Nowhere in Europe, investors are as unsure about the direction the world economy is heading to as in Luxembourg. Most fund selectors admitted when our researcher interviewed them at the end of April that they don’t really have any idea what guides markets. They feel that the effect of QE as a driver of asset prices is petering out.
Negative rates may be beneficial on the short-term though, they contend, as they force investors with large cash holdings to redeploy these into investable assets. They are to a large extent speaking about themselves here, as the majority have cash positions between 10 and 15%. This reflects both their uncertainty and lack of a long-term growth driver, as markets are perceived to be in need of a new drug to replace QE. However, Luxembourg’s fund buyers haven’t given up all hope. The area where they see most glimmers of hope is emerging market equities.
Best upside potential
Luxembourg’s fund buyers have perceived several buying signals for emerging market equities since the beginning of the year. They note EM equities had been the worst performing asset class from 2013 to 2015, before bouncing back in the past few months. Contrary to most of their peers in Europe, fund buyers in Luxembourg are not predominantly underweight emerging markets, and they are looking to increase their exposure strategically, rather than tactically.
Four in 10 investors plan to increase their allocation to global emerging market equities. Those who are underweight now believe they are missing out on the rebound, and want to have some skin in the game. Others prefer to wait for a setback before increasing their positions. A global approach to emerging markets is preferred by most interviewees, as many see interesting opportunities in the commodity price rebound, which has been a major driver of recent EM equity returns.
Hunting for yield
Equally popular as emerging market equities are developed market corporate bonds. This is a consequence of two things: negative yields on close to half of European government bonds and the ECB’s inclusion of corporate bonds in its QE programme. The combination of the two makes it a compelling trade to Luxembourg’s investors. Four in 10 interviewees plan to increase their allocation.
European high yield bonds are often mentioned in the same breath as their investment-grade counterparts in Europe, because they are supposed to benefit equally, and possibly even more, from QE and the hunt for yield.
As Luxembourg is heavy in private banking, local fund buyers are wary not to take on too much risk though. Most of them therefore are satisfied with the spread offered on investment-grade corporate bonds. But a quarter of interviewees also plan to increase their exposure to high yield bonds, as they feel coupons on high-quality bonds are simply too low on the long term to provide satisfactory returns.
Unconstrained bonds are more popular as a less risky alternative, with close to half of those interviewed planning to increase their exposure. In fact, this is the only area where Luxembourg’s fund buyers significantly detract from the European trend, as most of their peers in the rest of the continent don’t use funds that can invest across the fixed income spectrum.