Asian money goes west

Asiamoney, September 2013

Money is fleeing Asia for the developed world, from debt and equity to real estate. But is private wealth following? Private bankers are split, with some saying the home bias holds strong, and others that the region’s wealthy are moving with the herd and shifting assets to the west.

It is quite a turnaround after a decade in which it has often seemed an unarguable truth that Asia, and emerging markets generally, are the future of global growth and wealth generation. But a long-running period of underperformance by emerging markets versus the US has become considerably worse since April and May, when Ben Bernanke’s comments on tapering prompted a period of capital flight from Asia and Latin America that has yet to show any signs of reversing. At the same time, a sense that Europe’s problems have plateaued is providing further reason for investors to go against the prevailing wisdom of the 2000s to date and move money west, not east.

“There’s no hiding from the fact that flows are clearly moving from emerging markets to developed markets,” says Urs Brutsch, managing partner and founder of HP Wealth Management in Singapore. “A lot of easy money that was printed left, right and centre through QE found its way into emerging markets, and the region was perhaps on a bit of a sugar high from this money. The moment Bernanke said maybe this will not last forever, a lot of people said: cut exposure to emerging markets.” According to data from JP Morgan and the IMF, this outflow was well underway in 2012: India had US$29 billion of portfolio outflows during the year, Hong Kong $2 billion, and Singapore $49 billion, and

they will certainly have been joined by a host of other emerging market nations in 2013.

And that’s just how it starts. Once a trend like this gains momentum, everyone else follows it, exacerbating it. “And very often these investments are made on a leveraged basis, where people ride the carry, financing it in a low interest currency and then investing in something like the Indonesian rupiah,” says Brutsch. `’That’s nice on the way up but it really kills you on the way down.” Indonesia is the classic example: with upwards of 30% of its local currency bonds held by foreigners at the peak, it is particularly exposed to capital flight.

“India, China, Brazil: you need a very good line of argument why you would still want to be overweight those markets,” he says. “You can see green shoots in Europe, and definitely the US; it’s a tough call to say you really want to remain overweight emerging markets.”

HP Wealth Management’s balanced portfolios have an equity exposure of 47%, which is now exactly split down the middle between developed and emerging markets. That’s a change from last year, when Asia and emerging markets were a considerable overweight. Since half of HP’s business is discretionary, the manager gets to choose where the money goes, so by definition, that represents a flow of capital from Asian high net worth to the west. “You cannot stand in front of the flows,” Brutsch says.

But what about those clients who don’t trust ask managers to make the decisions, just to implement them? Are they moving their money too?

Here, the picture is less clear. “In terms of flows from private clients from here to developed markets, we haven’t seen a lot of it actively materialising,” says Kelvin Tay, regional CIO for southern APAC at UBS’s wealth management arm in Singapore. “There are spots of it here and there, but not in the ways a lot of people were expecting. Asian clients have a very strong home bias to the markets here.”

Tay says that any changes are at the margin. “Any interest in developed markets, whether US or Europe, will centre on stocks they are familiar with: the names they have had for some time,” he says. These tend to be the big names: Citi, Apple, Microsoft, Coca-Cola, Starbucks.  There’s nothing particularly technical or visionary about it. “Just because developed markets are likely to do better in the next 12 months doesn’t mean they change their asset allocations.”

He reckons that Asian private wealth has only the most modest allocation to developed markets. “For most clients, I would think it would be an extremely small proportion. I would be surprised if it’s more than 20% of equities.” This is, coincidentally, precisely the target allocation to developed world western nations that Temasek has.

Still, whether the advice is heeded or not, private bankers are generally advising their clients to look west, at least in the short term. “Since the beginning of the year we have recommended our top investment ideas to focus on the US recovery theme,” says Fan Cheuk Wan, chief investment officer for Asia Pacific at Credit Suisse Private Banking and Wealth Management in Hong Kong. “Based on the more constructive growth acceleration trends in the developed world, we recommend clients to invest in developed markets.” Aside from the US, Credit Suisse also recommends overweight positions in Japanese equities. In Fan’s view, it’s a simple appraisal of “the relative risk reward profile of investment opportunities in Asia versus the developed world.” Credit Suisse recommends underweight positions in Asian countries with current account deficits, chiefly India and Indonesia.

But she, too, notes the attraction Asian investors still feel towards their home markets. “Despite the weakening in the fundamental outlook in a number of Asian economies, we continue to see the domestic investor retaining a strong home bias towards their local markets,” she says. “This home bias is a long-established investment preference of the Asian investor, as they tend to put money into companies that they have the best knowledge of. It would not be easy for them to totally change their investment approach overnight.”

In the short term, though, the arguments for developed world investment are convincing even for those who are long-term believers in Asia. Tay, for one, doesn’t doubt that developed market equities are a better prospect in the next three to six months, for a combination of reasons: recovery in the US gaining momentum, stability in the Eurozone, and this year’s bold monetary steps in Japan being reflected in better corporate earnings there. “On a short term basis, the news flow from developed markets looks pretty good.”

Additionally, there are greater complications in emerging markets. “In previous US recessions, whenever a recovery has been in place, it has been positive for emerging markets and Asia. This one is a narrow-based recovery, based largely on the US housing market and the construction industry. Therefore there is little leverage to it for Asia.” And then there is the question of the capital flows, which no doubt have further to go as we move closer to the end of the US’s QE programmes. “I don’t think that is fully priced in,” says Tay. “About 50% of the market seems to expect it [a formal timetable for tapering] in September – so if it does finally happen in September, the other 50% have to react as well.”

That being the case, the recent outperformance of the developed world is likely to remain in place for some time. “It’s got longer to run,” says John Woods at Citi. “Until the earnings picture turns materially in emerging markets’ favour, which it hasn’t yet, the momentum from an investor perspective will continue to favour developed markets. Certainly they are driving growth relative to emerging markets, and when you have that valuation, technical and fundamental tailwind, then I think developed markets continue to outperform.” Woods says he is “looking a lot more positively at Europe, with evidence of a bottoming out in growth and forward-looking indicators like PMI indicating the eurozone economy is now expanding. We are seeing investors rotating out of the US into Europe on growth considerations.” Woods says Citi sees Asia-based investors focusing on dividend-paying stocks in Europe, Japan and the US.

Nevertheless, nobody is arguing that Asia is going to become irrelevant.

For a start, even if US recovery has started out with a narrow base, it ought eventually to lead to sectors that will benefit Asia. “North Asia looks particularly well positioned to benefit from an upswing in developed market growth,” says Woods. “There will be much greater stability in currency markets, equity markets and even bond markets as North Asia’s fundamentals reflect this upswing in demand.” Citi Private Bank moved to an overweight position on Chinese and Taiwanese equities in June, and is already there in Thailand, Hong Kong, Singapore and Malaysia, though it is underweight South Korean equities and all Asian investment grade and local currency debt.

Also, while capital flows around tapering are a long-term worry, they won’t last forever. “Once the process of tapering gets started, we should see the overhang removed,” says Tay. “There are two unknowns here: we don’t know how much less they’re buying, and when it is going to end. When we know these factors, we will know how to react and where to reposition ourselves. Markets have no problem with volatility: it’s uncertainty we don’t like.”

Brutsch agrees. “It [Asia’s ascendancy] will happen again, it’s just a question of when, and how much flows out before it does,” he says. “Investors will at some point realise that rates in developed markets are substantially below those in emerging markets, except for Brazil. China and Indonesia are still growing at six or seven per cent. At some point, that is going to translate again into flows into these markets.”

“Some people talk about a second Asian crisis,” he adds. “It’s completely different today from 1997.”

Is it? DBS analyst David Carbon put out a report on September 5 arguing quite differently. “Current account deficits, capital outflow, collapsing currencies – is Asia headed for 1997 all over again?” he wrote. “Absolutely.” He reckons it’s five years away, and that “a crisis isn’t pre-determined”, but warns that it might be on its way if leverage is allowed to get out of hand.

That view is still an outlier, though; most believe Asia’s long-term demographic and growth advantages are intact. “That long term view holds true,” says Woods. “Certainly we are expecting to see much stronger economic numbers out of North Asia, as improved trade balances and output support economic growth.” Even in decline, the bigger Asian nations boast growth rates dramatically higher than anywhere in the recovering developed world. “We are certainly looking more positively at North Asia, though we are a little bit concerned about south and southeast Asia, particularly on the back of their external account positions and the eventual effect of normalising rates in the US,” which would impact consumer credit in those countries,” he says.

“For Asia, the balance sheet is not an issue,” says Tay, who rates Singapore his most preferred nation in UBS’s Asia ex-Japan equity strategy, with Indonesia least. “It remains pretty strong, whether corporate or sovereign, with the exception of India.” There has already been something of a reversal in China, which perhaps reflects the roller-coaster trajectory of world attitudes to bigger emerging markets this year: first South Korea (because of the falling yen and North Korea issues) and China (shadow banking, property measures and slowing growth) under pressure; then Russia and Brazil as oil prices fell; then further flight out of Brazil because of riots; and then out of India – which until then had been receiving flows leaving those other BRIC economies – because of its deficit and falling currency. As money has moved from one to another, it has started to end up back in China again. “China’s is considered the most defensive currency in the world against the US dollar,” says Tay, “and at the time money started rotating back into Chinese equities, they were dirt cheap, with very low downside risk.” The same seems to be beginning to happen in Korea too.

In sum, the verdict seems to be: by all means shift assets to the developed world for a while, and pick up the bonhomie of recovering markets. But don’t forget where the people, the workers, the foreign reserves and the growth rates are, because sooner or later, they will drive market performance again.

Underpinning the long-term faith in Asia as an investment destination is this home bias Tay talks about. It is not a universal position: some private clients are marked to market, those that are quasi-institutional; they have to react quickly to market movements and will therefore have moved assets west. “But the individuals that most private banks are dealing with are likely to stomach the risk that the price of a bond might come off,” Tay says. “If yields are there, they are happy to collect them.”