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Supplements » China Report 2020

The case for selectivity

Li_Wei_BlackRockFunds Europe talks to Wei Li, managing director and head of investment strategy for BlackRock ETF and Index Investments about the biggest investment trends so far this year, the case for China and the need to be more selective about emerging markets.

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Funds Europe: How have various asset classes performed so far this year?
Wei Li: “The first half was one of two quarters. A strong start was very quickly halted by the outbreak of the pandemic. But then there was a much stronger rally than people expected, especially in the equities market. Across all asset classes, investors are being more selective. In equities, they are turning away from the US and more towards Europe. They are more cautious about the effectiveness of the US response to the pandemic, whereas they see the approach in Europe as more effective.

“In terms of emerging markets (EMs), there is less appetite to apply EM benchmarks across the board but instead look more at single country exposure. While it has always been true that emerging markets is not one homogenous entity, the Covid pandemic has really highlighted the distinctions between different countries by virtue of their management of both the pandemic and its health dangers and the economic impact. China’s management of the crisis and the flexibility of its monetary and fiscal policy have made it more attractive to investors, although risks including around trade tensions with the US, remain.

“We don’t see as much differentiation in fixed income. There are three areas we like: US government bonds where we expect yields to fall further so compare favourably price-wise to government bonds in other developed markets; EU corporate bonds where we foresee further rate compression in the EU because of quantitative easing; and global investment grade and high yield bonds, mostly for their income.”

Has sustainable investing also become more popular?
“Sustainable investing has seen greater activity from equity investors. It was already breaking records before Covid 19. The pandemic served as a reminder for investors that they need to build resilience into their portfolios. And now we are able to prove and demonstrate the long and short-term effectiveness of sustainable investment. Sustainable investments used to be seen as a performance drag but in the current environment, sustainability is actually a boost to performance so inflows have exceeded our expectation.

“At the start of the pandemic, investors removed any risky areas from their portfolios and then have gone back into more sustainable stocks when they have redesigned their portfolios. Companies that can prove their ESG credentials are likely to be rewarded by investors. And sustainable investing has received a considerable boost from both Covid and the Black Lives Matter movement and other protests around social justice. We believe it will only grow in importance. For example, we think several sustainable stocks are still undervalued because ESG factors such as the exposure to extreme weather are still not reflected in valuations.”

What investment themes have stood out this year?
“We have seen three investment themes in the year so far and while they are not new, they have been supercharged by Covid 19 which has coloured most of the year so far and will continue to do so for the rest of the year.

“The first is the restarting of the economy after the lockdown. It is so important for investors to differentiate between an initial rebound and a more sustainable recovery and to study mobility data if virus cases go up again. But the longer you wait to restart the economy, the deeper the cracks you have to fix, so it is a very fine balance. In terms of the impact on asset allocation, we generally prefer to lean into the momentum of these trends, so we have gone overweight on credit.

“The second theme is policy revolution. We started the year with a focus on central bank policy normalisation but that has been turned on its head because of Covid. A policy revolution has been needed to manage the Covid shock and there has been an enormous increase in central bank intervention with up to $7 trillion spent in the last quarter.

“But whereas in the past, central bank intervention has been the rising tide that lifts all boats, this has not been the case this year with different countries adopting different approaches to Covid and the economy. That said, since reopening has begun, central bank policy has been generally risk-positive. But in the medium-term, the blending of monetary and fiscal policy can be problematic. For example, if inflationary pressure returns, central banks may not be able to raise rates in case of mass defaults. The investment-implication of this is that we like inflation-linked bonds. And we like credit because of central bank intervention, especially in Europe.

“The final theme is resilience and selectivity. While Covid has supercharged some existing trends, it has changed other established trends. For example, there used to be a correlation between equities and government bonds – one was down, the other was up. But this is not the case in the current environment. Rates are already so low, that they can’t go lower because of an economic shock. So investors have to be more creative when looking to build diversification and resilience into their portfolios.

They will need to invest in assets that are within the spheres of influence of both China and the US. They will also need to look more closely at companies’ supply chains and their exposure to geo –political influences. The sustainability theme plays into this, so we have gone overweight on quality stocks.”

What investment prospects do you see for China specifically?
“We definitely see the world bifurcated between China and the US and this has become more intense as we approach the US elections. Investors need exposure to both drivers in order to have resilience in a de-globalising market. But very few investors don’t have US-based investments and far fewer have any China investments. China is still under-represented in several international investors’ portfolios. The journey for China and its coming of age is only starting. In the short-term, political risk may prove a headwind so investors may have to take their time to find good entry points but the long-term direction of travel is unmistakeable.

“China also wants to be less reliant on external factors and more reliant on domestic consumption, so global trade headwinds or tailwinds may be less significant for China and its assets than for other countries. But it is a very volatile market at present. A headwind can be turned into a tailwind very easily. The ability to stomach short-term volatility is really important if you are to benefit from the longer-term trends and not be distracted.”

The opinions expressed are as of August 2020 from BlackRock and are subject to change at any time due to changes in market or economic conditions.

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