Kaiser Partner Privatbank AG - Monthly Market Monitor May 2023 EN

In a Nutshell

Our view on the markets

Interest-rate zenith in the USA

The US Federal Reserve tightened the interest-rate screw again at the start of May for perhaps the last time. Europe, too, is slowly approaching the end of the rate-hiking cycle. Afterwards, central banks will be operating on the motto “higher for longer,” potentially ignoring the mounting signs of a looming economic downturn. The chances of a soft landing are fading fast.

Earnings recession – so what?

An earnings recession is a forgone conclusion by now, but a full-blown economic recession isn’t (yet). In the face of this state of limbo, many asset prices on the financial markets are drifting sideways amid low volatility. Diversification remains the name of the game. The low volatility currently provides a cheap opportunity to hedge beyond that for anyone who would like to do so.

IMF World Economic Outlook: The glass is half-empty

The latest World Economic Outlook from the International Monetary Fund (IMF) sketches out a rocky economic recovery with risks predominantly on the downside. The risks include an increasing fragmentation of the world economy into geopolitical blocs. The trend toward greater friendshoring and nearshoring has become a reality by now and is likely to take a toll on eco-

Chart of the Month

The calm before the storm… | …or is everything different this time? VIX volatility index and New York Fed recession indicator

nomic growth. Even the IMF does not have a simple solution to the problem.

Private credit: An all-weather asset class

The market for private credit is growing rapidly and is attractive for investors even in tough economic times. Although conventional interest-bearing instruments by now have resumed delivering higher yields, private credit is alluring investors not just with an additional yield premium, but also with robust defensive attributes at the same time. But whoever would like to profit from the benefits of this asset class has to be willing to sacrifice liquidity in return.

Will ChatGPT soon replace my private banker?

The subject of artificial intelligence has picked up a lot more momentum ever since ChatGPT was made available to the general public. The famous chatbot and its numerous kin really do look set to take some work off our hands in our jobs in the near future. But are they also suitable to act as investment advisors? Our virtual mystery shopping tour revealed that chatbots still lack the necessary financial education. Moreover, even more powerful generative language model versions in the future will not be capable of replacing intimate conversations between clients and advisors.

Investors who have been complaining these days about cognitive dissonance can put their minds at ease –there’s at least a reason for their queasy gut feeling: the macroeconomic climate appears to be continually deteriorating, and a variety of indicators are signaling an impending arrival of the dreaded recession. Volatility on the US equity market nonetheless calmed down in April to its lowest level since the start of 2022 and reflects a certain degree of investor complacency. However, this seeming contradiction will likely get resolved during the further course of this year. Either a recession won’t materialize (and the recession indicators are wrong this time), or things will soon get uncomfortable again on the markets. Low option premiums enable investors to hedge on the cheap right now against the latter possibility. A third possibility – a recession without the equity market dropping to a new low – would be a first in the last 70 years of stock-market history.

An earnings recession is a forgone conclusion by now, but a full-blown economic recession isn’t (yet).

Macro Radar

Taking the pulse of economic activity

The global rate-hiking cycle is slowly coming to an end. Afterwards, central banks will be operating on the motto “higher for longer,” potentially ignoring the mounting signs of a looming economic downturn. The chances of a soft landing are fading fast.

Interest-rate summit in the USA

The US Federal Reserve tightened the interest-rate screw again at the start of May. However, the hike to the new federal funds target rate range of 5% to 5.25% was garnished at the press conference with rather cautious comments by Fed Chairman Jerome Powell about the future economic outlook. This means that the policy-rate level in the USA may already have reached its summit. On the fixed-income market, there is already speculation that the Fed will have to revert to cutting interest rates from summer onward. This fits with the economic-activity picture being painted by analysts, whose consensus estimates for the second half of this year are now projecting a mild recession. The Fed itself is a bit more optimistic about growth (no recession) and the interest-rate level (steady until year-end). This glaring divergence will inevitably resolve itself in the months ahead.

The ECB is behind the curve once more

In Europe, meanwhile, policy rates have not yet reached the top of the flagpole. The European Central Bank upped the ante again at the start of May with a smaller 25-basis-point rate hike (compared to 50bp in March), but a signal that even more is in the pipeline. With the core inflation rate close to record-high

levels (5.6% in April), inflation pressure is indeed much stronger at the moment in the Eurozone than it is in the USA. Nevertheless, the bold actions by the Europeans could turn out in hindsight to be yet another blunder of tightening into an economic downturn. In any case, the one-off cyclical effects that have bolstered growth in recent months are soon likely to come to an end. On the other hand, the adverse effects of rampant inflation and tighter monetary policy on consumer confidence and lending dim the medium-term outlook.

China surprises on the upside

With GDP growth of +4.5%, China staged a startingly strong comeback in the first quarter after the end of the pandemic lockdown. Consumer spending and the services sector, as well as positive fiscal and monetary-policy stimulus, were the main growth drivers in the wake of the reopening of China’s economy. China’s growth target of “around 5%” actually looks set to be reached this year. Even the country’s housing market appears to have stabilized at the start of 2023. On the whole, however, we consider the upside surprise in China an “exceptional economic cycle” that only temporarily papers over the trend toward a permanently lower growth level.

Kaiser Partner Privatbank interest rates view

In the sweet spot between those two poles, the IMF sketched out a rocky economic recovery in which risks on the downside continue to predominate.

Satellite View

IMF World Economic Outlook: The glass is half-empty

The latest World Economic Outlook from the International Monetary Fund (IMF) sketches out a rocky economic recovery with risks predominantly on the downside. The risks include an increasing fragmentation of the world economy into geopolitical blocs. The trend toward greater friendshoring and nearshoring has become a reality by now and is likely to take a toll on economic growth. Even the IMF does not have a simple solution to the problem.

The IMF wags an admonishing forefinger

At this year’s spring meeting, the IMF stayed true to its traditional role as an alarmer and an admonisher. In its latest World Economic Outlook report, the IMF did not want to overly point to signs of a mildly improved macroeconomic climate, but nor did it wish to forecast the next financial crisis. In the sweet spot between those two poles, the IMF sketched out a rocky economic recovery in which risks on the downside continue to

Global growth: Not what it used to be

One sobering revelation in the latest World Economic Outlook report was the finding that the global economy will not return to pre-pandemic growth rates. With a projected world GDP growth rate of just +3% for 2028, the IMF’s long-term growth forecast this time around is lower than ever before (note: the IMF has been issuing half-yearly growth forecasts since 1990). After peaking at +4.9% in 2008, global poten-

Past

its

peak | Potential growth has been revised downward

for years Historical evolution of IMF’s 5-year world growth forecasts

Sources: International Monetary Fund, Kaiser Partner Privatbank

predominate. The IMF’s admonishing forefinger urged central banks to pursue steady but at the same time flexible and clearly communicated monetary policies that don’t repeat past mistakes (i.e. easing too soon by lowering interest rates). Meanwhile, in the face of rising budget deficits and mounting debt, the IMF’s message to governments was to rely less on economic stimulus in the future and to keep an eye on debt sustainability. Finally, the report again contained a call to halt global warming and to speed up the green transition.

tial growth has been continually revised downward ever since. The causes identified by the IMF for this seemingly irreversible trend make sense. Emerging economies like China and South Korea have raised their standard of living and, at the new level, can no longer continue growing at the high rates of the past. At the same time, growth of the working-age population is slowing or is even already contracting in many industrialized nations and some emerging economies. The dimmed outlook – particularly for former main-

stays of growth like China – brings forth many challenges. One of them is that poorer developing and emerging economies will now have an even harder time climbing the prosperity ladder in the future.

There’s no denying deglobalization (any longer)

The analysts at the IMF view the increasing geoeconomic fragmentation of the world as another reason for the particularly feeble growth outlook this time. The IMF devoted an entire chapter to this issue in its April report and accordingly delivered a lot of facts about it. Globalization, according to the IMF, reached its zenith in 2008 and has been on the retreat for more than a decade now. The continual increase in

the number of non-tariff trade barriers reflects this. A further intensification of the deglobalization trend has been observable since 2018 as a result of the stepped-up trade war between the USA and China. Furthermore, the analysts at the IMF have detected a shift in global foreign direct investment flows over the last five years or so. Asia (and especially China) have registered a decrease in foreign direct investment since then, particularly in strategically vital sectors. The splitting of global capital flows into geopolitically aligned blocs could shave up to two percentage points off global economic growth, according to simulations run by the IMF. The growth losses, though, would be unequally distributed: whereas economic output in

The dimmed outlook –particularly for former mainstays of growth like China – brings forth many challenges.

the USA would be reduced by only 1%, the “price” for countries particularly dependent on foreign direct investment and trade would amount to up to 6%. Developing and emerging economies would once again be the ones hardest hit.

No simple solution at hand

However, even the IMF does not have a (simple) solution to the problem to offer. It urges the world to come up with a concerted, coordinated answer and views strengthening the multilateral trade system as a lever to that end. This includes improving World Trade Organization (WTO) rules in critical areas such as agricultural and industrial subsidies and fully restoring the WTO dispute settlement system. Too good to be true?

In our view at least, it is very unlikely that the increasingly hostile blocs facing off against each other under

the antagonistic leadership of the USA and China will pursue rapprochement anytime soon. Meanwhile, the IMF also has taken a critical stance on the phenomenon of friendshoring. Although relocating production to nearby countries and “friendly” ones that share similar values (or repatriating production) reduces political risk and potentially preserves a technological advantage, in many cases it could reduce diversification of sources of materials and natural resources and thus increase vulnerability to economic shocks. Moreover, this “hedging” would lead to efficiency losses and ultimately to higher prices. Nevertheless, this trend, too, no longer seems reversible anytime soon. In fact, according to a study published by Capgemini at the end of 2022, more than half of all globally operating companies already reorganized their production over the last two years and three-quarters of them plan further relocations.

Deglobalization in charts (3) | “Reshoring” is the word of the hour Number of mentions of reshoring, friendshoring, or nearshoring in corporate earnings reports

Sources: International Monetary Fund, Kaiser Partner Privatbank

This includes improving World Trade Organization (WTO) rules in critical areas such as agricultural and industrial subsidies.

US-China trade war Ukraine war

Asset Allocation

Notes from the Investment Committee

An earnings recession is a forgone conclusion by now, but a full-blown economic recession isn’t (yet). In the face of this state of limbo, many asset prices on the financial markets are drifting sideways amid low volatility. Diversification remains the name of the game. The low volatility currently provides a cheap opportunity to hedge beyond that for anyone who would like to do so.

Asset Allocation Monitor

Cash Equities

Fixed Income

Sovereign bonds

Corporate bonds

Microfinance

Inflation-linked bonds

High-yield bonds

Emerging-market bonds

Insurance-linked bonds

Convertible bonds

Duration

Currencies

US dollar

Swiss franc

Euro

British pound

Equities: Earnings recession – so what?

• Most stock indices treaded in place over the past month amid very low volatility (exceptions like Switzerland’s SMI (+4%) confirmed the rule). The yearto-date picture, though, presents a differentiated tableau. European blue chips (Euro Stoxx 50) are up by around 15% since the start of this year and have recently taken aim at the November 2021 all-time high. The USA’s S&P 500 index has risen only half as much year-to-date. Moreover, its 7% gain on the year as of April 30 owes exclusively to more or less the three dozen largest stocks in the index – market breadth in the USA has been thin in recent months. However, although Europe is in a better technical condition, in the near future it will likely have a tough time continuing to outperform. The recent positive drivers (falling energy prices, the reopening of China’s economy, rising interest rates) are priced in by now, and there is a high bar for further surprises on the upside. In fact, there is a risk that the recovery in purchasing managers’ index readings will peter out and that bond yields will fall further in the medium term – both developments would put downward pressure on cyclical and value stocks, which have a high weight in Europe.

Global

Switzerland

Europe

UK

USA

Emerging markets

Alternative Assets

Gold

Real estate

Hedge funds

Structured products

Private equity

Scorecard - +

Macro

Monetary/fiscal policy

Corporate earnings

Valuation

Trend

Investor sentiment

• The first-quarter earnings reporting season has been so-so on the whole thus far, but clear trends are becoming apparent: profit margins are coming under further pressure, and an earnings recession – i.e. two consecutive quarters of negative profit growth – is a foregone conclusion. In the USA, earnings estimates for 2023 have been lowered by between 8% for mega-caps (S&P 100) and 18% for small caps (S&P 600) ever since the broad market bottomed last October. An end to downward earnings estimate revisions is not in sight yet. What does this mean for the outlook? In the long term, corporate earnings are the biggest driver of stock prices, but in the short term, the correlation between the two is less rigid. A total of 16 earnings recessions

Trotz technisch besserer Verfassung dürfte es Europa indes schwer fallen demnächst weiter outzuperformen.

have occurred since 1948, and on average, the US equity market has posted double-digit percent gains in the 12 months following a period of two straight quarters of negative profit growth. An earnings recession also doesn’t necessarily imply an economic recession. It would take an economic recession to significantly dim the prospects for the equity market for the months ahead. For the time being, we recommend a balanced equity allocation and advise refraining from making sizable bets on equity regions or stock investment styles.

Fixed income: Different positionings

• Prices on the fixed-income markets also fluctuated in somewhat calmer channels in April. The yield on 10-year US Treasury notes oscillated between 3.3% and 3.6%. This rangebound trend reflects the two market forces that are dominating at the moment. One of them is the mounting signs of a looming recession, which would cause bond yields to move considerably lower. The other force is the not yet entirely completed rate-hiking cycle and market participants’ potentially somewhat unreasonably high hopes of a pivot to rate cutting real soon, which would tend to make a case for constrained immediate downside potential for bond yields. A look at investors’ positioning likewise presents an unclear picture. Bank of America’s monthly survey of fund managers revealed that they are now significantly overweight in bonds again for the first time since the Great Financial Crisis. Speculators on futures markets, however, are positioned very short and are betting on falling bond prices and rising yields. We, meanwhile, place our ourselves in the fund manager camp. In our estimation, the 10-year yield – at least in the USA – already peaked last year at a level above 4%. We think that government bonds should be overweighted and are an effective buffer for a mixed portfolio in a recession scenario.

Alternative assets: Trend followers lack a trend to follow

• The price of gold in April failed for now in its third attempt to crack its all-time high of around USD 2,050 per ounce. However, a consolidation was to be expected in the wake of gold’s robust rally over the last half-year. A breakout through the technical resistance facing the yellow metal would generate a massive long-term buy signal. The best recipe for a breach of the resistance calls for an even weaker US dollar and lower interest rates, both of which have a particularly high probability of being brought about in the event of a recession. This makes gold, alongside government bonds, a second suitable insurance policy against a potential economic downturn.

• In 2022, trend-following strategies (CTAs) were the right insurance for portfolios and ranked among the few asset categories that generated positive returns. However, they have run out of steam ever since the equity market bottomed and bond yields synchronously peaked in autumn of last year. Rangebound

movements have dominated on most markets since then and have produced many false signals, which have already added up to a return of –5% year-todate, as measured by the SG CTA Index. From top to flop – the rotation is a renewed reminder of just how important the advice to adequately diversify really is for investors.

Currencies: US dollar under debt-ceiling stress

• EUR/USD: The EUR/USD exchange rate has been fluctuating around the 1.10 mark lately with a mild upward drift. The mounting risk of a US debt-ceiling showdown, which is inferable from the rising prices for credit default swaps on US bonds, hasn’t helped the greenback much recently. Moreover, interestrate differentials are gradually shifting in favor of the euro at the moment. The European Central Bank likely has more rate hikes left in store than the US Federal Reserve does. A long as the euro’s uptrend line (currently situated at 1.07 against the USD) remains intact, the single currency is at a slight advantage.

• GBP/USD: While economic-activity and growth data in the UK have surprised more than not on the upside in recent weeks, inflation has remained stubborn. For the Bank of England, this means that interest rates perhaps won’t reach the top of the flagpole quite so quickly after all. In any event, there is bound to be another policy rate hike on May 11. Despite support from the interest-rate side and in spite of sterling’s long-term undervaluation, we only have a neutral stance on the British pound at the moment.

• EUR/CHF: Peak inflation now appears to be definitively over in Switzerland. This possibly gives the Swiss National Bank a reason to curtail its interventions aimed at strengthening the franc, but not to already declare victory over inflation and proclaim the rate-hiking cycle over. On the contrary, the SNB looks set to raise its policy rate again in June. The franc remains well supported – we do not see any drivers at the moment that could push the euro back above parity.

• Has the stock market already pulled out of the trough? This is arguably one of the most important questions for tactical investors. Be it for calibrating the equity allocation or for allocating between cyclical and defensive sectors, knowing the right answer is essential for many portfolio decisions. The USA’s blue-chip S&P 500 index hit the low point of its descent from its all-time high on October 12, 2022, which was more than a half-year ago. A look back at all of the big index drops since 1950 reveals that after such a long period without a new low, the bear market was already over 10 out of 11 times. The bear market rally lasted significantly longer, for almost 200 trading sessions, only in the aftermath of the bursting of the US technology bubble in the year 2000. Will a new record be set this year? The fact that many market participants tend to be underinvested in stocks right now argues against that happening.

A look at investors’ positioning likewise presents an unclear picture.

An earnings recession also doesn’t necessarily imply an economic recession.

Has the stock market already pulled out of the trough?

This is arguably one of the most important questions for tactical investors. Be it for calibrating the equity allocation or for allocating between cyclical and defensive sectors, knowing the right answer is essential for many portfolio decisions. The USA’s blue-chip S&P 500 index hit the low point of its descent from its all-time high on October 12, 2022, which was more than a half-year ago. A look back at all of the big index drops since 1950 reveals that after such a long period without a new low, the bear market was already over 10 out of 11 times. The bear market rally lasted significantly longer, for almost 200 trading sessions, only in the aftermath of the bursting of the US technology bubble in the year 2000. Will a new record be set this year? The fact that many market participants tend to be underinvested in stocks right now argues against that happening.

Chart in the Spotlight

Trough in the rearview mirror… | …or a record-long bear market rally? Performance of the S&P 500 index after deep (20%+) plunges

Sources: Bloomberg, Kaiser Partner Privatbank

The trend appears to be unstoppable and is bound to be fueled further by the latest banking crisis in the USA sparked by the collapse of Silicon Valley Bank.

Theme in Focus

Private credit: An all-weather asset class

The market for private credit is growing rapidly and is attractive for investors even in tough economic times. Although conventional interest-bearing instruments by now have resumed delivering higher yields, private credit is alluring investors not just with an additional yield premium, but also with robust defensive attributes at the same time. But whoever would like to profit from the benefits of this asset class has to be willing to sacrifice liquidity in return.

A growing niche

The private credit, or direct lending, market has been registering rapid growth for years now. Private credit mutual funds managed only a total of around USD 100 billion in 2007, but the size of this asset class has exploded more than tenfold since then, and not by chance. Ever since the Great Financial Crisis, tightened capital adequacy requirements and stricter regulation have prompted banks, as traditional lenders, to increasingly pull out of certain areas of the lending business, thus opening space for new competitors like specialized private credit funds, for instance. The trend appears to be unstoppable and is bound to be fueled further by the latest banking crisis in the USA sparked by the collapse of Silicon Valley Bank. Banks will further restrict their lending in the future, and non-banks will gladly step in to fill the resulting voids. The private equity industry’s increasing demand for

borrowed capital will also likely continue to bolster growth in private credit.

Attractive yield premium…

Despite the vibrant growth, private credit until recently remained a small niche in the universe of private-market assets. Lately, though, the private credit segment is beginning to interest a somewhat broader swath of the investing public. Although the phase of ultralow and negative interest rates is over now and even classic interest-bearing investment instruments have resumed assuring solid yields, private credit nonetheless continues to lure investors with an attractive yield premium versus conventional corporate bonds. In US dollar terms, this yield pickup currently amounts to 6 to 7 percentage points above investment-grade bonds and 3 to 4 percentage points above high-yield bonds. But the expected yields aren’t just higher, they are

Lender Nonbank Lender

Banks are pulling out,… | …opening space for private credit Market share in loan financing for midsized US private equity deals

Sources: McKinsey, Kaiser Partner Privatbank

also much less volatile. This is because private-market loans carry variable interest rates and their coupons usually reset based on a pre-agreed reference rate every three months, which minimizes interest-rate risk. This adjustment mechanism provides effective protection against inflation at the same time because when central banks raise policy rates in reaction to elevated inflation, yield levels on private-market loans thus rise as well automatically.

…with good downside protection

Conversely – in the event of falling interest rates – this automatism is limited, however. Loan agreements typically stipulate a floor that guarantees a minimum coupon. Private credit offers defensive attributes that go beyond this. Private-market loans are usually senior loans positioned at the top of the capital structure that are serviced ahead of other creditors’ claims. Moreover, in contrast to high-yield and investment-grade bonds, private loan agreements often contain covenants obligating the borrower to not breach certain financial-ratio levels. Compliance with covenants is usually reviewed on a quarterly basis. Covenants protect the creditor by imposing limits on the borrower, such as a maximum leverage ratio, a minimum EBITDA, or a minimum fixed-cost coverage ratio. Such covenants help to detect signs of financial stress early on and to address them before they turn into more serious problems. Last but not least, private credit borrowers are often owned by one or multiple private equity firms, which work very closely with the management of the company and frequently provide an additional capital injection in financially strained times. In the past, all of these attributes have resulted in very low loan default rates, high recovery rates, and low loss rates in private credit products. The private credit asset class has con-

sistently exhibited a robust performance in the past even in turbulent economic periods and tempestuous market phases. Even during the Great Financial Crisis of 2008–2009 and the coronavirus crash of 2020, shareprice drawdowns in the private credit fund space remained confined to single-digit-percent territory. Over the long run, private credit promises stock-like returns, but with only around a quarter of the volatility.

A particularly fine vintage year

Private credit looks particularly promising at the moment – the 2023 vintage year even looks set to become the best one in a long time. Why? Because, on the one hand, reference indices have risen sharply on the back of massive interest-rate hikes by central banks (to more than 3% in the Eurozone and almost 5% in the USA). Moreover, the adverse capital-market climate and the broad abstinence from competition on the part of banks has further improved credit conditions from the perspective of lenders and thus ultimately for investors in private credit. Private credit funds now are not only able to demand higher risk premiums and fees, but at the same time can often also demand better collateralization. Despite the increased costs, however, private credit remains interesting for borrowers. This is because private credit transactions generally transpire much more quickly than traditional bank loan agreements do, and besides giving borrowers peace of mind that a deal actually will come to pass in the end, private lenders are frequently very flexible in custom-structuring loan conditions.

Nothing is for free

Naturally, the many benefits of private credit – like so many other things on the financial markets – don’t come for free. Besides the (product) costs to take into

Sources: Bloomberg, Kaiser Partner Privatbank

Despite the increased costs, however, private credit remains interesting for borrowers.

Besides the (product) costs to take into consideration in the private credit space, which are indeed higher compared to conventional interest-bearing assets, the not-for-free caveat particularly applies to liquidity.

consideration in the private credit space, which are indeed higher compared to conventional interest-bearing assets, the not-for-free caveat particularly applies to liquidity. Typical private credit funds lock in capital for several years and invest it only gradually, which hampers the practicability for the average investor. Evergreen funds try to counter this problem. Most of them offer the possibility of monthly subscriptions and monthly (or quarterly) redemptions for fund shares, making this inherently illiquid asset class at least semiliquid this way. Investors who find even these terms too

inflexible should remember that even the purported liquidity of conventional interest-bearing securities like investment-grade corporate bonds and junk bonds can dry up in times of crisis, potentially rendering them only tradable below their fair value. Moreover, the yields stamped on the label of these traditional instruments are only guaranteed if the securities are held to maturity – along the way there they are subject to large fluctuations. Private credit, in contrast, gives investors a less spectacular yield stream from month to month, but one that, in exchange, is all the more consistent.

Base Rate / Floor Spread & Deal Fees

Sources: Blackstone, Kaiser Partner Privatbank

In any case, AI certainly doesn’t lack self-confidence, not even when it comes to crafting the right wording.

Drawdown

Will ChatGPT soon replace my private banker? (Hint: Not so quickly!)

The subject of artificial intelligence has picked up a lot more momentum ever since ChatGPT was made available to the general public. The famous chatbot and its numerous kin really do look set to take some work off our hands in our jobs in the near future. But are they also suitable to act as investment advisors? We put them to the test.

Self-confidence at a click

Artificial intelligence (AI) has made tremendous advancements in recent years. This progress became not just recognizable to the general public, but also testable in late 2022 with the rollout of the ChatGPT chatbot. Be it for summarizing books and texts, as a source of inspiration and a brainstorming aid, for artistic/creative input, or even simply for amusement, generative language models can already help us today in our work and can provide fun entertainment. In any case, AI certainly doesn’t lack self-confidence, not even when it comes to crafting the right wording. This is demonstrated impressively when the chatbot is asked how Donald Trump would explain Bitcoin – you can hardly get the voice of the former US president out of your head afterwards. But are ChatGPT (from the US-based artificial intelligence research firm OpenAI) or its numerous kin also suitable to act as investment advisors?

Our virtual mystery shopping tour revealed that chatbots still lack the necessary financial education. Moreover, even more powerful generative language model versions in the future will not be capable of replacing intimate conversations between clients and advisors.

Advisor without a pocket calculator

When we enter OpenAI’s virtual office and ask our first question regarding a suitable investment strategy, the chatbot starts out by alerting us that it is not a certified investment consultant and cannot give specific investment recommendations. But as is the case with so many other subjects, ChatGPT quickly sheds its restraint when we chat about a hypothetical example. Our query asks ChatGPT to construct for an investor with a moderate risk appetite a multi-asset portfolio composed of 15 to 20 ETFs that outperforms a simple 50/50 portfolio of stocks and bonds over the long term.

A professional appearance… | …after multiple probing follow-up queries Recommended portfolio allocation

Sources: ChatGPT (OpenAI), Kaiser Partner Privatbank

Within seconds, the advisory bot recommends selecting a mix of low-correlated asset classes. Stocks, bonds, commodities, and alternative assets are just the ticket, the bot says, and it names corresponding ETFs. In response to a follow-on query, it also recommends specific weights for each asset class and ETF. Since we, as a conservativish client, think that a 20% allocation to commodities seems a bit too high, at our request the bot corrects it and does the same to the initially somewhat too one-sided confinement to large-cap stocks. After a few more follow-up questions, we end up with a portfolio of 25 ETFs that also incorporates small and mid-caps and sector-based, factor-based, and thematic strategies as well as exposure to international markets alongside the USA in its equity component. The original portfolio also becomes broader and more diversified in its fixed-income component (through the inclusion of TIPS and high-yield bonds) and in its allocation to alternative assets (through the inclusion of infrastructure) in the course of the “client advisory conversation.” However, the electronic advisor seems a little overwhelmed by a sophisticated client like ourself – in any case, the recommended weights in the portfolio of ETFs add up to a total of 120%. We, though, actually didn’t want to work with borrowed capital.

Solid performance, but short of the benchmark

After ChatGPT recalculated the weights for us, we could now subject the portfolio to a test or, more specifically, to a backtest. However, the backtest only stretches back to 2017 due to the relatively young theme ETFs in the portfolio (the ARK Innovation ETF and the Global X Robotics and Artificial Intelligence ETF). But that’s good enough for an interim appraisal.

Over the first six years up until the world equity market’s peak in late 2022, the ChatGPT basket gained more than 60% and outperformed the 50/50 portfolio

by up to 5 percentage points. But since November of last year, the much better-diversified portfolio of ETFs has fallen behind the simple benchmark. The chatbot thus shares the anguish of so many other investors who have difficulty beating the performance of a simple mix of stocks and bonds in the long run. Two other metrics also disillusion the client: the equity beta and the volatility of the portfolio recommended by the chatbot are both higher than they are for the 50/50 portfolio. This means that the asset mix does not (yet) quite fit our risk profile.

Personalized is different…

A number of additional question marks pop up for the client in other regards as well. Is the recommended portfolio really tailored to us? The focus on US-based ETFs, for example, is somewhat annoying – ChatGPT seems to be proceeding on the assumption that we regularly trade on US securities exchanges. After we inform the electronic advisor that our domicile is in Europe, it promptly proposes a comparable palette of “European” ETFs that completely excludes America. A similar scene plays out when we express our desire for a sustainable strategy, which prompts the chatbot to quickly generate a list of ETFs bearing “ESG” in their names. But serious concerns about the quality of the advice arise at the latest when we look at the original portfolio recommendation’s costs. The annual total expense ratio is 0.85% for one of the commodity ETFs (Invesco DB Agriculture Fund) and 0.70% for the emerging-markets ETF although far cheaper alternatives exist. Moreover, the almost single-minded focus on the two fund providers State Street Global Advisors (SPDR) and iShares raises doubts about ChatGPT’s independence. The chatbot must be given credit, however, for having pointed out its lack of training as a consultant right from the start.

But serious concerns about the quality of the advice arise at the latest when we look at the original portfolio recommendation’s costs.

No better than the benchmark… | …but respectable ChatGPT portfolio vs. 50/50 portfolio Sources: ChatGPT (OpenAI), Kaiser Partner Privatbank

Refreshingly self-critical

The conversation ends with the consolation that the advisor at least is refreshingly self-critical. When asked if artificial intelligence poses an existential threat to professional asset managers, the chatbot replies:

“Artificial Intelligence (AI) has the potential to disrupt many industries, including the financial industry. However, it is unlikely that AI will present an existential threat to professional money managers. Here are a few reasons why:

• AI is a tool, not a replacement: AI is a powerful tool that can assist professional money managers in making investment decisions. However, it cannot replace the human expertise, experience, and judgment that professional money managers bring to the table. Professional money managers have a deep understanding of the markets, the economy, and the companies they invest in. They can use AI to enhance their decision-making process, but they will always be needed to interpret the data and make final investment decisions.

• AI has limitations: While AI is becoming increasingly

In summary, while AI will continue to play an important role in the financial industry, it is unlikely to present an existential threat to professional money managers. Professional money managers can use AI as a tool to enhance their decision-making process, but they will always be needed to provide the human expertise and judgment that AI cannot replace.”

We have little to add to the bot’s assessment. As things currently stand, an investment advisory meeting in cyberspace cannot replace a dialogue with a private banker in any way whatsoever. Whoever puts trust in the inadequately educated chatbot most likely will end up with an impersonal standard strategy or in the worst case will even receive a far too risky investment recommendation. Even more powerful generative language model versions in the future will not be capable of replacing intimate conversations between clients and advisors. And you also don’t get a good cup of coffee in a virtual conference room.

P.S.: Those who find the chatbot’s opinion too dry can also elicit a somewhat more humorous response from

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Asset classes

Asset classes & agenda

• May 9: Liechtenstein Finance Forum

This year, the Liechtenstein financial center’s leading finance symposium will once again bring together hundreds of high-caliber decision makers in the financial industry throughout the German-speaking world. Under the title “The Financial World of the Future”, the forum will feature an array of interesting talks and panel discussions, informative workshops, and attractive possibilities for networking.

• May 14: Presidential and parliamentary elections in Turkey

Around 64 million eligible voters will be called upon to cast their ballots. They will be going to the polls just three months after the devastating earthquake that killed around 50,000 people and left more than 2 million homeless in Turkey alone. President Erdogan, who has been in office for two decades, is squaring off against an

• May 19 to 21: G7 summit in Japan

The heads of state and government of the world’s seven leading industrialized nations will meet this year in the Japanese city of Hiroshima. Further support for Ukraine, the climate and food crisis, and the global economic growth outlook will probably rank among the top issues discussed at the summit. Future relations with China will likely also be high on the agenda.

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.

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Editorial Team: Oliver Hackel, Senior Investment Strategist

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