By Tho Li Ming / The Edge Malaysia | August 11, 2016 : 11:00 AM MYT
This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on August 1 - 7, 2016.
Asian markets and beneficiaries
Apart from bonds, negative and low interest rates have boded well for some financial instruments and asset prices around the world.
Esther Teo, head of fixed income at Affin Hwang Asset Management Bhd, says whenever central banks deliver these goodies, the financial markets react positively. “Risk assets will perform when they ease or there are announcements of a quantitative easing (QE) programme. So, the credibility of central banks is intact and people still believe in them. For example, when the ECB announced a bigger QE in March, we saw equities rally. Fund flows came into riskier assets.”
Negative rates have triggered a rush for safe-haven assets such as gold, which rallied for the first few months of the year. Pacific Mutual’s Teh says the performance and use of gold have been unique following the implementation of negative interest rates.
“Post-global financial crisis, it has behaved in one of three ways. First, the price is inverse to the US dollar — if the dollar strengthens, the gold price, which is in the US dollar, falls.
“It is also a safe haven. When risk aversion is high, people buy gold. There is demand for US treasuries and dollars. In this case, both the US dollar and the price of gold increase.
“The third way is behaving like a commodity. In the past, it was not the norm to have gold as a permanent holding in a portfolio. But this is not the case these days. The argument that gold does not generate yield or interest, hence one is always at a disadvantage when investing in gold, no longer holds true when holding cash generates negative or very low returns. I expect the gold price to appreciate in the long term as investors seek diversification or when faith is lost in certain currencies.”
Emerging markets have benefited from the negative interest rate polices and will continue to be the investing destinations of foreign investors. Yeah says this part of the world has been a beneficiary because of the tremendous amount of liquidity flowing from advanced markets.
“Malaysia is a direct beneficiary of the funds that are seeking higher yields, that are looking for positive interest rate differential and risk diversification. While most of the flows went into Malaysian government bonds, our stock market has also benefited, mainly the blue chips,” he adds.
On July 26, the average dividend yield for the FBM KLCI was 3.07%, higher than the MSCI AC Asia ex-Japan Index’s 2.68% and the Dow Jones Industrial Average’s 2.5%.
Affin Hwang’s Teo expects the strong inflows into emerging market bonds to continue in the near term, especially with the expectation that developed market central banks will cut rates again and become more negative. “Investors would then come to Asia, and we have seen that happening. Our MGS market has done well.”
Chang says yields on the 10-year MGS have fallen more than 0.5% from 4.2% in late December last year to 3.6% currently. “This would make subsequent refinancing of these maturing bonds cheaper for Malaysia and emerging markets. The US dollar-ringgit will be another indicator of such negative rate repercussions, with the ringgit strengthening 10% year to date in July, to 4.01 from 4.40 in late 2015.”
The ringgit surprisingly strengthened in July after Bank Negara cut the interest rate. “One of the reasons why that happened is that the central bank provided reassurance to investors that it was committed to supporting growth and the move was to keep the growth trajectory intact,” says RAM’s Fong.
While that bodes well for the ringgit, Sunway University’s Yeah points out that there is a higher risk premium for using emerging market currencies such as the ringgit. “There is a flight to safety among international investors. They will get out of emerging markets at the first sign of instability and head back when interest rates are raised.
“So, the shock to emerging market currencies is very much higher, that is why their currencies are much more volatile despite benefiting from the decline in the value. They are used as a safe haven.”
Leong Lin-Jing, fixed income (Asia) investment manager at Aberdeen Asset Management Asia Ltd, says there will be bouts of risk-off periods that cause a sell-off in Malaysian bonds and the ringgit. “Given the headwinds surrounding 1Malaysia Development Bhd and the high concentration of foreign investors in the market, Malaysian bonds are often treated more credit-like these days. On the whole, we do expect to see lower bond yields and ringgit strength more often than not.”
The more broad-based impact from negative interest rates will translate into lower returns from assets. According to the report, Diminishing Returns: Why Investors May Need to Lower Their Expectations, released in April by McKinsey Global Institute, slowing gross domestic product growth and low interest rates mean North American and Western European firms will struggle to reward investors with the same returns in the coming decades.
In a slow-growth scenario, the total real returns for equities and fixed income in the US and Europe over the next two decades are expected to plummet, averaging 4% to 5% for equities and 0% to 1% for fixed income, say the McKinsey researchers. These percentages are lower as equities on both continents have returned an average of 7.9% over the last 30 years while US and European bonds have seen returns of 5% and 5.9% respectively.
Affin Hwang’s Ng advises investors to lower their target returns for equities, based on their fund performance. “Our internal targets for equity funds across the spectrum will be in the range of 8% to 12%. Previously, we set targets of 12% to 15%. While our flagship funds are still reaping 15% to 16%, we believe things are more challenging now.”
Assets that will outperform
There are still opportunities to be found in Asia, assets that will yield positive returns for investors. Ahmad Najib Nazlan, CEO at Maybank Islamic Asset Management, says as far as the region is concerned, developed markets will be the place to take cover during the current turbulence.
“Country-wise, the US seems to deliver better earnings prospects, albeit lower on historical perspective. Hence, it is considered the most viable safe haven in terms of jurisdictions for investments in the recent years. However, yields in the US have reached historical lows and may not be sustainable in the long run. Hence, money may flow out of the US, looking for better yielding assets that compensate for the slightly higher risks,” he notes.
“Some stable developing countries — for example, Malaysia and South Korea — may attract investors looking for better yielding assets after they have exhausted other avenues, such as the US and other developing markets. Risks in developed markets are also rising, especially after Brexit. Hence, stable emerging markets with consistent policies may be attractive places to house assets, which will flourish in the current economic slowdown.”
Pang Kin Weng, multi-asset fund manager at Schroder Investment Management (Singapore) Ltd, expects positive global growth this year and thus, believes there are still equity sectors producing positive earnings. “Low interest rates, when combined with growth, create good investment opportunities. For instance, utilities and infrastructure companies have a steady stream of earnings that stretch out over several years, and these multi-year revenue streams are examples of positive returns supported by the structure of the industry and are laid out in contractual terms,” he says.
“High-yielding markets can typically be found in developed parts of Asia-Pacific, such as Australia, Singapore and Hong Kong. Utilities in Australia and Hong Kong are still offering attractive yields despite outperforming the broader market.
“From an investment perspective, it is important to take a longer time horizon. Identifying and combining investment assets in a diversified portfolio will provide more stable returns.”
Bullish on currencies
Affin Hwang’s Teo remains bullish on emerging market currencies in Asia. “These currencies have been performing because the US dollar has been weak, owing to expectations that the Fed will not hike rates until next year. But the economic data coming out of the US is improving and remains quite strong, so I think it is in the position to hike interest rates as early as September. If that happens, we will see a stronger US dollar.
“We think the ringgit could trade on the stronger side (despite Bank Negara cutting rates) barring any 1MDB headlines. It is not only negative interest rates but also commodities that will play a role in the direction of the ringgit. This quarter, we are looking at the currency trading at 3.8 to 4 against the US dollar.”
Those who are considering currencies can look at the greenback, which is set to see a “modest appreciation”. However, Menon says retail investors should avoid currencies because of their volatility.
“Retail investors may want to stay away, but high-net-worth individuals can consider currencies. If you are a 12-month investor, consider the US dollar. In the next year or so, I think it will see a modest appreciation. While the currency appreciated about 27% between 2014 and 2015, I do not think you will see double-digit appreciation anymore,” he adds.
While the pound sterling has weakened, Menon thinks it is too early to go into the currency due to the Brexit fallout. “It is still too early because things are still playing out. At this point, the pound is 1.32 against the US dollar, but you do not know what will happen in the future. If there is a trade spat between Europe and the UK, all that will weigh on the currency.”
Menon does not expect the yen to strengthen any further. “The yen has strengthened a lot, but I would not bet on it to appreciate further from here. The line in the sand is ¥100 to the US dollar. The yen has not successfully broken through those levels yet because there is talk that the BoJ will intervene when the currency hovers over these levels,” he says.
For ringgit bonds, Teo says the company aims to achieve between 5% and 5.5% returns this year. “This year has been quite a good one. For our Asian bond funds, we are looking at 5% to 6%.”
Affin Hwang’s Ng says alternatives that have less mark-to-market risk will be more sought after. “One of the investments we advocate to our clients is to find a good bond like the Genting Singapore Perpetual Bond, which has a yield of about 4%-plus. That may not seem great, but you know this company is good.”
Mohammad Hasif, fixed income (Asia) investment manager at Aberdeen Asset Management Asia Ltd, believes India’s local currency bonds still offer positive returns. “With 10-year government bond yields in the mid-7%, similarly attractive real yields and an improving fundamental economic picture, India’s local currency bonds provide a viable source of positive returns for investors,” he says.
Singapore properties could also be considered by investors, says Ng. “Recently, we introduced a wholesale Singapore property fund. Singapore property, especially the high-end segment, has seen 11 quarters of declining prices. That is because all of the tightening measures the government has implemented. Lately, we have seen an increase of transactions at discounts. That is usually seen as a bottoming of the market. But investors of our fund should have a five to seven-year horizon.”