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Thriving in a tough investment climate
- Vincent Mortier, Deputy Chief Investment Officer, Amundi Asset Management
- Michael Hasenstab, Chief Investment Officer, Templeton Global Macro at Franklin Templeton Investments
- Al Clark, Global Head of Multi-Asset, Nikko Asset Management
- Julien Lepine, Vice-President and Senior Investment Strategist - Asia-Pacific, at State Street Global Advisors' Investment Solutions Group
Moderator: Francis Kan
Business Times: What asset classes show the most promise in the current environment and why?
Vincent Mortier: We live in a very low bond yield environment, and that will remain the case for a long period of time. In this context, the search for yield will continue to prevail.
Over the past few months, all asset classes have recoupled as if there was one single global economic cycle: that is not consistent with the decoupling we see between economies - for example, services versus industries, oil producers versus oil importers.
Equity markets have recently overreacted on the downside, it's more a financial stress than an economic crisis, and we expect central banks to react with more accommodation, notably in the eurozone. Stock markets on a medium-term horizon remain the most promising asset class even though we can expect a bumpy road ahead.
Julien Lepine: We expect that the global markets in 2016 will continue to be weighed down by concerns about China's growth, the strengthening US dollar and ongoing pressure on oil and commodity prices. Against this backdrop of slow growth, low inflation and tepid investment returns, we believe that defensive assets classes, such as cash and bonds, will show the most promise in the current volatile environment with its focus on income generation.
Al Clark: It is a tough investment climate going into 2016. In this type of environment, we are treading carefully, only adding capital to assets that satisfy the following three criteria: cheap valuations - so we are adequately compensated should the risks escalate; stable momentum - with many assets selling off, we are at a minimum looking for some stability in an asset's price but more importantly stability in its earnings; supportive macro backdrop - favouring beneficiaries of lower oil and commodity prices and avoiding those at ground zero for the recent volatility, such as commodity producers.
Unfortunately in equity markets only a few clear these hurdles: Japan, North Asia and some parts of Europe. US equities are interesting but we believe that they are not cheap enough to compensate for the growing risks in the US economy.
Credit markets offer more promise with the significant widening in spreads providing useful valuation support. We are inclined to stick to our long-held mantra of high quality, low duration in credit markets and so favour US and Asian investment grade credit, with high-yield markets still susceptible to poor momentum and macro headwinds.
Michael Hasenstab: We are currently seeing compelling valuations across specific areas of the local-currency bond markets and across select currencies. The depreciations of several emerging market currencies during the ongoing periods of market volatility have been excessive, in our view.
We've used the volatility to add to our strongest convictions within the local-currency markets, and we expect underlying fundamentals to re-emerge over the medium term. Specifically, we see value in select countries that offer positive real yields but don't have undue interest-rate risk by our assessment.
We prefer some of these select local-currency bond positions in countries that we believe have solid underlying fundamentals and prudent fiscal, monetary, and financial policies.
Additionally, we favour the currencies of countries where growth remains healthy and inflation pressures have increased, yet the local currency remains fundamentally undervalued. On the whole, we currently find several local-currency areas of the fixed income markets attractive on a risk-adjusted basis.
BT: What are the key risks that investors should look out for?
Vincent Mortier: In emerging economies (mainly Asia and Latin America) corporate debt denominated in US dollars has surged since 2008; the depreciation of Asian currencies has weakened further these corporates.
In the US, corporates have re-leveraged. In the energy sector, defaults will surge as a result of the oil price fall. Financial stress at a global level (as well as in the US) has surged to levels unseen since 2011. Hence credit risk is a key factor to monitor.
The situation in China also requires a close monitoring, in particular the resilience of the internal consumption is key to avoid a "hard landing" scenario.
Finally, central banks interventions need to be well calibrated and communicated to markets, which is a growing challenge in an ultra-low interest rate environment.
Julien Lepine: China's continuing economic slowdown is widely seen to be the most likely cause for further unease in 2016, and we believe that the yuan will be a key determinant of global economic performance for this year, as a large yuan devaluation would likely devastate Chinese industry.
Other key risks that investors should look out for include geopolitical events from conflict in the Middle East to instability in Europe, the US Federal Reserve's cautiousness and structural challenges, which will all play their part to increase uncertainty and, through that, volatility.
Al Clark: In the same way that equity markets suffered a dramatic repricing in January as fears of deflation permeated markets, government bonds could suffer a similar fate should those fears subside.
The degree of manipulation in sovereign markets is significantly more extreme than in equity markets so the damage could potentially be more.
We prefer cash as our defensive asset in portfolios given the asymmetric return profile currently offered by government bonds.
Michael Hasenstab: We continue to believe that fears of global deflation are unwarranted and that interest-rate risks are being broadly underappreciated.
We think inflation could surprise the markets. In our view, markets have overestimated the extent to which lower headline inflation reflects structurally weaker global demand. Supply factors have been the main driver behind falling energy and commodity prices, which in turn have pushed headline inflation lower.
These are short-term effects, and their disinflationary impact should wane as commodity prices stabilise. The belief that inflation has become structurally lower has made some investors complacent in taking interest-rate risk, in what we believe is a dangerous part of the yield cycle.
In our view, there are more risks to inflation moving to the upside than to the downside, yet markets appear to be pricing in deflation and downside risks. Any normalisation of inflation pricing in global bond yields and in US Treasuries would drive yields higher.
BT: Which geographic markets do you expect to do well in the coming year?
Vincent Mortier: The economic cycle in the eurozone is still at an early stage - we expect monetary and financial conditions to remain accommodative, and profits should gradually recover.
That is not the case in the United States where the share of profits in gross domestic product is close to an all-time high.
In addition, the gap between dividend yields and bond yields in the eurozone is at historical highs, which should be favourable for equities versus bonds.
Julien Lepine: Europe has the potential to be a key investment area for four reasons: the European Central Bank's (ECB) keenness to support the market may lead to additional rounds of quantitative easing (QE); relative valuation of European stocks is attractive compared to that of the US; weak euro, low interest rate, low raw material prices and low energy prices create strong market conditions; earnings have gradually picked up and growth is now expected to improve in Europe, albeit at slow pace.
In emerging markets, a trio of factors could possibly reignite the fortunes namely, China and the associated commodity trend, foreign exchange and local debt dynamics, and the pace of reform programmes.
Michael Hasenstab: We currently see attractive valuation opportunities in select countries across several regions and, at the same time, we see countries within those very same regions that we avoid.
We believe that investors should not look at emerging markets or regions as a whole, but instead to need to distinguish among very different individual economies. In Latin America, we currently find Mexico to be exceptionally undervalued, but we are avoiding countries such as Venezuela that have high oil dependency and policy concerns.
In Asia ex-Japan, we see value in countries such as Malaysia and Indonesia that are being priced as if conditions are worse than they were during the Asian financial crisis, yet there underlying conditions are fundamentally much stronger, with larger foreign reserves and healthier economies.
A strengthening US economy, along with the likelihood of higher US interest rates, may increasingly magnify these fundamental differences between healthy and vulnerable economies. We anticipate that countries with relatively stronger fundamentals, such as Mexico, will likely be in a better position to potentially raise interest rates in conjunction and in advance of US interest-rate hikes. However, countries with relatively weaker fundamentals, such as Turkey and South Africa, are likely to be negatively impacted by US interest-rate hikes.
BT: How can investors best ride out the current volatility?
Vincent Mortier: Volatility has come back, and investors should get used to it. In this environment, volatility products are an interesting add-on to portfolios. Macro hedging can also be realised through the purchase of US Treasuries. Gold would be a protection against systemic risks.
Al Clark: The level of manipulation and experimentation currently being thrust upon markets by central banks makes it difficult to have a high degree of conviction in investment views. It is hard to know the possible outcomes of these unprecedented experiments, and - at any time - the central banks may change the rules without warning.
We recommend maintaining a liquid and well-diversified portfolio with the capacity to adjust allocations quickly and efficiently. With this level of flexibility, investors are able to adjust to any new curve balls that the central banks may send their way
Michael Hasenstab: We continue to recommend a patient assessment of the underlying fundamentals while resisting the impulse to overreact to the near-term volatility.
When investing globally, many investment opportunities may take time to materialise, which may require weathering short-term volatility as the longer-term investing theses develop. Markets are currently in a state of transition from a period of high commodity prices to low prices, from zero interest rates in the US to rising rates, and from China growing at double-digit rates to moderating and rebalancing its economy.
This has caused market volatility, but we believe that markets have over-sold the risks. We believe that when commodity prices stabilise and when the US Fed continues to hike rates while China's economy appropriately moderates, markets will be in a better position to drive valuations back towards what the underlying fundamentals justify.
BT: What is the one piece of investment advice you want investors to take away with them?
Vincent Mortier: We should not underestimate the commitment of the authorities - both central banks and governments - to contain financial stress. At the end of the day, economic fundamentals should prevail and equity markets remain attractive in the medium run if financial stress abides.
Julien Lepine: Investors will still require some level of exposure to growth assets even as volatility looks set to remain.
Our four investment ideas to help investors navigate through highly volatile market are: adopt managed or low volatility strategies to target lower volatility and smaller drawdowns by investing in lower beta stocks; set up a target volatility trigger as a downside risk protection programme on top of your allocation; target the right asset mix depending on market conditions; and consider liquid alternatives, leverage, and global macro funds, which can also play a role by generating absolute returns while managing total portfolio risk.
Al Clark: No one knows what is going to happen in the future.
Michael Hasenstab: We believe that investors are best served by sticking to sound, well-researched investment convictions and avoiding the impulse to reactively sell during periods of excessive risk aversion.
Overall, we see significant investment opportunity amid the volatility and believe that markets have over-sold the risks. We expect underlying fundamentals to re-emerge, and we currently see several opportunities for longer-term investment value.
Conditions currently feel a lot like they did during the financial crisis in 2008 and 2009, when we were buying into emerging markets that were completely out of favour with the entire investor base.
In fact, recent discussions we've had with investors in Asia indicated that their least favourite asset classes are currently emerging markets and local currency markets. We feel we've reached a point of maximum pessimism on emerging markets, and those types of extreme sentiments usually indicate an opportunity.