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INVESTMENT INSIGHTS

THE PITFALLS OF CROWD INVESTING

MONTHLY ISSUE #15

April 1st, 2016

EDITORIAL VIEW Page 2

• Early turmoil in markets turned 2016 consensus forecasts upside down

• Consensus positions have asymmetrical risk/return profiles

• High-conviction bets should be sized according to consensus positioning

GLOBAL STRATEGY & MARKET REVIEW Page 3-5

• Strategy: Some signs of hope

• Stocks: A relief rally after an emotional sell-off

• FX & Rates: the USD is driving global markets

INVESTMENT THEME Page 6

• Gold investing: More than meets the eye

ASSET ALLOCATION Page 8

• Upgrade government bonds to neutral, while reducing cash

• Reduce overweight in European stocks and slightly upgrade EM regions

• Reduce our maximum overweight on alternatives

Editorial View

2Please see appendix at the end of this document for information on sources, important disclosures, and disclaimers

Consensus investing is usually good for analysts

but not for money managers. Indeed, winning

often enhances analysts’ reputation, but is not

profitable in the long run. The reason to always

take consensus positioning into account is

simple: the fact that the crowd is investing like

us may affect the final outcome, even when

markets perform as we expect. In essence,

conviction investing is a two-stage strategy:

• First, try to beat the odds with superior

analytics and insights.

• Second, manage the size of your bets against

the crowd to limit losses, remain in the game,

and capture gains.

We had two regional equity convictions late last

year: (1) European stocks for fundamental

improvements, and (2) Emerging Markets for

long-term attractiveness. With consensus

positioning clearly biased toward the former,

sizing our bets judiciously, i.e. being only slightly

overweight in Europe but heavily overweight to

EM, would have resulted in a better overall

performance than the reverse.

Beware: when the crowd fails, it could bring you down

• Early turmoil in markets turned consensus forecasts upside down

• On average, consensus positions have asymmetrical risk/return profiles

• High-conviction bets should be sized according to consensus positioning

At the end of last year, most analysts were

optimistic for stock markets in 2016. In the first

quarter, however, global markets lost 2%, even

reaching a low at –12%. Meanwhile, consensus

view was to be underweight government bonds

and gold. They actually proceeded to appreciate

by 3% and 15% respectively during that same

period. Finally, equity strategists started out the

year favoring Europe and Japan while reducing

Emerging Markets allocation. All of these calls

were proven wrong.

The first three months of 2016 offered a harsh

reminder that “forecasting is difficult, especially

about the future!” Our aim is not to blame or

mock analysts for their misguided views, since

we shared some of them ourselves. Instead, this

observation leads us to consider how best to

deal with consensus thinking.

Historical studies show that the consensus view

is right 55-60% of the time – not a bad track

record. The problem is that its gain/loss profile

is asymmetrical: when consensus is right, it wins

small, because expectations are already priced

into the markets, but when it is wrong, it often

loses big.

April 1st, 2016

Asset classConsensus

March 2015

1-year

performance

2016 YTD

performance

Consensus

March 2016

Cash Underweight 0.0% 0.0% Underweight

Gov. bonds Underweight +0.8% +2.9% Underweight

Credit Overweight -0.2% +2.5% Overweight

Equities Overweight -6.9% -2.4% Overweight

-Europe Overweight -16.0% -8.3% Overweight

-USA Neutral -1.0% 0.0% Neutral

-Japan Overweight -13.9% -12.1% Neutral

-Emerging Underweight -15.2% +2.2% Underweight

Commodities Underweight -29.1% +6.4% Underweight

Chart of the Month

Global Strategy

3Please see appendix at the end of this document for information on sources, important disclosures and disclaimers

Markets are driven by economics but also by

central banks, and the monetary backdrop

currently is supportive. Central banks have been

quite active during the month on both sides of

the Atlantic, sending a clear dovish message: "As

long as growth is at risk, we will be there". The

ECB refers to a possible deflation scare to act

beyond its mandate (focus on inflation), and the

Federal Reserve cites global uncertainties to

delay its hikes, considering that the USD

strengthening has done part of the tightening

job.

We have remained cautious for the last couple of

months, with a bias toward opportunistic buying.

However, given the improving backdrop, we now

remove this defensive stance and remain close

to neutral. Moreover, we favor some rotation as

the recent decline in the USD is a game changer

for major assets.

• Equities: more constructive on EM stocks

while reducing European exposure.

• Fixed income: (1) stay cautious on long-term

bonds, which increasingly provide negative

yields; and (2) favor corporate bonds to

benefit from improving credit prospects.

• Maintain strategic positions on gold: dovish

central banks will not raise rates significantly

this year, while inflation will accelerate.

Some signs of hope

• US consumers seem to be overriding the growth scare led by manufacturing

• Global manufacturing may be bottoming, but the jury is still out on China

• OECD monetary policies converged again in a dovish stance, supporting gold

ECONOMICS & ASSET ALLOCATION

After growing evidence of the Chinese

slowdown, the past six months have seen

investors pondering the chances of a global

recession. Naturally, the main focus has been on

the US economy. Until recently, global figures

were mixed, but now they seem to be

improving, with global real GDP likely to expand

2.3% in the first quarter.

Following half a year of deterioration,

manufacturing is stable but still weak, as shown

by the latest ISM reading of 47. The industrial

cycle will probably hit bottom soon. On the

consumer front, households are still doing all

right, with signs of a healthy housing cycle. In

general, recessions arise only months after these

cycles peak. Building permits and housing starts

remain steady at about 100K units per months,

thanks to an improving job market and low

interest rates. This is unlikely to abate for the

coming months and should even drive a

consumer durable goods cycle, including

furniture and appliances.

In Europe, recovery is underway, but remains

fragile, especially in the wake of broadening

terrorist attacks. In the coming weeks, politics

will remain center stage; the “Brexit” will

undoubtedly become a major issue for European

officials, as the Leave camp is gaining traction in

the polls. In most OECD regions, we expect to

see an upswing in inflation, which is already

visible in core inflation figures.

April 1st, 2016

2%

20%

33%

43%

2%

Verybearish(<-5%)

Bearish(-5% to -

1%)

Flat(+/- 1%)

Bullish(+1 to+5%)

Verybullish(>+5%)

Investor stock market expectations for April 2016 (S&P 500)

30

40

50

60

70

2006 2007 2009 2010 2011 2013 2014 2015

US manufacturing activity

Activity index (NAPM)

Propects index (NAPM new orders)

EQUITY MARKETS

Just as the sharp sell-off in equities earlier this

year seemed somewhat disproportionate in

relation to the modest changes in global GDP

growth expectations, the nearly complete

reversal in financial markets appears equally

excessive. With downside risk fading and global

growth apparently set to return to a more trend-

like pace, attention is now turning to inflation.

For stocks, the first part of this rally seems

justified, given previously depressed levels. But

beware excessive optimism, lest the trend turn

into symmetrical exuberance. Indeed, looking at

corporate fundamentals, the picture is far from

rosy.

US firms on the whole have reported weaker Q4

earnings. Almost half of the companies in the

S&P 500 announced a year-on-year decline, with

nearly 70% of the negative growth coming from

outside energy, materials, and industrials. S&P

500 operating earnings per share declined by

11% on aggregate, while net income was down

15.4%. Equity investors clearly had other factors

in mind when driving markets upward.

In fact, price action within and across asset

classes is currently being dictated by the US

dollar, not corporate earnings. A peak in the USD

was indeed behind the recent sharp reversal in

commodity prices but also the rallies in

emerging market equities, value relative to

growth, low relative to high quality, and high

relative to low beta constituents.

The Federal Reserve’s recent dovish stance has

had a spectacular impact on the USD, which lost

4% over the month before turning into a major

market catalyst. The Fed is deliberately slowing

the inflation pick-up.

With dovish central banks, it is likely markets will

perform well and the USD remain under

pressure. However, we believe fundamentals will

be the key differentiator between winners and

losers. Hence, the devil remains in the details.

For us, the “risk on” rally is overbought among

low-quality assets, in a context of compressed

profit margins. These assets now have limited

upside, in our view, and we stay away from risky,

short-term speculative bets. Instead, we remain

focused on higher-quality growth opportunities

(e.g. Millennials theme) and non-cyclical

industries in a world still characterized by

constrained macro growth.

In terms of regions, we believe the leadership

reversal favoring the US and EM is not over, and

might persist into Q2. We have upgraded EM

stocks from their depressed level and slightly

downgraded our positive bias on Eurozone

equities, as the strengthening of the common

currency, the uncertainty surrounding the Brexit,

and persistent geopolitical risks could weigh on

local firms. Notwithstanding better valuation and

lower exposure to such external factors, we also

moderate our positive view on Italy.

Market review

4Please see appendix at the end of this document for information on sources, important disclosures and disclaimers

A relief rally after an emotional sell-off

• The speed rebound was built on previous excess pessimism

• Stocks will soon be driven by fundamentals again

• Avoid low quality assets that have rallied too fast and too high

April 1st, 2016

Low quality stocks performance US Earnings revisions

CURRENCIES & COMMODITIES

The driver of all markets

Currency markets in March reflected the entire

marketplace, driving most assets into a “risk on”

rally. Central banks in Europe and the US

delivered two equally dovish messages, with

additional asset purchases by the ECB and

delayed rate hike by the FED. The main

consequence was a 4% decline in the USD, as

consensus was overwhelmingly bullish on the

greenback.

The main surprise came from the Federal

Reserve, as most of the ECB action had been

communicated to markets as early as February.

FOMC inaction is placing downward pressure on

real US short-term interest rates relative to the

rest of the world, a development that is helping

to cap the upside in the trade-weighted USD.

Given the Fed’s explicit dependence on data, the

story is set to become circular, in that US activity

is expected to benefit from the recent

weakening of its currency and an

accommodative monetary policy. If so, the cycle

will gain traction and the likelihood of tightening

will increase; the currency should then

appreciate and slow activity. In conclusion, the

USD should remain range-bound.

The clear winners will probably be EM

currencies, which suffered from capital outflows

driven by USD repatriations. The GBP, on the

other hand, is still at the mercy of the Brexit

outcome, which might be more disputed than

markets expected.

FIXED INCOME

Expect an unusual tightening cycle

In the midst of the “risk on” rally and receding

risk aversion, OECD government bonds pulled

back. After accommodative announcements

from central banks, however, they rallied again,

albeit at reasonable levels. Although cyclical

inflation is building up, we do not expect a

sudden increase in structural inflation any time

soon. But the current trend is still likely to

deliver negative real returns on short-term rates,

pushing investors up the curve in the absence of

tightening risk. We are therefore neutral on this

fixed income category.

Corporate credit spreads over Treasuries have

moved significantly wider during the last year,

driven by factors such as declining commodity

prices, concerns over China, the uncertainty

surrounding monetary policies and fears of a

possible US recession. From a valuation

standpoint, credit looks compelling relative to

history, but the current environment of

uncertainty requires a cautious approach and

focus on individual bond selection. We remain

neutral on investment-grade credit in the near

term and underweight on high yield. We want to

avoid the accelerating defaults and squeeze on

access to capital markets suffered by the

weakest companies. In the longer term, the

credit cycle should recover from a purging of

weaker issuers, thus compensating for any

opportunistic exposure to depressed bonds, but

it still is too early to tell.

4Please see appendix at the end of this document for information on sources, important disclosures and disclaimers

• USD uptrend is broken

• Federal Reserve will remain crucial

• EUR/USD should remain at 1.10-1.15

• EM currencies are in relief mode

Market review

• Bond markets are booming

• Government bonds have receded

• IG credit is favored over HY

April 1st, 2016

90

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120

130

2013 2014 2015 2016

Ind

ex (

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=A

pr-

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12)

USD vs. EUR

0%

1%

2%

3%

4%

1996 2000 2004 2008 2012 2016

US core inflation

Investment Focus

GOLD INVESTING: MORE THAN MEETS THE EYE

6

Given the number of discussions, articles, and

Internet forums on gold investing, it might be

assumed that the yellow metal is the most

popular asset in everyone’s portfolio. In fact, the

the opposite is true: gold is relatively absent

from balanced allocation, with the exception of

Switzerland, where the notion of safe haven is

still dear to local bankers. Even institutional

investors have often discarded the metal on the

grounds that it is a “barbarous relic” with no

economic yield.

An inalterable metal with a sheen like no other,

gold clearly excites the imagination. But it is first

and foremost a universal mean of exchange,

which has somehow managed to maintain its

value over time. Gold has been valued

everywhere throughout history and used to

meet survival needs. The Old Testament, for

instance, describes an ounce of gold as worth a

year’s supply of food, more specifically 350

loaves of bread, which is still broadly true today!

For centuries, gold has shielded individuals

against property destruction or confiscation at

times of war or revolution.

In peacetime, it is primarily viewed as a hedge

against inflation. This explains why it lost its

luster in the two decades of disinflation that

followed the 1970s. It returned to favor after

2000, increasing five-fold in a period of low-to-

moderate inflation, due primarily to the decline

in real rates that began in the US before

spreading to OECD countries.

In the absence of war, therefore, real rates are

the true driver of gold prices in advanced

economies. Gold trading behaves like any other

currency. The precious metal provides no yield,

but it appreciates with inflation over the long

run, so its value against any currency is a

function of the gain, net of inflation, from

holding cash in that currency, like any carry cost.

In the 1980s and 1990s, aggressive monetary

policies imposed positive real rates in an effort

to defeat inflation. Conversely, since the tech

bubble, monetary authorities have generally

acted to reflate economies so as to generate

growth, with a extra push after 2008. That was

very supportive for gold.

After the growth scare in summer 2011, the US

has returned to a healthy growth path. It was

then expected that monetary policies would

normalize at some point with higher rates, which

led to a 5-year bear market for gold (in USD).

Regardless of whether the US is heading into a

recession or not, gold is likely to appreciate in

the years ahead. Indeed, Janet Yellen and her

colleagues made it clear in their last two

committees that monetary policy in the US

would favor growth over inflation targeting,

even this late in the recovery (despite

unemployment at 5%!). In Europe, the ECB does

not seem to be in any hurry to normalize either.

We believe this should be a positive game

changer for the yellow metal in the wake of

accelerating core inflation, as it lowers the

opportunity cost of holding gold.

Please see appendix at the end of this document for information on sources, important disclosures and disclaimers

• Gold investing is haunted by popular beliefs, but it remains rationally priced

• In advanced economies, gold trading is about currency arbitrage

• Dovish central banks are opening a new round of gold appreciation

April 1st, 2016

400

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-1

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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Go

ld p

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SD

per o

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Real in

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(%

, in

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)

Gold prices and real interest rates

USD 5-year real rate

Gold

Performances

7Glossary - TR: Total Return (i.e. Price change plus coupon or dividend), Govt: Government, 10Y: 10 years, GER: Germany, bps: basis points (1/100th of a percent), chg.: Change

Past performance is not an indication of future results. Please see appendix at the end of this document for information on sources and disclaimers.

As of 31.3.2016 Asset Current level 1-m change (%) 3-m chg. (%) YTD chg. (%) 12-m chg. (%)

MSCI World Equity (USD) 1 648 6.5 -0.9 -0.9 -5.3

EuroStoxx50 Equity (EUR) 3 005 2.0 -8.0 -8.0 -18.7

S&P500 Equity (USD) 2 060 6.6 0.8 0.8 -0.4

Topix Equity (JPY) 1 347 3.8 -12.9 -12.9 -12.7

SPI Equity (CHF) 503 0.2 -9.6 -9.6 -11.7

MSCI EM Equity (USD) 837 13.0 5.4 5.4 -14.1

EURUSD Currency 1.1396 4.9 4.9 4.9 6.1

EURCHF Currency 1.0913 0.8 0.4 0.4 4.6

USDCHF Currency 0.9577 -3.9 -4.3 -4.3 -1.4

GBPUSD Currency 1.4373 3.1 -2.5 -2.5 -3.2

JPYUSD Currency 112.40 -0.4 -6.6 -6.6 -6.3

EURBRL Currency 4.0386 -6.6 -6.0 -6.0 17.7

As of 31.3.2016 Asset Current level 1-m chg. (bps) 3-m chg. (bps) YTD chg. (bps) 12-m chg. (bps)

10-Year GER Bond (EUR) 0.16% 5 -48 -48 0

10-Year US Bond (USD) 1.77% 1 -53 -53 -16

EU Inv. grade Bond (EUR) 1.08% -20 -33 -33 16

US Inv. Grade Bond (USD) 3.22% -34 -46 -46 30

EU High yield Bond (EUR) 4.32% -87 -32 -32 85

US High yield Bond (USD) 8.39% -85 -48 -48 178

April 1st, 2016

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2013 2014 2015 2016

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Hedge Fund Index

Commodity Index

US Treasuries (10Y)

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S&P 500

Eurostoxx 50

Swiss Index

MSCI EM

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2013 2014 2015 2016

TR

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Currency Markets vs. EUR

JPY GBP CHF

USD Gold

Copyright © 2016 by Decalia Asset Management SA. All rights reserved. This report may not be

displayed, reproduced, distributed, transmitted, or used to create derivative works in any form,

in whole or in portion, by any means, without written permission from Decalia Asset

Management SA.

This material is intended for informational purposes only and should not be construed as an

offer or solicitation for the purchase or sale of any financial instrument, or as a contractual

document. The information provided herein is not intended to constitute legal, tax, or

accounting advice and may not be suitable for all investors. The market valuations, terms, and

calculations contained herein are estimates only and are subject to change without notice. The

information provided is believed to be reliable; however Decalia Asset Management SA does

not guarantee its completeness or accuracy. Past performance is not an indication of future

results.

External sources include: New York Times Syndicate, ISAG, UBP, Goldman Sachs, Federal

Reserve Board, FRED, Bloomberg, ISM Institute, BOA/Merrill Lynch, Dynamic Funds, JP Morgan

Finished drafting on April, 1st 2016

Contacts

DECALIA Asset Management SA

1, rue Robert-Céard

Case postale 3182

CH – 1204 Genève

Tél. +41 22 989 89 89

Fax +41 22 310 44 27

info@decaliagroup.com

Asset Allocation

• We neutralize our duration exposure, upgrading government bonds,

• We lower cash to neutral and lower our strong overweight on alternatives

• European stocks are back to neutral while we upgrade EM by a notch

April 1st, 2016