BlackRock overweight in China and Singapore
Investment Outlook Series: Nick Scott, CIO for Asian equities at BlackRock, favours companies with strong balance sheets and those likely to benefit from low interest rates.
This is part of an AsianInvestor series on the 2009 investment outlook of fund managers with Asian portfolios.
Nick Scott is the Hong Kong-based CIO for Asian equities within the portfolio management group at BlackRock. He is responsible for building the fund houseÆs Asian investment platform and capabilities.
Before joining BlackRock in January 2007, he was CEO and CIO at Prudential Asset Management Hong Kong and was responsible for the overall business in Hong Kong and investments in Asia.
The Asian equity team that Scott heads at BlackRock covers Asia-Pacific ex-Japan markets. The team manages more than $2.2 billion in retail and institutional mandates.
Globally, BlackRock has around $1.3 trillion in assets under management.
What are the biggest opportunities that you see in the coming 12 months?
Scott: Widespread selling in Asian markets has brought valuations down to levels that have rarely been seen in the past three decades. This presents a significant opportunity for investors with a long-term horizon to purchase quality companies at an attractive price.
My current strategy has two broad components. I invest in high-quality companies with strong balance sheets, which are likely to take advantage of the current turbulent environment by growing market share through acquisitions and developing more advanced products. At the same time, I buy companies within certain sectors, which have been oversold and are likely to benefit from low interest rates.
There are also shorter-term trading opportunities thrown up by the extreme volatility. For example, there has recently been a wide divergence between the A- and H-share prices of certain Chinese companies and the team has been taking advantage of the opportunities this can provide.
How has the global financial crisis affected the way you manage your portfolios?
The crisis in the US and European financial sectors has affected investor confidence globally. Although AsiaÆs financial system remains fundamentally sound and regional banks are not at immediate threat of insolvency, local markets have been punished for their relatively high risk profile as investors have fled for safer havens.
Recent market movements suggest that investors are increasingly confident that a systemic collapse of the financial system has been avoided. Whilst this may encourage short-term optimism, it does not alter the fact that the global economy continues to slow, with much of the developed world already in recession. We believe that earnings expectations continue to be too high in many sectors and market volatility is likely to continue until this is priced in.
In this environment, my portfolios maintain a bias towards companies with predictable earnings growth and strong cash generation. This has resulted in an increased exposure to telecom stocks and an underweight in industrial exporters and technology companies which rely on consumption in Europe or the US. Recently, as valuations have fallen to very attractive levels, I have started to build positions in those stocks which may benefit from the current low-interest rate environment. The exposure in leading financial franchises has also increased.
However, my fundamental philosophy and the process which underpins my portfolios are unchanged. Times such as these, when investor sentiment is fragile and swinging wildly, throw up many opportunities to buy stocks that the market has mispriced due to euphoria or fear. It is these stocks that I am seeking, taking advantage of market sentiment and aiming to deliver outperformance over the full market cycle.
What is the biggest lesson you have learned from the US credit crisis?
Trade surplus and trade deficit nations suffered equally as trade imbalances have been reduced, which is a demonstration of the impact of globalisation on the world economy. The credit crisis has also shown us the degree to which markets and financial systems are increasingly integrated.
Mortgages sold in the US were grouped and layered into a series of instruments which were taken up by banks in the US and around the world and then sold on to their clients.
When the US homeowner started to default on their mortgage payments, it set in motion a chain which ultimately swamped markets around the world, destroying investor confidence. This was true even in Asian markets which only had a small exposure to the mortgage-backed instruments.
This demonstrates that the talk over the last few years of Asia decoupling from the US and the wider global market was misplaced. For all the growing strength and stability in Asian economies, their medium-term fortunes remain tied to that of the developed world.
Have you made any significant changes to your asset allocation in terms of markets or sectors in the past few months?
My portfolios are driven primarily by bottom-up stock selection, although asset allocation does have a role to play in adding value.
In recent months the portfolios have been defensively positioned. This has meant a greater exposure to consumer staple stocks and telecom companies, where revenues are less likely to be affected by a reduction in consumer spending. It has also involved avoiding industrial exporters, which are vulnerable to cutbacks in consumer spending in the US and Europe.
In terms of countries, my portfolios have been overweight in Singapore, a traditional safe haven in Asian markets, and in China, which enjoys greater resources with which to stimulate the economy and maintain healthy economic growth. I have avoided Korea, where the outlook appears grim in the face of consumer capitulation in the US and where cyclical industries such as shipbuilding are entering a severe downturn.
What are your favoured markets in Asia?
We maintain a significant underweight in Korea and Hong Kong, funded out of overweight positions in China and Singapore.
China retains a relatively strong degree of control over its economy and has significant financial reserves which it can deploy to stimulate economic growth as its export sector slows down. We have seen evidence of this recently in the large stimulus package released in November. This puts it in a relatively attractive position.
Singapore is also attractive due to its defensive qualities. The market includes a high percentage of good quality telecom companies and banks which enjoy strong deposit franchises.
What markets are you bearish over?
Korea is an export-dominated economy and the reduction in US and European consumer demand will have a significant negative impact on its ship-building and consumer electronics industries, among others. At the same time, the Korean property market is stagnant and Korean consumers are tightening their belts and deleveraging. Although we like specific stocks within this market, as a whole we want to be underweight.
The underweight in Hong Kong is driven primarily by an aversion to the utility and financial sector. Despite the correction, Hong Kong utilities remain expensive compared to their valuation in past economic downturns. Hong Kong banks have significant exposure to GuangdongÆs export industry, which is a notable victim of slowing global consumption. There are also concerns over the effects of the Minibond issue on the banking sectorÆs wealth management arm.
What are your market weightings within an Asia ex-Japan equities portfolio?
The BGF Asian Dragon Fund had the following portfolio weighting, as of end-October:
China û 26.56%
Hong Kong û 10.58%
India û 9.22%
Indonesia û 2.28%
Korea û 14.08%
Malaysia û 2.37%
Pakistan û N/A
Philippines û 1.43%
Singapore û 10.45%
Sri Lanka - N/A
Taiwan û 16.27%
Thailand û 3.63%
United Kingdom û 0.80%
Vietnam - N/A
Cash û 2.32%
Which sectors do you expect to outperform in the coming year?
The only prediction which is easy to make is that the next 12 months are likely to be volatile. The impact of the financial crisis, coupled with the likelihood of global recession, is still unfolding. There is a stark difference between the financial sector in the US and Europe now, to that 12 months ago. Prestigious institutions have shrunk, merged or folded with a speed that would have been unthinkable twelve months ago. This alone serves to remind us of the danger in making short-term predictions in such volatile times.
Telecoms and consumer staples could outperform the broader market in the first part of 2009 due to their predictable earnings, yield and low ratio of capital expenditure requirements to cash flow. Singaporean banks also look well set due to their strong capital positions, deposit franchises and manageable levels of non-performing loans.
Which sectors do you expect to underperform?
We believe that earnings expectations are still too high in the technology sector, which could lead to further disappointments and underperformance in early 2009. The banking sector in certain countries such as Hong Kong and China seems to be too optimistic in their outlook for loan defaults and we believe that disappointment may lie in store here also.
What are the main challenges that you expect to face in the coming 12 months?
As we move into recession, governments around the world are likely to attempt economic stimulation through increased spending and tax cuts, coupled with low official interest rates. The success of these measures is crucial to reviving consumer demand.
The lending environment may also take some time to recover as banks have tightened their requirements and look to increase the quality of loans on their books. This will make it harder for companies to expand and dampen growth until lenders regain confidence.
Investor sentiment will remain fragile in the short-term as the global economy slows and we may see an increase in earnings disappointments and corporate insolvency. The market is also suffering due to forced selling by hedge funds and by global equity funds reducing their emerging market exposure.
What are the main risks of investing in Asia at the moment? How are you managing those risks?
The key risks in Asian markets include further de-rating of equities as earnings expectations in certain sectors are proven to be too high; an increase in investorsÆ risk aversion causing emerging markets to underperform; further tightening in credit availability stifling growth; and a prolonged trough in consumer demand weighing on the regionÆs exporters.
The portfolios are maintaining a defensive position, with a significant underweight in Korea and Hong Kong, and an overweight in China and Singapore. Across all countries, we are avoiding stocks which are reliant upon the consumers in the US and Europe. We are also avoiding those sectors where we feel that earnings expectations are still too optimistic.
However, we are also confident that the structural changes which have driven Asian growth over recent years will reassert themselves over the medium to long term. As a result, the current low valuations offer a fantastic opportunity to invest in those companies which have a strong chance of emerging as leaders in the economy and the market.
Nick Scott is the Hong Kong-based CIO for Asian equities within the portfolio management group at BlackRock. He is responsible for building the fund houseÆs Asian investment platform and capabilities.
Before joining BlackRock in January 2007, he was CEO and CIO at Prudential Asset Management Hong Kong and was responsible for the overall business in Hong Kong and investments in Asia.
The Asian equity team that Scott heads at BlackRock covers Asia-Pacific ex-Japan markets. The team manages more than $2.2 billion in retail and institutional mandates.
Globally, BlackRock has around $1.3 trillion in assets under management.
What are the biggest opportunities that you see in the coming 12 months?
Scott: Widespread selling in Asian markets has brought valuations down to levels that have rarely been seen in the past three decades. This presents a significant opportunity for investors with a long-term horizon to purchase quality companies at an attractive price.
My current strategy has two broad components. I invest in high-quality companies with strong balance sheets, which are likely to take advantage of the current turbulent environment by growing market share through acquisitions and developing more advanced products. At the same time, I buy companies within certain sectors, which have been oversold and are likely to benefit from low interest rates.
There are also shorter-term trading opportunities thrown up by the extreme volatility. For example, there has recently been a wide divergence between the A- and H-share prices of certain Chinese companies and the team has been taking advantage of the opportunities this can provide.
How has the global financial crisis affected the way you manage your portfolios?
The crisis in the US and European financial sectors has affected investor confidence globally. Although AsiaÆs financial system remains fundamentally sound and regional banks are not at immediate threat of insolvency, local markets have been punished for their relatively high risk profile as investors have fled for safer havens.
Recent market movements suggest that investors are increasingly confident that a systemic collapse of the financial system has been avoided. Whilst this may encourage short-term optimism, it does not alter the fact that the global economy continues to slow, with much of the developed world already in recession. We believe that earnings expectations continue to be too high in many sectors and market volatility is likely to continue until this is priced in.
In this environment, my portfolios maintain a bias towards companies with predictable earnings growth and strong cash generation. This has resulted in an increased exposure to telecom stocks and an underweight in industrial exporters and technology companies which rely on consumption in Europe or the US. Recently, as valuations have fallen to very attractive levels, I have started to build positions in those stocks which may benefit from the current low-interest rate environment. The exposure in leading financial franchises has also increased.
However, my fundamental philosophy and the process which underpins my portfolios are unchanged. Times such as these, when investor sentiment is fragile and swinging wildly, throw up many opportunities to buy stocks that the market has mispriced due to euphoria or fear. It is these stocks that I am seeking, taking advantage of market sentiment and aiming to deliver outperformance over the full market cycle.
What is the biggest lesson you have learned from the US credit crisis?
Trade surplus and trade deficit nations suffered equally as trade imbalances have been reduced, which is a demonstration of the impact of globalisation on the world economy. The credit crisis has also shown us the degree to which markets and financial systems are increasingly integrated.
Mortgages sold in the US were grouped and layered into a series of instruments which were taken up by banks in the US and around the world and then sold on to their clients.
When the US homeowner started to default on their mortgage payments, it set in motion a chain which ultimately swamped markets around the world, destroying investor confidence. This was true even in Asian markets which only had a small exposure to the mortgage-backed instruments.
This demonstrates that the talk over the last few years of Asia decoupling from the US and the wider global market was misplaced. For all the growing strength and stability in Asian economies, their medium-term fortunes remain tied to that of the developed world.
Have you made any significant changes to your asset allocation in terms of markets or sectors in the past few months?
My portfolios are driven primarily by bottom-up stock selection, although asset allocation does have a role to play in adding value.
In recent months the portfolios have been defensively positioned. This has meant a greater exposure to consumer staple stocks and telecom companies, where revenues are less likely to be affected by a reduction in consumer spending. It has also involved avoiding industrial exporters, which are vulnerable to cutbacks in consumer spending in the US and Europe.
In terms of countries, my portfolios have been overweight in Singapore, a traditional safe haven in Asian markets, and in China, which enjoys greater resources with which to stimulate the economy and maintain healthy economic growth. I have avoided Korea, where the outlook appears grim in the face of consumer capitulation in the US and where cyclical industries such as shipbuilding are entering a severe downturn.
What are your favoured markets in Asia?
We maintain a significant underweight in Korea and Hong Kong, funded out of overweight positions in China and Singapore.
China retains a relatively strong degree of control over its economy and has significant financial reserves which it can deploy to stimulate economic growth as its export sector slows down. We have seen evidence of this recently in the large stimulus package released in November. This puts it in a relatively attractive position.
Singapore is also attractive due to its defensive qualities. The market includes a high percentage of good quality telecom companies and banks which enjoy strong deposit franchises.
What markets are you bearish over?
Korea is an export-dominated economy and the reduction in US and European consumer demand will have a significant negative impact on its ship-building and consumer electronics industries, among others. At the same time, the Korean property market is stagnant and Korean consumers are tightening their belts and deleveraging. Although we like specific stocks within this market, as a whole we want to be underweight.
The underweight in Hong Kong is driven primarily by an aversion to the utility and financial sector. Despite the correction, Hong Kong utilities remain expensive compared to their valuation in past economic downturns. Hong Kong banks have significant exposure to GuangdongÆs export industry, which is a notable victim of slowing global consumption. There are also concerns over the effects of the Minibond issue on the banking sectorÆs wealth management arm.
What are your market weightings within an Asia ex-Japan equities portfolio?
The BGF Asian Dragon Fund had the following portfolio weighting, as of end-October:
China û 26.56%
Hong Kong û 10.58%
India û 9.22%
Indonesia û 2.28%
Korea û 14.08%
Malaysia û 2.37%
Pakistan û N/A
Philippines û 1.43%
Singapore û 10.45%
Sri Lanka - N/A
Taiwan û 16.27%
Thailand û 3.63%
United Kingdom û 0.80%
Vietnam - N/A
Cash û 2.32%
Which sectors do you expect to outperform in the coming year?
The only prediction which is easy to make is that the next 12 months are likely to be volatile. The impact of the financial crisis, coupled with the likelihood of global recession, is still unfolding. There is a stark difference between the financial sector in the US and Europe now, to that 12 months ago. Prestigious institutions have shrunk, merged or folded with a speed that would have been unthinkable twelve months ago. This alone serves to remind us of the danger in making short-term predictions in such volatile times.
Telecoms and consumer staples could outperform the broader market in the first part of 2009 due to their predictable earnings, yield and low ratio of capital expenditure requirements to cash flow. Singaporean banks also look well set due to their strong capital positions, deposit franchises and manageable levels of non-performing loans.
Which sectors do you expect to underperform?
We believe that earnings expectations are still too high in the technology sector, which could lead to further disappointments and underperformance in early 2009. The banking sector in certain countries such as Hong Kong and China seems to be too optimistic in their outlook for loan defaults and we believe that disappointment may lie in store here also.
What are the main challenges that you expect to face in the coming 12 months?
As we move into recession, governments around the world are likely to attempt economic stimulation through increased spending and tax cuts, coupled with low official interest rates. The success of these measures is crucial to reviving consumer demand.
The lending environment may also take some time to recover as banks have tightened their requirements and look to increase the quality of loans on their books. This will make it harder for companies to expand and dampen growth until lenders regain confidence.
Investor sentiment will remain fragile in the short-term as the global economy slows and we may see an increase in earnings disappointments and corporate insolvency. The market is also suffering due to forced selling by hedge funds and by global equity funds reducing their emerging market exposure.
What are the main risks of investing in Asia at the moment? How are you managing those risks?
The key risks in Asian markets include further de-rating of equities as earnings expectations in certain sectors are proven to be too high; an increase in investorsÆ risk aversion causing emerging markets to underperform; further tightening in credit availability stifling growth; and a prolonged trough in consumer demand weighing on the regionÆs exporters.
The portfolios are maintaining a defensive position, with a significant underweight in Korea and Hong Kong, and an overweight in China and Singapore. Across all countries, we are avoiding stocks which are reliant upon the consumers in the US and Europe. We are also avoiding those sectors where we feel that earnings expectations are still too optimistic.
However, we are also confident that the structural changes which have driven Asian growth over recent years will reassert themselves over the medium to long term. As a result, the current low valuations offer a fantastic opportunity to invest in those companies which have a strong chance of emerging as leaders in the economy and the market.
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