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Funds seek opportunities amid 'lower for longer' setting

Be it emerging market debt, alternative assets or rotational plays, investors are trying to come to terms with the low-yield environment

As bond prices continue to defy gravity and central banks cause bond yields to plummet to historic lows, the financial world is grappling with the implications - even as it vainly encourages savers to take more risk to achieve returns.


A FUND house is preparing to launch a global long-short equity strategy. Another is buying emerging market local currency debt in India and Indonesia. And a fund manager is rotating from expensive consumer and tech names into cyclical stocks like US banks and energy stocks.

As bond prices continue to defy gravity and central banks cause bond yields to plummet to historic lows, the financial world is grappling with the implications - even as it vainly encourages savers to take more risk to achieve returns.

Andrew Formica, CEO of Henderson Global Investors, told The Business Times that the "lower for longer" scenario - lower economic growth leading to lower interest rates for a longer period of time - could easily last another five years. "I don't think people are taking more risk, people are taking less risk," he said.

"Quantitative easing was designed to encourage investing. But what you're seeing is cash pools at increased levels. People are worried, (seeing what central banks) are doing, that things must be really bad."

But Mark Matthews, Asia head of research at private bank Julius Baer, said some investors are being pushed into high-yield bonds, emerging markets, or real estate investment trusts.

"Anything in the world with a yield of 5 per cent or more will be given even greater benefit of the doubt," he said.

Low Guan Yi, who manages Asian local currency bond portfolios at Eastspring Investments, is buying Indonesia and India bonds, seeing "substantial room for rallies". Valuation models are being reassessed, she said. "If there's negative yields in Japan and Europe, and a very delayed Fed hike, government bonds which we previously thought were expensive probably do not look so now."

The central bank-induced rush into bonds has led to trillions of dollars of bonds with negative yields, notably in Europe and Japan. In some cases, investors hungry for income are forced into alternative assets.

Hedge funds that offer daily pricing, known as liquid alternatives, have been popular because they promise investors some returns while mitigating market volatility.

Henderson, which managed £92 billion (S$164 billion) in 2015, is planning to launch a global long-short equity product by the end of this year. Said Mr Formica: "A lot of people are now looking for absolute return, market-neutral capabilities as a diversifier from fixed income."

Direct commodities and agricultural investments could also effectively diversify one's portfolio, he said. "Another area is sustainable investing. People are starting to look at demographic shifts, climate changes, and areas that capture these trends."

Elsewhere in the market, investors are rushing into "quality stocks" like consumer staples and tobacco stocks.

These stocks generally possess strong and stable cashflows with rock-solid balance sheets. They have become very popular because of the steadily growing dividends they can pay out. The rush to quality, along with the pound depreciation, had caused UK's FTSE 100 Index to trade higher than its pre-Brexit levels.

Julius Baer's Mr Matthews thinks the UK has opportunities. "The UK has the highest weighting of quality stocks in Europe," he said.

The rush for quality in the past year has prompted some to take profit, not necessarily by choice.

At Columbia Threadneedle Investments, Stephen Thornber, who manages US$5 billion worth of funds in global equity income strategies, sold US stalwarts McDonald's and Microsoft this year due to the income fund's mandate of not owning equities that yield less than 3 per cent.

Both companies have rallied 20 to 30 per cent in the past year, but their dividend yields were pushed below the 3 per cent floor.

Mr Thornber told BT that another "safe" UK stock that saw heavy investor demand post-Brexit was consumer giant Unilever. The firm sells well-known brands like Dove and Lux soaps, Knorr stock cubes, Lipton tea and Magnum ice cream.

It is up some 15 per cent compared to a month ago.

"I've been a fund manager for 25 years, I don't remember Unilever at (24) times earnings, the average was probably close to 16, 17, and a lot lower during difficult times," he said.

Mr Thornber is looking instead at some badly-beaten industrial stocks like General Motors and Daimler, which trade at single-digit multiples.

He has been buying energy stocks and banks on the sidelines, raising their proportions within his portfolio by a few percentage points each.

Meanwhile, he is sitting on gains from North American theme park operator Six Flags. Savings from cheaper oil are being spent on mass market items like tobacco, food and drink, even as the US consumer becomes more confident with full employment and rising wages, he noted.

"People feel slightly better about themselves," he said.

Henderson's Mr Formica, a former equities fund manager himself, thinks pharmaceuticals are attractive.

"They capture demographic trends, are better with cash discipline, have a good balance sheet and are throwing off cash," he said.

Meanwhile, given uncertainty in Europe, upcoming elections in the US and rich valuations, emerging markets are looking more interesting, Mr Formica said.

He is not alone in eyeing the asset class. Flows into emerging markets have picked up this year, as hard-hit countries like Brazil saw their currencies appreciate significantly.

The rally in Brazilian bonds still has some way to go, said Andre de Silva, HSBC's head of global emerging markets rates research. He is targeting a 9 per cent yield on Brazil's 10-year local currency bond. Yields were close to 17 per cent at the beginning of the year.

Mr de Silva is also targeting a 6.5 per cent yield on Indonesia's 10-year local currency government bond, from 7 per cent currently. In Asia, sentiment has improved on local currencies once endangered due to a Fed rate hike and a Chinese yuan devaluation. Now, the yuan is still depreciating but markets have shrugged it off.

Eastspring's Ms Low explains it thus: "Just as there's a recognition that Brexit is not a systemic crisis, there's a recognition that the Chinese have not lost control of their currency and economy."

Neeraj Seth, head of Asian credit at asset manager BlackRock, said emerging market debt has enough growth and yield to be attractive, while currencies have also stabilised. In Asia, he likes local currency and US-dollar denominated debt in India and Indonesia, while being cautious on the hard commodities sector.

In the developed world, it is harder to figure out what yields mean because they reflect central bank action and not just slow economies, he said.

He thinks the US 10-year yield will trade between 1.25 per cent to 1.6 per cent this year. Mr Seth is sanguine about the ongoing South China Sea disputes. He said China has not been involved in conflicts through traditional warfare in its history. "I won't put a high probability on tensions going out of control."