Asiamoney: placing wealth when markets are panicking

Asiamoney, September 2011

Asian private wealth clients had only just started trusting the markets again. After many lost as much as half of their wealth in the global financial crisis, the years since 2009 have been characterised by steady recovery and accumulation. But the further we have got into 2011, the more it has started to resemble the bad old days of the crisis: macroeconomic problems, both in the US and Europe; capital moving on rumour and panic; and problems with debt, only this time at a sovereign rather than a banking level.

David Pinkerton, chief investment officer of Falcon Private Bank, describes global capital markets as characterised by five Ds: demographics, debt, denial, deflation and devaluation. Demographics refers to “a sharpening of the age pyramid: this huge bubble of people who drove demand in the developed markets but who are now entering the twilight of their lives, not spending as much, and are funding their lifestyle with a reduction of equity exposure,” as has already affected Japan. The other Ds – depressingly, to add another – are obvious enough, and they’re not going away any time soon. “These are the conditions in the developed markets from a long term trend standpoint,’ he says. “You are going to have periods where optimism give people some hope and lead to bear market rallies, but basically statistics are showing us that the growth isn’t there despite all these QE2 and 3 propositions.”

One obvious corollary of this is that emerging markets offer the reverse situation: youthful population, growth, demand, no debt. “We see there to be significant opportunities for growth in many of these countries,” says Pinkerton. “But the big challenge asset allocators face is whether these countries will succeed and grow in an environment where their traditional end customer – developed markets – shows declining appetite for their goods.”

It’s grim all right, and no surprise to see investors still heading for the exits. “There’s generally a defensive tendency,” says Pinkerton. “It depends on the character of the investor, but almost by definition someone that has hired a private banker has wealth to protect. So there’s an element of preserving purchasing power in the face of these devaluation forces – this is what’s been driving gold, real estate and other hard assets.” There are surely opportunities out there, but many clients have already been hurt by the phenomenon of catching falling knives by buying into declining markets in 2008, and are less likely to do so again. “If there are clients with opportunistic attitudes, it’s very short term oriented,” says Pinkerton. “I liken the mentality to looting on a battleground. There are opportunities to go out and grab financial assets that are oversold or cheap, but when you run across the battlefield to grab something you risk getting shot.”

How are private clients responding? “Most clients are extremely defensive,” says Lee Boon Keng, head of the investment solutions group in Singapore for Bank Julius Baer. “What we are telling our clients is the following: amidst all these uncertainties and volatility, what we need to focus on are the things that are the least uncertain.”

What does that mean? Well, sitting in Singapore, there may be one windfall just around the corner. “After the SNB [Swiss National Bank, Switzerland’s central bank] fixed the Swiss franc against the euro, we will probably see two things: one, the new establishment of a replacement for the Swiss franc as a safe haven currency. And two, that this safe haven currency is likely to be Singapore dollar. The make-up of the economy is extremely similar: the rule of law, they are both key financial centres, they have very good governance. And that is going to make the Singapore dollar a very attractive currency to have over the course of the next couple of years.”

If that’s true then, as Lee says, “once you have the Singapore dollars, the question becomes what you do with them.” He is advising clients to put money into high yielding stocks in Singapore, “particularly those that are stable and will be able to give you a substantial pick-up above putting the money in deposits. Then you get the stability in the Singapore dollar, with a high chance it will appreciate; and the dividend yield from stable companies like Starhub and the REITs.”

The other thing Lee sees as least uncertain is China. In his view, problems in Europe and the US are going to speed up a process already in train: the internationalization of the RMB. “The RMB is going to appreciate steadily and the Chinese will internationalize it in a much speedier fashion than the market has been pricing in.” Already, in August, China has increased the scope of Chinese issuers who can access the offshore RMB markets to all corporates; at the same time, it has announced it will allow the remittance of proceeds of offshore issues back onto the mainland in the form of foreign direct investment. That ought to mean an increased supply both from Chinese companies and international issuers, which ought to alleviate some of the supply-demand imbalance that has characterized the dim sum market to date. “It opens greater avenues for you to get involved in that space,” Lee says. “The appreciation of the RMB alone is going to offer you a significant pick-up.”

Lee is generally a fan of the whole China story, equities included. “I’m telling clients that if you look at the Chinese equity market, we are at valuations last seen in 2005 – well below valuations in 2008. Why are you waiting for that minus 10 to 15% potential drop before you dip yourself into the water? We may have bottomed out already.” Julius Baer has QFII quota and is launching a fund to invest in Chinese equities, combining A-shares (those traded in RMB on domestic exchanges) and H-shares (Chinese companies listed in Hong Kong and traded in Hong Kong dollars); on the dim sum side it works with DBS on a fund to get access to bonds. “There is a megatrend in the China story, and it is not just about China’s fantastic growth but also what is happening in the US and Europe,” Lee says. “It’s a congruence of timing and events.”

Running to Asian currencies and emerging stocks and bonds as safe havens? Are we changing our views of what constitutes a defensive asset? “It’s a question we think about all the time,” says Pinkerton. “At the end of the day, the US is probably the best house in a bad neighbourhood. The US is downgraded; Italy, Spain, Portugal and Japan have massive debt levels; which country, at the margin, has the better demographic profile, and the better diversification from a standpoint of industry? It’s still the US. That’s continuing to cause people to run into the safety and liquidity of the US treasury.”

While the investment environment is clearly challenging, most private wealth investors are at least in better shape than last time around. “I would say most clients are much better positioned this time,” says Haren Shah, investment strategist for Asia Pacific at Citi Private Bank. “You don’t get a sense of panic compared to the global crisis: that was more of a black swan event, with people off guard; nobody expected it to be as bad as it was. This is more like a slow train wreck.” While that might seem to be damning with faint praise, there has at least been plenty of warning this time: Greek debt problems have been evident for about two years now. Correspondingly, Shah says most clients are not as geared as they were and are much more attuned to risk management. “We are telling clients risk levels are definitely higher and they’ve got to be well diversified,” says Shah. “Get away from high beta to low beta. Stay in bonds, but move towards high grade from high yield. In equities, you need cheap markets – we think Japan is cheap – but be very selective in what you buy. Go for stocks with high dividends, great balance sheets, and go for bigger caps, not smaller companies. In this environment you want things that are solid.” In summary: “What we are trying to say is, go after quality.”

At HSBC, Arjuna Mahendran, head of investment strategy for Asia at HSBC Private Bank, says investors “should aim to put their liquid assets to work to fetch a yield ahead of inflation, which is running above 5% in Hong Kong and Singapore.” He says there are “numerous opportunities in high-yield investments” and says that defensive equities with good yields, and investment grade bonds in Asia and the US, are HSBC’s preferences today. It has overweights on Indonesia, Malaysia and Thailand now, and expects Australia and Canada to offer interesting opportunities next year. Like Lee, Mahendra also says investors are looking for exposure to the offshore RMB market.

One particular facet of the latest round of market volatility is the pronounced downward pressure on three of the key world currencies – dollar, euro and sterling – while the fourth, the yen, has done the complete opposite (much to the surprise of the Japanese, who tend to react with great surprise to any idea that their 200% debt-to-GDP laden, earthquake-recovering, politically directionless economy could be considered a safe haven in the world). At the same time, Asian currencies, and anything linked to a commodity economy, have all pushed onwards and upwards. HSBC’s Mahendran says that playing the currency depends on where the client is: if already heavily skewed to dollars, euros or sterling, “we think it would be opportune and appropriate now to consider a diversification into yen and Canadian dollars to reduce volatility,” but for clients with assets mainly in Asian currencies, “timing of conversion is crucial as Asian currencies in general are expected to appreciate.”

Currency is now, says Pinkerton, “the most important thing in asset allocation. If you were invested in the Swiss franc for safety, you lost 10% of that safety protection yesterday relative to the US dollar [the interview took place the day after the SNB intervention]. You have to put currency exposure into the equation whenever you buy equities or fixed income. Traditional instruments of wealth storage, safety and protection have been debased and devalued. It’s why gold is in so much demand.”

The world’s investors are clearly still in love with gold as a safe haven; it is at record highs. But private bankers are generally not encouraging their clients to put more money there. “Gold and precious metals as a safe haven are somewhat overplayed,” says Lee. “They have become not safe havens but speculated commodities. At these levels they don’t feel like safe haven assets anymore.”If clients want to trade gold or other metals, he suggests using stop losses and trading only with a short term view. “Would I put gold as an important part of my portfolio right now? At this price, probably not.”

The message that comes through across the board is one of caution and uncertainty. “There are plenty of opportunities,” says Pinkerton – he names hard assets, exposure to frontier markets, and private equity as examples – “but the overall environment is one of danger. It’s one that really no longer supports the old fashioned asset allocation of: buy equities and hold them for 10 years and you’ll make more than you make in bonds. That premise has been disproven in the US and Japan.”

A difficult time to give the right advice, to a client base that remembers being mis-advised not long ago. It is a time that prompts fabulous mixed metaphors from a troubled private banking community. “We kicked the can down the road, but it came home to roost again,” says one banker. There’s just no arguing with that.