Editor’s note: Wealth managers are wrestling with the issue of how to protect and grow client assets at a time of negative real interest rates, and face up to the rise of emerging markets and debt woes in the West. Here are the views of David Stewart, global chief investment officer at Butterfield Bank.

A hallmark of our investment approach is to “win by not losing” - preserving and growing clients’ wealth by trying to avoid the blow-ups and sensibly diversifying, rather than seeking to shoot the lights out with nary a thought for the potential downside. Thus, we often write more about what worries us than what excites us. At the present time this is no hard task, but it is never our sole focus. To fulfill our role we also need to find opportunities to grow wealth. Ideally, these will be big, global multi-year themes which define a broad opportunity set, to allow us to maintain a prudent level of diversification.

Unsurprisingly, such themes are not common. Where they do exist, they are often the result of a fundamental economic shift caused by, for example, changing demographics, new technologies, or the emergence of new markets. This will be accompanied by a compelling narrative which explains why the opportunity is so vast (although all too often this boils down to the most expensive four words in investment: “this time is different”). In this context, the opportunity investors usually point to is the emergence of huge new economies in the developing world, often symbolized by the acronym BRIC (Brazil, Russia, India and China), but which more accurately also includes the “N-11”– the “Next 11” economies such as Indonesia, Turkey and Mexico.

However, the rise of the emerging market economies is not the only fundamental economic dislocation faced by investors. Just as important is the fact that the indebtedness of many western nations has soared over the last few years, as they responded to the credit crisis.  Furthermore, due to demographic changes in coming decades as populations age, the growth rate of their economies will slow, even as social costs rise dramatically. For many countries – including some very close to home – deteriorating credit ratings and ultimate insolvency is not so much a risk as a cast-iron guarantee if current trends persist.

Of course, for most countries it will never be allowed to get to that final stage. But in itself this indicates government bond markets can expect to see some dramatic changes in coming years. Thus, the sovereign debt of many developed nations, for a long time regarded as effectively a “risk-free” asset, is now regarded as something rather less safe. And there is a world of difference between “risk-free” and “almost risk-free”. It is quite normal at this stage of the economic cycle for investors to migrate from cyclical industries to duller blue chips, and this is already the preferred strategy of a number of commentators.

But we think there may be something more far-reaching happening. The economic dislocation of the credit crisis caused a huge relative quality shift between government and “blue chip” balance sheets. This will be compounded by the vastly different growth profiles of the two groups: the companies are positioned to benefit from the long-term emerging market growth dynamic referred to above, whilst western governments face huge growth and spending pressures due to changing demographics and the “graying” of their populations and tax bases.

Our thesis is that, in the decades to come, the biggest multinational companies will prove more secure than many of the sovereign bonds previously considered safe. With their strong balance sheets and stable, well diversified business models they will have both financial stability and strategic flexibility. This is in stark contrast to the prospects of western governments’ enormous debt-load and deteriorating demographics. In place of a static interest payment from a government which will have a vested interest in “stealth” default outcomes such as devaluation or inflation, we will be paid a good and growing stream of dividend payments. And, instead of being tied to a single, challenged economy, these multinationals will follow growth around the world.

But even if one believes both the economic dislocation and the compelling narrative, a rationale is necessary to explain why large caps have consistently underperformed small caps worldwide for a decade. There are two elements to that rationale:

- The operating environment for companies has changed dramatically. In an era when liquidity was abundant, there was no virtue in being big enough to be self-sustaining, and nimbleness ranked above stability. After all, if a company needed funding to develop an opportunity, there were plenty of willing lenders. And decent returns were looked down upon, until they could be turned into great returns by applying layers of leverage. We would suggest the business environment in coming years will be rather more rugged and size, strength and stability will be virtues rather than constraints

- Price is what you pay, value is what you get. We have reconstructed “mega cap” indices to demonstrate that, at the start of the last decade, the largest firms were valued at a significant premium to the overall market. At the start of 2000, an index composed of the largest 50 public companies in the world had a price-earnings ratio of 35 times earnings and a dividend yield of just 1.2 per cent, compared to 30x and 1.3 per cent for the world equity index. Over the succeeding 11 years, the “Mega Cap 50” has underperformed the world index by over 50 per cent and the valuation metrics have changed dramatically. The equivalent basket of stocks now stands on a PE multiple of just 13x and has a yield of 3.2 per cent; these metrics appear attractive against the global benchmark on a PE of nearly 15x and with a yield of only 2.5 per cent.

We are intrigued at the potential for an integrated approach that looks across the capital structure of these blue-chip mega caps to capture equity and credit market opportunities by identifying “sweet spots” in the risk-reward spectrum. While a portfolio of such investments would not be risk free, since stock markets can and will go down sometimes, it is equally unlikely to present sudden and permanent “haircuts” on wealth of the kind that may await many government bondholders in coming decades.

At the extreme, whilst a portfolio of this kind could lose all its value, the reasons why this might happen would be so calamitous that it is likely that a portfolio of “safe” sovereign bonds would also be wiped out. To quote Woody Brock of SED, “If we never again possess 'riskless assets' in the sense of textbook finance, a portfolio of such companies may prove the best approximation to risklessness that is available.”