Navigating volatile markets - 3 investment themes to consider

WE are only 2 months into 2022 and it is shaping up to be a very challenging year - with inflationary concerns accelerating imminent rate hikes, continuing Covid outbreaks and geopolitical risks including the current Russia-Ukraine situation and the ongoing US-China tensions.

Amid these challenges, there are underlying opportunities. However, selectivity and active management remain key.

The slow unbundling

One of our key themes is what we call "the slow unbundling", in which the United States and China continue to diverge in terms of monetary policies, pandemic/endemic management, and strategic priorities. This unbundling will have consequences for developed and emerging market assets alike.

Although earnings dynamics have lagged, in part because stringent Covid-19-related restrictions have crimped economies in the region, we see equities in Asean countries as well-placed to play catch-up with equities elsewhere. Undervalued Asean equities also represent a way to play attempts to revive Chinese growth, without taking direct exposure to China. In the longer run, they could benefit from the ongoing relocation of major manufacturing facilities away from China.

On the trade front, the Regional Comprehensive Economic Partnership is a major milestone in the Asian growth story. The Asean countries will benefit from the increased trade flows and longer-term China secular growth.

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Over the past decade, Asean's growth has paled in comparison with China's stellar growth. The tide could now be turning with the bloc's promising outlook - it is now the fourth largest exporting region, after the European Union, US, and China, and on track to be the fourth largest economic bloc by 2050.

Asean is also on a more sustainable path now - having transited from a phase of economic re-leveraging and double-digit credit growth following the global financial crisis, to handling challenging tax reforms and starting various infrastructure investments over the past 10 years.

While the growth path ahead would be uneven with Covid continuing to create further uncertainty, the prospects for Asean continue to be strong.

Several Asean countries are reaping the so-called demographics dividend, with a younger workforce and higher fertility rates. The bloc is also benefiting from global supply chain migration, which was triggered by US-China trade tension and disruptions due to stringent Covid lockdowns. The gradual reopening will also benefit tourism. Thailand had one of the world's highest tourist arrivals, pre-Covid.

Too big to fail

The other theme specific to Asia is the notion of the Chinese real estate sector being too big to fail.

Besides the headwind from the ensuing US-China tensions, the Chinese economy has been going through considerable upheaval - brought upon by regulatory crackdowns, and the moves to haul in over-leveraged sectors. Issues in the heavily indebted real estate sector - and how those issues impinge on domestic consumption - will be a key focus in the year ahead.

Within the real estate sector, it is pertinent to comprehend the new paradigm in credit assessment. With refinancing risks being one of the key risks in 2022, we are watching the list of survivors in this sector very closely and triangulating beyond what the companies' financial statements tell us. It is important to move decisively away from a price momentum-driven style to a more fundamental-driven approach.

On the macro level, construction and property-related activity account for a high share of Chinese GDP (close to 30 per cent by some estimates) and housing-related spending for a much bigger percentage of personal consumption than in the US. We believe the sector is too big to fail, and there are already signs the authorities are moving to contain damage from the problems incurred at the most highly indebted real-estate companies.

The lack of contagion from the real estate-dominated Chinese high-yield market to the rest of the Asian credit universe is also noteworthy. We continue to like Asian credits, given that they show superior potential risk-adjusted returns.

Green Marshall Plan

Finally, looking beyond the near-term concerns, we turn our attention and continue our commitment to environmental, social and corporate governance (ESG) investing in our green Marshall Plan investment theme.

ESG factors have impact on investment risk and reward. They help to identify investment opportunities and also avoid material risks that can detract from performance. Companies pursuing sustainable business practices are more likely to thrive in the long term as they are better at identifying, understanding and managing longer-term challenges. Integrating ESG practices is not only the right thing to do; it also adds value in the long term.

We continue to prefer the green Marshall Plan as an investment theme as US infrastructure spending plans roll forward, EU next-generation funds begin to flow, and China moves to support flagging growth momentum and continues to move towards net zero carbon emissions by 2060.

In Asia, we continue to see ESG investing picking up speed in 3 areas and these should provide more opportunities over time.

First is the regulation on transparency, which is one of the key pillars of the ESG transformation. Both the Hong Kong Monetary Authority and the Monetary Authority of Singapore have initiated their journeys in terms of regulation relating to ESG investing. This should provide an impetus to both corporate and financial institutions to increase the level of transparency.

Second is the issuance of ESG bonds. Currently, the emerging market ESG bonds sub-sector has already grown to over US$100 billion, with Asia contributing almost two-thirds. This trend should continue to pick up speed.

Third is the involvement of the next generation. The new generations in Asia are already demonstrating huge affinity towards ESG, with millennials launching their own impact investing funds and convincing family businesses to transform.

• The writer is head of Asia investments, Pictet Wealth Management Asia.