A tumultuous 2018 has led to a spate of investing uncertainties for Asia Pacific's institutional investors.
As we discussed, at the top of the list is the growing trade war between the US and China. But while this concerns asset owners over the short- to medium-term, the impact of tightening monetary policy and its effect on liquidity and credit dominates their long-term thoughts.
Leading central banks are tightening, after years of loose policy. The US Federal Reserve began normalising its balance sheet in October 2017, the European Central Bank kicked off tapering measures in January, and the Bank of England recently raised its bank rate for only the second time since 2009.
Global markets are moving towards a period of prolonged rate increases, and there will be challenges in this transition, said MetLife’s Scully.
“The market hasn’t really dealt with steadily rising rates in many years, and so that’s likely to lead to some deleveraging stress, potential shortfalls in liquidity, and deterioration in the capital of organisations as their bond portfolio drops in value,” he said.
Kristian Fok, chief investment officer of Australian superannaution fund Cbus, said his organisation is responding by identifying higher return investment opportunities where it can fill gaps in liquidity without increasing risk, such as direct infrastructure and direct lending investments.
The Australian superannuation fund saw over A$2.4 billion ($1.7 billion) in net cash flows last year, and it’s looking for ways to allocate capital to domestic corporates, like financing asset-heavy parts of their businesses via direct loans.
“We think that that will be the advantage, particularly if we see a pullback in lending from banks – we feel that’s an opportunity for us to step in,” Fok said.
Fellow superannuation fund AustralianSuper retains quite strong equity investments but has been reducing exposure to real estate, where it believes returns are relatively modest, said Alistair Barker, head of portfolio construction.
“We’re shifting the portfolio back towards equities and taking a bit more risk in equities, rather than in property or credit,” he told AsianInvestor.
The strategy is short-term, however; the superannuation fund expects it’ll have to eventually reduce their equities exposure due to a deteriorating economic outlook, which Barker anticipates will happen sooner rather than later.
“It’s been a while since we’ve had the last very substantial pullback in markets – one would think we’re closer to the next bear market than we are from the last one,” he said.
For insurers like HSBC Insurance and MetLife, less liquid opportunities offer the best prospective investment returns in a rising rate environment.
“We are shifting our asset mix to include a larger proportion of investment in alternative credit investments and other alternative asset classes to reduce reliance on equity for returns,” said William Chan, chief investment officer for HSBC Insurance’s Hong Kong operations.
Current economic conditions are pushing MetLife towards alternatives as well, including privately placed corporate bonds, infrastructure, and commercial mortgages, which offer key benefits in return for giving up some liquidity.
“We’re getting wider spreads on these types of assets, we are getting better credit protection, and private corporate bonds will have better covenants than you can get in the public markets,” said Chuck Scully, chief investment officer for Asia at Metlife.
Non-fixed rate credit is also a key portfolio factor in a rising rate environment. We like floating rate investments in fixed income in order to benefit from a further rise in short rate, Chan told AsianInvestor.
“If you have a portfolio where you’re concerned about that rising rate risk, you can use floating rate commercial mortgages,” agreed Scully.
Yet despite uncertainty over how best to invest amid tightening monetary policy, investors believe policy makers have been relatively successful in managing the process.
“The Fed and the ECB have been traveling on paths that have been relatively easy for markets to adjust to and absorb,” Andrew Jackson, head of fixed income at Hermes Investment Management, told AsianInvestor.
“We aren’t even at the point of restrictive monetary policy yet,” agreed Patrik Schowitz, global multi-asset strategist at JP Morgan Asset Management. “It’s probably too early for most investors to reduce their risk yet.”
Look out for the final part of this feature on the chief concerns of Asia Pacific's CIOs, which has been adapted from the AsianInvestor August/September 2018 edition. And click here to read the first part of this article.