“Should US investors cross the Atlantic?” asks Yves Bonzon, Pictet Wealth Management
Yves Bonzon, CIO at Pictet Wealth Management, discusses reducing US equity allocation in favour of European stocks.
“With an increase of up to 20% in certain indices, equity markets in the eurozone began 2015 with a bang, leading many investors to wonder if it might be sensible to reduce their US equity allocation in favour of European stocks. Quite a few have already taken the plunge, as shown by capital flow statistics.
“The asset-purchase programme announced in January by the ECB is obviously the source of this portfolio rebalancing. Its transmission has two mechanisms. On the one hand, investors are going into eurozone stocks and getting out of bonds, which yield virtually nothing. At the same time, surplus funds are leaking into other markets, leading to a sharp drop in the euro. This fall in the currency will boost the profits of European companies which has been anticipated in the market’s rise.
“Ironically, much of this performance is a money illusion. Measured in a common currency, the performance of European indices is hardly different from other regions. Thus since 1 January, the Euro Stoxx has risen by 20% in euros, but for a Swiss investor the return is only 4%, or 7% for a US investor, which would not even cover the exchange risk. By comparison, the Swiss stock market is up 4% over the same period, or no better than the Euro Stoxx measured in Swiss francs.
“In portfolio management, the generally accepted practice is to minimise – or even eliminate – the currency risk in nominal assets (bonds and their equivalents), and not to hedge the currency risk for real assets (stocks, gold and similar assets). Nevertheless, in the case of shares, you can sensibly argue about the relevance of short selling the Swiss franc to hedge the currency risk on a holding in Nestlé. The multinational is indeed quoted in Swiss francs, but its underlying economic exposure is global. From this perspective, a position in Nestle, protected by a forward sale of the Swiss franc against the investor’s base currency, corresponds to an investment in a basket of countries and currencies, combined with a speculative short position in the Swiss franc, without any underlying economic rationale.
“More fundamentally, we have never supported unequal allocation of assets between US and European equities. Indeed, expressed in the same currency, their long-term total returns are very close.
“The addition of European equities to a US investor’s portfolio brings little improvement to the overall risk/return ratio. For a European investor, the case is a little less obvious, because the US market is extremely rich in technology and biotechnology stocks, which are rare in the European markets. For this reason, a selective exposure to American stocks in these areas makes sense in a European investor’s portfolio.
“US assets may continue to outperform the rest of the world, including Europe, in the two or three years to come, as a result of the secular rise in the dollar.”