Monthly Market Monitor
December 2023
Content Macro Radar
Satellite View Geopolitical heat map
Taking the pulse of economic activity
In a Nutshell
4
Number 1 in Private Banking
9
Asset Allocation
6
8
Theme in Focus Private markets – the right way
Notes from the Investment Committee
10
13
Ask the experts
The Back Page
Agenda
What stirred our clients (and moved the financial markets) in November 2023
Asset classes
23
20
22
Kaiser Partner Privatbank AG | Monthly Market Monitor - December 2023
3
In a Nutshell
Our view on the markets
In 2023, which is winding down now, the restrained to pessimistic economic forecasts proffered during last year’s outlook season were exceeded for the most part.
The end of the year is outlook time During the closing weeks of a year, economists and investors naturally turn their sights to the outlook for the next year. In 2023, which is winding down now, the restrained to pessimistic economic forecasts proffered during last year’s outlook season were exceeded for the most part. There again are hardly any analysts exuding euphoria about the outlook for 2024. The consensus anticipates a sharp slowdown in economic growth in the United States, stagnation in the Eurozone, and renewed maneuvering by China around that country’s 5% growth target. No escalation, but further provocations The conflict in the Middle East has stayed confined to that region over the past several weeks, though there have been some pinprick strikes against Israel by groups sympathetic to Hamas. One of them was an attack on a cargo ship in the Red Sea by Houthi rebels as a new variant of belligerence. This incident illustrates the vulnerability of shipping lanes around the Arabian Peninsula. Rally right in line with the seasonal schedule The directional arrow on equity markets turned upward at the end of October, right in line with the seasonal schedule. The year-end rally has been underway with vibrant momentum since then. Meanwhile, this year is
Chart of the Month One year after the inflation shock… | …the situation looks a little more relaxed again Inflation rates
12% 10% 8% 6% 4% 2% 0 -2% 2015
2016
2017
2018
2019
USA
United Kingdom
2020
2021
Eurozone
Sources: Bloomberg, Kaiser Partner Privatbank 4
Monthly Market Monitor - December 2023 | Kaiser Partner Privatbank AG
2022
Switzerland
2023
also coming to a conciliatory end for bonds as well. The end of the year is also a time for forecasting what’s in store for next year: the outlook for 2024 gives no reason to bet on extreme-case scenarios. Many asset classes look set to generate solid returns in the year ahead. Private markets – the right way Investments in private-market assets have long ceased to be the exclusive preserve of institutional investors these days. More and more private-market investment offerings are explicitly being aimed at retail investors, but not all of the products on the market are retail investor-friendly. Kaiser Partner Privatbank offers a comprehensive solution that combines diversification and an attractive risk/return profile with comparatively high liquidity. Ask the experts What is the Sahm Rule all about? Is cash still a good investment in the months ahead, or have (Swiss) bonds now become (more) attractive again? Is gold a good investment in light of the current geopolitical uncertainty, and should an investor buy physical gold? What are the performance drivers for cat bonds, and does this asset class remain interesting for the months ahead? And has the “Yale model” outlived its usefulness? You’ll find our answers to these questions in our quarterly Q&A. Twelve months can make quite a difference. A year ago, the annual inflation rate in the Eurozone was in double digits and a return to the European Central Bank’s 2% target seemed a long way off. But at the turn of the year at the latest, the word “disinflation” started making the rounds, and renewed talk of deflation has even been heard recently here and there. Widespread price declines are unlikely next year, but a stabilization of inflation close to the central bank’s target is arguably realistic, in large part because economic activity in the Eurozone will simmer on a low flame again next year. However, inflation is a notoriously sluggish indicator. To keep inflation from resuming to overshoot on the downside soon, central-bank officials in Frankfurt should already start thinking sooner rather than later about reverting to cutting interest rates. From where we stand today, though, a proactive rate cut soon by the ECB would be pretty surprising.
Kaiser Partner Privatbank AG | Monthly Market Monitor - December 2023
5
Macro Radar
Taking the pulse of economic activity
This year, economic outlooks for 2024 once again have to entertain the question of whether there will be a (US) recession. Various indicators that were helpful in the past suggest that a recession is long overdue. Whether one materializes next year will depend in large part on the proactiveness or inertia of central banks. The end of the year is outlook time During the closing weeks of a year, economists and investors naturally turn their sights to the outlook for the next year. In 2023, which is winding down now, the restrained to pessimistic economic forecasts proffered during last year’s outlook season were exceeded for the most part: the world economy grew more strongly than expected thanks to the USA, recessions were confined to just a few countries (one of them being Germany), and inflation tended to recede faster than anticipated. There again are hardly any analysts exuding euphoria about the outlook for 2024. The consensus anticipates a sharp slowdown in economic growth in the United States, stagnation in the Eurozone, and renewed maneuvering by China around that country’s 5% growth target.
Whether economic growth in 2024 surprises on the upside or downside will likely depend particularly on the proactiveness or inertia of central banks.
Who will be the first to cut interest rates? Whether economic growth in 2024 surprises on the upside or downside will likely depend particularly on the proactiveness or inertia of central banks. Inflation in the USA and Europe looks set to pull back relatively close to the 2% target by as early as mid-year, causing the real interest-rate level to become much more restrictive yet again in the months ahead. If central bank officials stick to the current policy rate levels for too long, they risk Gravity | The oil price is not a showstopper Brent crude oil price and consensus forecast 130 120 110 100 90 80 70 60 50 2021
2022
Sources: Bloomberg, Kaiser Partner Privatbank 6
Monthly Market Monitor - December 2023 | Kaiser Partner Privatbank AG
2023
2024
(needlessly) slamming the brakes on economic growth. Taking that kind of risk on the homestretch to getting inflation back to normal would be unnecessary. Financial market participants view it the same way and already expect to see some interest rate cuts over the course of next year. It remains to be seen whether central banks will fulfill those hopes. China not a growth driver again in 2024 China this year was not the economic growth engine that people were wishing for – the economic rebound after the end of the COVID-19 lockdown turned out to be shorter-lived than anticipated and hoped. Since mid2023, the government of China has been stabilizing economic growth by employing a variety of selective supportive measures in combination with an easing of monetary policy. This ultimately may turn out to have sufficed to reach the 5% growth target for 2023 after all. The leadership in Beijing is likely to stick to this formula in 2024 and will probably continue to refrain from its past practice of dishing out economic stimulus with a giant ladle. Rectifying the country’s economic imbalances, particularly the distortions in the real estate market, will likely still take quite some time. Aside from that, demographics will become an additional challenge more quickly than expected.
Oil price unlikely to act as a brake on economic activity Analysts at the moment are also hard at work devising forecasts for the price of oil. However, point forecasts for the price of petroleum and for most other macro variables and markets are difficult to get right and are devoid of added value, in our opinion. The consensus forecast sees the price of Brent crude oil
at USD 85 per barrel at the end of 2024. At that level, crude oil at least would be neither a brake on economic activity nor an obstacle to continued disinflation. The slumping price of oil in recent weeks is actually acting rather as a support for those consumers who drive cars. OPEC(+) extended its oil production cuts once more in late November to halt the recent price decline.
Consensus estimates
Kaiser Partner Privatbank interest rates view 2023
2024
2025
GDP growth (in %)
Last
3M
12M
Key interest rates (in %)
Switzerland
0.8
1.1
1.5
Switzerland
1.75
→
↘
Eurozone
0.5
0.6
1.5
Eurozone
4.00
→
↘
UK
0.5
0.4
1.2
UK
5.25
→
↘
USA
2.4
1.2
1.7
USA
5.50
→
↘
China
5.2
4.5
4.5
China
2.50
→
→
Inflation (in %)
10-year yields (in %)
Switzerland
2.2
1.6
1.3
Switzerland
0.85
→
↘
Eurozone
5.5
2.7
2.1
Eurozone
2.44
→
↘
UK
7.4
3.1
2.0
UK
4.18
→
↘
USA
4.1
2.7
2.3
USA
4.33
→
↘
China
0.4
1.7
1.9
China
2.68
→
→
Kaiser Partner Privatbank AG | Monthly Market Monitor - December 2023
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Satellite View Geopolitical heat map
The conflict in the Middle East has stayed confined to that region over the past several weeks, though there have been some pinprick strikes against Israel by groups sympathetic to Hamas. One of them was an attack on a cargo ship in the Red Sea by Houthi rebels as a new variant of retaliation. This incident illustrates the vulnerability of shipping lanes around the Arabian Peninsula. No escalation… The actions by the Israeli Defense Forces in Gaza in recent weeks in response to the devastating surprise attack by Hamas on October 7 have been extensive and intense, as Prime Minister Benjamin Netanyahu announced they would be. Not unexpectedly, “collateral damage” has been inflicted on the civilian population of Gaza, and the humanitarian catastrophe has sparked vociferous international protests. The past several weeks have seen intense negotiations for the release of some of the Israeli hostages held by Hamas and for a temporary ceasefire. The only – small – bright spot is the observation that the conflict thus far has largely remained confined to the Gaza Strip. Skirmishes with Hezbollah along Israel’s northern border with Lebanon, for instance, have not escalated further thus far.
The risk scenario formulated in the November issue of Monthly Market Monitor, under which other countries intervene in the conflict, has thus not materialized to date.
8
…but further provocations The risk scenario formulated in the November issue of Monthly Market Monitor, under which other countries intervene in the conflict, has thus not materialized to date. This is also reflected in the plunge in the price of oil since mid-October, which was down by more than 20% for a time. Although much of that price decline is attributable to the ample supply of oil and contemporaneous concerns about demand for petroleum next year, a certain part of it probably also owes to the market having priced a geopolitical risk premium back out of oil. The tail risk of a blockade of the Strait of Hormuz, which is a vital waterway for global oil trade, has diminished recently in
Monthly Market Monitor - December 2023 | Kaiser Partner Privatbank AG
any case. However, another incident illustrating just how vulnerable shipping lanes around the Arabian Peninsula are occurred in November when Houthi rebels hijacked a car transport ship in the Red Sea and rerouted it to Yemen. The hijackers threatened to attack any ship that they believe has a connection with Israel to support their “spiritual brothers” in Hamas. In this sense, the act of piracy was directly linked to developments in the Gaza Strip. Nothing new (unfortunately) The only thing new about this latest incident on a major shipping route was the professionalism of the hijackers and the sophistication of their equipment (they used a helicopter). Violent attacks on ships have been a big – and growing – problem for a long time. The International Maritime Organization registered more than 200 acts of piracy in 2020. Over 100 people were taken hostage in those incidents. Ships usually get attacked for financial gain because the billions of dollars worth of goods that they often carry and their deep-pocketed owners make for lucrative business. A new twist in the latest hijacking is that it was politically motivated. Since the fundamental danger posed by piracy is well known and has existed for years, no major shifts in the main trade route between Asia and Europe (through the Red Sea and the Suez Canal) are likely in the immediate future. Detouring around Africa would be much more time-consuming and more costly than the moderate rise in expenses for anti-piracy countermeasures and insurance coverage.
Number 1 in Private Banking Kaiser Partner Privatbank AG
Kaiser Partner Privatbank once again achieves top performance in FUCHS | RICHTER Prüfinstanz Kaiser Partner Privatbank was once again able to impress across the board in this year's quality test by the renowned FUCHS | RICHTER testing institute. With an overall rating of "very good", it is one of only nine institutions to receive the absolute top rating. For the second time in a row, it achieved first place among all audited institutions in Liechtenstein. FUCHS | RICHTER has been auditing almost 100 banks and asset managers from Germany, Austria, Switzerland and Liechtenstein every year since 2003. On the basis of anonymous client interviews, the categories of advisory discussion, investment proposal, beauty contest, investment competence and transparency are tested. The quality test initiated by the long-established German publishing house Fuchsbriefe is the most important private banking ranking in the Germanspeaking world.
In this year's 21st edition of the competition, FUCHS | RICHTER presented the asset managers tested with a classic investment case: the assets of EUR 10 million resulting from a real estate sale were to be invested in such a way as to preserve purchasing power and at the same time generate a return that an annual distribution of EUR 175,000 could be achieved. With above-average ratings in all core competencies, Kaiser Partner Privatbank was not only able to impress in all areas in this test case. With a very good performance in the beauty contest and an investment proposal that was also rated as very good, it was also able to set itself apart from the competition. In the conclusion of its report, the FUCHS | RICHTER review panel states: Kaiser Partner Privatbank is "a remarkably client-oriented and competent address in private banking [...] and plays in the top league in German-speaking countries." With innovative and customized solutions and excellent investment expertise, Kaiser Partner Privatbank will continue to strive for continuous improvement in the coming year and at least maintain the high level of standards it has achieved. True to the motto: "Those who stand still, fall by the wayside".
Kaiser Partner Privatbank AG | Monthly Market Monitor - December 2023
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Asset Allocation
Notes from the Investment Committee
Right in line with the seasonal schedule, the directional arrow on equity markets turned upward at the end of October. The year-end rally has been underway with vibrant momentum since then. But this year is also coming to a conciliatory end for bonds as well. Meanwhile, the Middle East risk premium has gotten priced back out of crude oil. Asset Allocation Monitor -
10
+
Cash
Equities
Fixed Income
Global
Sovereign bonds
Switzerland
Corporate bonds
Europe
Microfinance
UK
Inflation-linked bonds
USA
High-yield bonds
Japan
Emerging-market bonds
Emerging markets
Insurance-linked bonds
Alternative Assets
Convertible bonds
Gold
Duration
Hedge funds
Currencies
Structured products
US dollar
Private equity
Swiss franc
Private credit
Euro
Infrastructure
British pound
Real estate
Equities: Rally right in line with the seasonal schedule • At the end of October – bang in line with the seasonal schedule – the directional arrow on equity markets turned upward. The year-end rally that we had considered very probable has been underway with vibrant momentum since then. The buoyant upward momentum not only fits with the typical yearly trajectory pattern, but also with the typical US presidential cycle pattern, in which the third year (2023 this time around) is the best-performing one by far in the four-year cycle. Technology stocks are once again one of the driving forces behind the recent upward impetus. The Nasdaq 100 index already pulled even with its summer peak in mid-November and is now only a few percentage points away from hitting a new all-time high. There is likely to be some selling interest among investors on the index’s first attempt to clear this hurdle, but there’s a high probability that the second try will propel the index to lasting new highs.
Scorecard
Monthly Market Monitor - December 2023 | Kaiser Partner Privatbank AG
-
+
-
+
Macro Monetary/fiscal policy Corporate earnings Valuation Trend Investor sentiment
• The small caps in the Russell 2000 index also pivoted in late October at a crucial level: at the low point of the current bear market, which is already in its third year now. The big performance discrepancy between large and small caps has by now reached levels where small-cap stocks regularly embarked on a comeback in the past. We currently see good chances for small caps to post an above-average performance in the near future and recommend building out exposure to this segment a tad. There are arguments in favor of greater exposure not just from a tactical and technical-analysis perspective, but also from the standpoint of valuations: small caps are very inexpensively valued, particularly compared to the “Magnificent Seven”, i.e. the top seven tech stocks.
• Besides looking through the tactical lens, investors are faced with the year-end question of what’s a suitable investment strategy for 2024. Corporate earnings at least are unlikely to soar next year. A continuation of the rally, which is entirely possible given the current momentum, would thus be on account of a further valuation expansion. The monetary policy of the tone-setting US Federal Reserve looks set to rank among the biggest influencing factors again in 2024. If the Fed succeeds in engineering a soft landing, double-digit percent returns are realistic, but if it sticks with a restrictive course for too long and ends up provoking a recession, the “fat and flat” sideways market trajectory of the last two years is likely to continue. Fixed income: After the (final) selloff • When stocks pivoted at the end of October, the direction on fixed-income markets turned around at the same time. The 10-year US Treasury yield’s brief excursion (for one day, to be precise) above the 5% level was a climax and marked the end of the selloff in all likelihood. Although the cheapest entry point for buying bonds may already be in the rearview mirror now, the risk/reward tradeoff is still very good even at the current price level. The downside potential in 2024 is limited to around 50 basis points, which corresponds more or less to a breakeven return. But if the yield level continues to pull back further – regardless of whether sparked by a recession or caused by a proactive easing of monetary policy – returns slightly in double-digit territory would beckon. • However, the menu selection to choose from in the fixed-income universe is attractive next year also beyond investments in government bonds, which are the safest way of playing the bond sector. High-yield bonds likewise offer an asymmetrical risk profile and promise even higher returns in the better economic scenario. Whoever would like to invest also outside the realm of conventional interest-bearing securities and is open to niches that stand a little less in the spotlight may find a position in insurance-linked catastrophe (cat) bonds a good choice. On the heels of a stellar 2023 for cat bonds, another year with returns north of 10% looks set to follow on the back of high base interest rates and big risk premiums. Alternative assets: Oil prices experience the force of gravity • In the wake of the attack on Israel by Hamas on October 7, the price of oil initially climbed 10% to almost USD 90 per barrel in the span of a few days. Shortly afterwards, though, the conflict in the Midd-
le East already was no longer an acute or price-determining issue, at least not on the oil market. Instead, classic price-driving factors – in this case, a robust supply situation coupled with contemporaneous concerns about muted demand next year – regained influence. This latest price episode illustrates yet again that commodity markets in general and the oil market in particular are suitable for tail hedging in exceptional cases, but are not suitable for long-term buy-and-hold investments and/or for protection against inflation. Other alternatives such as real estate or infrastructure assets are better suited for those purposes, in our opinion. Whoever would like nonetheless to participate indirectly in and cash in on the recurrently observable trend movements on commodity markets can do that via an investment in trend-following CTA strategies. Similar to the case with hedge funds, the performance dispersion between good and subpar managers is very wide in the CTA segment, and professional expertise is therefore needed in selecting managers. Currencies: The euro catches its breath • EUR/USD: The EUR/USD exchange rate has gained considerable ground in recent weeks. It got a particularly forceful upward boost in mid-November from the latest US inflation data, which came in better (lower) than expected and cemented the end of the US rate-hiking cycle for good. But looking ahead to 2024, not only is the US dollar losing some of its interest-rate edge, the USA’s growth advantage over the Eurozone is also melting. Given its relatively cheap valuation, the euro has further upside potential in the no-recession scenario. • GBP/USD: The British pound has also appreciated lately, but with a bit less momentum than the euro. The question for 2024 is how quickly UK inflation will recede and whether the Bank of England will revert to cutting interest rates soon. Without support from interest rates, the British pound remains a comparatively weak currency plagued by fundamental problems, one whose undervaluation could persist for much longer. • EUR/CHF: Risk-on mode on equity markets usually means headwinds for the EUR/CHF exchange rate on currency markets, and that’s exactly what has happened in recent weeks. At the moment, though, we see only constrained upside potential limited to an exchange-rate level of 98 centimes. Switzerland looks set to outpace the Eurozone again next year in terms of economic growth. But Switzerland’s continually large current-account surplus, its low inflation, and its safe-haven nature in times of (geopolitical) uncertainty are even more relevant to the future exchange-rate trajectory.
When stocks pivoted at the end of October, the direction on fixed-income markets turned around at the same time.
Kaiser Partner Privatbank AG | Monthly Market Monitor - December 2023
11
After the last rate hike by the Fed on July 26 to a target range of 5.25%–5.50%, the US federal funds rate is now at its highest level in more than 20 years. Bonds are now more attractive relative to stocks than they have been for a long time. At the same time, a higher interest-rate level also means higher discount rates in valuation models and corresponding downward pressure on stock valuations. However, the direction of interest rates is more relevant to the equity market than the actual interest-rate level. Since the uptrend in interest rates is now over and they are more likely to hold steady or head downward in the near future, the outlook for stocks is very constructive: over the last 40 years, the US equity market has consistently traded higher six and twelve months after the final policy rate hike. The lone exception to the rule was the year 2000, when the final rate hike was followed by a recession just nine months later. If a recession doesn’t materialize in 2024, the S&P 500 index would very likely climb to a new all-time high.
12
Monthly Market Monitor - December 2023 | Kaiser Partner Privatbank AG
Chart in the Spotlight 5 to 1 | The stats make a case for higher stock prices S&P 500 index before and after the final policy rate hike 140 130 120 110 100 90 Last hike 80 70 -6
-3 1984
1989
0
Months
3
1995
2000
2006
Sources: Bloomberg, Kaiser Partner Privatbank
6 2018
9 Average
Actual
12
Theme in Focus
Private markets – the right way
Investments in private-market assets have long ceased to be the exclusive preserve of institutional investors these days. More and more private-market investment offerings are explicitly being aimed at private investors, but not all of the products on the market are private investor-friendly. Kaiser Partner Privatbank offers a comprehensive solution that combines diversification and an attractive risk/return profile with comparatively high liquidity. On the way to becoming mainstream… Investments in private-market assets – i.e. investments in non-publicly traded enterprises and startup companies (private equity and venture capital), private credit, and real assets (infrastructure and real estate) – have long ceased to be the exclusive preserve of institutional investors (pension funds, foundations, family offices, insurance companies) these days. In fact, private investors’ access to private-market investment products has improved considerably in recent years as a result of the drive to democratize private markets. Digitalization and innovative fintech companies are to thank for this trend, but it was also caused by a shift in thinking by private-market managers like Blackstone and StepStone, which, after the institutional client business had reached the limits of its growth by now, identified the private client channel as a new source of capital with market potential in the multi-billions. At the same time, though, more and more private investors are also recognizing the opportunities that private markets offer. Even though the era of ultralow interest rates is over and conventional fixed-income assets like government and corporate bonds have become a decent investment alternative again in the meantime, several points nonetheless argue in favor of blending
private-market assets into an investment portfolio even under the new interest-rate regime: • Enlarged investment universe: Access to private markets expands an investor’s investment universe many times over, particularly in the private equity space. Only 10% of all companies in the USA with annual revenue above USD 100 million are listed on a stock exchange, and only one in 20 companies in Europe with revenue of that size has an exchange listing. Meanwhile, young growth companies are staying in private hands for longer and longer, which means that the bulk of their value appreciation remains reserved to accrue to those investors who (are able to) invest in venture capital. The private credit sector is also steadily expanding because banks are increasingly pulling out of the business of extending credit financing to medium- and larger-sized companies. In the real estate sector, there are many exchange-listed alternatives to choose from, but their prices are generally very volatile and far removed from their intrinsic net asset value. The selection of vehicles for investing in infrastructure, on the other hand, is comparatively limited in public marketplaces.
A lopsided ratio | More companies (and opportunities) outside stock exchanges Companies with more than USD 100 million of annual revenue 100%
80%
60%
Access to private markets expands an investor’s investment universe many times over.
40%
20%
0 North America
Europe public
Asia
private
Sources: Hamilton Lane, Kaiser Partner Privatbank Kaiser Partner Privatbank AG | Monthly Market Monitor - December 2023
13
Companies are staying private ever longer | Venture capital pockets the returns Age of company at time of IPO 12 10 8 6
3
IPO: Return since IPO:
1997
2004
2012
2019
2020
180'000%
9´000%
500%
0%
-20%
Sources: Bloomberg, Kaiser Partner Privatbank
• Protection against inflation: Even if inflation rates are on the retreat by now, preserving purchasing power remains a prime investment motive for many investors. Infrastructure and real estate assets particularly stand out among private-market assets in this context. They provide inherent
protection against inflation because their earnings streams are normally linked to inflation indices. Meanwhile, investments in private-credit loans whose variable interest rates are tied to central-bank policy rates provide indirect protection against inflation.
Real assets outperform in times of high inflation… | …and provide protection against inflation Average quarterly returns under different inflation regimes (Q1 2008 – Q3 2022)
4%
3%
2%
1%
0 Lowest Infla on Tercile (0.6%)
Middle Infla on Tercile (1.9%)
Equities
Private Credit
Private Equity
Highest Infla on Tercile (4.4%)
Infrastructure
Real Estate
Sources: Apollo, Kaiser Partner Privatbank
• Performance: Private-market assets have consistently generated higher returns than their exchange-listed counterparts over lengthy periods in the past. The outperformance by classic private equity buyout funds, for example, has amounted to around 300 to 500 basis points per annum and is attributable in par-
14
Monthly Market Monitor - December 2023 | Kaiser Partner Privatbank AG
ticular to an illiquidity and complexity premium. The further growth of this asset class and the challenging and competitive environment in which it operates could cause this excess return to diminish in the future, but it is nonetheless likely to continue delivering a certain return pickup versus public markets.
Constant outperformance | Private-market assets regularly generate more value Historical risk/return tradeoffs (15 years) Public vs. Private Markets
Private Equity
Return
Private Credit
Global Equities
Infrastructure Real Estate
Global Bonds Hedge funds
Volatility
Sources: Hamilton Lane, Kaiser Partner Privatbank
• Enhanced risk/return profile: The performance of private-market assets is not just superior to that of stocks and bonds that trade daily, but is also steadier and less volatile due to specific valuation methods and longer valuation intervals. Although one can reasonably assume that the “true” value of private equity or private credit fluctuates at least just as much as asset values on
public securities exchanges do and that a corresponding (de-smoothed) performance is estimable, this theoretical higher volatility does not show up in one’s investment portfolio. Blending private-market assets into a mixed portfolio composed of stocks and bonds thus substantially reduces portfolio volatility while at the same time boosting the return.
Greater return… | …with less risk Historical risk/return tradeoffs for mixed portfolios 12.0%
Equities
45% Private Markets
11.5%
Fixed Income
11.0%
Private Equity
Return
10.5%
Private Credit
10.0%
Infrastructure 30% Private Markets
9.5%
Real Estate
9.0% 8.5%
0% Private Markets
8.0% 8.0%
9.0%
10.0%
11.0% Volatility
12.0%
13.0%
14.0%
Sources: KKR, Kaiser Partner Privatbank
• Greater investment discipline: The real drawback of private-market assets – their illiquidity – actually tends to be more of an advantage from a behavioral science perspective. Since they cannot be offloaded on securities exchanges at the press of a button, this precludes panic selling during periods of market stress. The combination of illiquidity
and attenuated volatility makes private-market assets an anchor of stability in a portfolio that helps to avert investor errors that typically arise during market crises – mistakes such as elevated risk aversion, suddenly wanting liquidity, shortening one’s investment horizon, and extrapolating recent trends into the future.
Kaiser Partner Privatbank AG | Monthly Market Monitor - December 2023
15
The journey matters | Private-market assets provide stability and enhance investment discipline Wealth level and investor behavior
Wealth
with Private Markets exposure
without Private Markets exposure minimum acceptable wealth level Fear and possible failure to remain invested
Time Sources: Pictet, Kaiser Partner Privatbank
…but not without potential pitfalls The numerous benefits of private-market assets are readily evident, but whoever wishes to profit from them must also be aware of private-market assets’ idiosyncrasies (or hidden hazards…?), which include, for example, J-curve and blind pool risk. The J-curve describes the tendency for (net) returns on private-market investments (most notably in private equity and venture capital) to usually be low or negative in the first years because management fees have to be paid on the entire committed capital upfront while only part of this capital is actually invested right at the beginning. Blind pool risk, meanwhile, means that at the outset of his or her investment, an investor doesn’t know yet in which companies or transactions the private-market manager will ultimately invest the money. Another idiosyncrasy is the high variance of investment returns between managers. Compared to public equity and bond markets, where there is a perfor-
mance differential of 100 to 250 basis points between the best and worst 25% of managers, the dispersion of returns between top- and worst-performing private-market managers is much wider and even exceeds 15 percentage points in some cases. It therefore is imperative to perform thorough due diligence before selecting which private-market managers to invest in, and that requires professional expertise. In the end, however, perhaps the biggest drawback of an investment in a conventional private-market fund from the perspective of a private investor is the liquidity of the investment or, better said, its illiquidity. In the case of a typical private equity fund, for example, 12 to 14 years elapse between the time of the capital commitment and the time of the full capital repayment. Whoever wants to get the capital back sooner can often sell his or her shares these day on the secondary market, but usually only at a sizable price discount.
The good ones go into the pot | Astute selection is essential in private markets (Median) internal rates of return for private-market funds with vintages from 2009 to 2019 30% 25% 20%
18.4%
15% 11.4%
10%
5.6%
10.3%
5% 0 Private Equity
Private Credit
Infrastructure
Top 25%
Bottom 25%
Median
Sources: McKinsey, Burgiss, Kaiser Partner Privatbank
16
Monthly Market Monitor - December 2023 | Kaiser Partner Privatbank AG
Real Estate
Apples and oranges Common performance metrics in private markets can also prove to be tricky. The internal rate of return (IRR) metric in particular is a prominent target of criticism. Private equity managers frequently report astoundingly high IRRs of 15% to 30% for their funds. However, this metric always refers to the individual payment streams from a fund’s investments and various transactions and not to the total investment amount committed to by the investor. This means that an IRR of 20% that refers to just one-fifth of the committed capital equates to a much less spectacular 4% return on the total investment. Another problem with the IRR is the implicit assumption that a fund’s money that gets freed up over time can consistently be reinvested with the same high return. Moreover, the numerous adjustment screws that influence
a fund’s IRR allow the manager to easily tweak the fund’s performance. The IRR cannot be simply compared with the time-weighted rate of return applied to conventional investments. One alternative metric is the multiple of invested capital (MOIC). It measures by what factor the initial investment amount has increased and at the same time exposes the shortcomings of the IRR. In order to reach an MOIC of 2, or to double one’s capital, over a period of 10 years in the case of a conventional investment in which all of the capital is invested upfront, a 7% rate of return is necessary. In contrast, an investment in a typical private equity fund that makes capital calls gradually requires an IRR of around 15% to arrive at the same terminal value (assuming that any uninvested capital is parked in the money market earning interest and is not invested in higher-yielding assets).
Unuseful comparison | IRRs are not reflected in full size in a portfolio Return required to double an investment within 10 years (schematic diagram) Private Equity Fonds (closed-end)
"Evergreen" Fonds Money multiple: 2.0x Annualised return: 7% Net IRR: 15%
Full capital at work from day one Capital deployed over a 4-5 year investment period 1
2
3
4
5 6 Investment year
7
8
9
10
1
2
3
4
5 6 Investment year
7
8
9
10
Source: Kaiser Partner Privatbank
Broad menu selection: Ranging from “not ideal”… Being aware of the challenges of private markets is an important first step. Then an investor has to find a suitable means of implementing exposure to private markets. Investment minimums are no longer a major obstacle because nowadays access to private markets can be had for relatively small investment amounts. However, the ever widening spectrum of private-market offerings to choose from features better as well as less suitable options. We place investments in individual private-market funds or in portfolios of them that call and redeem investor capital at intervals in the latter category. These structures known as closed-end funds have been an established fixture in the institutional segment for decades, but implementing exposure to them is too complex and hardly manageable for private investors, at least if they wish to truly reap the benefits of this asset category with their private-market exposure. Investors have to contend with the following challenges:
• Diversification: A successful private-market portfolio requires maximum diversification across vintages, regions, sectors, company sizes, and types of investments (primary, secondary, co-investment), as well as across the four private-market categories: private equity, private credit, infrastructure, and real estate. To attain that diversification, ongoing periodic capital commitments have to made to different funds in each sub-asset class. Despite low investment minimums for individual funds, the aspiration for wide diversification can require very high total investment amounts and can overwhelm an individual investor’s administrative and financial capacity.
Kaiser Partner Privatbank AG | Monthly Market Monitor - December 2023
17
Administrative burden | A private markets investment program requires institutional expertise Rolling private markets investment program (schematic)
Source: Kaiser Partner Privatbank
• Reaching and maintaining the target allocation: Whoever would like to add a private-market component to his or her mixed investment portfolio needs to have a lot of staying power. Since capital call drawdowns occur over several years, it takes a long time to reach the desired target allocation for the priva-
te-market assets part of the portfolio. Once the exposure aimed for has been built up, an investor continues to face challenges because keeping this allocation in a predefined range is hard to do as a result of uncertainty about the timing of capital calls and distributions and thus necessitates corresponding expertise.
Arduous construction process | Long road to the target allocation Admixture of conventional private-market funds (with capital calls) into a mixed portfolio 100%
80%
60%
40% Target allocation: 30% Private Markets 20%
0 Years 0
1 Equities
2 Fixed Income
3 Private Equity
4 Private Credit
6
5
Infrastructure
7
8
Real Estate
Source: Kaiser Partner Privatbank
• Cash management: With an investment in an individual private-market fund as well as after having set up a comprehensive and diversified rolling investment program, in both cases there is always a certain part of the capital that is not invested in private-market assets at any given time. That cash component has to be managed actively in order to
18
Monthly Market Monitor - December 2023 | Kaiser Partner Privatbank AG
keep opportunity costs as low as possible. Reinvestment risk, on the other hand, cannot be averted, not even with good cash management. Depending on the new investment opportunities available and the market phase at the time, there’s a possibility that returned capital cannot be reinvested at an equally high rate of return as before.
Opportunity costs… | …and reinvestment risk Investment profile of a conventional private-market fund (with capital calls) 100% 80% Undrawn committed capital
Reinvestment risk
60%
40% Invested capital in private assets 20%
0% 0
1
2
4
3
5
6
7
8
9
10
Years
Source: Kaiser Partner Privatbank
…to investor-friendly and customized Even though it may seem alluring to get in on the game at eye level with institutional players by investing in individual private-market funds operated by prominent names like Blackstone, KKR, Carlyle, and the like, given the difficulties described above, there actually are better ways for private investors to invest in private markets. One way in particular is via evergreen funds, which have increasingly established themselves in the market in recent years. Evergreen funds allow investors to make an instant, widely diversified investment in private markets in a single ticket and provide partial liquidity usually on a quarterly basis. Since the investment made is in a portfolio that already exists, this not only reduces blind pool risk, but also nullifies the J-curve, making the desired target returns realistically achievable right from
the start. Evergreens make private markets semi-liquid and enable access to them without forcing investors to take on a multiyear commitment. However, investors should be aware that evergreens nevertheless are not daily tradable ETFs and should bear in mind that they pursue an investment horizon of at least three to five years, as is appropriate for this asset class. Kaiser Partner Privatbank has developed a comprehensive solution based on semi-liquid private-market funds that offers investors access to a private-market portfolio diversified across all asset categories. The Kaiser Partner Private Markets Solution aims for a long-term return of 10% to 12% per annum and lends itself as a supplement to an existing mixed portfolio or also as a separate satellite investment.
A solution to traditional fund problems Traditional Private Equity Funds vs. KPPMS
Custom-made and investor-friendly | Kaiser Partner Private Markets Solution in a nutshell Comparison of conventional private-market funds versus Kaiser Partner Private Markets Solution
Conventional Private Market Funds
Kaiser Partner Private Markets Solution
Often greater than $5M minimum commitment
Available starting from $500k ($250k*)
Multi-year investment period, negative/low returns in early years (“J-curve”) Involves processing capital calls and distributions with uncertain timing New fund subscription every 3-5 years, 10-14 year lock-up period with possible extensions Lengthy subscription documents prone to mistakes/delays and potential complex tax reporting
Instantly fully deployed, no “J-curve”
Minimum investment Capital deployment Cash flow planning Liquidity Administration Reporting Diversification Asset allocation
All capital funded up front, no capital calls Monthly subscriptions, 3-6 months redemption period** Simplified subscription process and easy tax reporting (similar to liquid funds)
Quarterly NAV with delays up to 6 months
Monthly NAV
Single lead manager – multiple manager selection requiring resources or fund of funds Mostly static, difficult to achieve and maintain target allocation
Diversified exposure to different private markets asset classes, sponsors, sub-strategies, regions, sectors, vintage years Dynamic based on market conditions, target allocation immediately achieved and adjustable
* simplified implementation possible ** majority redeemable within 6 months, full redemption may take 12 to 15
Source: Kaiser Partner Privatbank
*
simplified implementation possible
** majority redeemable within 6 months, full redemption may take 12 to 18 months
Kaiser Partner Privatbank AG | Monthly Market Monitor - December 2023
19
Ask the experts
What stirred our clients (and moved the financial markets) in November 2023
We are always available to our customers for concerns and questions about their portfolios. As a representative of this, once a quarter we summarize the most frequently asked customer questions and the answers provided by our experts, thus giving you direct insights into our asset management and investment advisory services. Economic activity: The Sahm Rule is frequently getting talked about these days in the context of the US employment market. What is the Sahm Rule all about? A big part of an economist’s job profile is to predict the next recession.
Kaiser Partner Privatbank: A big part of an economist’s job profile is to predict the next recession. A whole slew of indicators and rules that have proven helpful in foretelling recessions have amassed over the course of decades. The resulting anthology of indicators and rules includes, for example, the oft-cited US yield curve, which gives reason to expect a recession when it inverts so that short-term market interest rates exceed long-term rates. Every recession over the last 50 years has been preceded by an inversion of the yield curve, albeit with considerable time variances ranging from a few months to up to two years. The Sahm Rule, named after former US Federal Reserve economist Claudia Sahm, bases itself on the US unemployment rate and has been an equally reliable recession indicator in the past. The Sahm Rule says that when the 3-month average unemployment rate rises a half percentage point or more above the low of the prior 12 months, a recession is about to start (or usually has already begun). The logic behind
the Sahm Rule is an easily understandable self-reinforcing process: when unemployment increases (slightly), aggregate consumer spending decreases and businesses lose customers and thus need fewer workers. This causes more unemployment, and so on. The vicious cycle continues, the unemployment rate climbs ever higher, and a recession inevitably follows. Even in mild recessions like in 2001, this feedback loop caused unemployment in the USA to increase by at least two percentage points. After the rise in the US unemployment rate to 3.9% in October, the 3-month average currently stands at 3.83%, 0.33 percentage points above the 12-month low. So, right now it’s unlikely that the US economy is already in a recession. But it would no longer take much to tip it into a recession. If unemployment climbs to 4% or higher in the months ahead, that in all likelihood would trigger the Sahm Rule – it’s purely a matter of mathematics. But will a recession then really materialize? This is not certain. Perhaps the Sahm Rule will even prove useless in the current post-pandemic economic cycle. It wouldn’t be the first time something like this happened. The US economy, for instance, con-
Upward henceforth? | The Sahm Rule will likely be triggered soon US unemployment rate 4.2%
4%
3.8%
3.6%
3.4%
3.2% 01/2022
07/2022 Unemployment rate
Sources: Bloomberg, Kaiser Partner Privatbank 20
Monthly Market Monitor - December 2023 | Kaiser Partner Privatbank AG
01/2023 3-month moving average
07/2023
tracted for two consecutive quarters last year without the National Bureau of Economic Research (NBER) officially declaring a recession – that, too, was a novelty. The contraction was sparked by a sharp plunge in net exports and by big fluctuations in inventories, which were both caused by global supply chain disruptions. Recession indicators like the Sahm Rule are nothing more and nothing less than empirical regularities and are not laws of nature. The pandemic caused distortions and displacements that persist to this day. After more than two years of labor shortages, workers are coming back into the labor force faster than new jobs are being created at the moment. The labor force
Learn more on our blog:
participation rate for women in their prime working age has reached an all-time high, and workers with disabilities and Afro-American men have also notched historic employment gains this year. Moreover, after an interruption during the pandemic, immigrants on work visas have resumed flowing into America now. An increasing supply of labor is perhaps necessary in the current cycle to restore an equilibrium in the labor market even if it translates into somewhat higher unemployment rates at first. On the road back to normalcy, unemployment could climb above 4% for a while this time, triggering the Sahm Rule, but not a recession. Next year it will probably become evident whether this indicator, too, is losing credibility.
Recession indicators like the Sahm Rule are nothing more and nothing less than empirical regularities and are not laws of nature.
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Kaiser Partner Privatbank AG | Monthly Market Monitor - December 2023
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The Back Page Asset classes
Performance as of 30 November 2023 Asset class
YTD
1 Month
1 Year
3 Years
Cash CHF
1.4%
EUR
3.3%
USD
5.0%
Fixed Income
1.9%
Corporate bonds
5.1%
Microfinance
4.1%
Inflation-linked bonds
0.8%
High-yield bonds
8.7%
Emerging-market bonds
5.5%
Insurance-linked bonds
18.6%
Convertible bonds Equities
6.8%
Global
18.2% 2.9%
Europe
15.1%
UK
3.7%
USA
20.8%
Emerging markets
3.2%
Alternative assets
11.6%
Real estate Switzerland
-0.2%
Hedge funds
1.1%
Currencies
Monthly Market Monitor - December 2023 | Kaiser Partner Privatbank AG
5.4%
7.6%
2.9%
-0.1%
-13.1%
5.6%
5.5%
-13.9%
0.5%
4.3%
9.7%
3.0%
-1.8%
-11.0%
4.6%
7.6%
3.1%
6.0%
5.8%
-14.0%
1.1%
20.9%
22.4%
5.4%
5.5%
-4.9%
8.3%
12.2%
27.5%
4.4%
-0.8%
7.5%
7.9%
10.9%
25.5%
2.3%
2.3%
36.9%
9.4%
13.7%
27.5%
7.9%
1.5%
-18.1%
-2.7%
-12.3%
36.9%
2.6%
15.1%
14.6%
4.3%
1.2%
-3.7%
-1.3%
2.7%
13.6%
0
EUR/USD
22
3.1%
0.5%
0 -9.7%
Gold
GBP/USD
0.5%
3.5%
0
Switzerland
EUR/CHF
1.5%
0
Sovereign bonds
Commodities
0.1% 0.3%
1.7% -3.7% 4.5%
3.0%
4.6%
-8.7%
-1.0%
-3.2%
-12.1%
3.9%
4.7%
-5.2%
On our Agenda • December 11: International Mountain Day Mountainous regions are home to 15% of the world’s population and host around half of the world’s biodiversity hotspots. Melting glaciers, crumbling mountaintops, dwindling freshwater resources – climate change doesn’t stop at the gates of mountain habitat. Under the theme “restoring mountain ecosystems,” this year’s International Mountain Day again aims to remind the world of the dangers of climate change. • December 13 and 14: Fed, ECB, and SNB monetary policy meetings The final central-bank policy meetings this year look set to unfold rather unspectacularly. The rate-hiking cycle has reached its end, raising the question of when interest rates will start to fall again. Will it be higher for longer, a quick pivot, or a monetary policy mistake? Monetary policy looks destined to stay suspenseful in 2024 and is bound to provide lots of fodder for conversation. • December 31: New Year’s Eve The year 2024 will have 366 days and looks set to deliver at least an enthralling US election. You can read about what else can be expected in addition to that in business and financial markets in the January issue of Monthly Market Monitor. In the meantime, the board of management, the editorial team and all employees of Kaiser Partner Privatbank wish you joyous holidays, a relaxing time between Christmas and the new year, and a happy start to 2024!
Kaiser Partner Privatbank AG | Monthly Market Monitor - December 2023
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Monthly Market Monitor - December 2023 | Kaiser Partner Privatbank AG
The Executive Board Left to right: Franz Schädler (Head Institutionals), Roman Pfranger (Head Private Banking), Christian Reich (CEO), Reto Geiser (CFO), Hermann Neusüss (Deputy CEO, Head Business for Professionals)
Season's Greetings Wishing you health and happiness this Holiday Season and prosperity in the New Year 2024. Your Kaiser Partner Privatbank Team
Kaiser Partner Privatbank AG | Monthly Market Monitor - December 2023
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This document constitutes neither a financial analysis nor an advertisement. It is intended solely for informational purposes. None of the information contained herein constitutes a solicitation or recommendation by Kaiser Partner Privatbank AG to purchase or sell a financial instrument or to take any other actions regarding any financial instruments. Furthermore, the information contained herein does not constitute investment advice. Any references in this document to past performance are no guarantee of a positive future performance. Kaiser Partner Privatbank AG assumes no liability for the completeness, correctness or currentness of the information contained herein or for any losses or damages arising from any actions taken on the basis of the information in this document. All contents of this document are protected by intellectual property law, particularly by copyright law. The reprinting or reproduction of all or any parts of this document in any way or form for public or commercial purposes is expressly prohibited unless prior written consent has been explicitly granted by Kaiser Partner Privatbank AG. 26
Monthly Market Monitor - December 2023 | Kaiser Partner Privatbank AG
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