As the world moves from quantitative easing to quantitative tightening and the easy money ride cruises to an end, investors who piled on the risk in the hunt for alpha could find themselves feeling vulnerable and exposed as more hidden problems rise to the surface.
Indeed, a few warnings shots have already been fired.
That’s the view of Ritu Arora, chief executive and chief investment officer for Asia at Allianz Investment Management, the in-house manager for the German insurance group, which invests the various premiums earned across its life, health, property and casualty insurance operations.
“Capital markets in the last few years have been characterised by very high valuations on the equity side and very low interest rates on the debt side," she told AsianInvestor this month. "This forced some investors to increase risk in their portfolios in order to earn adequately.”
But now that interest rates are rising and the ultra-easy credit environment is disappearing, we do expect some hidden problems to come to the forefront, Arora added.
Investors have already been given a glimpse of this in India after Infrastructure Leasing and Financial Services (IL&FS) defaulted last year.
Considered a quasi-government institution with a $15 billion balance sheet, IL&FS's loans default in September shook markets, she said.
As interest rates rose sharply on its short-term borrowings, IL&FS began running out of cash and missing payments on its onshore debt. Its long term credit rating was subsequently slashed to junk from investment grade as concerns grew about the risk of contagion across the Indian non-banking financial sector.
To prevent fear turning to panic, the government, in a rare move, then stepped in and took control of the IL&FS board.
The IL&FS fiasco had global implications too since some of its largest shareholders included the Abu Dhabi Investment Authority and Japan’s Orix Corporation.
“It is a classic case of asset-liability mismatch, accentuated by rising interest rates at the short end of the curve,” Arora said.
Investors would be well-advised to watch out for similar episodes in other nations, given changing global market condiitions and liquidity.
KEY RISKS FOR 2019
Singapore-based Arora said the possibility of rising US interest rates, along with any potential escalation in US-China trade frictions, pose the two biggest risks to Asia.
Both concerns battered emerging markets in 2018: the MSCI Emerging Markets index tumbled 15% last year, after pocketing 37% gains in 2017.
Those US rate hike worries have dissipated slightly in recent weeks due to dovish pronouncements by Federal Reserve policymakers. Even so, global liquidity remains on the retreat as the US central bank rows back on quatitative easing by shrinking its balance sheet.
It’s also easy to see why the trade issue looms large given most Asian economies are now heavily interlinked with China and derive a large part of their growth from China’s growth.
“Negative outcomes for China in a possible trade war will impact not just sentiment, but real growth in Asia,” Arora said.
On the plus side, stock market turmoil has also brought down equity valuations, making even high-quality stocks more reasonably valued after a long time, she noted. “Hence it is also an opportunity for long-term investors to improve the quality of their portfolios.”
For now, Allianz IM is sitting on the sidelines, while selectively building positions where the risk-reward equation is favourable, she added.
She believes 2019 will be an interesting year for investors.
“Globally, we expect broad based growth to slow down moderately. However, we expect a soft landing rather than a deep recession,” she said.
The global economy is projected to grow by 3.5% in 2019, 0.2 percentage points below its previous estimate in October, according to the IMF’s world economic outlook update published on January 11.
“Financial conditions have already tightened since the [autumn]," the update said. "A range of triggers beyond escalating trade tensions could spark a further deterioration in risk sentiment with adverse growth implications, especially given the high levels of public and private debt. These potential triggers include a 'no-deal' withdrawal of the United Kingdom from the European Union and a greater-than-envisaged slowdown in China.”
With clear signs of slowing global growth emerging, investors are starting to bet that the Federal Reserve could hit pause on rate hikes, at least over the next few months, as it takes into account the growing global risks.
Some commentors – such as Vanguard's chief economist Joseph Davis – now expect only one more rate rise this year.
Asia's fundamentals continue to be strong, with economic growth still on a solid footing and inflation under control for most of the region, according to Arora.
So with markets fretting about the broader trade-spat implications and the changing global liquidity conditions, some interesting opportunities are opening up for investors, she said, noting how oversold China A-shares currently looked.
China’s Shanghai Composite plummeted 24% in 2018, making it the worst-performing major stock index in the world as worries over corporate earnings and the broader Chinese economy gripped investors in the wake of the growing trade dispute. According to Bloomberg data, it's up 3.44% so far this year.
The correction in the Philippines and Indonesian equity markets have also thrown up some interesting opportunities, Arora added. “We are utilising these opportunities to improve the quality of our portfolios,” she said, without providing further details.
Arora has previously also said that Allianz IM is eyeing private market opportunities, having already invested in ride-hailing platform Go-Jek in Indonesia.
For further insight and analysis into how insurers are seeking to invest and navigate regulatory changes, look out for AsianInvestor's 6th Insurance Investment Forum in Hong Kong on March 12 and its inaugural sister event in Singapore on March 14. For more information, please click here.