Asset owners’ ongoing struggle to find asset value amid yield compression and high equity valuations could be compounded by central banks’ accelerated unwinding of quantitative easing policies by late 2018, say Australian superannuation funds and consultants.
The investing landscape for institutional investors is already looking difficult, following a surprisingly strong year for equities in 2017. Tim Ridley, chief investment officer at Melbourne-based super fund Cbus, told AsianInvestor he expects portfolio returns over the medium term will be lower than long-term expectations: "Valuations for the asset classes the fund invests in remain in the fair value to very expensive range.”
Higher yielding asset classes, such as property and infrastructure are particularly expensive, he added, reflecting low sovereign debt yields.
Chris Trevillyan, director of investment strategy at Melbourne-based asset consultant Frontier Advisors, agreed. “It is difficult to identify particularly attractive opportunities at this point of the cycle,” he told AsianInvestor.
Frontier has recommended an overweight to emerging markets and continues to be positive about prospects in the context of improved global economic growth. “However, after returns of more than 30% in 2017 (for EMs) this has partially already played out in markets,” Trevillyan said.
In terms of asset allocation, Cbus is currently targeting a modest overweight exposure to growth assets, favouring international equities over Australian equities, mainly reflecting greater downside risk to Australian earnings. The MSCI World index, perhaps the standard for global equities, has an emerging market exposure of 12%.
Although Cbus has a neutral view on emerging market equities, another Melbourne-based fund, MediaSuper, was more positive on opportunities “as various [emerging] economies move further into growth mode”, according to chief executive Graeme Russell.
But the fund is concerned about geopolitical risks, “especially on the Korean peninsula”, and unforeseen consequences, said Russell.
Credit markets are providing increasingly limited reward for risk, with high yield bond spreads having contracted from almost 9% in early 2016 to around 3.5% today, according to Trevillyan.
“Although the near-term outlook is likely to remain reasonable for credit, with historically low default rates, the upside is limited, risks are rising and the return for risk is low,” he said. Ridley noted that Cbus has reduced its overweight exposure to credit “as spreads are currently tight”.
Investors pointed to the turning of monetary policy globally as a key factor for financial market performance over the medium-term.
In the short term, consultants and CIOs believe the world’s leading central banks appear unlikely to make any sharp policy changes. “For now, with relatively low inflation, monetary tightening by central banks is likely to be extremely gradual,” said Trevillyan.
But he warned that pressures on inflation are building: “It may be that late in 2018 or in 2019, central banks are tightening more aggressively than markets are currently predicting.”
This risk, when combined with the lack of US excess industrial capacity, increases the risk of a material US economic slowdown commencing in 2019, suggested Ridley.
MediaSuper’s Russell is also concerned about market risks surrounding an accelerating tapering of quantitative easing (QE).
“We don't think anyone really knows what might happen as the ECB (European Central Bank) and Australia's Reserve Bank join in (with the US Federal Reserve)," he said. "I guess we're all hoping that the central banks move cautiously, and collaboratively, so that as economic stimulus is withdrawn, higher investment and economic growth takes up the slack.”
Meanwhile, Cbus noted that a key concern regarding Asia is that Chinese economic growth proves materially weaker than expected, as the government clamps down on the country’s credit boom. A slowdown is already anticipated; the World Bank forecasts China’s economy to grow by 6.4% this year, down from 6.8% in 2017.
The risk of a more severe market correction, which some market pundits have raised on the basis of a 10 year continuous bull run in equities coming to an end, does not overly concern Australian commentators.
Trevillyan notes there are some signs that market risks are rising, such as the high level of corporate debt in the US. “But overall a major correction does not appear imminent,” he added. “The pace of central bank tightening and how markets respond will be key to how this view evolves.”
However, the strong appeal of alternative asset classes could begin to dim. Asset owners in Asia Pacific have steadily increased their exposure to private equity and debt over the last two years, but that trend may slow in 2018 as the vast levels of liquidity entering these areas lead to an increasing likelihood of diminishing returns, predicts Trevillyan.
“Global private equity has historic levels of undrawn commitments and entry multiples are increasingly expensive,” he said. “At this point in the cycle, committing to illiquid assets at historically low returns is becoming less appealing.”