Practical Applications of What Portfolio in Europe Makes Sense?

Abstract

In What Portfolio in Europe Makes Sense? from the July 2021 special issue on non-US financial markets of The Journal of Portfolio Management, author Gueorgui Konstantinov (of LBBW Asset and Wealth Management) analyzes European stock and bond performance. Investors have generally preferred European bonds, which have outperformed European stocks. However, eurozone economic development and demand for low-risk investments has recently driven bond yields down into negative territory. This, combined with poor long-term European stock performance, casts doubt on whether a balanced European portfolio with a large allocation to bonds can provide attractive returns.

The author analyzes long- and short-term European stock and bond returns and calculates the past performance of a model set of balanced portfolios. He finds that the popular European 40/60 stock/bond balanced portfolio is unlikely to provide desirable future returns because European bonds, not stocks, are now the riskier investment. This is due to the bonds’ negative yields and high volatility, plus rising inflation. However, European emerging-market bonds have the best risk–return profile, and European stock returns are improving. The author says balanced-fund managers may wish to add emerging-market bonds and derivatives to portfolios, while investors may wish to switch to a 60/40 stock/bond allocation.