China’s bond market and Western misconceptions about China were among the topics discussed by our panel. Chaired by Romil Patel in Hong Kong.
Allen Wang (head of distribution – Hong Kong & institutional sales Greater China, Aberdeen Standard Investments)
Showbhik Kalra (head of intermediary and product – Asia-Pacific, Schroders)
Richard Tang (vice chairman, ICBC Credit Suisse Asset Management – International)
Karine Hirn (partner, East Capital)
Eleanor Wan (chief executive, BEA Union Investment)
Eric Poon (managing director, head of sales, Value Partners Group)
Funds Europe – What have been the most in-demand products or solutions for Asian investors in 2018?
Karine Hirn, East Capital – The rise of environmental, social and governance-related (ESG) products and the interest for sustainability as such is striking. It is still lower than Europe, but it is definitely happening. There is much more engagement from clients to discuss these things and you can see it in Hong Kong with a number of initiatives being taken, with conferences and so forth.
Allen Wang, Aberdeen Standard – I would echo that. It used to be quite muted, especially compared with Europe, but recently there has been more of a push, especially from the government-led campaign. The other one is the multi-asset.
Showbhik Kalra, Schroders – We started off 2018 with relatively strong demand for risk assets, with clients allocating to Asia, broader emerging markets and US assets. Fixed income as a category has not seen much traction all through the year as fears over rising rates and rising leverage costs (as some clients accessed the asset class with leverage provided by intermediaries) have negatively affected demand. Since May, as markets retreated and volatility has risen, client demand has largely been focused on multi-asset products with an income flavour.
Eric Poon, Value Partners – I would say three things. At Value Partners we are Asia and China experts, so our view is slightly skewed towards this part of the world. The first thing is a Greater China high yield bond strategy. As most of you have seen in the Hong Kong IFA data, we still have positive inflow into the Greater China high yield bond space, which is quite a pleasant experience.
Sporadically, we see some China in terms of onshore/offshore demand starting to creep in. It could be because of the inclusion [in MSCI Emerging Markets], it could be because of the drop in valuations, it could be due to the fact that people are so underweight or zero weight in China from the overseas institutional perspective.
Looking at the size of the China bond market, it is one of the largest in the world. Secondly, the yuan is relatively attractive, but I think the issue is some international investors, perhaps in Europe, are concerned about the rating. Is it Standard & Poor’s or Fitch Ratings, or is it a local rating agency?
There is also the question of if there are, could there be more? If you look at our default rating, it is really next to nothing. It is a matter of having good fundamental bottom-up research and explaining and cultivating the issues that we talked about, rating agencies and so on.
Wang – China’s bond market remains an unchartered territory for global investors. We think now is an opportune time to add China in global portfolios. Major indices inclusion will boost the market’s prospects. Also, it has historically been less correlated to other emerging market local currency markets as well as developed market core rates, providing potential good diversification benefits for international investors. Overall, with highly competitive yields, a market where the interest rate trajectory is trending down, a low correlation to other markets as well as exposure to the Chinese economy, we certainly see an investment case where onshore China bonds can potentially reap handsome gains and, more importantly, improve the risk-return profile of investors’ portfolios. Sovereign and quasi-government bonds are investors’ top targets in China.
Poon – We think in the emerging markets debt space, exposure to the Asia and Greater China sides is relatively low, so from a Europe/global perspective, there could be room to grow.
Eleanor Wan, BEA Union – The market continues to be very volatile. Looking back, we can split the calendar into two. Markets were full of excitement and expectation in the first quarter of the year. Equity was king and everyone came to us for more exposure in equity and the China story was very strong. In January , we launched a new fund which invests into China, we call it the China Gateway, which is really a tap into China for both the onshore and offshore equity and fixed income. However, since launching, the story stopped very quickly. We had an observation of the market that it is too good to be true and we had been cautious in our investment strategy. After April/May, it was very bumpy.
In terms of the product, as I say, the first part of the year was very much equity-focused, China is a very strong story on that. Ever since then, it has been more of a mix. None of the asset classes have been performing so far, apart from the US equity market.
For institutional investors, there is big difficulty because of the very low interest rate environment on a global basis. They come to Asia for yield enhancement, but they are still very cautious.
Richard Tang, ICBC CSAM – In the first quarter, there was a lot of demand from our institutional clients in China and Hong Kong as they were talking about equity. This year we have almost 40% growth in assets under management (AuM) because of those US dollar bonds and the Hong Kong equity mandate. The reason is very simple: we also lost in the equity side, but less than 10% compared to our peer group, which is top-three Stock Connect and mutual fund top gun. Last year they lost 20%-30%, so a lot of institutional clients came to us.
Funds Europe – Unlike 2017, which was a fantastic year for China, 2018 has seen some quite strong headwinds. How do investors view China now?
Wan – I see China as a very big topic in the investment world, whether on the equity side or fixed income side. We have a couple of requests for proposal (RFPs), which are all about China strategy.
In the investment world, we invest into the future opportunities rather than the market of today, so China is really outstanding in this part, providing a strong growth story.
In the meantime, institutional investors realised that they are underweight in China after its inclusion in MSCI. If they cannot get the alpha from somewhere else, they need to immediately stock up for China to at least match with the index.
Poon – With the MSCI A-share inclusion and China being the second-largest economy in the world, there are interesting themes. For example, education has been taking a hit, consumption is always a decent field and healthcare could be a theme.
Whether or not there is a trade war, your health still needs to be taken care of and you still need to go to school. Hopefully, this time people with a medium-term view could look at China.
We are also busy with a number of RFPs, as well in different pockets of the world. Hopefully, it is a way to get more institutional investors into the China A-share market.
Kalra – We have seen China go through an adjustment in 2018 and markets have sharply corrected. From a fundamental perspective, though, market participants should be pleased that China is not turning to more stimulus as it has done in the past. China continues to make progress towards much-needed reforms, and is transitioning into an era of slower but more sustainable growth going forward. We strongly believe in both the long-term investment opportunities and investor demand for Chinese assets. In the near to medium term though, it is likely that investors will be looking to some thawing of the trade tension between the US and China before allocating more capital to China.
China is an area we continue to invest in to build on our existing and already substantial capabilities. We have added portfolio management and research resources on the ground in Shanghai. From a product development perspective, in 2018 we launched Ucits versions of our top-performing China A-shares strategy and an All-China strategy that allocates across opportunities in China equities, both offshore and onshore. In 2019, we are planning to do more on the fixed income front to make opportunities in the China bond markets available to global investors.
Funds Europe – There is a gross underexposure to emerging markets among UK institutional investors, but getting them to actually do something about that is a problem. They all recognise they need to invest, but is there still a lot of misunderstanding about China in the West?
Hirn – I think there are some enormous misunderstandings, and this year even more than ever – especially in Europe. Just look at the headlines, it is constantly about the US and China and the trade war. There is not much realisation that in China, one of the actual real drivers for the poor performance so far in 2018 has to do with reforms and deleveraging. These are things that have been much spoken about in China, but when you are far away, you do not necessarily realise that.
Then there is the question of how do investors view China? If you are investors, hopefully for the longer term, right now is a fantastic opportunity to build up positions because in terms of valuations, we are really approaching unprecedented levels in terms of discount to developed markets.
Valuations are also attractive in other metrics, such as A-shares to H-shares (offshore Chinese equities). But we are back to the fact that it is paramount to have a long-term perspective when you invest. Markets are lacking confidence right now, and when investors lack confidence, it means a lot of worries, instead of focusing on fundamentals. But if you are long-term and fundamental, this is actually a great opportunity because you can find very attractive companies.
Wan – The story about China is not just whether you are interested and you want to increase your exposure. The challenge, in particular for Western investors, is the operational process. It is such a big market which is opening on a gradual basis, so there are a lot of initiatives and policies to get it done in a controlled manner. That is the part where Western investors are a bit sceptical.
Hirn – Markets which are more challenging in terms of access and information imply also good opportunities for fund managers, because otherwise people would just be buying stocks directly.
Wan – Yes, and I believe our proximity and understanding of the language and culture is a benefit. For global firms with offices in Europe or the US, it might be more convenient to service their clients in the Western world. Nevertheless, I always say you really need to come to check. I can verify that, even some of the advice we receive from legal firms in Europe is different from the legal firms here, so you need to verify that yourself. That is the challenge.
Tang – There are two parts. One you saw what Europeans did, especially European institutional investors. They just continued to give us the ticket – even if it is not big ticket – in the last couple of months through our exchange-traded fund (ETF).
Education on China is a very necessary project. We have to continue to try, because they have very good intentions and interest in China, but the headlines are pretty negative. It is not necessarily right or wrong, but the media just give one side or their perception about what is going on in the trade war and so on, but not always exactly what is happening in China, like deleveraging etc.
Global institutional investors, especially European, and the non-US institutional investors like Canadian institutional investors are neutral to positive about the valuation right now in the trans-Asian market, they think long-term they are very interested. They are actively looking into this market right now as they think other markets are too expensive, other than Asia. China is attractive at present purely from a pan-Asian perspective.
Because they are in the market, the majority of Chinese institutional investors’ investments are China-related. Chinese institutional investors are more cautious, are more negative than the international institutional investors, according to my observation.
Hirn – What I find striking when speaking to Chinese investors is that we are still in this situation of “bad (macro) news means good news,” as they are hopeful that when bad news comes, the government will stimulate. They have been disappointed in 2018 because there has been stimulus, but it has not yet reached the levels that were hoped for. It is supposed to be a stock market with free-market mechanisms, but the market remains policy-driven in many aspects.
Wan – We need to give them more time for the market to keep developing. Looking to the equity market in China, it is very much retail investors, there are not enough institutional investors here, so that is why the volatility comes. Investor education is a continuous story – it never ends.
Hopefully, more institutional investors will join the market, and help the development of the pension system in China, but it will be a very long road ahead. Nevertheless, as I say, we invest for the future, so we need to get started now.
Poon – This is a bit provocative. If some managers can deliver some type of absolute return in a reasonable timeframe, that could be a solution for certain investors in the West, because everyone likes the upside, but the volatility is what they have to swallow.
Funds Europe – There are a lot of areas where China is actually going to start being number one in the world in areas with big exportable technologies. How much opportunity is there going forward?
Tang – The demand is still pretty good, but the bubble is squeezed at the same time. Some great companies still get very strong demand, both on the investor side and the client side, and the growth is very solid. Technology still has momentum, but from the government side, especially from President Xi’s side, keeping up China’s growth is key.
Wan – Technology is definitely a growing sector, and China is a very important part of it. We already see how advanced it is compared to other places – even Hong Kong – with all these paperless and moneyless transactions. But there is a sense of bubble starting.
The recent US-China tariffs highlight the gaps that China needs to develop in the next ten years. In the past, a couple of big names have dominated, but you would be amazed at how far technology has advanced. China is completely different to the West, where people are very worried that technology will replace humans. The Chinese never have this worry. It is a different mentality, and people are using technology to either influence their daily lives or as an investment concept and I do not think there will be an end to it.
Wang – The country-wide aspiration is to grow and transform China from a traditional manufacturer to a high-tech technology hub, like America. Take Ping An, for example, a large financial conglomerate, but actually they are a technology company now. Their technology on artificial intelligence (AI) and face recognition is top in the world, so you use that technology in all kinds of applications, not just on the financial side. There is a good future overall, and a good possibility for China to become a leader in that space, particularly as they have a large market to support that aspiration.
Funds Europe – Consolidation in the industry has come to the fore, combined with more specialisation in the case of many smaller players. How do you see this developing?
Kalra – Given some of the challenges that the industry is facing, it is likely that we continue to see consolidation at an industry level. At Schroders, we have taken a range of steps to diversify our business mix in recent years, and our focus has been, and is highly likely to remain, on making bolt-on acquisitions. In recent years, these have included insurance-linked securities, private equity, securitised credit, infrastructure debt and direct lending.
Hirn – It is definitely going to be more and more for two very simple reasons: the regulatory pressure, which keeps growing, implying increasing costs. This makes it very difficult if you are too small a player to remain profitable, and clients’ expectations in terms of size of funds and firms, which offer economies of scale that are beneficial to clients too.
Even if it is more difficult to have smaller funds and there is a winner-takes-it-all mentality, size sometimes can be a problem in some smaller and less liquid markets, such as frontier markets. In these markets, if you are too big, you would have issues with liquidity or you would just have to basically invest in the most liquid and index names, which are sometimes the least interesting stocks.
We are working with the concept of being a “responsible investor”, looking for “responsible owners”. Companies understand it when you speak to them about that. In one of our core markets, Russia, where we started more than 20 years ago and where we are among the top two or top three investors, this framework has helped us a lot in our engagement with companies.
Wang – Mergers and acquisitions can be a necessity for asset management companies to survive to some extent, especially in the face of the rise of passive investing globally. Most active managers are suffering to various degrees, so you need a certain scale or skill – scale to drive efficiency and skill to specialise in investing in things that people want. If firms do not possess scale or skill, it will probably be quite difficult for them to survive in future. We think that consolidation will continue, and people need to find a means to survive.
Wan – I am with you on the integration and acquisitions. This is an ongoing thing for the asset management industry, where there will always be times when a company’s objective changes or you want to do something else.
On the one hand, consolidation means that companies would like to become bigger because of their presence, the scale, the product they would like to offer, so they want to get more, acquire the different parts to make themselves bigger, and it is a quick way to grow.
On the other hand, there will also be the specialisation issue, so I would not rule out whether it is only the big players or the small ones. In particular, it is so challenging in terms of facing the regulatory developments.
If you are bigger, you have more challenges because it is very difficult to manage the different parts. For example, there is the reputation risk if there is a breach of regulation in a small office located in a very small country of a global firm. There will always be a space for smaller companies.
Funds Europe – The closing stages of 2018 have seen significant market volatility. How does that affect your outlook and how do you think it will affect investor demand going into 2019?
Poon – Valuation has come down, so obviously it is way better than if it had been going up and up. It is not a one-way train, so I think it is a good, balanced view. Asset managers should look at a solutions approach – we are talking about multi-asset, private, China bond, Asia bond, equity and thematic. Some of the private banks in Europe might look at innovation, education, healthcare, this type of theme. It is a good sign whereby demand from Europe and the world is getting a bit more diverse in this region, as opposed to the good old days of just core China and core Asia equity.
The question is how do we deliver alpha? Looking at the China A-share market, alpha generation of 8%-10% could still be a possibility. If you look at some of the track records of a number of asset managers, where in the world can you get 8%-10% alpha consistently on a three-to-five-year basis? Looking at the track records of some of the China A-share managers, that has indeed been possible, because the A-share market is still an inefficient and less transparent market, which means alpha could still be a possibility compared to some of the markets in the West, which are very efficient.
Hirn – We started the year  with a melt-up scenario in January – I had never heard the term before. Now investors in general seem quite confused, and of course, in a way, it is quite expected as the resolution of US-China trade tensions weighs on the visibility. Moreover, Europe also lacks visibility, with Brexit and currently the Italian budget situation. These are major things: major sources of potential volatility in terms of what will be the impact on listed companies and the macro-economic situation. However, when things sound very negative, that is actually usually the time to invest, and we are seeing some excellent opportunities emerging.
Wan – Investors are still looking for yield enhancement under a relatively low interest rate environment. Institutional investors are looking for yield enhancement investment solutions. On the retail space, multi-asset strategy with regular dividend pay-out should be their choice as people are very sceptical, very worried about volatility these days.
Wang – As a firm, we remain overweight risk assets as a whole in spite of market volatility because of company cash flows. We anticipate one or two market corrections in 2019, just as in 2018. Potential triggers include monetary tightening, trade disputes and political unrest or populism. But a lot of bad news has already been priced in. Without a major policy error or inflation shock, we still expect healthy single-digit profit growth globally in 2019. While our portfolio remains pro-risk, we have added in safe-haven assets and inflation protection as there are risks to our predicted shape of the global economic cycle.
Kalra – Most asset classes are now in negative territory for the year. While a lot of the froth has left the market over the last few months, we expect markets to remain volatile as we head into 2019. There is a lack of consensus in the market and it is not clear where (region, country or sector) we can expect to see market leadership in the coming quarters. Hence, unless investors can take a longer-term view, there is likely to be a lack of conviction in the markets and investor demand will be negatively affected.
Tang – Most of the valuations in developed countries are not cheap. That is the scenario, and all the markets are getting ready for crash mode and volatility will carry on for the next year. When we hit the bottom – and bear in mind that no one can tell, we are not fortune tellers – I am relatively positive because during this year of volatility, my firm is doing relatively well compared to in a bull market.
In a volatile market, the more conservative and better risk-managed firm can relatively correct the clients, because no matter if it is a bull or bear market, people have money to invest, just in a different asset class, and they hope they can get a more absolute or relatively better return.
Funds Europe – Are you feeling positive or negative for 2019?
Wan – I am actually quite positive in a way. Not with regards to the market, which I think will continue with its story, and will dampen investors’ interest of getting into the market. But in the institutional space, it is much more active than before. They are either coming back to emerging markets with China as the focus or they are searching for yield-enhancement solutions. With the build out in the last couple of years, I am very confident that my company will be benefiting from this trend.
Wang – We are also positive. Expected returns from traditional developed markets, especially equities, have come down. Emerging market valuations look attractive, provided we do not see a major appreciation in the US dollar; we have found good investment opportunities in both equities and fixed income. Among emerging markets, Chinese equities suffered a rout in 2018, with some quality companies caught up in the sell-off. That offers opportunities to a stock-picker like us to find value.
Poon – I also agree. Echoing what Eleanor said, judging from the RPs in the market, judging from the inclusion that will be synching in, it has happened. But judging from Stock Connect, potentially also Bond Connect and maybe ETF Connect, there are a number of initiatives, it is not just fluff and talk, it is actually happening. With more investor education, more solutions, private equity, private debt and themes that investors can relate to, such as education, technology and healthcare, there could potentially be some decent years for investors.
Kalra – As active managers, we are quite positive about 2019, as we believe our disciplined and proven alpha generation capabilities will clearly stand out as quantitative easing gets withdrawn and markets return to fundamentals. In addition, we have innovated to develop products specifically designed to take investors through the late stages of this market cycle. I specifically highlight two of our Ucits solutions, Global Target Return and Global Credit Income, the first an objective-based multi-asset strategy and the second an unconstrained fixed income strategy.
By managing the risk of loss for our clients by avoiding assets vulnerable to drawdowns, clearly this is easier said than done, as the strategy design, toolset and investment process needs to have enough flexibility in security selection, asset allocation to significantly reduce, or remove exposure to those assets which are most likely to lose money. We have started to see very encouraging progress with both intermediaries and end-investors with this set of products over the last couple of quarters.
Hirn – I am very positive. When you look at the world today, and specifically at equities, it is true that Europe is in a fragile state, we all know that. But there are some pockets of growth here and there. Eastern European markets, for instance, are doing quite well. The US has been strong, but we are in the eighth or ninth year of an upcycle and it is going to stop at some point, and investors’ appetite for other markets might recover. The US market has been very much fuelled by tax reforms, the US dollar strength and political statements.
However, when you are more fundamental and look at what is happening in these emerging markets, there are a lot of reasons to be very positive because the reform momentum is still very strong, many countries have been fighting against the vulnerabilities that were their real issues a few years back, and look at what happened this year. We had two of the three weakest emerging markets in terms of macro, namely Turkey and Argentina, going through a crisis, but there was no serious contagion to the whole asset class. Emerging markets are different and you can find quality when you diligently look for it.
Tang – I am very positive over a three-to-five-year time horizon. The very simple reason is actually China and Asia becomes the cheapest region valuation-wise. On top of that, all the international firms try to open their house in China, and I think it is the right time. Even if you probably cannot raise a very big fund, I think it will definitely make money if you hold it for three to five years. A lot of people argue about political risk over there domestically and expect a trade war; I think the real risk will be the US market will get a big correction.
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