issue of wealth creation (via higher share prices) versus income creation (via higher GDP). If there is a preference towards buying companies over spending on capex, GDP growth will be slower.   

 

William De Vijlder

Vice – Chairman of BNP Paribas Investment Partners