The coronavirus is the wildcard bringing the most uncertainty to our outlook. It is too soon to know how this will play out, but one positive factor is the early and aggressive steps China has taken to contain the virus.
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The Quarterly Investment Forum (QIF) is an ongoing cross-investment team discussion and debate about the most relevant active risks in major markets and across asset classes and funds.
Each QIF is a mix of 'top down' and 'bottom up' perspectives, beginning with a 'top down' discussion of the major macroeconomic themes identified by the Asset Allocation Team. Each quarter, a rotating roster of portfolio managers present a 'bottom up' view of major active risks in their portfolios.
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1Q 2020 Quarterly Investment Forum highlights
The investment opportunity in China
Barry Gill, Head of Investments, shares his thoughts on the current investment opportunity in China for asset allocators.
Evan Brown, Head of Multi-Asset Strategy explains how the coronavirus outbreak changes the macro outlook.
The case for China fixed income
Hayden Briscoe, Head of Fixed Income Asia Pacific, explains the three trends investors should keep in mind when looking at the Chinese fixed income market.
How is coronavirus affecting the Chinese equity market?
The coronavirus outbreak in China has affected its equity market, but not as much as similar outbreaks in the past, says Geoffrey Wong, Head of EM Equity.
The active investment opportunity in China today
Barry Gill, Head of Investments, Hayden Briscoe, Head of Fixed Income Asia Pacific, and Geoffrey Wong Head of EM Equity
From an asset allocation perspective, the structural dynamics of China's equity and fixed income markets offer clear opportunities for active investors, especially when events like the current coronavirus outbreak drive down already-low prices.
Fundamental drivers are creating an attractive universe for investors in China
Investors have long considered the Asian economy as one dominated by exports to the developed world, but that is changing. Today, over 60% of Asia's exports are intra-Asia, and we are seeing an infrastructure 'arms race' to support cross-border development and trade within the region, creating a growing universe of investment opportunities.
Like other emerging countries before it, China is changing in ways that are unlike developed markets. Rapid urbanization and a growing middle class are two trends driving the formation of innovative companies to cater to these trends. China's population of 1.4bn has gained purchasing power, and more Chinese companies than ever are focusing on domestic consumption and services. All this comes at the expense of industries connected to China's past economic strength, such as farming and mining. All of these trends suggest expanding opportunities in China's fixed income and equity markets.
Chinese equities may be structurally mispriced; significant opportunities for active investors
Even so, Chinese equity market's capitalization stands at a much lower share of GDP than other APAC countries, suggesting that Chinese equities may also be structurally mispriced.
And although China's A-share market has averaged about a below-GDP 4.4% annual return over the last 12 years, pricing dispersion between companies is much larger than in other equity markets. The reasons for this include low investment bank research coverage compared to other major equity markets, and from the high ownership by retail investors who buy and sell frequently, which leads to high pricing volatility.
There are therefore big winners and losers in China's A share market. At the same time, the differing sector biases of China's onshore and offshore markets offer investors additional diversification. Investors who already hold H shares are beginning to consider expanding into A shares to take advantage of this. Against this backdrop, we see significant opportunities for active investors.
China fixed income: sovereign and high yield bonds attractive
Meanwhile, China's fixed income market ownership is currently dominated by domestic banks and insurers. Only about 2.3% of China's outstanding debt is foreign-owned, compared to 18% for the US, 55.7% for Europe and 18% for Japan. Generally, broader ownership of securities results in better price discovery. As China's markets open up and foreign capital flows in, we believe that there is likely to be a positive effect on prices.
In recent years, China's sovereign debt has offered a considerable yield pick-up and persistently stronger risk-adjusted returns than the government bonds of other G10 nations. We see this continuing. With a nominal yield of around 2.8%, ten year Chinese nominal government bonds continue to offer an attractive premium relative to the benchmark bonds of other major economies, very high levels of liquidity as well as diversification benefits. We therefore believe investors would be wise to consider a China fixed income allocation. In our view, Asian High Yield corporate bond spreads are also attractive in the context of low corporate bond yields elsewhere in the world.
Coronavirus: tough measures taken, buying opportunities for longer-term investors remain
As of early February, the coronavirus outbreak in China has negatively affected the equity market and seen yields fall on Chinese government bonds but not as much as similar outbreaks in the past. During the bird flu epidemic, for example, equity prices fell from the first outbreak until the peak of the infection, then quickly regained lost ground. Three months after the peak, markets were actually significantly higher than when the outbreak first occurred.
We haven't seen as big a drop this time. We attribute that partly to the many precautions that have been rapidly taken, such as restricting travel and extending the Lunar New Year shutdown. But restaurants and movie theaters in China are still empty right now. But despite the short-term impact of the coronavirus, we believe Chinese markets will continue to present attractive buying opportunities for longer-term investors across the capital structure.
Head of Multi-Asset Strategy
Our base case continues to call for a re-acceleration in global economic growth in 2020, helped substantially by last year's global wave of interest rate cuts. The biggest risk to that outlook is the ongoing coronavirus outbreak, followed by the US election season. Trade policy risk continues, although in the background.
Coronavirus: measures coming to support the economy
The coronavirus is the wildcard bringing uncertainty to our outlook. It is too soon to know how this will play out, but one positive factor is the early and aggressive steps China has already taken firstly to contain the virus and, separately, to support businesses and wider economic growth via lower interest rates. The virus will likely result in a big hit to China's economy in the first quarter, and the longer it goes on, the more likely it is to have knock-on effects to the global supply chain. There is still a lot of uncertainty but there are likely to be more measures to come to boost the economy.
US elections and trade remain a risk
The second risk to our base case, and the reason we are slightly underweight US equities, is the US election season, which began in earnest on February 3 with the Iowa caucus vote. In general, the Democratic party has moved quite a bit to the left since President Barack Obama left office. All Democratic presidential candidates favor raising taxes, and several go much further with government expansion, though none of these policies will likely be put in place unless Democrats control both houses of Congress as well as winning the presidency. Meanwhile, trade policy risk continues. President Trump has turned his attention from China to Europe and has threatened tariffs on the latter's important auto sector if the European Union does not agree a deal.
Lower rates will cushion economic activity
We believe the sharp decline in global short-term interest rates over the last year will provide a nice cushion for economic activity, assuming these major risks stay under control. Economies usually experience a lag of nine months or so after easing before it begins to take effect, and we believe we are beginning to see that healing, especially in economies hardest hit by the global manufacturing slowdown and the trade war, especially Europe and emerging Asia.
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