Market Views: What are Asia’s best safe haven assets?
After the record high returns in global markets last year, the first six months of 2018 has seen markets struggle to meet the same level of return.
The MSCI emerging markets and world indices, for example, have posted year-to-date returns of -6.66% and 0.43%, respectively, after returning 37.28% and 22.4% in 2017.
Volatility spiked sharply too. In 2017 the CBOE Volatility Index (Vix) most traded between 10 and 12 points, but in early February it spiked to 37.32, and while it has dropped it remains well above its previous range.
Adding to market uncertainty is the decision by more central banks to shift from quantitative easing to quantitative tightening. The US Federal Reserve, for example, began normalising its balance in October 2017, and the European Central Bank kicking off tapering measures in January 2018. And on Thursday the Bank of England raised its bank rate for only the second time since 2009, increasing it by 25 basis points to 0.75%.
All of this is taking place against a backdrop of increasing trade frictions between the US and the rest of the world, particularly with China. On July 6, president Donald Trump's administration hit $34 billion of imports from China with a 25% tariff, and this will eventually grow to cover up to $50 billion of imports. It also began to impose a further 10% tariff on $200 billion of Chinese imports – a figure that could increase to 25%, according to recent media reports.
Asian markets have not been immune to these events, with the Shanghai Composite Index, the Hang Seng index, and the Korea’s Kospi composite index all down double digits from their late January peaks, as of August 2.
We asked a private banker, an emerging markets investment specialist, an Asian equities specialist, and a multi-asset investment director where to find the best safe haven assets in the region.
The below responses have been edited for clarity and length.
James Cheo, investment strategist (Singapore)
Bank of Singapore
By definition safe haven would mean that these assets would do well or be relatively resilient in whatever situation, but from our perspective we think things in terms of risk-reward. So given the current situation, we think that where greater opportunity, in terms of risk-adjusted returns in the second half of this year, would probably be is in high yielding bonds, especially from those in emerging markets.
That's really because fundamentals for credit are still fairly attractive, and also in terms of valuations in the first half of this year, in terms of spread, it has widened somewhat, so now it looks like a fairly interesting entry point for investors. So in terms of our asset allocation we have actually turned overweight on emerging market high yielding bonds. We just made the upgrade a few days ago.
In Asia, it's definitely Chinese bonds. So in China we want to be fairly selective and look at the larger Chinese companies with stronger fundamentals and higher quality, especially the developers. Of course, you have to be very careful in your selection of these bonds. For this month, that's our key decision and where we've made our shifts. We have been fairly cautious, holding quite a lot of cash, and this is one area that we are starting to deploy into.
Where we are avoiding right is the investment grade bond space, especially bonds with higher duration. We want to be a bit more cautious because we're in a rising inflationary environment and rates are set to continuously rise, especially developed market government bonds. We have to be very careful in terms of having exposure there. We have been underweight on investment grade since late last year.
Janet Tsang, investment specialist for emerging market and Asia Pacific (Hong Kong)
JP Morgan Asset Management
For investors concerned about volatility, income-generating equities can provide a slightly more defensive approach, as these shares provide an income and tend to have a lower volatility profile than the broader market. Dividends are an integral part of total returns from investing in stocks. They are also the most stable component of returns – whether it’s a bull or a bear market, you still receive the dividend.
Asia Pacific ex-Japan currently has more companies yielding more than 3% than Europe or the US. In emerging Asia stock markets such as China and Korea, government and company reforms to encourage higher payouts are underway. And developed Asia stock markets like Australia already have a well-entrenched dividend culture. With nearly 300 listed companies on the MSCI AC World Index from Asia paying attractive income, there is a lot more to choose from than investors might expect.
That said, not all dividend yields are created equal. High yield can be the result of a high dividend (typically found in reliable but boring sectors like telecoms or [real estate investment trusts], known as ‘low beta’ stocks) or a low stock price (typically found in cyclical sectors such as financials and energy, known as ‘value’ stocks). Diversified dividend investing includes both low beta stocks, which offer some cushion against volatility, and value stocks, which provide more upside potential.
On the bonds side, diversifying into fixed income can help to balance out the risks of holding stocks. Over an average 12 month period, fluctuations in Asian equities tend to be significantly bigger and more frequent than in bonds, making them a good stabiliser for a balanced portfolio.
In what is sure to be a continued volatile period for Asian equities, investors can harvest consistent yield and mitigate volatility by tapping into sources of income across dividend paying equities and bonds.
Mark Tinker, head of Framlington Equities for Asia (Hong Kong)
Axa Investment Managers
Investors are currently said to be looking for safe havens in Asia, but where and what they are depends on the different types of investor and how they balance acceptable risk and required return.
If you want a safe haven, to reduce your risk, you need to accept a lower level of return. The ultimate safe haven is cash, but for most investors this is a short term tactical trade, especially with inflation adjusted rates being almost universally negative. Currently the equity and bond markets have heightened volatility risk, which means that traders have certainly cut their gross and net exposures, reducing leverage and liquidity. Longer term investors however, for whom volatility is not a problem and is thus a risk they are prepared to be paid to accept, are not changing their asset allocation.
On the other hand, many of them are moving within asset classes because of perceived benchmark and credit risk. The most obvious example of this is the allocation between emerging markets (EM) and developed markets (DM) and I would suggest that it is a classic EM/DM rotation that is underway at the moment.
As such we have a reasonably familiar playbook to work from with the US dollar playing a lead role. At the end of the second quarter, a stronger US dollar triggered a rotation out of EM back into DM, and while the concern over trade wars has been the economic rationale to justify selling, much of the activity has been to reduce an overweight position in EM equity and debt.
For companies and indeed countries that have borrowed in US dollars, local currency weakness also presents higher credit risk, which has led some bottom up stock and credit fund managers to reduce exposure to companies with poor quality balance sheets. This movement has been exaggerated by a structural shift to tightening of liquidity conditions in China as the authorities seek to deleverage the shadow banking system.
Thus the trader sees their safe haven as more cash and reduced leverage while the asset allocator at the long term institutional investor sees their safe haven as hugging the benchmark and the bottom up manager moves to higher quality balance sheets.
To me, these current market conditions are not particularly unusual and nor are the responses. At some point the traders will put on more leverage and the asset allocators will rotate back into EM — although this time I believe that they will carve Asia and particularly China out from the rest of EM. In the meantime the bottom up managers are looking for value situations where high quality stocks and bonds have been oversold.
Jerome Nunan, investment director for multi-asset (London)
Aviva Investors
Markets have been very calm in recent years, almost regardless of asset class or region. Indeed, for many investors the lack of volatility has been both a challenge as well as a source of confusion. We believe that the outlook for the global economy continues to be very positive. We expect that momentum will continue to build, with global GDP rising from 3.8% in 2017 to 4% in 2018, and similar growth next year.
However, there are meaningful risks that could derail this benign outlook. These include the impact of rising tensions on global trade or the possibility of the Chinese economy slowing more than expected. Equally, a stronger US dollar could impact those emerging market economies that have become overly dependent on dollar funding.
Investors can incorporate strategies into their portfolios that could provide a degree of protection against some of these risks. As a key provider of commodities used to power infrastructure expansion, Australia has become very sensitive to any slowdown in Chinese growth. For this reason, we like Australian duration as a way of hedging this risk.
Equally, we believe that exposure to China via supply chain linkages means that countries such as Korea and Taiwan would be sensitive to an escalation of the current trade feuds. So short positions in the Korean won or Taiwanese dollar are not only an efficient way of getting exposure to US dollar at a time that the [Federal Open Market Committee] is in hiking mode, but they also mitigate some of these trade war risks.