CIO views: mapping trends from change

Asia fixed income: the great leap continues

The greatest change in our lifetimes is arguably the rise of China from an agrarian society to one of the largest economy by GDP in the world. It has dwarfed even the rise of Japan and South Korea, two other leading industrialised economies today. The Asian “leap” has occurred on the back of a potent mix of market-oriented reforms since the 1990s, integration with the global economy via trade and foreign direct investments, high savings rates, significant investments in infrastructure and human capital, improving quality of education and sound macroeconomic decision-making.

Today, we are at yet another inflection point for Asia. This time, the region is becoming more self-reliant and dependent on internal consumption, rather than relying on export-driven growth. Asia’s share of global output has risen to 40%, but more importantly, Asia will become home to half of the world‘s middle class in 2020. To cater to this mushrooming segment, Asia needs even more (a) infrastructure development, (b) real estate redevelopment for continued urbanisation and (c) an efficient, secure and sustainable energy supply. We think these are the mega-trends for the next two decades for Asia, and arising from this are long-term opportunities to lend to sustainable companies leading the transformation in these areas. This ranges from airports to renewable energy generation in India, to refineries and industrial township development in South East Asia, to large-scale residential developments and consumer technology in China.

Equities: solutions for sustainability challenges

Long-term trends and structural themes are key determinants in the creation of alpha as they provide growth opportunities for companies. We believe our current economic model is unsustainable, meaning the companies that thrive in the future will be largely determined by their ability to adapt and transition to a more sustainable future. Companies able to provide solutions to key sustainability challenges, such as climate change, will present investors with new sources of growth. These challenges are already evident, and the COVID-19 pandemic is a catalyst and accelerator for several dynamics. 

The digitalisation of consumption, corporate life, financial services, and healthcare is in full effect, and the pandemic has underscored the need for more flexible business models. Digitalisation will also support the reorientation of elongated supply chains, towards a re-shoring of production in developed markets where emphasis is placed on ‘just-in-case’ rather than ‘just-in-time’. Such relocalisation would mean more flexible, automated, robotised production processes in countries where the working population is shrinking, as a consequence of an ageing society.  An energy transition will further support this industrial renaissance, providing cleaner, cheaper, decentralised and independent sources of power. This energy transition is also supported by a number of governments who view ‘green deal’ proposals as a powerful tool to boost weak economies.

Capturing such investment opportunities requires the selection of  companies able to harness and compound the economic value of growth. Too many companies are growing to death, especially when access to capital is cheap and easy. Assessing the creation of superior excess economic return (EER) by primary trend signals companies remains, therefore, at the forefront of our selection process, and is the other essential determinant of alpha creation. 

Convertibles: primary trend signals

The biggest change affecting the convertible bond asset class over the past few weeks is undoubtedly the strength of the primary market, and how new issuers are likely to affect the asset class performance and risk profile in the future.

For an idea of the scale of the acceleration in new issuance, consider that the convertible bond asset class saw USD53bn in new issuance this year (as of the first week of June), or the same amount of issuance for all of last year¹.

Although some of the new issues could be classified as “rescue capital” for companies most affected by the COVID-19 pandemic (cruise-line companies, airlines), the asset class continues to see great dynamism from high-growth companies in the technology and healthcare sectors. 

In particular, investors should note the high proportion of convertible bond issuers engaged in activities fitting the description of “working or consuming from home”.

Over the coming months, investors in convertible bonds will therefore be increasingly exposed to both the broad theme of economic recovery (travel, transport, consumer discretionary and industrial companies) and to the high-growth technology names that are likely to benefit most from the already visible changes in workplace and consumer behaviour.
 

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  ¹ Source: Bank of America

Multi-asset: managing change and uncertainty

Managing multi-asset portfolios is primarily about managing change and uncertainty. History (which doesn’t necessarily repeat itself, but certainly rhymes) has shown us some things change (asset classes do not always all work at the same time) but others don’t. Diversification, in various guises, is and remains the bedrock of our portfolios: across asset classes (so as to capture their relative dynamics across the macroeconomic cycle) but also across sources of return and beyond -- diversifying indicators, techniques, models. 

Concentration is the worst response to uncertainty, in our view. Dealing with change requires challenging the consensus and continuously improving our (systematic) investment process. In the face of waning diversification benefits offered by sovereign bonds (correlation with stocks has remained broadly negative over the recent shock but the extent of the protection has proved much weaker than say 2008), we diversified into other sources of protection – from the trivial (cash) to the sophisticated (convex volatility-based tail hedges). Both proved very effective in sheltering our portfolios from this year’s turmoil. Equally, human nature doesn’t change much and so behavioural biases and market inefficiencies continue to play a useful role in diversifying sources of return, in our view.

Finally as regards diversifying models, our recent research has focussed on incorporating implied volatility (which is forward looking and reflective of investors’ expectations for future market movements) in addition to our existing historical volatility models – anticipating change rather than merely reacting to it.

Alternatives: the permanence of change

The COVID-19 crisis has divided individuals into two schools of thought. The first camp believes once the pandemic has abated and lockdowns have loosened, life will return to normal. The second believes that the recent events will leave indelible scars and change the way we live.

We are in the latter camp. We believe the recent events will accelerate trends that were underway and create new ones. From this, disruption is likely to occur in many sectors, and clear winners and losers will emerge. To name a few key examples: 

• Rising awareness of sustainability - People are likely to reassess human impact and relationships with our eco-system, in order to control the spread of new diseases 
• Change in consumers’ behaviour - Individuals have altered their purchase decisions and behavior during the lockdown, and will likely change the way they consume, travel, date, etc
• Emergence of new technology - Technology is keeping our society functional during the pandemic, and we expect innovation in communication, pharma, entertainment and many areas, further accelerating alternative data creation.

Abrupt shocks result in changes, which create disruption and result in the emergence of new trends. They also lead to financial market volatility. In our view, this creates attractive investment opportunities and the perfect storm for unconstrained long/short strategies in particular.