April 2020

Hong Kong roundtable: A ‘fragile Goldilocks situation’

With the global economy at a crossroads, our panel of experts share their thoughts on the market conditions, geopolitical volatility and growth opportunities. Chaired by Romil Patel in Hong Kong. Hong_Kong_roundtable Junjie Watkins (chief executive – Asia ex-Japan, Pictet Asset Management)
Rakesh Vengayil (deputy chief executive – APAC, BNP Paribas Asset Management)
Eleanor Wan (chief executive, BEA Union Investment)
Bruno Lee (regional head of retail wealth distribution, wealth and asset management – Asia, Manulife Investment Management)
Thomas Poullaouec (head of multi-asset solutions – APAC, T. Rowe Price)
Frederick Chu (head of ETFs, China Asset Management, Hong Kong) This roundtable took place in Hong Kong in January 2020 in the early stages of the coronavirus outbreak and has since been updated prior to publication. Funds Global – What is your investment outlook for Hong Kong and Asia and which regions, themes and asset classes are you keeping an eye on? Rakesh Vengayil, BNP Paribas Asset Management – We started the year with a very optimistic view looking into 2020. Despite the trade war and challenges posed by the geopolitical and macro environments, markets virtually saw all major assets posting a once-a-decade performance in 2019. Overall, risky assets benefited from central banking easing in 2019, but now that growth will need to drive returns. As a global asset management firm, we are broadly of the view that we are in a “fragile Goldilocks situation”, where the growth is on trend, inflation is under control and the interest rates are generally low. Therefore, we are overweight on equities, but we are cautious and prepared to be tactical about it, because we expect the markets to be choppier and we think the search for yield will continue. In this context, we see potential in emerging markets. Moreover, if we think that the US dollar has topped out, then it is essentially beneficial for emerging markets. As an asset class, we think the emerging markets should come back – it has not been in fashion for a few years now, so there is good potential, perhaps we are not there yet, but we can get to a situation like that. Thomas Poullaouec, T. Rowe Price – At the beginning of the year, our outlook for 2020 followed major themes: election, duration, disruption. At the start of the year, we saw economic data rebounding across the board and that boded well with a lot of the emerging markets. We also saw some tensions clearing away at the end of last year with the China-US trade deal. However, the effect the coronavirus has had on the global economy and markets has destroyed the hope for a more “normal” market in 2020. Until we get more certainty about when behaviour will revert to normal, we could anticipate heightened levels of volatility to continue. Emerging markets is one of our strongest overweights, both in equity and in fixed income. Asia is the largest part of emerging markets, so that is why we hold a positive and constructive view on these markets. Wan, BEA Union Investment – In general, the economic data is not too bad, though geopolitical tensions are creating market volatility. At the start of the year we had a positive outlook, especially on the developed economies. For the emerging markets, we are confident about the fundamentals of China. The lower economic numbers are not something to be overly worried [about]. They reflect the economic reform China has been undertaking to focus on high-quality growth rather than high-growth targets. Some cautious investors, however, cast doubt on the Chinese property market outlook. Yet we see resilience in the sector. Several policies have been relaxed amid a continued effort to stabilise land and home prices. Junjie Watkins, Pictet Asset Management – We were seeing signs of a nascent recovery across global economies at the start of this year, but when the coronavirus epidemic was added to the investors’ wall of worry, markets gyrated. To make things worse, markets became dysfunctional when the world’s two largest oil producers entered into a price war and competed for market share. We think the disruption prompted by the outbreak is substantial, as it adds notable uncertainties and has the potential to be disruptive, particularly for China and the Asia region. Hong Kong could also see sizeable economic impacts. While acknowledging the risks and uncertainties from the virus, global central banks are headed into coordinated easing. As such, we still see equities being more attractive than low-yielding fixed income securities. But equities exposure needs to be selective, and we still have faith in secular themes like the US and Asia tech leaders as well as environment-related theses. With more countries vowing to tackle environmental challenges, companies capable of enhancing resource efficiency and environmental quality will be increasingly valued and present themselves as an alternative type of secular growth opportunity. On the defensive side, long-dated TIPs and US Treasuries proved to be good diversifiers amid the outbreak’s disruptions. Gold also serves as a diversifier in this low-yielding environment. Bruno Lee, Manulife Investment Management – Compared to last year, with some of those uncertainties – particularly the US-China trade tension and Brexit – there seems to be some kind of a lower risk appetite. Volatility is particularly affecting retail investors in this part of the world. Despite what happened to the very positive market return in equity and fixed income last year, most customers in this part of the world are putting their money into the income-oriented type of fund, which indicates risk averseness, and there is still a very strong bias towards that, especially those stable, long-term dividend-paying investment products. Frederick Chu, China Asset Management – Our view is generally positive. The biggest hidden risk is still going to be the US-China trade tension – we don’t think it’s going to be just the phase-one deal and then we move over to phase two, it’s going to drag on for longer. For China, it’s going to be very tricky. The consumption upgrade is still going to be leading the economy, but at the same time be increasingly concentrated towards the sector leaders – those who already have the market share and can invest more into the market share, especially in the healthcare sectors. For China, if you look at disposable income, it’s actually deteriorating – that hurts domestic consumer power and household debts are building up. We are neutral on Hong Kong, we don’t see a big upside encouragement or downside risk, despite the social unrest. Funds Global – What are the top investment and business risks that you’re currently navigating and how is the global growth story affecting your allocation? Watkins – The oil market crash has compounded the already fragile state of the market resulting from the outbreak. Personally, I think whether or not a recession is around the corner will depend on how the credit market behaves going forward. Disruptions from the epidemic will have global impacts. Global supply chains and consumption patterns are disrupted, but the full extent of the implication is yet to be ascertained. Albeit major economies are headed for synchronised easing, the current problem is not a result of tight liquidity or high rates. So, interest rate cuts alone will not solve it. The big determinant will be how the US public decides to deal with the threat. Will it be a full retreat and social distancing, or will it be more a brave face as envisioned by New York State governor Andrew Cuomo, that the infected will “self-resolve” with the survival rate at 99%? A key sign is not to have the medical systems overwhelmed, causing loss of confidence. This reaction will determine the global economy. The outbreak will likely fan the flames of economic decoupling which has already been underway in recent years. The episode will prompt more questions like: are we overly dependent on a particular country? Shall we rethink our supply chain or revenue mix? We are also experiencing a period from wealth accumulation to wealth distribution, so we expect lower margins for corporate profits. It’s like a cycle, we’re just reaching that stage of the cycle where the wealth will have to be distributed. Globally, this is the risk that we have to think about and what that implies for the economy and to the corporate profits. I think that would imply lower margins, so how do we invest with that in the background? Vengayil – I completely agree and we see the potential risk of a fragile Goldilocks situation being disrupted. We see two main risk scenarios: one is a synchronised slowdown risk due to trade tension or geopolitical risks, which tend to benefit the US dollar. Another one is the reflation risk due to fiscal easing. But generally, during times where volatility is on the rise, low-risk or minimum volatility strategies tend to outperform, but we are believers in these strategies more on a strategic basis. In the past few quarters, we have implemented a number of tools to help clients strategically form a volatility buffer around their portfolios and we utilise tools such as low-volatility strategies and downside-protection strategies to efficiently do that. Overall, portfolio construction has to be carefully calibrated in order to contain those risks, and that’s where you’re seeing greater demand for multi-asset solutions in play for downside protection within portfolios. Poullaouec – Adding to those risks around accumulation and distribution, the rise of populism that we see in the world – and the policies that then might be implemented are not in favour of spurring global growth, but more pleasing local people. You see that not only in the US, but also in Europe, where we will potentially have policies that will be put in place that risk long-term fiscal stability. These are the things that we will be watching, because we don’t think that populism will be going away any time soon. Another theme that we are watching on the stabilisation of the data is really looking at Germany, because Germany is the signpost of globalisation and they have been impacted not only by the China-US trade war, but also by Brexit and some of the risk of the tariffs on the carmakers from the US. So, German data is not that strong, it’s stabilising, but we are anticipating a rebound there, so that will be also a signpost whether this reflation story has legs or whether it’s not really taking off from a low level. The risk is again that the stabilisation of economic data is not as strong and watching German data over the first quarter will be a key signpost of it. Wan – We are also monitoring multiple interim topics arising from the short-term cycles, as we take a more conservative stance in our asset allocation. In terms of wealth distribution, we see a more potent force in drawing money from the pool than adding in, due to a rapidly ageing population. Lee – We are looking through an Asian customer lens and what are they looking for, in view of this global uncertainty, headline risks and all these things together with the ageing population. Our focus in terms of the asset allocation is different from the traditional risk-return model. Rather than allocating assets in different regions or different asset classes, we are focusing on how we can select the underlying to generate income or an alternate source of income. In the low interest environment, people can put their money in bonds, in bond funds, and they can generate pretty decent cash flow for their income needs – but in this current low interest environment, in terms of our business strategy, how do we deal with that to continue to grow the mutual fund business in the region? How can we translate our business strategy, investment strategy to deliver the income that people are looking for? Poullaouec – Yes, one of the key risks for the decade is how people are using bonds. We have seen a lot of investors using bonds because of their past characteristics. In fact, they have delivered very good returns for 20 years because the yields went from 4% to record low levels, even below zero. People are using bonds for income and diversification, and it’s clear that these two attributes will be challenged in the next decade, so it’s how can we as an industry find different ways to provide diversification for tail risk management and with the like of multi-asset strategies, generating incomes not only through yields but through total return? Chu – If you look at low interest rates, it means there is a lot of liquidity. If you look at Asia, the majority of investors and individuals, property probably accounts for over 50% or the majority of their entire wealth portfolio where equity investments is relatively low. If then the interest rates do remain low, you can get cheap money, but would that then concentrate more into the property sectors? It’s going to be one thing we’ll be looking at. Funds Global – Where do you expect to see rotation within the Asian markets and how is this impacting yield selectivity? Chu – If you’re looking at exposure to China over the next couple of years, it will be more concentrated on sector leaders, the so-called White Horse. Our predictions towards the average earnings growth on the broader base big caps is probably at the higher single digit, but where the sector leaders will still be maintaining a double digit around 15% or a little bit higher. It’s lower than a couple of years ago, but it’s still growing at a very good pace. If those that already own the market share can increase this and expand their business model from domestics to international, those are the ones with the highest potential that will potentially attract more investment interest. Vengayil – We are in the camp where we see China’s growth of around 6% comprising of higher-quality growth and responsible easing. We have done some interesting analysis taking data from the last 15 years and comparing it to other markets. China is generally perceived as a market with high volatility. We compare the CSI 300 with other BRICs as well as developed markets, and what we noticed is that CSI 300 is either at the very top or very bottom of the table, and seldom in the middle. In fact, this has only occurred twice in 15 years. However, when you look at it from an earnings perspective, it has been quite stable, it’s always been on the top or in the middle, never at the bottom. So, if one is invested in China’s earnings growth, one would have done well. From that perspective, you can make volatility in China your ‘friend’. Poullaouec – Foreign ownership of A-shares is about 3% to 3.5%, and the average for Asian markets is 20% to 30%, so it’s really a big gap and it can be ten times what we have today over the next decade, so definitely it’s an opportunity that investors should consider. The index might not be the best way to look at that, because there are a lot of hidden exposures that you could get in the A-share market if you do the analysis, so going active also there could be a way to go. Lee – In terms of sectors and this rotation trend, we look at two different dimensions. One is within the global context – what are the key implications for the US-China trade tension? We believe this will change the long-term strategy of the whole supply chain management. Who will benefit? Probably not those US component manufacturers for the technology products, but rather their direct substitutes such as companies from South Korea and Taiwan, or even domestic Chinese manufacturers, as Chinese brands would want higher control over the supply chain. Vengayil – Some of it is a conscious effort from China because they want to go up the value chain. Lee – Exactly, and so that’s one dimension – how that will not just impact the investment opportunity in mainland China, but actually that will benefit the peripheral Asian market as well. The other dimension within China itself is the whole upgrade in various aspects, like people, the population, hukou, people are moving from the countryside to the second/third tier, to the first and second-tier mega-hub city, so allowing them to move that will perhaps impact people who are looking for quality education, quality healthcare as their wealth and affordability upgrade and increase. So, China in itself is going to move up both in terms of the technology leadership, particularly in the area of 5G, artificial intelligence (AI) and the like. On the other hand, because of the population dividend, they can benefit from that creating a really substantial domestic consumption market – and they are also looking for higher-quality services. Wan – This is precisely the point. When you compare the numbers, the living standard in China seems not quite comparable to the global level. Yet don’t forget that the lifestyles and habits on the mainland differ a lot from the West. China is a leader in e-commerce growth. Our investment themes this year mostly focus on localisation and virtual banking. An important localisation in China is the development and adoption of 5G telecoms. Chips and components which are vital to building base stations for 5G networks are sourced mainly from the US. The country’s move towards tech independence has started to benefit the region, with Taiwan being one of the beneficiaries. The booming tech development has brought about significant benefits to people and economies, fostering many new economy sectors. Virtual banking, another important theme on our watch, is likely to see substantial and exciting development and impacts, not limited to big ones, but also in the lower-tier cities. The transformation to the new economy has fuelled new banking needs and shaping new investment behaviour. Watkins – The outbreak highlights and accelerates the shifting trend to the new economy. The themes that will benefit from this migration include e-commerce, networking and cloud, together with related infrastructure such as servers, processors, memories and related capital equipment. These areas were already seeing robust long-term demand growth, a cyclical upswing late last year, and now also experience an acceleration. This stay-at-home economy will see an increase in its application, both for killing time and staying productive while staying safe. To us, quality tech serves are new defensive plays that enjoy secular growth with attractive returns relative to bonds. This low-yielding environment reinforces our investment thesis for tech leaders. After the emergency 50bps cut, we believe the US Federal Reserve still has an additional 100bps cuts at its disposal. China has room for monetary and fiscal policies also. Funds Global – What are the key market reforms that you would like to see Chinese regulators address in order for the inclusion of more stocks in the MSCI indexes? Lee – Consumption-driven economy is very different from the historical approach, which was dominated by state-owned enterprises (SOEs). Typically, consumption-driven businesses are not necessarily huge in terms of the size or capital investment, unlike technology enterprises or banks, which call for a high level of control. On the contrary, these companies need flexibility to be agile as they need to move quickly according to the changing market dynamics. The key is, pivoting to consumption is a big thing. Imagine even if you’re just talking about the top 5% of China’s population of 1.4 billion people, it is already more than the whole of the US middle class, and they have access, and aspire, to the same messages, the same brands around the world. The opportunity is just so huge. Vengayil – From a foreign investment management perspective, when you look at a market like China, there are three important factors. The first one is the access to the market, which has significantly improved over a period of time with liberalisation and industry efforts. The second challenge is that some of the key enablers are not there, for example access to hedging and derivatives, the lack of listed futures and other derivatives products may result in foreign investors’ ability to implement and manage A-shares risks in the MSCI indexes less efficiently. The third would be to eventually get a level playing field when you are competing with a domestic provider; you can get access, you can have a 100% share owning in a local company, but if you are not well positioned to compete with the local provider, it doesn’t make much sense. Increasingly, what we are seeing is that they are much more open to ideas; local authorities are more consultative these days, so if you look at the investment industry forum like ASIFMA [the Asia Securities Industry and Financial Markets Association], the level of engagement is much higher. There are multiple forums within Asia where asset managers are able to provide inputs to the SFC [Hong Kong Securities and Futures Commission], the CBRC [China Banking Regulatory Commission] and the CSRC [China Securities Regulatory Commission]. Chu – I would want to see two things happen. One is the financial futures; that is something that I think the China capital markets is moving towards. You have the crude oil futures, or the international version, now you have the commodities coming in, but you’ve yet to see an equity or fixed income futures that’s been tradable by foreign investors. That hinders on the hedge side of the investors who want to put in their investment into China. It’s been on the table for some time and there has been talk about the China Financial Futures Exchange opening up an international version, the Hong Kong Exchange want to put up the MSCI, but it’s still back and forth. The second thing I am hoping for is a delivery versus payment (DVP) model for the stock settlement. Vengayil – For global asset managers like us, from a quant solution perspective, we would also like to see advancement of the derivatives market in China. This will allow investment managers to price risk in a much more quantitative way and thus instil even greater confidence in the market. Lee – In terms of reform, we can look at it from two angles. First, although it is now possible for foreign fund management companies to set up 100% owned entities in mainland China, they are still pretty much restrained to offering domestic equity and fixed income products. But if you look at what is selling like hot cakes around Asia in the past five or ten years, it’s multi-asset income with the use of covered calls, put options and derivatives to try to hedge the risk, or manage the volatility, or generate the income. At the moment, these aren’t available to retail investors in the mainland Chinese market for portfolio diversification purpose. On the other hand, we should also look at how we allow for channelling of global money into China from an investment perspective. With the equity and fixed income market, how do we access the market in a more seamless way? Wan – The higher the transparency by the listed companies, the easier it is for global investors to conduct research and make investment decisions. As China’s capital markets continue to evolve and remove barriers to entry for overseas investors, there remain structural and operational challenges – the settlement process being one of them. To ensure transactions go smoothly and orders are safely placed, we always do dry-run tests for both directions. Understanding the uniqueness and complexity of Chinese corporate culture and practices is critical. Operational details derived from commercial practicality, in contrast to the top-down directives, are essential elements not to be overlooked. Watkins – It’s the international practice. Globally, if trades were settled in a couple of days, then hopefully in the Asia market, we could do that as well as the settlement. Funds Global – Are you optimistic or pessimistic for the fund management industry in Hong Kong, and indeed Asia, over the next 12 months? Wan – For Hong Kong, I still am very optimistic about the development over the next 12 months. The infrastructure is still very stable. With the success of the secondary listing of Alibaba in Hong Kong, we will have more of this type of relocating or listing in Hong Kong, so our capital market will remain very strong. For the fund industry, I definitely still think it is growing because people are more accepting of professional investment funds rather than in the past where they would do their own investing, so there is a greater understanding of how the structure works. However, a threat for the industry is that it still does not have enough talent in the market – this really is a prolonged threat to development. Poullaouec – That’s also a global issue because in the past, people wanted to go into the finance industry after graduation and now, they go into technology. I am still optimistic in the way that we see digitalisation of our industry, so more use of technology tools to give advice to clients. Beyond a year, the trend is very favourable for the Asian asset management industry, given the necessary changes to the retirement landscape and to ensure that people have the tools to save by themselves. Innovating both in terms of the investments and funds that we offer to deliver outcomes for retirement, but secondly on how we package and deliver that through digitalisation, is where we will see a lot of development – and we will potentially see tech companies also venturing into asset management. Vengayil – A couple of observations I have is that unlike other financial industries, like a bank or an insurance company, the inflow from outside is very limited in asset management. We try to look for experienced people within and that’s one challenge. A large part of the problem is created by us looking inwards and not outwards, and that is something which needs to change. My assessment would be in relation to getting new people from campuses, internships and getting lateral recruitment from other industries. Watkins – After a very challenging first quarter and possibly an extended lacklustre second quarter, I try to remain cautiously optimistic for the second half. It seems to me that this virus will be endemic and it’s very likely here to stay. In times where volatility is high, managing client assets is always going to be a duty we take very seriously. I do expect pent-up demand will be unleashed once the dust settles. Investors will need to stay invested to generate real return against an accommodative environment. We have a very constructive view about Hong Kong as the leading financial centre in Asia. As long as Hong Kong has international law and an efficient information system, investors will have confidence in the Hong Kong market. In terms of the fund industry, Hong Kong still has the advantage of being part of Greater China, and so the Greater Bay area Wealth Connect and mutual recognition of funds (MRF) efforts are opportunities not just for the next 12 months, but for the future, so we are constructive about that. Lee – I am cautiously optimistic because in a low interest environment, there is a need to search for better returns or higher yield, so that will drive the demand for alternatives. I am also cautious, because the market volatility is going to make it more difficult for people to decide, or if the market moves up and down too quickly, then people will stand still. Longer-term, the major hurdle for industry growth in Hong Kong and Asia in general is the alignment of interest between fund providers and distribution channels. Chu – We are very optimistic on the ETF development in Hong Kong, partially because of the awareness of the individual investors in this city. The investment behaviour has been very much on speculations, they do not hold equity investments, but they want to do equity speculations and derivative speculations. This trend has been changing in the past two or three years. Obviously there are still a lot of people coming in and out of the market, but the sense of going in, catching the trend of the market via an index rather than going to individual stocks or particular derivatives, probably because they lose too much money, has been emerging and the interest towards that has been growing as well. In terms of the institutional usage within this region, the best bit of it is it’s an open market, everyone can have a very favourable channel into any products or ETFs here in Hong Kong. That’s going to remain the same, and as long as it’s an open market and the institutional usage are looking for low-cost investment tools to access the market in a timely way, that will be very beneficial to the Hong Kong market. Poullaouec – We should not oppose ETFs, passive and active, because we see a lot more active ETFs, so that will be coming to the market, and that will fit a need for retail because passive was great in the last decade, and I am not sure the passive return will be as exciting in the next decade. We have looked at whether the implication of more passive ETF usage for tactical transactions is creating opportunity for active investors. There is a tipping point where you see the amount of passive money flowing in without looking at the fundamentals of the company is creating opportunities for active investors, so there will be more packaging of active strategies for ETFs, and they could be successful because of the use of passive ETFs that are creating opportunities for them. Lee – If you look across Asia, except for Hong Kong, Singapore and maybe Malaysia to an extent, the member choice retirement arrangement, through this regular investment discipline, every month good market/bad market, you have 5% or 10% of the money going into investment, and these monies are not gambling by picking stocks and buying/selling and day trading, but rather using funds as long-term instruments to help them build up their retirement preparation. That will have a significant impact to not just the fund industry, but in terms of the healthy development of the capital market in the respective markets, if they have these kinds of long-term pension member choice plans. In Asia, lots of countries talk about it but are still struggling to bite the bullet and roll it out, because bureaucrats always get the feeling that they have more moral responsibility to help the people who have absolutely no idea what to invest in to help them to manage, and to provide the national pension rather than allowing the individual to take more control of their own financial future by setting up the right infrastructure to encourage them to make regular contributions for their long-term retirement savings. © 2020 funds global asia

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