Finding Answers Amidst The Volatility

iGP, the Singapore platform for Accredited Investors, has published an interview in their latest iGP magazine.  Since I am one of three investment directors providing answers to iGP questions, I wanted to include it here on the blog as well, as you may not be able to obtain the magazine where you are. For ease of differentiation, my responses are in bold.  But that does not mean that the other guys aren't worth reading.

Titled "Finding Answers Amidst the Volatility", iGP considers it "...wise to relook at your investment strategies. Find out what three investment experts have to say."

"With the kind of market volatility we have seen this year...

"It has been quite a year. The events in Egypt and Libya affecting the Middle East as well as the catastrophe in Japan early in the year had put some pres­sure on the global markets. Coupled with the ongoing US and Europe debt crisis, investors find the markets to be fraught with uncertainties."

We interview Ernest Low, General Manager, Product and Research, Profes­sional Investment Advisory Services Pte Ltd; Rainer Krieg, Associate Director (Investments), SingCapital Pte Ltd; and Victor Wong, Director of Wealth Manage­ment, Financial Alliance Pte Ltd; on the economic outlook for the coming year.

iGP INSIGHTS (iGP): With the sovereign debt crisis, are there any investment advantages to be taken from it?

Ernest Low (EL): It depends on how one looks at the situation and the time frame. If you are a more aggressive investor and subscribe to the philosophy of buy­ing low and selling high, you should be finding resources (but not your emer­gency cash) to buy when markets have fallen significantly.

Valuations are currently looking at­tractive even when factoring in earnings downgrades. However, one should be prudent by breaking new buys into a few tranches because no one knows when the bottom of the current bear market is reached. In this way, you can dollar cost average your new entries when markets are lower. You should also have a longer term time frame in mind if markets do not turn around quickly enough.

For those who are more wary of the US and European government bonds, you can consider Asian bond funds, short duration bond funds, and total return bond funds. Several of the Asian governments and investment grade cor­porates are in better financial shape than some of the Western nations. However, you might want to especially focus on those that are SGD hedged to minimise foreign currency impact as the SGD re­ mains relatively strong against many of the other currencies.

Victor Wong (VW): Our view is that the sovereign debt crisis means risky assets such as equity will find it hard to perform well going forward as risk aversion heightens. In this kind of chal­lenging market condition, we are taking a very cautious stance. The primary ob­jective is not to get a return out of capi­tal but rather to preserve capital. Hard commodities, such as gold, as part of a well-diversified portfolio should per­form well in this environment.

Rainer Krieg (RK):  Presently, the sover­eign debt crisis is ‘limited’ to European countries, and the US. Yet, should there be defaults by any, European or US, government, the fallout on the rest of the world’s economies cannot be ruled out. In today’s globalised world, debtors and borrowers are linked intricately. Im­agine, Singapore’s primary investment companies, Temasek or GIC, having to write off a US bond or German Bund, arguably an extreme scenario – but not out of the question!

This would be a point in time, when we would no longer just be concerned with the default per se, but with the struc­tural damage to the financial systems that would be inflicted. Banks, the hold­ers of bonds, are the weakest link in the structure, both in Europe and the US and would probably suffer terminal damage that would likely be worse than what banks faced during the 2008 liquidity crisis. These are the thoughts that pre­vent many from looking for investment advantages that arise nonetheless!

At present, advantages abound in Singapore bonds as well as Japanese and Swiss bonds, because of the strength in these currencies, and the security its sovereign bonds represent relative to the US and peripheral European peers. This is despite the recent downgrading in Japanese bonds. But such advantages are fleeting opportunities. As soon as the USD regains some strength, foreign bonds will be discarded. The repatria­tion of proceeds back to the US and the USD follows.

Future opportunities will only arise when all issues surrounding the debt cri­sis in European countries and the US are tackled at a level that:

• Resets parameters of borrower’s fu­ture liabilities;

• Retains a healthy level of fiscal liquid­ity;

• Facilitates a return to a sustainable growth phase in global economies.

Even a conceptual agreement sug­gesting such an outcome would be enough to rekindle investor’s appetite for risk and the desire for better returns. Even today, investment opportunities present themselves in corporate and high yield bond funds, followed promptly by rising equity prices globally.

iGP: How do you think Asia, Middle East and Emerging Markets will fare compared to the US and Europe?

EL: The emerging markets are certainly stronger than before with a significant rise in the domestic consumption within themselves, thus they can trade with one another and not solely rely on the West­ern nations alone. If we are not looking at a double dip scenario, emerging mar­kets are expected to grow at a moder­ate rate. In fact, this is to be welcomed as the emerging markets need to take a breather after a very fast recovery right after the Great Recession. Inflation has been an issue for the emerging markets and some form of slowdown will help them to control inflation from getting too high.

However, if the developed nations fall into a deeper recession, emerging markets will also take a tumble as we are too integrated with them to escape. The view that the emerging markets have decoupled from the US and European regions is naive. The Western nations are simply too big to ignore. If developed nations generally do not fall into a sec­ond dip, then the emerging markets are one of the best places to be in.

But some of the developed nations stocks can be attractive too as a signifi­cant amount of them have tied their growth to the emerging markets. But it would take time for markets to recog­nise their attractiveness as they are still perceived as developed nations compa­nies.

RK: Cyclically, the regions are in entirely different economic phases. In addition, Asia and emerging markets enjoy bet­ter financial health than the developed world. The Middle Eastern countries are going through their own social restruc­turing stress but continue to play their part as the world’s foremost oil and en­ergy resource.

But we cannot simply disconnect regions as if they are autonomous and insulated from what else is going on glo­bally. Each faltering step in the US and European fortunes will have repercus­sions elsewhere. And yet, the prospec­tive growth in emerging markets, and Asia in particular, might help mitigate much of the negative impact, by rein­forcing growth and consumption in their respective region. How long and successful they can withstand the rever­berations of a double dip recession in the US and Europe, for example, is a hotly discussed topic in professional circles. It would be wildly speculative of me to make any definitive assertions here. 

If however, the problems of the de­veloped world are reined in, Asia’s wor­ry over inflation and economic stagna­tion will disappear.

VW: Looking at the fundamental of the various regions, we think that Asia and Emerging Markets will fare better going forward. Asia and Emerging Markets are grappling with a potential stagfla­tion problem, i.e. high inflation and slow economic growth. Hence the primary concern of most central banks in the two regions is to rein in inflation by tighten­ing monetary policy.

On the contrary, central banks in the developed markets are keeping interest rates near historical low for a prolonged period to stimulate their economies. However, the fiscal position of most Asian and Emerging Markets countries are still relatively healthy as compared to US and Europe which are plagued by a crippling sovereign debt problem. Hence, if there is another global finan­cial crisis, Asia and Emerging Markets central banks have room to lower inter­est rate and the governments have the means to pump-prime their economies.

We are also likely to see re-allocation of monies from the developed market to Asia and Emerging Markets financial markets as Fund Managers move monies to regions that have better fundamentals plus potential of currency appreciation relative to their home currency.

iGP: What is your take on the slow eco­nomic growth and high inflation rate?

VW: The loose monetary policy globally plus various policy measures such as quantitative easing undertaken by the developed market central banks have resulted in a lot of liquidity in the global financial system. The abundant liquid­ity has found its way into the Asian and Emerging Market economies, resulting in high inflation while economic growth has remained subdued.

My take is that above average infla­tion rate is likely to stay for a while in Asia and Emerging Markets as long as global interest rates are kept artificially low. In fact, over the next 2 years, this low interest rates environment is likely to persist as the US Federal Reserve has pledged to kept short term interest rates unchanged over the next 2 years. In this kind of slow economic growth with higher than average inflation, commodi­ties such as gold will again perform well as commodities besides being a good inflation hedge is also a good store of value in uncertain times. Hence, having some exposure to commodities will help in portfolio diversification.

RK: Talk to Europeans and ‘slow econom­ic growth’ is the preferred scenario rather than hot and bubbly. Americans are des­perately looking for growth because they got loans to (re-) pay, while in Asia, gov­ernments are reining in excessive growth to mitigate rampant inflation.

What the Europeans are concerned with is that the Euro remains stable, as it will allow the region to stay in control of external inflationary pressures. They would not mind if the currency loses some strength, as it might contribute to easing the pressure of the large debt burden.

The American government and the Fed are playing down the risks of infla­tion, stating that slower growth impedes the rise in goods and services, which would lead to a reduction in inflation rates in the coming months. There is still a notion that a lower USD will resolve the debt issues faster/easier, but many now realise that this is a two-edged sword, as it disconcerts the deployment of local and foreign investment in the US, and USD. 

 

In Asia, we experience inflation as a real threat to our buying power, and we get restless wondering whether to de­mand higher salaries, go on strike, or replace a non-performing government. A slowdown in economies would therefore not really pose such a great danger to our region as it is made out to be, unless you have a company that is leveraged to the hilt (and beyond?) betting on 20% growth every year just to break even. Hopefully, this type of 1997/8 excesses will not be repeated in the short term.

As every one of the above parties has different preferences, the resulting outcome to inflationary pressures will probably be a contentious compromise at best – or a muddle where everyone serves only his own interests. That’s yet another Pandora box to open eventually, imposing more changes to the longer-term outlook.

EL: Inflation is only high in the emerg­ing economies but not a real problem for most of the developed nations. Inflation often reflects the state of the economies. As the emerging economies have been growing very well in the last few years, inflation has become a prob­lem. Therefore the respective govern­ments have been employing inflation controlling measures such as raising interest rates, raising banks required reserve ratios, property cooling meas­ures, and appreciating their curren­cies. However, commodity prices have softened somewhat in the recent past and inflation is likely to peak soon for many of the economies. As long as the emerging economies’ growth start to moderate, inflation will likely moder­ate downwards too.

However, there is always a possibil­ity that we may face low growth and high inflation if there are constraints in commodity prices. For example, if there are poor weather conditions in the food producing nations, prices of agricultural related commodities will likely go up.

But base metals and energy prices have higher correlation to the global economic growth. So if the whole world slows down dramatically, including China and India, commodity prices will be softer and so will inflation. Of course inflation is also made up of property prices, transport, education, and other components. But it is difficult for many of these other factors to remain high if global economies are impacted nega­tively.

On the other hand, the developed na­tions are not experiencing high inflation as they have spare capacity and high un­employment which keeps prices more controlled. So this is not an issue that is a key concern for now. Rather, their focus is more on growth, job creation and debt management.

iGP: Which investment classes deserve the heaviest weightage in an investor’s portfolio for the coming year?

RK: A year is a long period and the com­ing twelve are prone to frequent turna­bouts in various economies.

My strongest conviction over 12 months:

• An 8-10% weighting on gold, not gold stocks, but gold prices;

• The inflation theme I talked about in the beginning of 2011 remains in full swing, hence we need to include sen­sible weightings on defensive equity, dividend yielding stocks and prop­erty REITS.

But in the short term, i.e. over the coming six months, I would also put a strong focus on the materials, energy and tech sector, rounded up by the almost perennial consumption theme - as soon as investment conditions look less daunt­ing. Seasonally, September is a month of change, and if the change is ushered in by way of enlightened political and fis­cal decisions, this could turn out to be a splendid starting point for a good rally in stocks and other real assets.

VW: Due to our cautious stance current­ly, we are positioning our clients’ port­folio more into short duration Singapore bonds, principally to preserve capital. We believe that markets will continue to be volatile going forward, giving us opportunities to move back into equity market in the future.

EL: That really depends on the clients’ risk profile. For those who are aggressive in nature and take a longer term view, Emerging Markets equities would look more attractive whenever there are significant market falls. For those who are more conservative in nature, Asian bond funds, short duration bond funds, and total return bond funds are some of the instruments they can consider.

iGP: What kind of alternative invest­ments can help in this current market situation?

VW: We advocate having some exposure to the hard commodities such as gold and precious metals for portfolio diver­sification. In times of uncertainty, real as­sets such as gold will do well as investors look for safe haven to park their monies. However, the trade-off is that commodi­ties is a very volatile asset class, hence a large exposure to a hard commodities fund might skew the risk of the portfolio without adequate compensation on the return aspect. 

Another alternative investment that might potentially do well is the Managed Futures strategy. This is a trend follow­ing strategy which has little correlation to the equities and bonds markets. In the last financial crisis in 2008, this Managed Futures strategy delivered double digit positive return while equities market and corporate bonds suffered one of the worst negative returns in capital market history.

RK: Alternative investments have yet to deliver on their promises during vola­tile, uncertain investment conditions. As with equity funds, alternative strate­gies, too, need ‘trending markets’, ideal investment conditions to capture and accumulate gains. Uncertainty, however, is not such a stimulating feature. Since so few of alternative investment fund managers are active and suc­cessful in managing risk, alternative in­vestments as a separate asset class will continue to see an underperformance vis-à-vis an actively managed portfolio, which rotates asset allocations in line with trends.

EL: In bearish periods, managed futures and volatility funds can thrive. They can also be a form of risk hedging tool if markets remain bearish. However, one should also note the currency of the in­struments. Gains made on these instru­ments may be offset to a certain extent if the SGD strengthens against the instru­ments’ currency. So do try to invest in SGD-hedged versions if they are avail­able, if you are a SGD investor.

iGP

And then there is the magazine's disclaimer:

CTOBER 2011 - MARCH 2012 59

Article disclAimer: This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any fund. No investment decision should be taken without first viewing a fund’s prospectus. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. As some of the authors/contributors may have a personal interest in some of the funds commented on, investors should seek the advice of professional advisers regarding the evaluation of any product, unit trust or other financial instruments, report, index, opinion or any other content contained herein, to ensure the investment instrument is suitable for them. In the event that investors choose not to seek advice from a professional adviser, they should consider whether the investment instrument is suitable for them. Past performance and any forecast is not necessarily indicative of the future or likely performance of the fund. The value of units and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. iFAST Financial and/or its licensed financial advisers representatives may own or have positions in the funds of any of the asset management firms or fund houses mentioned or referred to in the article, or any unit trusts or Singapore Government Securities bonds related thereto, and may from time to time add or dispose of, or may be materially interested in any such unit trusts or Singapore Government Securities bonds.