Efficiency 2015 Annual Report

Time for Conservative Strategies

Neither sharp fluctuations of oil and gold prices, nor the volatility of the leading global stock markets have changed the attitude of ABLV clients; safeguarding savings is more important than making (no)profits on speculations. Leonīds Kiļs, Chairman of the Board of ABLV Asset Management and ABLV Capital Markets, tells us about expected growth and the level of yield above which unpredictability begins.

Let’s summarize the results of 2015. It was a complicated year for investors, especially on the stock and oil markets.

As the song says, “hard times are over”, but those coming are also going to be tough. In my opinion, nothing has changed in this life: every past year is hardly easier than the following one. However, the year 2015 definitely cannot be described as an easy one for in­vestors. The pace of life has become so fast that many fundamental things are not working out anymore.

Like what?

I’ve been kidding about markets behaving like women, namely, they are characterised by the irrational thinking of investors. In the past, the logic was textbook clear: if there is inflation, the market expands and GDP increases, which, in turn, drive the growth of stocks, precipitate a decrease in bond yields and a rise in consumption. Today, this logical chain no longer works or else works in its own idiosyncratic way.

In 2016, the sentiment on the world’s markets changed. Whereas previously it was said that when America sneezes, the world catches a cold, now everyone is watching China sneezing. And some people profit from this. We have clients who use third-order derivatives aggressively: there is a volatility index, futures on it, and an option on the futures. And these people say: whereas previously they switched on their computers in Moscow at 2 p.m. and calmly monitored the fluctuations; now they are at their computers as early as at 6 a.m. in the morning.

Watching Asia?

Yes, the Chinese stock exchange is already open at this time. And if the Chinese stock exchanges decline by 7% early in the morning, the American indices will most likely become negative in the evening. Moreover, whereas in the 90s the fluctuations in the S&P 500 of 1% and more during a day were considered dramatic, now fluctuations of 1% mean it’s been a very quiet day.  

Have the investment horizons of clients become shorter too?

I discussed this with a client recently. We agreed that the current investment horizon is not more than 12 months. This is the limit for trying to take a look into the future. Making plans for five years is pointless. Who was able to anticipate the events of 2015 in 2010, at least in terms of global finance? It is difficult to look into the future even as far as one year ahead.

There is a saying, “uncertainty is worse than bad news”. And currently we are in a situation where too many events have uncertain outcomes. Will the sanctions against Russia be revoked? We don’t know. However, sanctions against Belarus were repealed in February and nobody had expected this. No one knows what the oil price will be by the end of the year. Experts say the price of a barrel will rise to USD 50 again. But these are just words; they will not fill a bushel. Who could predict oil dropping all the way from USD 140 to USD 30 so quickly a couple of years ago? The sum of these unpredictable factors makes it difficult, if not impossible, to build strategies for the long term.

Risky investments are like spices: it is possible to get by without them, but the food will not be very tasty.

What were the results of ABLV funds?

The year was not among the best. Our conservative funds worked well as a defensive strategy. So, safeguarding what we have comes first, and only then growth. In contrast, the performance of more lucrative programmes was poor. All markets in which the investors expected to gain not even a two-digit return, but plus 5–8% were eventually either negative or showed a minimum increase.

This is good for those who did not stay in stocks at the end of 2015 and the beginning of 2016.

We are very conservative in this regard. We consider that the portfolio should include 80–90% of bonds and just 10–20% of more risky assets, i.e. stocks, gold, and oil. And those willing to risk should understand that oil price fluctuations of ±6% per day are common nowadays. In general, risky investments are like spices: it is possible to get by without them, but the food will not be very tasty.

Investing a small part of the portfolio in oil, would you buy futures or the stocks of oil-producing companies?

The simplest instrument for an investor is an ETF (exchange-traded fund) investing in oil futures. The fund’s charges are minor, just hundredths of one percent. To buy stocks of oil companies, additional analysis is needed to establish what their production costs are, who their trade partners are, how much debt they are carrying, and the corporate risks they’re exposed to...

As for ETFs linked to the price of oil, which are better: simple or triple-leveraged ones, in order to have more accurate sense of volatility?

Triple ETF with volatility of 15–20% per day? I would never recommend this one. To deal with such strategies, one should clearly understand the path taken. We have a couple of risk-taking clients who make profit on this actively, but they represent an exception to the rule.

In February 2016, American stock markets dropped by almost 20%. At that time, did clients start to transfer part of their money to the stocks, which became cheaper?

There are two major groups of clients. Those in the first group are rather conservative and more prone to safeguarding their money. They do not respond to additional opportunities during a market decline and do not change their defensive strategy. They certainly don’t mind being called and told of an additional profit opportunity. But the bank cannot guarantee that this will be an opportunity to make profit and not incur losses.

For example, in December 2015, many believed that stocks became significantly cheaper and it was time to buy. However, in February 2016 they declined even more. You never know whether another drop will occur tomorrow. Therefore, in asset management, we consider that the main thing for our client is to avoid losses. The client will not be very upset if the portfolio loses 1–2% and will not be extremely happy if it grows by 3–4%.

The other group is either comprised of clients, for whom operations on the financial markets are part of their professional lives, or by those who speculate financially as a hobby, but for whom, over the course of time, it has become something more serious. They are inclined to adopt more aggressive strategies. Nevertheless, bonds are popular with them, since bonds can be used as security to obtain financing from the bank. For example, someone has bought the bonds of Russian Sberbank at 5% p.a., obtained 50% financing secured by those offering 3% p.a., and then purchased the same bonds — therefore the profit can amount to 6–7%. Nowadays, this is rather a good return.

And a specific case among clients are those employing strategies on marginal markets. There the global statistical data is evil: 75% lose their money during first three months, and 15% over the course of a year. The remaining 10% are not exactly lucky, but people who understand what they are doing. The main thing there is to realize the risk and return ratio.

There are stories about marginal traders who, having opened a position, went to buy some bread. Upon their return, they found the market had moved the wrong way, they’d lost their money, and they could no longer afford to buy a car.

And it will be a long time till they can eat bread again. (Smiles) Right, but I would like to note that the bank’s shareholders do not welcome such risky operations and are very reluctant to offer them to clients. We do not particularly advertise them, because a client with no experience of trading will lose his savings quickly and will definitely not be happy. The bank does not need this.

Meanwhile, we have access to absolutely all instruments available globally — for those who know what they are doing. Therefore, brokers begin work at 8:30 a.m. and end at 12:00 a.m.

Current investment matters are being discussed at a monthly meeting of the Investment Committee

What are the forecasts for 2016?

I believe that during the spring, the major global indices, i.e. the American S&P 500, German DAX, and Chinese SSE will turn and start climbing. And this will be a good opportunity to make profits for those who were buying low at the beginning of February. Another question is whether the markets will compensate the losses incurred earlier. It is known that to compensate a decrease by 50% an increase of 100% is necessary. And it is always harder to rise than to decline.

Traditional conservative policy of ABLV increases the security of funds.

And what about the classic truth from books saying that investments in stocks are preferable when considering an investment horizon of over five years?

We are still relatively conservative. Moreover, our clients are mostly businessmen and not professional financial experts. They do not attempt to maximize profits using our programmes. Their logic is that earning is hard and safeguarding funds is even harder. And our task is to facilitate the safeguarding of the money they have earned and to help them earn a little extra. Therefore, we prefer bonds.

Furthermore, most managers usually buy ready-made global bond or stock funds, which are already packed with everything.

We also buy ETF bond funds, but the manager still has to keep a clear head. Not only does he need to choose the right funds, he also has to decide upon the correct time to buy or sell them and in the right proportion. And then the story begins, i.e. which manager is better at guessing and entering.

Do your clients from Russia and CIS states, where the economy is experiencing hard times, withdraw their savings for business needs or simply for living?

No, there is no such trend! Even as far as their businesses are concerned, people have different moods. Some say there are plenty of opportunities in Russia right now; others argue that everything is in a bad way.

Has the appetite for risk remained the same as well?

Both we and our clients mature, and the willingness to take risk decreases with age. There is an observation that until the age of 50 a man is inclined to earn actively, until 60 — preserve his capital, and then to spend. Today, those who started business in the 1990s are about fifty years of age. At this age, the attitude towards risk is not the same as at the age of 20. Some people have to take care of their children and grandchildren. You understand that your actions will affect your relatives, not just you.

You have mentioned gold as a risky asset. How much demand has there been at ABLV Bank Luxembourg for the service of purchasing physical gold?

It is not a mass market product, although there are people for whom physical form is important. But unallocated gold, in the form of bank account record, is purchased more, and the price fluctuations are reflected on the account.

The peculiarity of physical gold is that even those who purchase it do not take it out of Swiss and Luxembourg banks, because after gold is withdrawn, the bar should be subject to expert examination for resale. And in terms of storage, the cheapest way is to buy gold futures.

Most probably, all your clients from Russia and CIS states also receive services from their local banks. Why do they choose Latvia for savings and asset management?

There are different reasons. First of all, it is said to be for the reason that the further you hide it, the closer you find it. The fact that the traditionally conservative policy of ABLV increases the security of funds on deposit also plays its role. It is no secret that many banks in Russia still sin by using clients’ money for their investment programmes. As far as we are concerned, this is impossible. Many investors split their assets: keeping one part at home and the other part abroad. It is difficult to name the major reason for the demand to keep savings in Latvia; there are a number of factors.

The role of tax planning and information protection is decreasing. The world is changing and the banking secrecy that was present 20 years ago is disappearing. Even in Switzerland it is no longer possible to conceal information about clients with regard to taxation. And this is true for all, be it in US or Europe. In Russia, the programme of joining the information exchange system will start functioning in 2018. There is no need to cherish illusions. Life is changing.

Yes, in the 1990s, Latvian banks opened anonymous accounts, having learnt this from their Austrian colleagues. Now this should be forgotten or recalled over a glass of beer, telling stories about past possibility to open an account without a passport by just saying a combination of ten digits. There is no such technology anymore. Now the human factor and convenient communication with the bank are becoming increasingly important for clients.

Many investors split their assets: keeping one part at home and the other part abroad.

It is said about 2016 that the major investment concept to earn and lose the most money will involve oil price fluctuations. As far as I understand it, most of your clients do not play in this risky area.

No, this is not our investment idea and we are not going to implement it for our clients. The opportunity to earn several times more, or lose several times more… My personal opinion is that currently the market is unfair for investors. Earlier it was like: you aim to earn 3% and realise that losses can amount to 2%. Or your target 10% earnings and you are aware of the risk of losing 20%. Now though you aim to earn 5% and your losses can be 50%. It is like swimming in the ocean: you take two steps, and in taking a third one you find yourself totally under water.

For which instruments is this true?

Investment-grade bonds, not the highest ones. Once upon a time, these were considered to be largely resistant to volatility. However, looking at the lists of these bonds at the beginning and the end of 2015, one finds that many of these became junk bonds over the course of the year. And you actually wanted to earn 5%, but your losses in a year amounted to 7–8%, because the relevant countries or companies turned out to be problematic in the opinion of rating agencies.

One particular example is Russia at the end of 2014. At that time, the value of most Russian bonds dropped by 30%. Those who waited for a year eventually broke even. But those who became afraid or market hysterics actually lost 30%. Although, nothing seemed to bode ill, people were not looking to play a risky game and to earn two-digit returns. Their target was growth of 5–6%.

What is the bond yield that remains relatively predictable?

3%. And as soon as you want to gain more than 3% p.a. you should ask yourself whether you are ready to lose 10 times more. Therefore, we recommend more conservative bonds and a small portion of stocks or other risky assets.

One can definitely say that: I earned 50% or more on the S&P 500 over a five year period, whereas with the bonds you offer the return is just 10–15%. Yes, it is possible to gain more. But the question is whether the client, in waking up every morning, is ready to watch quotations of stocks and oil instead of thinking about his own business.

Table of Contents

Creative team: Arnis Artemovičs, Ernests Bernis, Jānis Bunte, Anna Celma, Ilmārs Jargans, Jekaterina Koļesina, Sergejs Mazurs, Samanta Priedīte, Jūlija Surikova, Romans Surnačovs
Project managers: Anna Celma, Jūlija Surikova
Interviews: Jānis Bunte, Ingrīda Drazdovska, Konstantīns Gaivoronskis, Katrina Gordejeva, Ilmārs Jargans, Jekaterina Koļesina, Sergejs Mazurs, Romāns Meļņiks, Sergejs Pavlovs, Romans Surnačovs, Jānis Šķupelis
Text authors: Leonīds Aļšanskis, Jānis Bunte, Anna Celma, Vladislavs Hveckovičs, Jānis Grīnbergs, Māris Kannenieks, Ļubova Kazačenoka, Jekaterina Koļesina, Zane Kurzemniece, Aleksandrs Pāže, Gints Pumpurs, Dmitrijs Semjonovs, Jūlija Surikova, Kaspars Vanags, Benoit Wtterwulghe
Photography: Arnis Artemovičs, Uldis Bertāns, Mārtiņš Cīrulis, Ieva Čīka, Krišjānis Eihmanis, Andrejs Hroneloks, Alise Jastremska, Valdis Kauliņš, Valts Kleins, Marks Litvjakovs, Sergejs Mazurs, Reinis Oliņš, Samanta Priedīte, Gatis Rozenfelds, Polina Viljun, LETA foto, Marka.photo, Studija F64
Proofreader: Jānis Frišvalds
Translators: Jekaterina Koļesina, Nataļja Malašonoka, Lidija Marsova, Jūlija Surikova
Design: Aivis Lizums, Valters Horsts

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