After two tenures, AsianInvestor's 2021 Standout CIO Jang Dong-hun looks back on the past six years at Korea's Poba with satisfaction.
What kinds of products and asset classes are you offering to your clients right now?
Mahesh: It depends on the clientÆs risk-return profile. Some of the things in which we are engaging our clients in terms of asset class are rates, credit and commodities. We believe that clients today need to be thinking in terms of inflation.
Certainly the current round of inflation has been driven by commodity price inflation, more so than in the past where labour price inflation has been a big push. Especially here in Asia, the region as a whole is a net importer of commodity goods and hence Asian Investors are generally negatively exposed to rising commodity prices not only in their investment portfolios but also in their businesses.
Is this something you have been recommending for quite some time?
We have been recommending this since around the second and third quarter of last year.
In the popular press however, the inflation story really began to appear when oil prices climbed above $100 per barrel.
There are a couple of ways in which inflation can be played out.
The first way is through commodities, which are not only an inflation hedge but also a good portfolio diversifier. We like soft commodities, which have not appreciated as much so far. While we like energy, we are not necessarily very bullish on energy from current levels. In fact, we believe that at current prices we could see demand destruction coming in from non-subsidised countries. Also as Asian countries increasingly dismantle their subsidy regime, we could see demand destruction and switch to alternatives in the region where demand growth has been among the highest in the last few years. However, having said that, we have maintained that energy is an important diversifier in a client portfolio and must be present in most portfolios. The exact nature of the product depends upon clientÆs individual risk-return profile.
Another way to gain exposure to the inflation and the commodity space is to invest in markets of commodity producing countries. Within the emerging market space, Brazil, Eastern Europe and Russia are net commodity exporters and despite the market turmoil this year, the equity markets in these countries have fared relatively well.
Inflation also impacts bond yields and hence applying strategy to reduce fixed-income durations in clientsÆ bond portfolios, while benefiting from the increased credit spread has been a strategy that we have been recommending to our clients for some time now.
What have you been focusing on in terms of your advice to your clients?
Credit has been our fundamental call. We are one of the few banks to have aggressively built up a platform to offer a whole range of credit products including derivatives. We see value in this asset class, even though we are somewhat bearish on long term rates and would like to hedge out the rate risk out of fixed income instruments.
Put simply, we feel that yields are likely to go higher in response to the fact that they are at a historically low level û which means the government bonds are at a historically high level û and also because when inflation continues to remain high, long-term bonds will likely be selling off.
At the same time we are finding a lot of value in credit as credit spreads have sold out, specifically in response to what has been happening in the US and Europe. But within that space, we like investment grade credit and we do not yet like high yield credit as much.
You have been recommending this for quite some time. Until when will these themes last?
For a long time to come. If you talk about a strategic portfolio, we would always like to maintain a certain percentage of a client's assets at any given point in time in fixed income assets.
For a client who is less risk tolerant, we believe that they should have even a higher percentage of investment grade credit in the portfolios because the volatility on that piece of the clients portfolio is expected to be lower and itÆs a great time to be adding that exposure from a valuation view point.
At the same time, we also want to strip out credit rate risk in a bond. If a bond has a longer duration, we reduce the duration by overlaying derivatives because we donÆt like the interest rate duration in a bond right now because thatÆs expensive on a historical basis. When an investor buys a bond, he is buying two elements û one of which is expensive, one of which is very cheap.
To give you an idea, investment grade bond as a universe is implying a 20% default rate going into the next five years. Even in the worse case, the default rate for investment grade bonds tend to be in the region of 2.4% to 2.6%, so you can see the amount of value in the investment grade universe that is being represented as an asset class.
How do structured products and hedge funds factor into your offerings?
From an investing stand point, hedge funds should be taken into consideration in clientsÆ portfolio as allocation to this asset class is likely to reduce overall portfolio volatility and this asset class tends to be less correlated to traditional asset classes like equities and bonds.
The decision about investing via structured products is secondary to the discussion about investing in a particular asset class. Structured products are a great way to create a bespoke product that fits in very well with a clientÆs specific risk-return profile.
How do your clients get exposure to equities?
When you decide you will do fixed income, you will do so through cash or structured products. For equities, thatÆs the same case. Currently, on an average, clients are not really looking to add incremental exposure to equities. Our clients use exchange traded funds, cash equities, mutual funds and structured products to gain exposure to equities. Structured products are also an important way to express hedging solutions on other equity exposure that the client may have in his portfolio.
Are you looking for innovative products, such as inflation-linked products for example?
We are looking at inflation-linked products but I personally donÆt favour inflation-linked products that are linked directly to the US or Europe price indices, which is pretty much the only tradable variety of inflation products available in the market today. The reason is that our clients in Asia are exposed to inflation in Asia and not necessarily to G3 inflation. We are looking at ideas which play inflation in Asia, and driven by very different factors compared with inflation in developed markets.
What kind of new products are you looking for?
Commodity linkages, because we believe that inflation in Asia is very much commodities driven. We are looking at any idea that reduces effective duration. Clients are looking at basic interest rate swaps, or buying swap options to hedge exposures to rates. For opportunistic clients, they may wish to make use of the high volatility in the rate space. This is very much dependent on the clientÆs needs.
Within an equities allocation, we will probably want to tilt allocation within countries that are commodities producers and exporters rather than to those who are net commodities importers.
We are also looking at private equity and hedge funds. While it is very difficult to precisely forecast the price of oil, we do believe that the way the whole energy landscape is evolving and current elevated energy prices imply a much higher entrepreneurial activity both in the traditional and alternative space. Getting exposure to private equity funds that play out that theme makes a lot of sense.
Another way of playing private equity and hedge funds is potentially in the area of farm land. Farm land presents many opportunities today. On one hand, demand is increasing û driven by consumers changing food habits (switching to more protein rich diets) and on the other hand, arable farm land is in scarce supply driven by competing land use. Additionally, yields are not rising at the same rate as they once were driven by scarcity of irrigation resources and changing weather patterns driven by global climate change. Farming skills are getting scarcer as the most talented work force does not want to take a career in farming.
While the entire upstream (seeds, pesticides) and downstream (logistics and transportation) can be played through listed companies, there are not many companies engaged in the midstream (farming) that are listed entities. We are looking at private equity and hedge funds-type opportunities to let us have our clients get access to these midstream farming opportunities.
What is your client profile?
Our typical clients across Asia are entrepreneurs. They are mostly around 50 to 60 years old. They have a second generation who, from an educational background, is a little bit savvier. Some of them are even from the Ivy League schools. As a result of their education and upbringing, they tend to be somewhat more westernised in their thinking and outlook. Some of the second generation is slowly trying to get involved in the family business. In cases where the second generation does not want to get involved in the family business, the family patriarch may try to monetise their business.
Over the years, as the clients have been through many investment and business cycles, they have become a lot savvier from an investment stand point. The client has been around, has experienced the good and the bad in the markets, and has seen the risks. The second generation is also getting into the whole equation in terms of relationships. They probably have an education from the US or Australia, so they command theoretical knowledge which they bring to the conversations. Therefore it is important to connect with the relationship at multiple levels.
The September edition of AsianInvestor magazine contains a feature on private banking trends in Asia.
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