DWS Investments charts a course through the crisis
This year DWS Investments held its annual European Investment Conference in Rome, where the main theme was how asset managers should handle the eurozone crisis. James Norris reports
How does one continue investing in Europe when other more exciting investment prospects await? This is one of the key questions facing European investors today, said Wolfgang Matis, global chief executive of DWS.
Speaking at the sixth DWS European Investment Conference, this year held in Rome, Matis set the scene for the challenge that faces all asset managers in the current, volatile economic climate. In particular, they will face the fear and volatility surrounding the potential break-up of the eurozone, affecting investors and asset managers alike.
The only way forward, Matis said, is through wealth creation and active fund management because, although the picture is bleak, it is not hopeless. “The picture today is extremely negative,” he said. “It is difficult to stay positive, but I believe Europe will make it. A eurozone break-up is not likely.”
The next two to five years will see huge volatility and uncertainty, and there is no doubt that the European asset management market will be a challenge. The eurozone will stay cheap and it will be difficult to persuade European investors to invest in sovereign bonds, among other assets.
But it is not all bad news: the German economy is a very compelling investment prospect, Matis said. “There is hardly any unemployment, the cost of capital is close to zero, everywhere you look there are construction cranes, hotels and restaurants are booked up – all this is evidence of strong growth that I have not seen before in my life.”
Years of wage restraint have enabled Germany to restructure its economy, making it perhaps the most competitive in Europe. But in the debate around the Greek debt crisis, wage restraint has become a bone of contention as it compounds the distress of other eurozone economies.
Turning to Italy, Matis said that “it is wrong to bet against Italy remaining in the eurozone”. The country is solvent, has considerable potential, low private sector debt; one of the highest household savings rates in Europe; and a record of delivering primary surpluses over the past decade.
The one problem is the question of growth – non-existent for at least a decade, and which prime minister Mario Monti is attempting to address. Overall, Matis said: “The Italian economy is stable and can become a stabilising factor in the eurozone.”
Looming over all European economies is the apparent lack of leadership from the authorities at EU level. The most immediate concern for European legislators is an urgent need for the so-called ‘Plan B’, says Barry Eichengreen, professor of economics and finance at the University of California, Berkeley.
“Without growth,” he said, “fiscal consolidation won’t work. It’s scandalous that no one at the ECB or the European Commission has spelled out what that ‘Plan B’ might be.”
Eichengreen, an expert on the Great Depression, EU finance, banking and the global economy, said: “The impetus to hold the eurozone together is stronger than that holding the gold standard in the 1920s.”
He called for the recapitalisation of the banks – “the single most important thing Europe can do” – and said the EU needs a rethink on the extent, timing and nature of restructuring. He added: “Expansionary fiscal consolidation is a myth.”
The prospects for the euro are not as bleak as they appear to be. The prize for the EU is to see the euro become the alternative to the US dollar on the global markets.
“The euro was launched with this in mind, but it has failed so far,” Eichengreen said. The US dollar still dominates, but for how much longer?
“The US is no longer as dominant as it was after World War II. It is no longer a financial monopoly. We now also have some very deep and liquid markets in Europe and Asia.”
Also undermining US financial dominance is the declining US fiscal capacity. The US Treasury bonds provide the benchmark for ‘safe assets’, and so form the core of the investment portfolios for all investors, whether retail, institutional, corporate or government.
The US, so far, has been the only economy capable of meeting the demand for such safe assets, but this looks set to change. As Eichengreen said: “The dollar remains the only true global currency, but this cannot last forever.”
Asoka Wöhrmann, DWS’s chief investment officer, also addressed the eurozone crisis. He echoed Eichengreen’s plea for a Plan B, saying that Plan A – the austerity route – is failing politically and economically.
A key measure is that 60% of the eurozone debt should be pooled. However, this may be achieved, Wöhrmann said: “We want to avoid talking about ‘Eurobonds’. We must plan a way to get rid of the debt, with the debt repayment being backloaded. Pooling is a good idea as it gives more room for manoeuvre.”
Wöhrmann added that a big challenge facing asset managers as a result of the eurozone crisis is the prospect of financial repression, or the transfer of wealth from savers to debtors. “Managers must take this on board and set out strategies to prevent this happening,” he said.
The main strategy he recommends is to avoid savings accounts, Bunds, gilts, Treasuries and G-4 currencies.
On a long-term investment basis, they will only lose value. Strategies he favours, again on a long-term investment basis, are dividend, value and emerging market stocks because they will provide a real return.
The ‘real’ issue
Stefan Kreuzkamp, DWS’s head of fixed income Europe, talked about the ‘real’ yield issue. Growth is not evident, and indices are turning negative but global recession is unlikely.
Prices for AAA-rated assets are artificially high, making yields artificially low, while no one wants the higher yielding assets of Portugal, Ireland, Italy, Greece and Spain. He suggested asset managers should hold Bunds, but not for investment reasons as they will suffer from value destruction over a period of 30 years.
Particularly attractive in the fixed income sector are covered bonds, which have become the “sovereign substitute”, Kreuzkamp said. These assets are bankruptcy remote, collateralised vehicles, protected by strong legislation and good transparency.
The ‘darlings’ of the fixed income sector, Kreuzkamp said, are corporate bonds because companies are running such huge cash positions, though sector rotation is key.
Thomas Schüssler, DWS’s head of portfolio management dividends, said the equity markets are depressed but equities at 4% are necessary for capital preservation.
Such returns are moderate, but useful in difficult market conditions. Dividends should be sustainable, he said, giving them bond-like properties in an equity market.
Britta Weidenbach, DWS’s senior fund manager of European equities, said the key message to remember is that Europe is suffering a sovereign debt crisis, not a corporate debt crisis.
Some companies, especially those with a strong global footprint and the bulk of their profits coming from exports, are recording high profits.
She said: “Earnings are at a record high, with valuations at a record low. Many companies are trading at 25% to 30% discounts, depending on the benchmark.”
Coming all the way from Beijing to speak at the conference was Henry Zhao, chief executive of Harvest Fund Management, which with more than $34bn in AUM is the second largest fund manager in China. DWS holds a 30% stake in the company.
Zhao set out to counter a number of misconceptions held by investors from developed markets. He said: “Investment in emerging markets is different to developed markets. The market cap-weighted benchmarks are the wrong methodology.”
Developed market investors tend to view emerging markets as one region, analysing them according to the same criteria of consumption, inward investment, exports, and so on. But each emerging market country is unique, requiring a tailored approach.
One by one, Zhao dismissed all the well-rehearsed reasons that would cause investors to hesitate before investing in China. Is the economy heading for a hard landing? Unlikely. A housing bust? Unlikely. What about those local government debts? Containable. The banking system facing a crisis? No, not likely.
But he did agree the Chinese economy needs to be rebalanced. Work on external imbalances is making progress, while internal imbalances need more time. ■