Hong Kong-based Silverhorn Investment Advisors has seen most of its clients switch out of directional credit and equity strategies and park as much as 30% of their portfolios in cash, amid the ongoing market turmoil.
Historically a lot of the multi-billion-dollar wealth manager's clients have had 30% in credit exposure in the past three to four years, particularly in Asian high-yield bonds, said Mike Imam, managing partner at Silverhorn. But that figure has fallen to zero or single digits for many of them.
“[Credit] spreads have not really widened as much as people talk about, so it remains a very difficult asset class from a directional perspective at the moment,” he noted. “At this stage we don’t like directional credit at all.”
While Asian high yield did grind down last year, it still held up very well, added Imam, with the JP Morgan Asia Credit Index up by 2.80% for 2015. But the future is looking less rosy for such investments.
The main concern for credit for the coming year is the potential impact of the anticipated US interest rate hikes, Imam said. “Corporates in Asia have releveraged their balance sheets using cheap credit. Some have been able to finance themselves too cheaply and/or by gearing themselves more than is ultimately healthy. This situation is particularly worrying for high-yield credit.”
Moreover, more bond defaults in China last year – particularly Baoding Tianwei, the first state-owned company to default – have shown there is no quasi-state support for everything ultimately owned by the government, said Imam.
“The mindset of Chinese clients is changing,” he noted. “They are starting to realise that risk is eventually going to be more and more priced by a market mechanism than fully controlled by the government. For proper pricing of risk, this is ultimately a good development.”
In addition, now that investors expect a negative carry on renminbi from a dollar perspective – given the yuan is expected to go on weakening against the greenback – offshore RMB issues are much less in demand, added Imam. Hence they’ve become more properly priced versus dollar issues of the same or similar quality.
Dumping directional equity
Meanwhile, already during 2015, many Silverhorn clients have taken money out of directional stock exposure and put it either in non-directional equity – such as market-neutral strategies – or cash, said Imam. Over the past two years or so, their biggest allocation of risk assets has generally been to Asian equities, with some exposure to US stocks.
In the current environment, he noted, most of his firm's clients are happy to have at least 20-30% of their portfolios in cash, as they are seeking real or absolute returns. “Unlike a lot of benchmark-referenced mandates, many of our clients allow that kind of allocation to cash.”
Silverhorn has cut down its directional equity exposure because it does not see any directional momentum in developed markets such as Europe and the US. And the MSCI Asia-Pacific Index is down some 10% in just over two weeks since the start of the year.
“We would rather hold equities through either market-neutral managers in the hedge fund space or really good stock-pickers,” said Imam. “By design they carry less broad market beta and have the ability to generate skill-based returns in a difficult environment.”