Opportunities for the coming year – Asian Wealth Management and Asian Private Banking

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1. Why buy subordinated debt now?

2. As inflation picks up, should investors still buy bonds?

3. If there is a risk of recession, what are the implications for European banks?

4. What are the prospects until the end of 2022?

Video Transcript

1. Why buy subordinated debt now?

I think the main reason to own subordinated debt is that fixed income investors who care about preserving capital and capturing high stable income, that’s pretty much the place to be . I mean, we’ve been managing strategic subordinated debt since 1985 with a compound annual return of almost 8%. That’s over a thousand percent return. But above all to own superior quality transmitters. And the high income we capture through the increased income from subordination, which means we don’t have to take on more credit risk, interest rate risk or liquidity risk and have very good predictability in terms of future income.

2. As inflation picks up, should investors still buy bonds?

Clearly in an inflationary environment, I mean the questions, I mean should I still own bonds? And you know what we always tell investors, you have to adjust your portfolio to an inflationary environment. Not all sectors are impacted in the same way, of course. I mean, the financial industry is taking advantage of this rate hike and talking to the banks. We are seeing a recovery in terms of net interest margin. It’s good for winning, it’s good for profit. Towards the corporate sector where some sectors are telling us that this inflationary environment is impacting the margin and also the rising rates in terms of funding costs. So the key message just in terms of sectors, buying financials rather than corporates is a good way to hedge your portfolio against rates/inflation. Second, not all bonds are the same. Clearly, for the same issuer, if you hold a floating or fixed bond, it is not the same result. In our case, when I look at subordinated debt, the majority of subordinated debt in Europe is issued with a coupon called a fix to floater, a fixed coupon for a few years and then becomes a floater. I think that’s another way to mitigate inflation risk. Now, just to follow that, year to date, it’s been a surprise in terms of inflationary pressure. Central banks know this, they must act. This is why the Fed is rising, you expect fed funds above 3% by the end of the year. This means that central banks are fighting inflation at the cost of driving the economy into recession. When we speak of inflation today, that means that tomorrow we will speak of recession. This means that, for your portfolio, you need to position yourself not only for inflation risk, but also for recession risk. And so the implication is that you actually want to increase the overall credit quality of your portfolio, which means investment grade should outperform high yield. It was interesting with the subordinated debt, the matter of the issuers are investment grade issuers.

3. If there is a risk of recession, what are the implications for European banks?

Keep in mind that in 2008, 2009 we had a global financial crisis. The problem at the time was that the financial sector had problems in terms of asset quality, too much leverage, too little capital. Now, if we look at 2022, it’s a completely different outcome. We are in a situation where the European financial sector has never been so strong, looking at the equity ratio, the solvency ratio, the liquidity ratio. And even looking at asset quality. So if Europe were to go into a recession, well, one of the buffers that we have right now is that due to rising rates, we’re currently seeing an increase in net margin of interest. Profitability therefore increases. And from what the sector tells us, this increase in profitability should completely absorb the expected future losses if the European economies enter a recession. So again, due to regulatory pressure from the regulator on the financial sector, we believe that if we were to go into recession, European banks could potentially emerge as one of the most resilient sectors, due to solid fundamentals.

4. What are the prospects until the end of 2022?

For the rest of the year, we are very constructive. Regardless of market conditions, we will capture high earners. I mean, right now we’re aiming for a return of around 6%. And this is really independent of whether the price goes up or down. But on top of that, subordinated debt was not immune to the sell-off. And so, on average, we’ve seen pretty significant price drops. I mean, we’re currently down 9.5% year-to-date (at time of record in July 2022). Whenever we go through a systemic crisis, and we tend to see a crisis every two and a half years, so this time is no different, we usually get a full price recovery within six to nine months. This is called a “power link attraction”. In short, we are very constructive. And our best-case scenario is a double-digit return for the rest of the year. Part from revenue and the rest from price appreciation. Now, you know, double-digit returns might seem like a big number, but don’t forget that in 2020, we’ve been impacted by COVID. In the first quarter of 2020, bond prices fell by 20% and we ended the year in positive terms. We therefore see no reason for this period to be different, hence our very positive outlook for the rest of the year.