Market views: Where can instos find defensive assets?
Global stock markets have staged a turnaround, ascending from the deep trough into which Covid-19 pushed them just a few months ago. The MSCI World index, for example, has risen 37.3% from March’s low thus far as of June 26.
The exuberant rally, on the other hand, looks too good to be true, with some experts predicting a more painful and abrupt decline than the previous one.
“Arguably, the worst false dawn seen during the Great Depression years occurred in the period from November 1929 to April 1930,” Duncan Lamont, head of research and analytics at Schroders, said on June 23.
“The market soared by 48% in only five months. What happened in the next two months? A 30% fall. What happened in the next two years? It fell by another 80%,” he added.
Moreover, the elevated equity and bond markets are not immune to headwinds such as potentially bleaker-than-expectated economic data, a second wave of coronavirus outbreak, and the recent surge of political uncertainty across the US, China, India and Korea.
Meanwhile, traditional safe haven assets such as the US Treasuries may not offer investors the same level of protection. Cash, for example, was bashed by Australian superannuation fund Hostplus’s chief investment officer Sam Sicilia as being the riskiest asset class.
As central banks carry on with their quantitative easing drive, even the most fundamental diversification theory – the 60/40 ratio of equities and bonds – is being challenged. So investors are going to have to get creative in finding defensiveness for their portfolios.
In this week’s market views, seven contributors look into how investors can shield their portfolios from further downturn in asset classes spanning from equities, fixed income to real estate.
The following extracts have been edited for clarity and brevity, and appear alphabetically by asset class.
ALTERNATIVES
Sumit Bhandari, lead portfolio manager for Asia private credit
Allianz Global Investors
We believe investing in Asian companies whose business models are supported by time-tested long-term secular trends is attractive. Middle market companies in Asia face persistent structural credit deficits created by bank retrenchment.
The onset of Covid-19 hasn’t changed our approach towards private market investing. We invest in businesses which are driven by exposure to underlying fundamental demand that is resilient and provides those businesses with capital structures that are fully funded. Consumption patterns for households tend to be sticky and have a predictable growth profiles, and household spending is the most important part of aggregate demand in Asia. Where the rubber meets the road is how to invest in businesses that are defensive within these themes.
In the current scenario, we think it’s key to invest in businesses which will see limited impact on demand, such as telecom towers, pharmaceuticals and data centres, or sectors that will show a quick recovery (healthcare, education, business software etcetera).
It is true that current travel restrictions pose challenges to an investor’s ability to diligence assets and business owners. This is where having a team with a long history and knowledge of companies and potential borrowers are helpful, as well as, to partner with blue-chip financial sponsors and help them with new acquisitions and portfolio company management.
Steven Brown, senior portfolio manager
Steven Rodriguez, portfolio manager
Chris Chen, senior investment director
American Century
Global Real Estate covers many defensive property sectors, among them, are technology-related sectors like data centres and cellular towers. As the globe becomes more connected through web and data devices, and the work from home environment persists, these sectors, which possess defensive attributes, will see continued demand growth.
In this space, we like Equinix and GDS Holdings Sponsored ADR Class A. Other sectors include Industrials, as the secular trend of e-commerce penetration has risen dramatically over the last decade, and that accelerated through coronavirus lockdowns, will continue to benefit these warehouses. We like Prologis in this space.
Also, affordable mass-market rental housing is generally undersupplied; as a result, this property sector has a structural demand/supply imbalance and is, therefore, less impacted by the economic cycle. Midway through a tumultuous 2020, many of the companies in these property sectors have actually seen their business outlook improve.
Though companies in these sectors are not guaranteed to win, therefore the investment process requires a thorough analysis of business models, balance sheet management, macro events that could alter property fundamentals, and they still must be able to execute on their business models.
Shawn Khazzam, head of Asia Pacific alternative solutions
JP Morgan Asset Management
We think institutional investors can find defensive characteristics in a number of core real estate assets and sub-sectors, as these properties tend to have long-term stable cash flows and high tenancy/occupancy rates given their high quality.
For example, in Asia, we specifically continue to like logistics properties that will benefit from accelerated growth of e-commerce as well as Japan multi-family properties that are beneficiaries of demographic trends.
When it comes to logistics properties, particularly in China, this sector is growing rapidly as online shopping increases. High-quality logistics properties in China are still in short supply, making them attractive investments. However, investors still need to conduct appropriate and rigorous due diligence, including on the ground research.
EQUITIES
Chris Dyer, director of global equity
Eaton Vance
In any market environment, we believe that investors must focus on the sustainability of each company’s business model. In the US, much of the defensiveness in equities has been driven by the so-called Faang stocks – Facebook, Amazon, Apple, Google and Microsoft. These companies are at, or very close to, their all-time highs and represent more than 20% of the S&P 500. How much higher can these stocks run should the growth and momentum factors propelling them give way to value and cyclical leadership in 2020?
In contrast, European equities are trading at historically low valuation levels versus their US counterparts. In our view, there are some compelling reasons we think European equities are well-positioned for the long term, including low-interest rates, relative valuations and geographical market rotation driven by mean reversion.
We are seeing the global economy start to reopen, at different paces in different regions and countries. The effects of emergency fiscal and monetary stimulus appear to have significantly bolstered the global and the US economy. However, the full trajectory of the coronavirus and the economic repercussions have yet to be seen. We believe it is important to monitor the pace of economic reopening globally as there is likely to be a persistent tug of war between attempts to revive economic growth and contain the virus.
Flavia Cheong, head of Asia Pacific equities
Aberdeen Standard Investments
Investors should focus on the firms that are best positioned to weather the Covid-19 storm, and consider what normalised company earnings would look like. We like the technology sector, which remains underpinned by structural growth drivers such as cloud computing, data centres, 5G and digital interconnectivity.
The longer the Covid-19 pandemic persists, the more the disruption to economies will stymie recovery. A second wave of infections in countries where curbs were lifted too early also remains a key risk.
Moreover, any flare-up of US-China tensions and the fractious run-up to the US presidential election this November presage further volatility. Although sustained stimuli from governments and central banks will offer continued support to markets, investors should remain cautious.
Progression of the pandemic has varied considerably across Asia Pacific. We see risks to the economy and even social stability in countries such as India and Indonesia. At the same time, many Asian governments have proved adept at managing this crisis.
Although investors need to be mindful of risks on the horizon, the market appears largely to have priced these in. Even taking the recent market rebound into account, Asian equity valuations remain undemanding. Areas of interest include premium consumption in segments such as health care, wealth management and insurance; adoption of technology services such as the cloud and rollout of 5G; and the region’s growing urbanisation and infrastructure needs.
FIXED INCOME
Wilfred Wee, portfolio manager
Ninety One
China’s fixed income markets, onshore renminbi bonds as well as offshore US dollar bonds, cover a large and increasingly diverse opportunity set. The onshore renminbi bond market, in particular, offers yield pick-up and diversification benefits.
It is key to distinguish any headline noise from China's bond asset class, and how it actually provides return potential. Empirically, over the last five years of extreme growth headwinds and geopolitical negativity, as well as the strength of the US dollar, investing in a portfolio of China bonds would still have given investors a generally positive dollar return experience. While history is no promise of the future, we expect this is likely to be the case going forward, given the starting level of yields today and the overall resilience of the Chinese economy.
Familiarity and mutual acceptance of the asset class is one hurdle. It has been just over five years since the onshore China bond market opened to foreign investors with the introduction of the various bond access schemes.
As China’s weight goes up in other mainstream indices, it will be natural for institutional investors to re-assess their China bond allocations. Issues of liquidity, valuation and credit risks are not dissimilar from other emerging domestic bond markets. Foreign investor accessibility has its specificities but is increasingly easier. Importantly, unlike the case for the bond markets of smaller economies, domestic China growth-inflation dynamics and technical factors tend to dominate price behaviour in this market.
MULTI-ASSET
Mark Robertson, head of multi-strategy
Aviva Investors
The traditional source of defensive assets is duration positions. While the inclusion of bonds will likely improve outcomes through risk reduction, return generation is unlikely to be at anything like the levels seen for an extended period. The extent to which yields have declined means that additional types of diversification strategies might be helpful to those currently setting their strategic asset allocation.
Multi-strategy investors have the flexibility to access a wide range of defensive strategies. Hurdles such as high levels of corporate debt can restrict the opportunity set available to long-only investors but can be beneficial for those able to take relative value equity positions.
Our Good Balance Sheet vs Russell 2000 strategy systematically runs a long position on an index of companies within the Russell small-cap stock universe with balance sheets that can be broadly defined as robust. Against this, we hold a short position on the Russell 2000 Index. This strategy explicitly takes advantage of the quality factor, which has previously worked well in environments of slowing earnings growth with declining interest coverage ratios, such as we are now in.
Joe Marsh contributed to this article.