“For each asset class we invest in, we prefer to select several funds which pursue very different strategies to then blend them together into one portfolio,” says Wennonen-Kärnä. “Like this we end up with an aggregate risk profile that is equal to market risk, but this blended portfolio enables us, in theory, to extract a return which is about 3% to 4% higher.
“When establishing a portfolio, the single most important thing to keep track of is how you mix the different instruments you use. We choose true stock pickers as well as disciplined, systematic investors who cover the whole market.
“Depending on the circumstances you could also choose a manager who knows one particular sector very well, or someone whose investment strategy is tailored to a particular theme like value-investing or generating free cash flow.”
European equities, a blending paradise
European equities is traditionally one of the asset classes Wennonen-Kärnä focuses on. As a senior portfolio manager and member of the fourperson strong fund selection team at Evli Bank she helps drawing up its European equity fund selection list.
For her, Europe is the perfect region to put her portfolio blending strategy into practice. “We have a large strategic allocation to Europe, as we find a good range of funds to choose from here,” Wennonen-Kärnä explains. “At the moment we are holding four different funds. The portfolio that we constructed out of these four funds gives us a lower volatility than the index and a much better return.”
One of the funds she has selected for her European equity portfolio is the Alken European Opportunities Fund, which won a Morningstar award as the best European equity fund this year. “We very much like this fund for its unconstrained stock-picker approach”, she says, understandably, as the fund outperformed the MSCI Europe by more than 10% in the last two years, though only after showing an underperformance of almost 4% in 2011.
However, Wennonen-Kärnä notes, this must not lead us to conclude that return is the most important aspect when it comes to evaluating a fund. “We would rather buy a fund that has performed consistently over time than a fund that has shown an amazing return over just the previous year. Consistency is very important for us.”
The BlackRock European Value Fund, which has consistently outperformed its benchmark over the past few years, is such a fund. “It has a strong focus on value stocks, and we partly like it because it doesn’t invest in banks. We estimate that the euro crisis is far from over yet, and expect to see quite some market turbulence still this year. We do not expect any good news fromthe earnings side, and the escalation of the crisis in Ukraine is also a main downside risk.”
On top of that, Wennonen-Kärnä is able to list a few more possible threats to investment return. “It might very well be that the ECB will not provide a new wave of cheap money to the financial system, the possibility of which is partly priced in already. The banks would suffer from this and, as their balance sheets are not particularly healthy, they won’t be able to provide loans to companies either. So you see, there are a lot of factors out there that will make this year more challenging than last.”
However, Evli’s European equity portfolio was designed to weather this storm. Next to the BlackRock one, Wennonen-Kärnä has selected another slightly conservative fund, the Invesco Pan European Structured Equity Fund, which more than offsets the risk added by the Alken fund’s opportunistic style.
“Its focus on low-volatility stocks makes it perform relatively well in downward markets,” she says.
The fund indeed only lost 2% in 2011, when most European equity funds made double digits losses. The European equity portfolio is completed by Evli’s own European equity fund which focuses on free cash flow generating companies.
In the mix
As a general rule, Evli’s portfolios are a mix of in-house funds and external managers. Third-party funds are mainly used on the equity side. “Right now we have more than half of our equity investments on our private banking side in external funds. On the fixed income side, most of our assets are in our own in-house funds, as we have a strong base of fixed income managers at our bank, especially on the corporate bond side.
“We have had a strong overweight in [developed market] corporate bonds over the past years which has delivered us great returns, but the golden age of this asset class is certainly over. We expect interest rates to go up, although this hasn’t happened yet this year. This has made us consider fixed income products that are focused on generating alpha, and are not as dependent on market conditions.”
Of course, we are talking about absolute return. Across Europe, fund selectors have turned to the asset class in an attempt to avoid the devastating effects of interest rate hikes. And so has Wennonen-Kärnä.
“We still have some allocation to developed government bonds strategically, but tactically we are in a large underweight within our fixed income portfolio.” Over the whole fixed income spectrum though, Evli Bank is not underweight versus equities.
“As part of our diversification strategy, we bought some new alternative fixed income funds this year. We have a 10% allocation to absolute return within fixed income now, and we might increase further depending on market conditions.”
Absolute return as an asset class is regularly criticised by investors for its lack of transparency and its elusive character. “It is true that it is a black box in one way or another. You simply have to trust the strategy and tactics of the manager”, Wennonen-Kärnä admits.
“Absolute return for me is an unconstrained investment strategy that contains long and short strategies and doesn’t have any limitations regarding sector or asset quality exposure. In the end, the reason we invest in these funds is not to lose money. In this low interest rate environment, a return of 2% to 4% on fixed income is pretty good for us.”
Cautious on Finland
While Evli Bank is overweight in European equities as a whole, their outlook towards Finnish equities is negative. “We are underweight Finnish equities, and are cautious in our allocation strategy,” says Wennonen-Kärnä. Most of our private client portfolios also only have a minor allocation to Finnish stocks.”
Finland is the only country in the eurozone still in recession, and she doesn’t expect the country to return to growth quickly. “Finland has not been able to implement any major reforms for more than 20 years. Therefore, it will take a lot of work to revitalise the economy. As there hasn’t been a sense of urgency, necessary reforms have been delayed.”
In this context, she is afraid Finland will lose its cherished AAA-rating. It is the only eurozone country besides Germany that still has all main three rating agencies’ top-rating. “The potential downgrade from AAA status is definitely a threat,” she says.