Q How important is the development of local bond markets?
A All of us in this region are looking at the supply of credit in the market and of course the dominant player has become China. So liberalisation of the bond market in China is a key strategic consideration, and with that is the development of more market-oriented risk pricing around credit, which we haven’t seen because to price risk correctly you’ve got to have defaults, which you haven’t had in mainland China. The right steps are being taken there, but that’s going to be a build-out over the next five years we think. That’s a challenge for all of us.
I think it’s fair to say that in many of the capital markets across this region, we would be disappointed when we look back to the Asian financial crisis [of the late 1990s] and the promise coming out of that, that things would be better. A lot of things are much better since then, but one of the promises coming out of that was the development of the capital markets. That has disappointed in many places in terms of the development of free-flow and the deepening of the bond markets. Change has been very slow and in some places not at all.
Q Why did that change not happen?
A I think we got over the problems of the financial crisis and, after a period of time, once we got to 2003, a lot of the write-downs had been made, a lot of the wealth destruction had occurred, national accounts were improved, corporate balance sheets were strengthened, money came back to the region. It seemed as though we’d solved the problem without having to go too far down that reform path. It’s unfortunate we stopped short. As you look back now, it would be very helpful, as we approach other considerations on a global scale, if we had more developed capital markets here.
Q So we may not see that reform in the foreseeable future?
A It’s not linear and it’s not guaranteed. You have to take opportunities when they present themselves. If you don’t they may go away for good, structurally. What we are seeing now is that with China’s continued development as an economy and as a financial system, it will continue to dominate. It’s only a matter of time before China is in most of the indexes, at which point the other capital markets of the region become less important.
Q Are you concerned about that?
A We are concerned because we are involved in each of these economies. We mobilise domestic savings and channel those into the domestic economy. We are part of the financial infrastructure and we feel we have a social responsibility in that respect.
Opportunities are being missed and we are actively engaged with a number of development agencies, regulators and other market participants. At the moment we are focusing on infrastructure and trying to see what can be done there to channel long term savings into infrastructure projects, given the banks are starting to pull back from some of these as well.
This all relates to the larger agenda of how to promote domestic capital markets. We are concerned in so far as deploying capital is what we do, and it has to be done efficiently. So what you’ve seen with insurance regimes in the region is, in the absence of ways to better deploy capital domestically, regulators have allowed more money to flow offshore. It’s good for diversification as it brings new opportunities. But in another way it’s also investment spend that could otherwise be deployed locally, so you could view it as leakage.
Q What can institutional investors do to balance risk and return in their portfolios?
A The risk you have in long-term investing is that rates come down further and risk premiums get compressed. And with the best intentions in the world, the tendency is to take more risk, but you may not necessarily get rewarded for it.
Long-term investors generally face that across the board. You’ve seen a mad rush into lower-cost investing as a result, and I think that is a recognition that getting returns is harder now than it’s ever been, certainly in living memory. And the risks involved don’t seem to have subsided significantly. In the absence of potential to generate returns we have seen in the past, people have focused on getting the cost down.
Q What specific changes or new ideas are you are looking to implement?
A We are looking at some alternative asset classes. Within the alternatives space, we don’t need short-term liquidity, so we focus on the opportunity to invest long term and try to pick up that premium, where it still exists. In particular as other institutions, notably the banks, due to increased regulatory oversight, need to pull back from longer term opportunities. So, there’s a risk transition taking place in markets globally, as banks pull back from lending, and insurance companies still have a book of business which requires long-dated liabilities.
So there are opportunities but it’s a question of assessing the risks appropriately. You can understand why, from a risk management perspective, there is caution around taking on additional risk, because interest rates and risk premiums have come down.
Q What should investors look out for?
AThere is a danger that we become complacent in the sense that we think the prospect of inflation has gone away; it certainly isn’t priced into markets today. And particularly in this region you have economies which have structural issues in terms of inflation, with a number of countries being prone to periods of high inflation. We haven’t seen much change structurally in those economies to suggest that they have been overcome.
What we have seen, though, is the effect of liquidity globally and economic circumstances locally push down long-term rates. Are markets pricing correctly that inflation is not a threat? It’s questionable, where pricing is the overwhelming demand [factor] for long-term paper in a period of subdued economic activity.
To read the first part of this Q&A interview, please click here.