Lecher is in charge of discretionary portfolio management, selecting what goes on the UBS wealth management shelf and what goes to clients.
He told FSA the biggest risk to client portfolios is disappointing economic growth. UBS, however, does not see a high risk of the synchronized global recovery coming to a halt.
“There is a concern that this is a very long cycle,” Lecher said. “But time does not determine how a cycle ends. It is determined by overheating economies or policy errors from central banks. We are in a long cycle but not necessarily at the end of the cycle.
“Inflation is not picking up, economies are not overheating and so far central banks are avoiding policy errors. Commodity prices are stable, volatility is low. The central banks’ gradual approach contributes to a good environment for risk assets. I am optimistic on 2017.”
A second risk is central banks making a policy error. “Central banks need to keep a gradual approach to tightening. We see relatively little risk to asset prices, especially in risky asset classes which yield more than fixed income, safe assets or cash. As long as that remains, we’ll keep a risk-on positon in portfolios.”
Inflation-linked bonds
Strategic portfolio allocation, which at UBS is reviewed on an annual basis, underwent some changes in the first quarter, Lecher said. The first was adding exposure to inflation-linked bonds.
“Over the medium term, having real inflation-linked bonds as part of asset allocation makes sense in an environment where inflation could overshoot or come back.”
He chose short-duration (average six years) US inflation-linked bonds, but worked with asset managers to develop a fund. “We go to asset managers and define what we want and they put up a fund dedicated to our clients that no one else has access to.”
The other strategic change was in the portfolio’s non-traditional exposure. UBS introduced a way of managing assets using risk parity.
“It is a risk-controlled approach to managing assets, with an equal contribution to risk from equities, inflation-linked bonds, credit bonds and commodities. The technique involves adjusting risk exposure as volatility moves.”
Trimming risk
Although UBS remains risk-on via equity overweights in client discretionary portfolios, there has been some trimming, Lecher said.
In terms of tactical allocation changes, typically done monthly, equity allocation has tilted from the US and moved to a broad global equity overweight.
In terms of regions, the firm is overweight Europe versus the UK and overweight China, Indonesia and Thailand, versus the Philippines and Malaysia.
In fixed income, the positions are similar and US and European high yield exposure has been reduced, he said.
UBS also includes currency trades in client portfolios. Lecher said the firm had been overweight the euro versus the US dollar since late 2016 and about three weeks ago took the position off.
“We have benefitted from the recovery of the euro versus the dollar.”
ETFs in DPM
In discretionary portfolios, strategic asset allocation is built with broadly diversified active funds and ETFs are used systematically.
“We try to do the tactical positioning with ETFs. For example, when we go overweight European equities versus the UK for six months. ETFs are used so they don’t disrupt the underlying management of the active funds.”
When choosing ETFs, low tracking error to the benchmark is important, as is physical replication (not synthetic) and product cost.
“The key criteria for choosing ETFs is to be very precise with respect to market exposure. Which indices does it give you? Liquidity is also important, given the trade in substantial sizes and you want to get in and out.”
Lecher, a former UBS fixed income fund manager, said that when he evaluates funds he asks the fund manager for details on investment philosophy and strategy.
“How does the manager explain the investment approach and the factors that contributed to performance? Did you generate the performance based on your investment approach and strategy or was luck involved?”
He is also wary of performance-based fees. “A manager may believe he has little chance to achieve the performance fees and therefore chooses to increase positions and risk beyond what he would typically do. That creates incentive for the asset manager to take on more risk he wouldn’t otherwise take. This is the danger.”
He prefers asset managers who invest their own private money in their own funds.
“It is a vote of confidence for me to see this commitment from portfolio managers,” Lecher said.
