Aiming For Real Value Preservation

Guest Author Thomas Schmied, CFA

I am very happy to introduce another guest author of the Gutmann Viewpoint newsletter: Mr. Thomas Schmied. Thomas started in 2012 as securities trader and, for the last 7 years, a portfolio manager with an emphasis on multi-asset management within the Chief Investment Office of Bank Gutmann. Enjoy his reflections.

Aiming For Real Value Preservation

The current rising inflation figures show how important it is to maintain the purchasing power of the invested assets. For investors, the real return of the portfolio is the decisive factor here. This indicates how much the return of a portfolio has generated after deducting costs, taxes and inflation - i.e. the real value preservation or capital growth.

Apart from rising inflation, there is another challenging development found within the financial markets for investors, negative interest rates! There are numerous government bonds with good credit ratings that nominally offer only negative yields. As such, after taking inflation into account, the real yield is even more negative and the loss of purchasing power here is enormous!

Purchasing power maintenance in the distant future

The chart below shows the development of the real yield of a 10-year German or Italian government bond. Pictures say more than a thousand words. Because even with an investment in a significantly riskier issuer like Italy, no positive real return is possible. Even corporate bonds can yield negative returns, both nominally and in real terms.

Source: Bloomberg. Past performance is not a reliable indicator of future results.

The conclusion: no real value preservation is possible with an investment in a pure bond portfolio and capital growth is not achievable in this scenario.?

One possible way out of this misery are equities. The crucial question arises, what equity weighting can be utilized in order to seek real value preservation, or at what point can one even expect an increase in value? This depends on your life situation. Every investor has his or her own personal basket of goods, the keyword being inflation. It is therefore difficult to give a general answer, but let us give it a try.

Inflation and earnings expectations

The financial markets are trading on inflation expectations for the next ten years (known in the financial industry as “break-even rates”), which are currently around 1.80% for the euro area. You may be shaking your head in disbelief now, as the media is talking about much higher inflation. True!

The inflation figures from television and business media last October were pegged at 3.60% for Austria and 4.10% in the euro area compared to the previous year. These figures are statistically measured and are not inflation expectations as described above. Since the measured inflation figures reflect the past or the present, we prefer to base our investment recommendations on inflation expectations, as your portfolio must be prepared for coming events in the future.

In addition to the inflation assumptions, the expected return - i.e. the strategy - of a portfolio is decisive for real value preservation. In the table below you will find the expected returns for conservative portfolios - i.e. from 0% to 20% equity weighting - up to portfolios with a dynamic equity weighting of 30% up to 50%.

Source: Bank Gutmann. Earnings expectations before costs: Forecasts are not reliable indicators of future developments.

As seen above, with a strategic equity weighting of 30% to 40%, a positive real return is possible. If costs are taken into account, real value preservation is achievable with an equity weighting of 30% or 40% or higher. For real capital growth, one needs to have an equity weighting of at least 50%.

More equities, more risk

Why not just buy 100% equities? As the economist Milton Friedman expressed, “There is no such thing as a free lunch”. As applied to our portfolio, along with a higher strategic equity weighting, an increased risk is to be expected. Bonds are also an important component of a portfolio and cannot be replaced across the board by other asset classes such as cash, alternative investments or equities, as the risk/return profile would change significantly.

For this reason, the quality of the companies we invest in have a specific priority in the management of Gutmann's portfolios. Every bond, stock and fund must undergo a rigorous due diligence process before the security is included into our portfolios. For you, the best is just good enough for us.

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This is a marketing communication. Investments in financial instruments are exposed to market risks. Past performance or forecasts are not reliable indicators of future results. Tax treatment depends on each client's personal circumstances and may change in the future. Bank Gutmann AG hereby explicitly points out that this document is intended solely for personal use and for information only. Publishing, copying or transfer shall not be permitted without the consent of Bank Gutmann AG. The contents of this document have not been designed to meet the specific requirements of individual investors (desired return, tax situation, risk tolerance, etc.) but are of a general nature and reflect the current knowledge of the persons responsible for compiling the materials at the copy deadline. This document does not constitute an offer to buy or sell or a solicitation of an offer to buy or sell securities.

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