Stable investments also cover ‘market neutral’ strategies that do not have a market beta embedded, either from the bond market or from the equity market.
Then there is the fourth bucket, opportunistic investments, which he fills for example with smart beta funds. “There is a lot of talk right now about smart beta, which is taking that idea that there are certain risk premiums that you can harvest in the market,” says Hoppe, taking as an example exchange-traded funds that have a bias towards value stocks.
“What we are trying to do is capture the pure risk premium. You can have a basket of equities that systematically fulfils certain criteria that could be considered value and then you short another portfolio that does not fulfil the criteria of being value.”
Right now, he likes two risk premiums within Europe, one is quality and the other one is earnings momentum.
“We have a long portfolio of stocks with a high quality in terms of their balance sheets. Then, at the same time we are shorting a portfolio of stocks that do not qualify as ‘quality’. I do not want to say it is a bond replacement, but it can play a very nice role within your portfolio, because it offers you the diversification you need.”
Turning to geographical breakdown, is he happy with the fact he has got a high level of exposure to Europe currently?
“If you look at equities, the risk contribution from Europe and from US equities, for example, is more or less the same, although we have a preference for European equities. Why? Because European equities, while they do not offer a huge valuation discount to US equities, they still have a higher expected earnings growth for the next year.”
Business cycle
He adds that Europe is behind the US in the business cycle: “The cycle in the US is extended. Valuations are not necessarily attractive and a lot of earnings in the US have been deteriorating since 2014. Profit margins have reached a peak, too,” he says.
But his view is that at least there is higher earnings growth coming out of Europe, which is the key reason why he prefers European equities.
In terms of the bond market, he has a relatively high exposure to European government bonds, in Italy and Spain.
“This is not because we like the bonds from the risk/reward perspective, but given the European Central Bank is still buying bonds, it offers us a stable return that we also need from our diversification point of view.
“In more normal times, with higher yields, bonds would fall in to the defensive category. We are currently reducing our government bond allocation to European or eurozone government bonds and instead investing, for example, in Australia, New Zealand and also in the US.”
China crisis
How concerned is he about the risk factors with China? “We think the events in China have been exaggerated by investors. China’s economy is slowing down but this is a managed process and it is not new. It is really a structural change that is taking place.
“Structural changes have negative repercussions during the transmission period, not just within China’s economy but also with other economies such as commodity exporters or countries that have strong supply chain links to China,” says Hoppe.
“As a consequence, we have been avoiding Latin American equities, mainly due to Brazil since the end of 2012.”
He has been favouring Asian equities, which he says from a risk/reward perspective are still more attractive than, for example, Latin America.
He adds that he has more of a focus on small caps in Asia, which are less exposed to that slowdown in China.
As for the outlook in 2016, he expects relatively muted economic growth globally this year, but not a recession.
“If you look at consensus estimates, economists are expecting developed market GDP to grow by 2.2% this year, slightly up from the 2% we expected for 2015. What is remarkable is that these growth expectations have been revised downwards throughout last year and we expect this will continue to happen in 2016.
“We expect to see even a slightly slower growth than what the economists are expecting today.”
A lot will depend on China, says Hoppe, while the US will play a role this year to define global growth, though the cycle there is quite extended.
“The lower oil price is benefiting consumers, but we do not see a catalyst for really strong growth in 2016.”
