ROUNDTABLE: Forget about safe havens, where are the returns?

Our panel discusses safe havens, the role of the Chinese currency for investors and the expansion of China’s asset management industry into Hong Kong’s financial services sector. (part 1) HK_roundtable
Ayaz Ebrahim (Amundi Hong Kong), Ken Hu (BOCHK Asset Management), Terry Pan (JP Morgan Asset Management)
Blair Pickerell (Nikko Asset Management), Mark te Riele (BNP Paribas Investment Partners) Funds Global: Following the downgrade of US credit worthiness, what do Asian investors perceive as safe havens? Terry Pan, JP Morgan: What was the major recipient of the flight to quality after the downgrade? The answer is US treasuries. This is still a very safe asset class, whether AAA or AA+. From an Asian investor perspective, for some Hong Kong-based investors, gold has been a very attractive alternative. It is tangible, something that has value; but they may have forgotten that gold at one point was 300 bucks, not 1,800. Hong Kong investors are still opportunistic. I don’t necessarily see them as looking at securities as safe havens but, instead, looking for a return. Ayaz Ebrahim, Amundi: Although there is a flight to gold, Asian investors are also looking more at certain emerging market asset classes. Even after the downgrade, they are still looking for yield, albeit from assets that are deemed relatively safe. And one of those is emerging market debt, including Asian debt, both local and hard currency, including high-yield. There is a lack of appetite for equities at this point but debt is certainly still favoured, though not junk bonds. Blair Pickerell, Nikko: There is a hunt for yield in general, whether it’s from US treasuries, global fixed income, even emerging market fixed income. We have seen quite a few clients who are worried about high volatility, especially the conservative institutions that would be blamed by shareholders if they see big losses in equities this year. There’s a tendency to increase the weighting to fixed income to de-risk. Mark te Riele, BNP Paribas IP: Money market funds are the traditional safe havens and we didn’t see any significant outflows from dollar money market funds after the downgrade. Globally, over the past year, we’ve seen this shift to gold. But more importantly, we’ve seen a big shift to renminbi deposits, renminbi bond funds, renminbi money market funds and CNH [offshore renminbi, typically held in Hong Kong] bond funds.
The renminbi is more and more becoming a safe haven and this is a significant development. Ken Hu, Bank of China AM: Renminbi bonds, specifically the high-quality ones, are arising as safe havens. While most Western countries and Japan are being downgraded, China is on a long-term upgrade trend. In most European countries, Japan and the United States, the governments have no clue how to control debts. If you consider a safe haven as a means of storing wealth, I would say that renminbi is a better choice. You may say that gold is better, but what would give you yields are Chinese government bonds. Onshore Chinese government bonds are yielding at around 4%, which are higher than G7 [France, Germany, Italy, Japan, the UK, the US and Canada] government bond yields. Some international investors may argue that the offshore Chinese government bonds have lower yields than the onshore ones for the same maturities. However, the offshore Chinese government bonds still give international investors higher yields than treasury securities across all maturities. Ebrahim: And there is upside on the currency. Hu: Apart from currency upside, the renminbi provides significant diversification benefits to international investors. We have studied 48 currencies and found the renminbi has a very low correlation, or even a negative correlation, with most other emerging markets and major currencies. Bond fund managers who include renminbi bonds into a global portfolio will reduce their portfolio’s risk. A second study found that over the past five to ten years, Chinese government bonds had the lowest volatility compared with government bonds of both emerging markets and G7 countries. The big picture is that China now is the second-largest economy in the world. Global bond portfolios would need to include Chinese government bonds, either offshore or onshore, for a truly global diversification purpose. Funds Global: Are Hong Kong and the mainland still feeling the after effects of the global financial crisis? Ebrahim: I strongly believe that Hong Kong and China did the right thing by stimulating their domestic economies in various ways in late 2008. Ironically, there are some side effects that are being felt today. For example, too much liquidity was pumped into the system. Also, fiscal policy was used and a budget deficit was created of around 21% of GDP. The fiscal side was not an issue, but monetary policy was made very loose. Bank loan growth grew at about 30% in 2009 compared with 19% the previous year and, last year, loan growth was still at roughly 20%. A lot of these loans went to local government, and there are now concerns about Chinese banks’ non-performing loans. Another issue, given Hong Kong’s peg with the dollar, is that it has no local monetary policy and is determined by the Federal Reserve. As a result, we have very high negative real interest rates in Hong Kong and in many other parts of Asia. That has helped fuel inflation in the property market. It could be argued, too, that the liquidity created by loose monetary policy has led to money coming into Hong Kong, driving up asset prices. Pickerell: In Hong Kong, the heat from China has been much greater than the chill from Europe. It’s as simple as that. Pan: Everyone still feels the after effects. Decision-making by buyers three years ago is harder today. It’s a lot more complicated, a lot more prudent. Pickerell: Inflation is much more of an issue in Asia than in the west and, to a certain degree, that’s because of the link that many countries have to the dollar. In the US, people tend to be thinking more in deflationary terms. But around the Asia region there is real inflationary pressure. Hu: I have a different view on inflation in mainland China. Although wages have been rising for several years, they are in line with the robust trend of productivity growth in mainland China. The wage rises mean that workers in mainland China could participate in the benefits of its economic growth, contributing to a more well-balanced economy. Sectors such as consumption and imports would be boosted. Overall, China would be able to afford inflation rates higher than the levels in the west given its higher economic growth rates. Ebrahim: For the average family, if you put money on deposit and you get close to zero and yet you’re seeing the cost of food, the cost of education, the cost of housing and the cost of wages all going up, it pretty quickly pushes you to invest in real assets. Hu: I agree. But the good thing is that the Chinese government is aware of that and they have been taking action to address the problem. Pickerell: The Chinese authorities have more administrative controls at their disposal to deal with economic problems than the US has. The authorities can basically direct bank officials to do their bidding. For example, to not lend to the property sector in Shanghai if they felt that was the right thing to do. They can do that and they have done that in the past. They can control things more directly. Whether that’s good or not, we won’t get into that, but they do have more controls at their disposal. Funds Global: Do you feel that emerging economies are decoupled from western economies, or are the two still linked because of consumer demand? te Riele: People try to look at decoupling as a binary thing, which is definitely not the case. In our view it is not moving in one direction or the other. We recently published a research piece where we advise our clients to buy European equities in order to get emerging market. The buying of German car manufacturers is the cheapest way to get exposure to China. I think de-coupling is a phenomenon that does not exist. In a sense it never will because markets and companies are so connected. Ebrahim: When there are periods of high volatility in global markets, there’s basically a high correlation between global equity markets. When you have a lower period of volatility, in other words more stability, that’s when correlations start declining. If you look at Asian equity market performances, when markets are calmer, the correlation with developed markets drops significantly, and that’s when Asian or emerging market equities have a tendency to outperform. If you look at it from the Asian financial crisis, Asian corporates are much healthier and much stronger. Hu: In contrast to the Asian financial crisis a decade ago, most Asian countries other than Japan have cut their government debts to low levels, their fiscal budgets have been persistently healthy and their banking systems have been recapitalised. Hence, Asian currencies, such as the Korean won and the Indonesian rupiah, which used to be very volatile a decade ago, have been quite stable recently, disregarding the intense market turmoil in Europe and the US. Again, the Chinese renminbi is likely to rise as a new safe haven as it is backed by huge foreign exchange reserves, more prudent fiscal and monetary policies compared with those of the US, most European countries and Japan. Looking forward, investors may need to take a proactive top-down approach to check which countries are printing money and losing control on their debts. Yet most European countries, Japan and the US are still struggling with their sovereign debt problems which, I believe, have originated from the way their political systems are running. End of part 1 ©2011 funds global

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