Fixed-income savvy crucial to portfolio design

We live in very uncertain times where the operative word is caution. And being cautious means being forward looking, says Vinay Pande, chief investment advisor, global markets research, Deutsche Bank.

Speaking at the CFA Institute Conference in Boston, Mass., Pande said investment as a forward looking business, though, could be a tricky proposition.

“If your business is prediction dependent then you’re on a very slippery slope in an unstable world,” he said. “The enormity of the problem we face is that the range of outcomes is vast [and], unfortunately, bad things almost always happen too quickly and good think happen very slowly.”

Europe these days serves as a ready reference for many of the world’s ills. Pande proved just that when he pointed out that “what is happening in Europe is very close to the worst levels of March 09.”

As a bond manager he advises the use of “fixed-income savvy” to design a portfolio. “And the fixed-income savvy is building a portfolio with a pay out profile, across scenarios, that suits the world we live in.”

The mistake, he said, in designing a portfolio that is based on an optimization value over history that is ceased to be relevant is that “fundamentally, you have spent the bulk of your bullets on something that is unlikely to happen around the centre of the distribution.”

Weather it is a multi-year bear market like the Nikkei, or multi-year bull markets like emerging markets or the European markets, the theme remains unchanged. “In Europe – [especially in Greece, Spain] – where the rescue has been inadequate and late, the distribution has gone bimodal. In high yield bonds, crossover bonds, commodities, the picture is the same.”

He asks if “Frau Merkel has to physically pay via a euro bond or with rolling guarantees over a period of time for the debacle that is unfolding across peripheral Europe how could bundes trade?”

Pande says six of the past 10 years have witnessed the highest growth rate in human history, but “we’ve also had some incredible disasters” such as the U.S. and European crises.

“Is there any market solution you can dream of for the problems of the U.S. auto workers or the European workers or for the financial institution that has promised to match their excessive liabilities?” he asked. “They are both losers in globalization and have some good policy; they held hands and jumped out of the window. That is called the sub-prime crisis.”

What is happening in Europe, he added, is no different from the [U.S.] sub-prime crisis. “They are both losers in globalization jumping out the window trying to help themselves.”

Emerging markets, one the other hand, have been benefiting from the growing disparity in the global economy that led to their decoupling. In a historic context, Pande said emerging markets are trying to recover from the huge ditch they dug for themselves over the last 300 years, collectively sliding from between 50% and 60% of global GDP, to barely 5%. “Recovering from there is surely something that represents opportunity.” The collective GDP of emerging world now represents the greater part of the overall world GDP having overtaken that of the developed world, he said. It won’t be long before investment portfolios begin to reflect that reality.