Multi-Asset opportunities in Asian assets
Our view is that after the sell-off earlier in 2018, valuations of Asian assets have become attractive and so the right approach is to maintain some exposures to the region in a risk-controlled manner.
This article was originally published in Citywire Asia Magazine (Oct 2018 issue).
Once again, Asian investors find themselves dealing with the consequences of external events. Trade tension rhetoric and the economic woes of other nations continue to upset local markets, even though underlying Asian fundamentals remain strong.
‘Markets have been very volatile this year, with a correction in February followed by trade tension escalating between the US and China. Non-Asian emerging markets have gotten into trouble, affecting sentiment in Asia,’ admits Patrick Brenner, Head of Multi-Asset Investment, Asia at Schroders.
In such an environment, private and institutional income-seeking clients have two core questions. Is this a good time for new investments in Asia? And for existing investors, how do they cope with on-going volatility?
The growing threat of trade tensions and tariffs is a different matter altogether, he suggests. If trade between China and the US deteriorates, there is a more direct hit on Asian economies that rely on China as part of their export chain. On the other hand, should trade tensions ease, Asian equity markets could well experience a solid rebound.
‘Given the fear of risks from a trade war, a lot of investors are staying away from Asia and emerging markets altogether. Our view is that after the sell-off earlier in 2018, valuations of Asian assets have become attractive, and so the right approach is to maintain some exposures to the region, in a risk-controlled manner.’ says Brenner.
One option is to invest in a multi-asset strategy which offers some participation to the upside but also offers downside protection. ‘In addition to helping investors in staying invested in the market while they wait to find out what will next happen to the Asian bond and equity markets, they can also enjoy the steady stream of incomes generated by the assets,’ Brenner adds.
Flexibility and agility
Schroders’ Asian multi-asset team puts a lot of resources into ensuring the right balance is in place between equities and bonds at all times, and into managing other risks that can detriment asset values and sources of income.
Schroders’ Asian asset income strategy has built-in flexibility to adapt to both the cycles of regional and local economies, and to outside events. Equity exposures can, and often do, vary between 30% and 70%. For instance, when markets were stressed in 2013 and 2015, equities exposure dipped to 35% as bonds offered investors cushioning on volatility.
The maximum bond exposure is 40% with the current exposure sitting at around 33%. The team prefers corporate issuers, but can invest in sovereigns and agencies should the need arise.
‘While having a balanced exposure to equities and bonds offers diversification, adjusting the mix at the right time is crucial to achieving growth and managing volatility. We also need to look at other dimensions of the portfolio, such as duration (interest rate) and currency risk to improve risk-adjusted returns,’ says Brenner.
He says currency risk management has played a big role recently. With the US dollar benefiting from the combination of tightening monetary policy and lower global risk sentiment, increasing the portfolio’s exposure to USD has improved the portfolio’s defensiveness this year. The team added hedges on Asian currencies with the US dollar exposure edging close to 85% earlier this year in February.
‘Currency is very actively managed. While we still believe that the US dollar could appreciate further, downside risks have subsided recently after the pullback in Asian assets, and hence we have reduced the greenback exposure to about 65%,’ says Brenner.
The US dollar is not the only currency that the multi-asset team is keeping an eye on. Emerging markets are prone to contagious effects— both from neighbours and from the other side of the world. Although alarming, the recent falls in the Turkish lira and Argentinian peso have a limited economic impact on Schroder’s Asian asset income strategy.
‘These are idiosyncratic, isolated incidences. We see limited risk of contagion to Asian assets, which fundamentals remain robust overall,’ says Brenner.
A dedicated approach
A successful multi-asset strategy is not only about active allocation and risk management, but also about having the right stocks and bonds, which are very important in achieving strong investment outcomes.
‘We believe that nobody is good at everything, and so we work in close partnership and have complete trust in our Asian equities and credit specialists to choose the right stocks and bonds for us,’ says Brenner.
This approach has worked well for the strategy with security selection contributing to strong performance and stability.
‘Our security selection philosophy for this strategy is that we want to focus on sustainable yield from high quality and stable businesses. We do not blindly chase after yield and sacrifice quality, as a seemingly high yield opportunity could often be a trap for investors, if the underlying operating cash flows of a business are volatile,’ adds Manish Bhatia, Asian equity fund manager for the strategy.
Collaboration and team work is what makes the strategy stands out. Working together towards the goal of sustainable and steady income, Brenner often needs to discuss with the Asian equity and fixed income specialists, especially during volatile periods. While technology nowadays makes communication easier, it could never replace the dynamics of having face-to-face meetings, whereby ideas are generated and solutions are debated without any barriers in building rapport.
‘Local resources are vital, especially in the modern, connected world. A new day starts when the sun goes up in Asia, and we are often the first to deal with events happened overnight in US and European markets,’ says Brenner.
One of the recent examples was the large depreciation of Turkish lira in August. When statements from the Turkish government and its central bank clashed over intervention, the team needs to assess the potential impact on Asia.
‘The three teams gathered and discussed about the event, and our conclusion was that contagion effect was limited,’ says Brenner. However as Asian investors are also aware, the next external event could be far bigger, and that’s why a well-rounded, dedicated team is required to provide investors with a smooth investment journey.