At two events organised at Banque de Luxembourg on 14 and 16 May, David Schmidt spoke about the current crisis, the background behind the crisis and the implications for the economy and markets, as well as investment alternatives in the current context. David Schmidt is head of portfolio management mandates, active advisory services and dealing room activities for institutional clients at Banque de Luxembourg.
The root causes of the financial crisis
The financial crisis started in 2008 following the collapase of the subprime market in the United States and the spectacular failure of investment bank Lehman Brothers. The impact was huge - the roots of the crisis lay in the phenomenal explosion of debt which has been building up over the past 30 years in the United States as in many other of the industrialised countries.
The constant rise in debt, mainly in the private sector, was driven mainly by the gradual fall in interest rates, which started with the central banks' victory in the fight against inflation at the end of the 1970s and continued with the extremely accommodating monetary policies conducted by the same central banks following the bursting of the tech bubble in 2000 and, closer to home, the housing and credit bubble in 2008.
The sovereign debt crisis
The scale and intensity of the financial crisis has called for huge government intervention, resulting in an almost instantaneous shift in private sector debt (mainly in the financial sector) towards the public sector, resulting in a situation of crippling government debt in most of the industrialised countries and the sovereign debt crisis we are seeing particularly in Europe right now.
The monetary and fiscal policies conducted in recent years by the governments have only served to deepen the structural imbalances by increasing the medium to long-term economic and financial risks. Worse still, the intervention of the central banks and their very low interest rate policy have served to bolster up a system heavily reliant on consumption and recourse to debt. In the end, these measures create profound distortions because they do not encourage savings; instead they encourage speculation, favour the creation of asset bubbles and distort capital allocation, thereby flouting the rules of the market economy.
A new environment
What was true yesterday no longer holds up today. There is no longer any such thing as a risk-free asset. Government debt issues from certain countries may default, while less risky debt offers practically no return or just returns below inflation. The same is true for returns on monetary investments that are eroding buying power in light of negative returns.
Equities are undoubtedly more volatile than bonds, but bonds cannot necessarily be considered as less risky than equities. On the contrary, certain issuers (regardless of whether they are governments or companies) expose an investor to a risk of losing part of their capital. And bond investments are much more volatile than in the past. As well as this, while corporate equities represent real assets that allow the investor to preserve their buying power, bonds - which usually have a fixed return - now have more in common with monetary assets.
How to invest
Although an investment strategy focusing on equities is currently the right approach, it is important to focus on quality companies that are operating in sectors with low levels of cyclicity, have a competitive advantage, a healthy financial structure and that are strongly exposed to the emerging markets and capable of paying out an attractive dividend. Everything points towards the fact that such companies will be able to be considered as the last safe haven stocks.
Finally, the current macroeconomic environment - characterised by fragile growth and high economic and financial risks - is arguing in favour of active management. By active management, we mean management that is based on a rigorous and disciplined section of good quality companies with a flexible hedging strategy designed to restrict the risk naturally associated with equities. Buying blindly into stock market indices and waiting passively is only valid in structural bull markets. Our conviction is that since 2000, we are currently in a sideways market punctuated by a high level of volatility.
Some ideas
Banque de Luxembourg currently favours three themes in the current environment:
- Pursuing a resolutely active investment strategy by focusing on quality stocks via our BL-Global Flexible fund.
- Selecting good quality companies offering a high dividend and/or growth companies. Our BL-Equities Dividend fund invests in international companies that reward their shareholders with high sustainable dividends.
- Finally, the future of the world economy is in the emerging markets. Our BL-Emerging Markets fund is a good entry point into these countries, and applies our investment philosophy and our selection methodology that focuses on quality stocks.
What are Banque de Luxembourg's investment principles?
"We invest in what we know best and understand with a long-term vision. We ignore short-term trends on the markets, and steer away from fashionable trends and trendy stocks. We adopt an entrepreneurial approach to stock selection, based on the principle that we only invest in quality companies as if we were planning to keep them forever. We select companies that have a management team, a management approach and business model that we appreciate. The selection of stocks is therefore not linked to a reference index - the aim is to find absolute performance with the underlying concern of capital preservation. But the emphasis is mostly on the valuation as in the end, it's the price paid that determines the future return on all investments." explains David Schmidt.
