Investors in China need to look beyond the top-down narratives coming from foreign countries and media to dig up the true story of what’s really happening in the market, argued Lirong Xu, the Shanghai-based chief investment officer of Franklin Templeton Sealand Fund Management.

“I think that’s our job as stock pickers to dig into different sectors’ companies to find opportunities,” Xu told an audience of global asset owners managing around US$7 trillion at Conexus Financial’s Fiduciary Investment Symposium held in Singapore.

“That may be quite a different story than what you hear from the top-down angle, especially from the media.”

Franklin Templeton Sealand Fund Management is an 18-year joint venture between US asset manager Franklin Templeton and China’s Sealand Securities. Xu said some in the audience may be surprised to hear that during the last three to five years, the median return of mutual funds in China has been quite high.

“Last year and this year to date, the market has been volatile and challenging, but from a longer perspective looking at the next three years as a stock picker, I’m confident we can find good opportunities in almost all sectors to achieve good alpha returns for investors.”

Old economy sectors contain industry leaders that, over the past three years, have increased their market share during a difficult market environment, Xu said. And in the new economy there are a lot of exciting stories of growth.

Innovation is playing a growing share in driving both old and new sectors of the economy, he said. And valuations are relatively cheap compared to historic levels and also compared to other emerging markets.

The disruption to supply chains is also a story that is overblown, Xu said, noting he is “not too worried about that.” China is moving up the value chain of production in the same way other Asian economies have done in the past, with some parts of the supply chain leaving China and other parts moving in and taking their place.

“FDI in China grew substantially in the last three years compared to the last ten years,” Xu said. “And with the new situation of the regionalisation of supply chains and becoming less kind of globalised, there are both good sides and bad sides of that in terms of supply chains in China.”

“So things are not that bad. Maybe not as good as the last 20 years, but definitely not as bad as the media has pictured.”

And on the issue of transparency, the Chinese market is becoming more institutionalised having previously been dominated by retail investors, Xu said. This has helped the situation, although it can be challenging for foreigners who don’t speak the language. An increasing number of companies are producing English versions of their annual reports, he said.

“We’ve seen a trend where many companies that are not so good have good PR and fluent English, so they get more attention than they deserve,” Xu said.

Despite the solar industry being a cyclical and crowded market, leading solar producers are promising and were able to expand market share when the government stopped subsidising the sector five years ago, Xu said.

“I believe they will continue to grow as long as they stay focussed on innovation and new technology to grasp opportunities in the solar sector,” Xu said.

The online wealth management industry is also seeing a range of smaller companies emerge that are focussed on core areas of business, particularly mutual funds which are appealing in a country with a high savings rate.

“We continue to focus on these companies and still have a high conviction on these names,” Xu said.

Managing the rise of great power competition between the US and China, and not letting it “go off the rails,” is the epochal challenge of our day, according to former US National Security Council member Richard Falkenrath.

“The history is not good on this,” said Falkenrath, now the head of geopolitics and chief security officer at Bridgewater Associates, noting most people in the room had “lived in an anomalous period of great power peace.” 

“History, when you go back hundreds of years, is replete with wars, including with wars that were economically illogical, as this one would certainly be,” Falkenrath said.

Falkenrath served in the early 2000s as deputy assistant to the US President and deputy homeland security advisor. He was discussing the impact of geopolitical tensions on economies and markets at the Fiduciary Investors Symposium held in Singapore, in a panel discussion with Ben Weiss, managing director, Asia Pacific, of global business consultancy Veracity Worldwide. 

The deterioration of the US-China relationship was underway before former US President Donald Trump “blew it up,” Falkenrath said.

“In a very blunt, crass way he articulated what both sides of the aisle were feeling, and that’s testified by the fact that with the Biden administration, they have reversed none of what he did, expanded it in certain respects and refined its implementation, execution and articulation.”

He said he suspects whoever succeeds Biden will continue this policy of comprehensive competition with China. Managing this without it deteriorating into outright conflict is the epochal question of our day, he said, and the US administration is “struggling” with this.

They “don’t want it to go off the rails, but they also don’t want to be had or humiliated,” Falkenrath said. In the absence of cooperation, both China and the US are capable of exaggerating each others’ power and malevolence, he said.

The United States is completely convinced of its own benevolence, with a one-sided narrative about maintaining peace, prosperity, democracy and a rules-based order, he said. China, like many intelligent observers, rejects that narrative and has constructed an alternative narrative.

It is hard to imagine what the United States could possibly concede to China amidst this narrative, he said.

“There’s not a lot to offer when you think that everything you are offering is already right and just,” Falkenrath said. “And so essentially the rules based system, the free flow of trade and information, the protection of intellectual property, the treatment of minorities, the treatment of the environment, when you think that…you’re conceding that, it gets pretty hard.”

Facing rising tensions without an end in sight, Ben Weiss, Managing director, Asia Pacific, at Veracity Worldwide, said Veracity was speaking to investors about three key issues in the context of rising US-China competition. 

First is the importance of scenario planning and building structures inside organisations to interpret developments. Key stakeholders at a very senior level need to be involved. This should involve a worst case scenario of leaving China in a hurry, he said.

“There’s often geopolitical analysis happening within businesses, but it tends to be siloed or influencing very specific parts of the business,” Weiss said. 

Second, companies need to assess the level of risk that comes with their exposure to China in light of the vast amount of new legislation and regulation in the United States governing business with China.

Third, companies should engage with the US government and other governments around the world regarding new legislation in the pipeline, as US officials are interested in engaging with businesses to understand their concerns regarding the effects of this legislation, he said. Outbound investment restrictions for US businesses investing in China are “very likely to come,” he said.

“I would just encourage all of you to, in your government affairs, not see that as strictly a Washington or London or Canberra–or any other capital–exercise,” Weiss said. “Certainly the United States government is taking that advice on board.”

 

MORE ON GEOPOLITICAL RISK

A video interview with geopolitical expert Professor Stephen Kotkin looks at the investor implications of the Russia Ukraine conflict, the recalibration in the US China relationship and where the “real” geopolitical risk lies.

 

CalPERS has $67 million exposure to stricken Silicon Valley Bank, the high-profile venture capital and start up lender shut down at the end of last week by regulators and taken over by the Federal Deposit Insurance Corporation after customers raced to withdraw their money.

In addition the giant pension fund also has $11 million exposure to Signature Bank, chief of the fund’s investment officer, Nicole Musicco, told the board during the $457.4 billion fund’s latest investment committee meeting.

Musicco said that “in the grand scheme of things” CalPERS’ assets at risk are a small percentage of its assets under management. And that a “tumultuous” and “wild weekend” as the banks unravelled proved the importance of CalPERS’ resilience and transparency.

The collapse of the banks could be a pivotal moment for private equity and venture capital groups given SVB is a significant lender to GPs and their portfolio companies.

CalPERS is among the funds building its private equity exposure in recent years.

Musicco said resilience, transparency and innovation are now core tenets of how CalPERS executes.

The investment team was quick to identify the level of exposure, and in a “shout out to the team” she said she had received detailed analysis over the weekend as the situation unfolded.

Moreover, the process has shown that CalPERS’ liquidity framework is robust, evident that lessons have been learnt “in how we manage liquidity.”

The turmoil has also highlighted how CalPERS is now perceived by partners. Mussico said she has received a “number of calls” in recognition that the investment community now sees the giant pension fund as a strategic partner with balance sheet and the agility to provide long-term capital and solutions.

Although CalPERS has “nothing right now in the works,” she said her phone continues to buzz. “The message is out” that CalPERS is “open for business.”

Other institutional investors that have announced losses and exposure to SVB and Signature Bank include Norway’s sovereign wealth fund and Sweden’s largest pension fund Alecta.

Alecta has reported heavy losses to SVB, Signature and First Republic Bank, amounting to €1.2 billion – around 1 per cent of its total managed capital – according to a statement.

Alecta began investing in SVB in June 2019 and made its last investment in November 2022. The pension fund is the fourth largest shareholder in SVB.

“Alecta now values the shares in the two banks at zero,” the pension fund said, adding that the effect on Alecta’s customers would be small and its own financial position was “very strong.”

Elsewhere, reports in the Korean press say that Korea’s National Pension Service is considering all possible measures in relation to its investment in the US bank, with a reported 100,000 shares in SVB.

This article was edited on March 19, 2023, to update CalPERS’ exposure to Signature Bank

Cash is now a viable investment option for the first time in many years, and its appeal will draw money from other asset classes leading to poor performance both in financial assets and the real economy, according to Greg Jensen, co-chief investment officer at global investment management firm Bridgewater Associates.

Facing this scenario, investors should re-think their portfolios beginning with a the risk neutral position of cash before considering whether to layer on passive investment – or beta – and possibly some active views for alpha, he said.

“The risk neutral position in cash is actually relatively attractive compared to beta,” Jensen said, speaking with Colin Tate, managing director of Conexus Financial, at Conexus Financial’s Fiduciary Investors Symposium in Singapore.

“Essentially there’s very low risk premiums priced into most asset classes,” he said. “That means the benefits of taking risk relative to cash are low relative to history.”

A range of headwinds will make markets less beneficial for assets in the years to come, Jensen said.

We are moving from a world of globalisation and integration to a world of conflict and fragmentation, he said. This world is less productive and more inflationary than the markets investors have come to know, with greater government intervention and populism, and the rising need for enormous investment in climate initiatives.

Central banks and fiscal policymakers that have been innovative and active will be constrained by high inflation and debt levels, he said.

After a “huge pulling up of cash flows” over the last decade, asset prices are now extremely high relative to cash flows generated by economies, Jensen said, noting the last time the gap was this large was in 1975.

“The last time assets were this high relative to cash flows, you ended up with assets being flat for five to seven years and inflation driving nominal GDP to catch up with those high asset valuations,” Jensen said.

NORMAL RELATIONSHIP BETWEEN CASH FLOWS

Nominal GDP could exceed returns on asset prices for a long period of time as markets return to a normal relationship between cash flows in the economy and financial assets, which would make the coming years a “very rough time for financial assets,” he said.

And with cash returns reaching “extreme levels” compared to 10-year yields, 30-year yields, corporate debt and earnings, cash is now a viable choice for the first time in many years, Jensen said.

“That’s a big deal because that’s going to gradually draw money from other assets into cash,” Jensen said, meaning assets are likely to do relatively poorly compared to cash.

Facing this situation, it will be important for investors to stress test for various scenarios. This could be recession, it could be central banks losing their nerve and allowing inflation to rise, or it could conversely be that monetary tightening works and markets end up with a “Goldilocks” environment.

Investors need to consider how to protect their portfolios against the possibility of long term inflation, as the threat of long term inflation is not reflected in long term asset prices, which means “there is still a large risk that asset prices will decline as a result of a recognition that inflation won’t just go back to target,” Jensen said.

They also need to consider geographic balance, with history showing countries that do well in one decade tend to do less well in the subsequent decade.

And they should seek out good diversified alpha by finding managers that have a low correlation to their portfolio.

“Most people aren’t doing enough to say: ‘What are my alpha sources, and are they negatively or zero correlated to my portfolio?’” Jensen said. “If so, crank those up.”

The challenges currently outweigh the opportunities in many classes of real assets, and funds have billions in dry powder waiting for better deals, but strong fundamentals will ultimately prevail in the long term, said the head of asset manager Nuveen’s real assets business.

The listed real estate sector was last year “trading at some of the biggest discounts we have seen to reflect the rise in rates and other geopolitical events,” said Mike Sales, chief executive of Nuveen Real Assets. But private assets still need more time.

In a discussion with Patrick Kanters, global head of private investment at APG in the Netherlands, Sales said there is a lot of dry powder sitting on the sidelines–around US$8 billion in Nuveen’s case–waiting for signs of distress or better opportunities.

“We are not investing at the moment unless we see some form of distress, or prices in our calculations reflect where we think the market should be today,” Sales said.

In a panel discussion exploring the benefits of real assets at Conexus Financial’s Fiduciary Investors Symposium held in Singapore, Sales said global population growth may be slowing but it is still a major contributor to the value of land-based resources, with senior housing needs in particular set to rise as the over 80s demographic explodes in the coming 10 to 20 years. 

The ongoing digital transformation is driving the need for data centres and logistics which are responsible for enormous growth in real estate and had delivered “incredible returns” over the last five years, he said.

There is also a rising global challenge to provide sustainable food, fibre and timber systems, and offer solutions to the challenge of eliminating net carbon emissions.

However while the sector does offer some level of hedging against inflation, inflation and rising rates have taken their toll by driving up the cost of debt by more than 300 basis points, he said. Patience is currently the game as the full impact of interest rate hikes has yet to sink into some sectors, particularly private real estate.

“Long term they are great asset classes to be in, but the right entry point is important and we’re not quite there yet,” Sales said.

APG–with close to €630 billion in funds under management–invests in real estate, infrastructure and natural capital which includes timber-producing assets and agricultural land, with roughly a third of its real assets portfolio in each of the three regions of Europe, the Americas and Asia-Pacific.

ATTRACTIVE TRANSACTIONS

On the topic of renewable energy, Kanters said APG still sees attractive transactions in the US whereas “in Australia more recently we are being priced out by 20% or so.”

There are some opportunities in renewables for large funds willing to monitor many transactions, stay selective and underwrite some development risk, he said, “but we are far more selective the past two years or so.”

“If you look at how much time I have spent over the last two years instructing the team: ‘You can wait a bit, sit on your hands a bit, the best years are still to come, plant a few small seeds for new platforms to make sure the money is sidelined and is there when the opportunities are there,” Kanters said.

The fund is committed to responsible investing, and “we are convinced we can make money by implementing that properly both regarding physical and transition risk,” Kanters said.

APG has €55 billion of listed and private real estate spread over different sectors, and has been disposing of retail and office assets while favouring alternative real estate such as student housing and healthcare facilities.

The fund’s co-plan strategy demands managers are able to catalyse returns based on one or more mega trend.

“That’s why you see us more and more in alternative real estate,” Kanters said. “That will, in time, become the traditional asset sectors.”

The fund’s natural capital assets are a relatively small portion of the portfolio at about €2.6 billion, and form a part of the fund’s impact investing.

After more than a decade of high-priced bonds, fixed income is now compensating investors more than many asset classes, argued Raymond Sagayam, chief investment officer, fixed income at Pictet Asset Management in the United Kingdom.

Speaking in a panel session titled ‘The renaissance in fixed income’ at Conexus Financial’s Fiduciary Investors Symposium in Singapore, Sagayam said markets had priced in unrealistic expectations that there will be a “ladder of de-escalation” in interest rates, arguing rates are likely to plateau at a high level for some time.

He also pointed to equity earnings yields contrasted with 10-year bond yields and argued investors are “not getting compensated” for the high price of equities, and “the last time we saw the equity earnings yield down at these levels was back at the GFC.”

Predicting a lot of pain still to come in equity markets, he said he was an advocate of shifting “from equities into fixed income assets in general.”

But he is not blindly advocating investors lap up everything in the fixed income universe, he said, noting he was concerned about full maturity credit funds and felt “there will be a much better opportunity to gain exposure towards the end of this year, maybe early next year.”

But two areas he is very bullish are short duration funds and cash, which is “now an asset class in its own right” with different options investors need to understand.

He also pointed to emerging markets where interest rate differentials are wider than in developed markets.

“The emerging central banks have been far more aggressive at hiking interest rates, they’ve been doing it early, it’s at a much higher magnitude, so you’re getting compensated,” Sagayam said.

Emerging currencies are also the cheapest they have been in 40 years relative to the US dollar, he said.

INFLECTION POINTS

Farouki Majeed, chief investment officer at Ohio School Employees Retirement System in the United States, said the last two years saw inflection points where investors could take advantage of macro changes.

It was “unusual” that his fund made the decision to be underweight equities and fixed income over this period, but it was a “fairly easy call to say both of these assets are going to face very strong headwinds,” Majeed said.

The fund ultimately saw a return of negative 5.6% in 2022, which was better than a lot of peers.

“If you were a 60/40 investor in 2022, 60/40 would have given you a return of negative 16%,” he said. “Many of my peers had double digit negative returns in 2022. This was a period where making some bold macro calls could have benefited value addition in a portfolio quite a bit.”

The fund is still holding to those positions but “the ones that I would first probably want to think about correcting is fixed income,” he said.

Majeed said he agreed with Sagayam that terminal interest rates could go higher still and remain high for longer than some expect, and that the short duration end of the fixed income market is attractive, while reserving judgement on longer duration plays.

“As far as equities are concerned, I am more cautious about equities at this point in time than fixed income, so we might be more underweight equities for a longer period of time,” he said, arguing financial assets will have a “pretty challenging time” for the next one to three years and the 60/40 portfolio “may have to be flipped the other way around” for the near term.